Credible Carbon Credits
How new innovations are trying to address credibility issues in carbon markets.
Opportunity Overview
There are two types of markets for carbon credits. In the compliance market, regulators set a cap on the total tons of emissions that a sector (e.g. transportation, energy) can emit. Companies that stay under their caps can sell excess credits to others that need more allowances (i.e. cap-and-trade).
In the voluntary market, businesses, governments and individuals purchase carbon credits to offset their emissions at their own accord. The voluntary market is almost 3 orders of magnitude smaller than the compliance market, but it is growing fast. The annual traded volume of voluntary carbon offsets is on track to hit $1 billion in value for the first time ever by the end this year. This will more than double from 2020, despite criticisms against carbon offsets as a greenwashing tactic and being full of fraud.
In an attempt to address some of these challenges, former Bank of England governor Mark Carney called for a new, unified and global voluntary carbon market last year. He believes new rules could spur the market to grow to $100 billion by the end of the decade. This week at COP 26, Carney unveiled an alliance of banks and other financial institutions “holding assets totalling more than $130 trillion committed to hit net-zero emissions by 2050”. Meeting these commitments will likely require carbon offsets if there are no hard requirements for financiers to divest from fossil fuels.
Current Landscape
The credibility issues with carbon offsets are well-documented. I illustrate the key points of contention using forestry and land use projects, which has been the largest project category by issuance in 2021.
Additionality. Answering whether a carbon offset project is additional necessitates creating a counterfactual: “would the trees have been cut down in the absence of the project? If not, then the project is not avoiding emissions.” In practice, this can be difficult to determine and faces the risk of being gamed.
Permanence. Ideally, a project will keep the carbon out of the atmosphere forever, but the permanence risk varies by project type. For instance, wildfires have affected forests that are enrolled in California’s carbon offset market.
Double-counting. This often comes up when there are two parties claiming the forestry offsets: an organization that purchased offsets to reduce its own emissions, and a host country that counts the project against its climate targets under the Paris Agreement.
Leakage. Protecting forests in one patch of land can lead to deforestation moving to other unprotected areas.
I outline a number of startups below that are trying to leverage technology and new business models to address these challenges. I’ve written about some of these companies in prior articles on forestry and carbon accounting.
🇺🇸 Pachama uses remote sensing and machine learning to conduct a secondary evaluation of carbon offset projects that have been certified by third-party certification groups (e.g. Verra). Pachama looks at satellite data to check that projects are indeed real, and then determines its level of additionality by comparing the project to surrounding areas. Remote sensing is also used to estimate the stored carbon in a forest project, as well as to evaluate any permanence risks (e.g. wildfires, pests, etc.).
🇺🇸 Natural Capital Exchange (NCX) is building a credible forest carbon marketplace by using remote sensing, detailed forestry data and timber economics. NCX estimates a landowner’s net present value (NPV) of owning an unharvested forest as a function of the growing period. In theory, forest owners will aim to harvest at the peak of the NPV curve -- anything earlier will leave money on the table. A project is then additional if the owner extends a forest past this optimal point in exchange for payment.
🇬🇧 Sylvera is also trying to provide more transparency into carbon markets through remote sensing and related technologies. However, they are strictly a data provider and do not sell carbon offsets themselves.
🇬🇧 Supercritical is a new startup that offers carbon measurement, reduction and offsetting services. One way they are differentiating themselves is through an exclusive focus on carbon removal projects, which helps prevent issues like additionality and leakage.
🇺🇸 Patch offers businesses APIs to easily measure their carbon footprints and purchase offsets. Patch is used by carbon accounting startups like Persefoni and Plan A. Persefoni and Patch recently partnered to offer a “Robinhood-style” platform for carbon offsets. This makes it easy for an average person to access the offsets market, which has historically been concentrated on large companies and brokers.
Apart from enhancing verification processes and curating projects, another way to address the credibility issues above is to scale nascent carbon removal technologies that face less additionality questions compared to carbon offsets (i.e. projects that likely only exist for the purpose of carbon removal) and permanence risks. Examples include direct air capture (e.g. 🇨🇦 Carbon Engineering), carbon mineralization (e.g. 🇨🇦 CarbonCure) and biomass (e.g. 🇺🇸 Charm Industrial).
Customer Value and Carbon Benefits
The voluntary carbon offset market is unregulated and relies on private third-party groups (e.g. Verra, Gold Standard, American Carbon Registry) to certify that the offsets are indeed credible. However, different research efforts have continuously found that the existing systems and processes could lead to bogus outcomes. For example, a joint investigation by The Guardian and Greenpeace found that offsets commonly used by airlines and accredited by Verra faced additionality issues:
“Projects estimate the emissions they have prevented by predicting how much deforestation and land clearing would have occurred without them. The reductions are then sold on as credits. We found their predictions were often inconsistent with previous levels of deforestation in the area and in some cases, the threat to the trees may have been overstated.”
Despite these challenges, the demand for carbon offsets is increasing, driven in large part by more and more companies making net-zero pledges. Moreover, companies such as Microsoft, Stripe and Shopify have also been trying to kickstart a carbon removal market. While they have supported traditional project types (e.g. forests), they have also served as initial customers to new companies attempting to commercialize new carbon removal technologies (e.g. DAC, mineralization).
Potential Market Opportunities
Giving Green is a non-profit dedicated to finding and sharing the ways donors and volunteers can best allocate their resources to reduce carbon emissions. They offer a thorough review of the voluntary carbon market, along with their recommended approach. They first differentiate offsets by the sector they are in (e.g. forestry, renewable energy), and then provide a more detailed project-level rating as shown in the table below.
Given the recent announcements at COP26, it looks like carbon offsets could play an even bigger role in this transition to a net-zero world. The non-profit Greenpeace argues that this is the worst outcome for this year’s conference. If heads of state do align towards a global carbon offset market, it does mean more opportunities for startups to help service this growing demand.
That said, I hope that the category winners will be those that can build a trustworthy brand, built through a well-vetted, credible offering that is informed by a framework similar to the one above -- and not simply those that offer the cheapest offsets. This is because “if prices are too low, offsets won’t generate enough pressure to get an individual or government or business to change their own carbon-intensive behavior, and in fact may simply grant them license to keep doing what they’re doing.”
Whether through remote sensing and machine learning, more curated project selection or bringing nascent technologies to market, we need more solutions that address credibility challenges in carbon offsets. The last thing we need right now is a license to pollute.
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