Our environment is changing, and this will have far-reaching consequences. Wherever we live, work or travel, we should all want to participate in the effort to combat global warming. At HAMERKOP, we believe that carbon offsetting and carbon finance (a subset of climate finance) are powerful tools which companies and individuals should understand and leverage to mitigate climate change.

Carbon (used for GHG emissions) offsetting allows for the balancing out of emissions in one place through a project happening elsewhere in the world. The idea of offsetting greenhouse gas (GHG) emissions emerged in the late 1980s and is based on the scientific evidence that emitting, absorbing or reducing emissions has the same effect, wherever it occurs in the world. In other words, since climate change is a global phenomenon, the effectiveness of actions to avoid GHGs entering the atmosphere does not depend on these actions’ locations.

Carbon offsetting offers organisations or individuals the opportunity to finance GHG emission reductions to an amount corresponding to their own emissions. When labelled or certified, these emission reductions can be called emission reduction units; certified emission reductions; voluntary carbon units; verified emission reductions; and many other names, depending on the organisation that issues them.

In this article, we review the origins of carbon finance; the difference between compliance and voluntary carbon markets; how organisations can balance out their own emissions; how carbon credits are created; and a range of other key concepts necessary to understand the contributions these make to current efforts in reducing global GHG emission levels.

The birth of carbon credits or carbon offsets

Carbon financing through projects originated from the Kyoto Protocol (1997), where a market-based mechanism (also called cap-and-trade) and two project-based mechanisms were developed: the Clean Development Mechanism (CDM) for developing countries and the Joint Implementation (JI), for industrialised countries. These project-based mechanisms work to subsidise activities reducing GHG emissions, providing an additional or complementary source of income for some projects and the only source of income for others. These so-called flexibility mechanisms were operationalized by the Marrakech Accords (2001). The CDM is due to expire at the end of 2020.

Until the end of 2020, the CDM had two key objectives: to reduce the costs of emission reductions for industrialised countries (Annex I countries of the Protocol) by enabling them to outsource their emission reductions to projects in countries where it is cheaper to do so, and enable developing countries (non-Annex I countries) to benefit from funding for cleaner and often more expensive technologies. Alternatively, the main objective of the JI was to offer a financial mechanism for industrialised countries to tackle emission reductions domestically, notably in sectors where emissions are more challenging to address (i.e. those not covered by a cap-and-trade carbon market).

Both project mechanisms of carbon finance (CDM and JI) have been structured in such a way to provide result-based incentives. It is only when projects have demonstrated a GHG emission reduction that they obtain carbon credits (interchangeably called carbon offsets) that can be sold.

In 2015, the Paris Agreement was signed. Article 6 of this international treaty includes provisions for the next generation of carbon market instruments, for which rules remain to be fully developed, even though the treaty enters into force in January 2021.

Compliance versus voluntary carbon market

Until the end of 2020, carbon credits issued for projects registered under the CDM are eligible to be used by heavily polluting industrial sites to fulfil a portion of their national emission reduction commitments as part of the Kyoto Protocol. These carbon credits are eligible to be used and exchanged under a so-called compliance carbon market, a market structured for regulatory purposes. The most notable example of this kind of market is the European Union Emissions Trading Scheme or EU-ETS (e.g. comprising 11,000 heavy energy-using installations). Under these markets the type of carbon credits that can be used are usually very restricted. As per the map below, many countries around the globe have implemented various national or subnational carbon taxes or carbon markets.

In parallel, and from 2006 onwards, a voluntary carbon market has developed. This voluntary market generally involves entities that buy carbon credits to support projects. These entities are generally in the service, consumer goods and retail industry but can also be individuals, NGOs or international organisations.

Unlike the compliance state-organised markets, the voluntary carbon market is not regulated by a central authority. Thus, there are no constraining rules regarding the type of carbon credits that are eligible. As a result, in addition to using carbon credits from the CDM, organisations which are active in the voluntary carbon markets have been increasingly using carbon credits issued by independent certification standards that started emerging around 2006 (well before, for some of them). The most heavily used at present are the Gold Standard for the Global Goals (from the Gold Standard Foundation) and the Verified Carbon Standard or VCS (from Verra). Today, most organisations who voluntarily offset their carbon emissions do it with carbon credits from these independent certification standards or so-called voluntary carbon standards.

How do organisations offset their emissions voluntarily?

Currently, offsetting generally consists of an organisation purchasing an amount of carbon credits that corresponds to the quantity of GHG they wish to offset and whose type enter either in scope 1, scope 2 and/or scope 3:

Scope 1 emissions are the direct GHG emissions emitted from sources owned or controlled by the organisation (e.g. the on-site production of electricity, heat or steam; physical and chemical processes; transportation of goods and people).

Scope 2 emissions are the indirect GHG emissions emitted from purchased electricity or steam consumed by the organisation (e.g. electricity from the national network).

Scope 3 emissions are the indirect GHG emissions emitted by the value chain of the reporting organisation (e.g. business travel, employee commutes, production of purchased materials, investments, leased assets and franchises, and waste disposal).

The money these organisations pay to purchase carbon credits contributes directly or indirectly to the funding of a specific carbon emissions reduction project. Project developers receiving these payments then implement a range of activities, from the installation of renewable energy infrastructure like wind turbines or biogas recovery from landfills to planting trees that remove and store carbon from the atmosphere.

For 2019, the transactional value of this market was estimated to be 320 million US$, representing 104 million carbon offsets transacted[1].

Which emission reductions can be certified and monetised as carbon credits?

The issuance of carbon credits is dependent on the unique processes, rules and procedures developed by each carbon certification standards. Currently, all commonly used carbon certification standards have based their core rules on those of the CDM. As a result, projects have to fulfil the following basic requirements of offering emission reductions which are real, measurable, additional, permanent, verifiable and unique. What these conditions entail is briefly defined below:

Be real: the emission reductions must have actually happened. There must be an emission reduction underlying each carbon offsets which corresponds to the outcome of the implemented project.
Be additional: the revenue from the sale of carbon credits is a determining factor in the implementation of the project. The survival of the project depends, to some extent, on the project developer’s ability to sell these carbon credits. In other words, this implies that the project could not have emerged had it not been financially supported by an offset scheme. This concept is known as 'additionality'.
Be measurable and verifiable: emission reductions can be calculated with scientific rigour and be monitored and audited. To do this, there must be calculation and monitoring methodologies that are appropriate to the context and technology concerned.
Be permanent: the emissions which have been reduced or avoided must last over time and must not be released back into the atmosphere by the project in question at a later date.
Be unique: each carbon credit must correspond to a single tonne CO2e. This also means that procedures to avoid double-counting must be put in place.

Additionality is a key concept of carbon finance mechanisms. Whilst some conditions are specific to each standard, the determination of a project's additionality generally focuses on these key questions:

Is the project financially viable and likely to attract financing without selling carbon credits? The answer must be no for a project to be additional.
Does the proposed project carry risks that make it difficult to be financed or implemented? The answer must be yes for a project to be additional.
Does the proposed project reduce/avoid GHG emissions beyond regulatory requirements? Is the proposed project already a common practice where it takes place? The answer must be yes to both of these for a project to be additional.
Does the project face significant organisational, cultural or social barriers that cannot be overcome without selling carbon credits? The answer must be yes for a project to be additional.

What are these carbon certification standards?

More than 15 voluntary carbon certification standards have emerged since the mid-2000s. Some of those which are still operating and recognised widely by the market are the Gold Standard for the Global Goals (GS4GG); the Verified Carbon Standard, Plan Vivo, the American Carbon Registry, the Climate Action Reserve, the Woodland Carbon Code and the Label Bas Carbone.

As part of the carbon certification process, a project must be eligible for both: (i) a set of conditions that are specific to the project specificities; and (ii) the rules and principles of the chosen certification standard. Each standard has its own requirements and eligibility criteria. Each standard notably has eligibility requirements based on the project geographical location, scale, or technology.

Each standard has a slightly different focus. Certain standards are limited to particular project types (e.g. forestry for the Woodland Carbon Code) while some others exclude certain projects (e.g. Plan Vivo excludes non community-based projects) or exclude technologies based on their features to focus on projects maximising social benefits (e.g. large scale hydropower plants are ineligible for the GS4GG).

Beyond emission reductions, voluntary carbon standards usually demand from the candidate project to achieve a range of co-benefits in the host country. These co-benefits usually imply contributions to development objectives in areas that matter: social (gender imbalances, discriminations against women and/or ethnic minorities); economic (poverty, access to jobs, and other economic opportunities); health (reduction in exposure to toxic air, chemicals); environmental (protection of old growth forests, of biodiversity, reduction in pollution levels, increase in access to clean energy); or humanitarian (improvement of refugees’ livelihood standards). These co-benefits are often in line with at least one or more of the UN Sustainable Development Goals.

Finally, the choice of certification standard is not only a choice from a project perspective, but it also guides the market on which the carbon credits will be sold and determines the prices at which they will be sold.

Carbon finance as an efficient financing mechanism

Providing financial support to projects through carbon credits, or carbon offsetting, is considered a critical part of efforts to tackle the climate crisis. Carbon finance provides concrete solutions, which are both economic and environmentally efficient, whilst also providing the opportunity to generate development co-benefits.

Therefore, carbon finance:

Is open to all actors and entities.
Enables the diffusion of climate change know-how and experience among corporate and institutional actors.
Offers an international source of revenues for projects, without the complexities of capital markets.
Allows equity to be decoupled from efficiency, and thus enable burden-sharing, whereby rich countries facilitate mitigation efforts in less developed countries.

In addition to the above, carbon finance is a result-based mechanism. This means that instead of paying for activities that may trigger results (generally positive outcomes), as it is the case for development aid, through the voluntary carbon market, organisations willing to balance out their own emissions are only paying for evidence-based results: emissions that have already been reduced or avoided. This means organisations which offset their emissions with carbon credits only direct financing towards projects that work and deliver positive outcomes, and projects find themselves incentivised to perform. Efficiency then becomes a key feature of carbon offset projects.

Certified vs uncertified projects

Today, almost all projects selling carbon credits are certified through a recognised carbon certification standard which issue labelled and recognised carbon credits. This was not so much the case 10 years ago. Actors in this environment built on past failures and made a substantial effort to build credibility and legitimacy in their activities.

While carbon offsetting is often criticised, many of these criticisms are ill-formulated, outdated or relates to how corporates use or communicate about it rather than to the suitability of the financing mechanism. Unlike bureaucratic certification organisations such as the CDM which has unfortunately struggled to keep up in this fast-paced environment, the voluntary carbon standards, initially set-up to address some of the gaps of the CDM, have been driving forces of innovation. They have strengthened their rules to ensure the environmental and social integrity of their certified projects. For instance, the risk of double-counting is now almost non-existent. This is also the case when it comes to ensuring the reality of emissions reduction (i.e. the risk of carbon credits being sold by a project that has not reduced emissions). In the near future, we expect monitoring procedures to require increasingly more accuracy, international registries holding carbon credits to be more transparent and social and environmental safeguards to be reinforced.

Carbon offsetting does however entail some risks. Whether you support a certified or a non-certified project, any project can go wrong. This can be even more true that it often exists an important asymmetry of information between the entity running the project and the entity financing it. On the other hand, when carbon offsetting is used to balance out the lack of action from a company not reducing its own emissions, this can lead to reputational issues for the financing organisation.

Carbon reduction, avoidance, sequestration and removals

Credit: Photo by Bas Emmen on Unsplash

When referring to emission reductions monetised as carbon credits, the term reduction is not always necessarily accurate, as it refers to a range of situations or actions:

Avoidance: most carbon projects reduce emissions in comparison to a theoretical situation that would have occurred in the absence of the project. For instance, if a country intends on installing a coal-fired power plant to expand national electricity production as it is the cheapest or most convenient way to do so, carbon credits can make the installation of an alternative hydropower plant as financially attractive by enabling the avoidance of those emissions that would have occurred otherwise. In this case, a carbon credit represents a tonne of CO2e avoided and not reduced.
Removals can be classified under two types:

Natural removal: most projects labelled as nature-based solutions remove carbon from the atmosphere. For instance, as a tree grows, carbon is being biologically sequestered in its stems and roots. In this case, a carbon credit represents a tonne of CO2e sequestered, removed or reduced.
Engineered removal: while such projects have not yet developed into certified carbon projects, this is a growing practice. Technology is being developed which has the capability to capture carbon directly from the atmosphere (also called direct air capture) or from flue gas (carbon capture and storage) and store it in geological formations. While the efficiency of such technologies is still being questioned and these are at the moment under-deployed, they could be considered as reductions. In this case, a carbon credit would represent a tonne of CO2e removed or reduced.

A company that offsets its emissions with carbon credits avoids making things worse by being accountable but does not prevent emissions to keep stacking up into the atmosphere in absolute levels. Offsetting only makes sense when integrated within ambitious emission reduction plans.

Conclusion

In this article, we hope to have offered you a glimpse of what carbon offsetting is, how it works, which emission reduction can be monetised as carbon credits, how carbon certification standards work and why it is considered as an efficient financing mechanism.

HAMERKOP’s experts have more than 12 years of experience helping companies, NGOs, and governments navigate the complexity of voluntary certification processes, from selecting the appropriate standard, to the successful sale of their first offset units and further, through the monitoring of their projects, thus ensuring their long-term economic, social and environmental viability.

If you are looking to engage with the voluntary carbon market, whether you are a company considering offsetting your emissions and looking to understand what project or certification standard to support and how to procure and negotiate carbon credits; or an organisation that have an upcoming project that reduces emissions potentially eligible to sell carbon credits, we can help, so reach out to us. We do not sell carbon credits and so we can advise independently as well as connect you with the right counterparts.

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[1] Voluntary Carbon and the Post-Pandemic Recovery (Ecosystem Marketplace, 2020). Link: https://www.ecosystemmarketplace.com/articles/demand-for-voluntary-carbon-offsets-holds-strong-as-corporates-stick-with-climate-commitments/

What is carbon offsetting? How does it work?