A growing number of large companies, including Microsoft, Shell and the airline easyJet, are using carbon offsets to address their climate impact. For their advocates, offsets are a powerful tool to reduce the costs of tackling climate change, accelerate emissions reduction and finance sustainable development in poor parts of the world. To their opponents, they allow companies and individuals to continue to pollute and cling to business models that need to change.

Put simply, a carbon offset is evidence of an activity that avoids, reduces or removes from the atmosphere a specific volume of greenhouse gas emissions. An offset is essentially the legal ownership of that emissions reduction, allowing it to be transferred or traded and used to balance out, or offset, emissions generated elsewhere.

Opinion is divided over whether carbon offsetting is an effective way of reducing carbon dioxide emissions from practices such as deforestation. (Photo by Dudarev Mikhail/Shutterstock)

Offsetting has its theoretical roots in environmental economics, which seeks to address the failure of markets to properly price externalities such as pollution. It found its first practical expression in the amendments to the US Clean Air Act in 1990, which allowed power plants that had reduced their emissions of acid rain-causing sulphur dioxide below federal targets to sell those surplus reductions to plants that were not going to meet their goals.

This allowed facilities that were able to reduce emissions at low cost (or which had invested in equipment that allowed them to exceed their targets) to sell offsets to those for whom meeting their targets would be expensive. It therefore enabled the attainment of the environmental goal – the reduction of sulphur dioxide emissions across the US economy below an overall cap – at a lower cost than if the US Environmental Protection Agency had ordered each plant to reduce emissions by the same amount.

This market-based alternative to the prevailing command-and-control approach to regulation offered a number of advantages: it provided companies with flexibility; it tapped into the ability of markets to meet supply and demand at least-cost; and it provided incentives for emitters to exceed their targets – all while delivering the required environmental outcome.

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By GlobalData

Carbon offsets and the Kyoto Protocol

When the international community came together to draft the 1997 Kyoto Protocol on climate change, US negotiators were able to point to the success of the US Acid Rain Program to argue for the use of similar market-based mechanisms to address carbon emissions. Indeed, carbon pollution is particularly suitable for offset use because the way greenhouse gases mix in the atmosphere means that the source of those emissions, or of any emission reduction, is irrelevant. They all have the same impact on global temperature.

In particular, the Kyoto Protocol established the Clean Development Mechanism (CDM). This system allowed developing countries – including middle-income ones such as China and Brazil that did not have quantified national emissions targets under the Protocol – to set up projects that reduced carbon emissions.

If those projects could demonstrate that they reduced emissions below what would happen if the project was never built – a hypothetical business-as-usual baseline – they could generate carbon credits. Rich world governments and companies could buy these credits and use them to help meet their Kyoto targets.

In the run-up to the first Kyoto target period, which ran from 2008–2012, the CDM developed into a multi-billion-dollar global market. It generated around $300bn in income for projects that generated renewable electricity, captured methane from municipal waste dumps, or, controversially, captured and destroyed powerful greenhouse gas created by chemicals plants.

According to the UN, these projects reduced emissions equivalent to almost two billion metric tonnes of carbon dioxide (CO2) in the developing world – roughly the total emissions produced by India, the world’s third-largest emitter, in 2017.

Carbon offsets and the voluntary market

For reasons of practically and impact, regulated carbon markets have, to date, focused on specific carbon-intensive industries: power generation, oil and gas, steel production and chemicals. A growing number of companies and individuals, however, have also sought to reduce their climate impacts and have turned to the voluntary carbon market instead of, or in addition to, reducing their own emissions.

As with regulated projects, such as those under the CDM, voluntary market projects need to demonstrate and verify that they have reduced or avoided greenhouse gas emissions. However, with no central regulator these verification processes were often initially ad hoc, relying on the buyer to get comfortable with the claims made by the seller. While most projects were legitimate, some, inevitability, were not as robust as they should have been – or were outright fraudulent.

Since then, standards have emerged with strict rules and generally high standards of environmental integrity, including the Verified Carbon Standard and the Gold Standard, which are maintained by not-for-profits Verra and the Gold Standard, respectively. These groups, as well as for-profit companies like APX, also run registries that track trades and ensure that offsets aren’t used more than once.

According to Ecosystem Marketplace, offsets representing just under 100 million tonnes of CO2 traded in 2018 (the last year for which data is available), with a market value of $295m.

Buyers in the voluntary market are often more concerned than compliance buyers with the reputational implications of their purchases. That means they often favour projects with strong social or non-climate benefits, such as those supplying clean cook stoves or protecting vulnerable rainforests.

Carbon credit controversies

For all the success of the US Acid Rain Program, the history of carbon offset markets has been dogged with controversy:

Credit where it is not due: The main critique of the CDM was that it awarded credits for projects that were likely to have gone ahead anyway or that could have been funded more cheaply using grants. The CDM massively enriched owners of certain chemical plants, who could reduce huge volumes of emissions at a fraction of the cost of the resulting credits. In hindsight, these mostly China and India-based projects, which destroyed hydrofluorocarbons (HFCs) produced as by-products of refrigerant manufacture, could have been mandated, or funded by the World Bank, at a fraction of the cost.

More insidiously, there is evidence the profits that could be made from destroying these HFCs incentivised more production of refrigerants than would otherwise have been the case.

Carbon cowboys: The voluntary market, in particular, has been plagued by unscrupulous characters selling the same carbon credits more than once or persuading retail investors to buy carbon credits at inflated prices.

Wrangles over REDD+: Projects that reduce emissions from deforestation and degradation (known as REDD+ projects) also raise challenging questions. By protecting forests at risk from logging or deforestation from agriculture, project developers can earn credits for leaving trees standing. However, if the effect is simply to push illegal logging elsewhere, there is no net climate benefit. Schemes that try and address deforestation over entire landscapes or jurisdictions can, in theory, solve these problems, but are clearly challenging to implement.

Enabling business as usual: Perhaps the most serious critique of carbon offsets is that they allow companies (and individuals) to continue polluting activities. Take the example of the SUV owner who buys carbon offsets rather than switching to an electric vehicle, or the oil major that uses credits earned by protecting tropical rainforests to continue selling fossil fuels.

This is a particular concern given the need to reach net-zero emissions by the second half of the 21st century to meet the goals set by the Paris Agreement. Offsetting is a great way to incentivise emissions reductions outside a capped system, but when the global economy needs to reduce emissions to zero, they become harder to justify.

Offsetting on the way to zero

Advocates of the use of carbon offsets accept this argument.

“We can’t offset our way out of the problem,” says Jonathan Shopley, managing director of environmental consultancy and climate finance advisor Natural Capital Partners.

This is a position taken by the influential Science Based Targets initiative (SBTi), a business-focused NGO that promotes corporate climate action. It encourages companies to set emissions-reduction trajectories that are aligned with the reductions needed to meet the goals of the Paris Agreement. To qualify, these targets must be met by reductions within companies’ own operations or in their supply chains.

Supporters say offsets can enable companies to set more ambitious voluntary emissions reductions than they would otherwise do. In doing so, they can enable reductions to take place more quickly, while allowing companies to address emissions for which there are currently no cost-effective alternatives, such as those from aviation.

Most environmental groups – while generally cautious about the long-term value of offsetting and mindful of earlier abuses – tolerate some use of offsets to address these residual emissions. Big questions remain, however, over how such residual emissions should be defined. Is an airline like easyJet, which offsets all the emissions from its use of jet fuel, acting as a responsible but pragmatic corporate citizen, or cynically perpetuating an unsustainable business model?

Environmental groups argue that the use of offsets should be placed firmly within the context of credible, long-term climate strategies that set out how a company plans to reach net-zero. Offset advocates would not disagree.