(Published in Wiley’s Oil and Energy Trends in August 2021.)
One of the most controversial areas of energy transition plans are carbon offsets, which enable – on paper at least – companies to meet net zero targets by capturing or avoiding emissions elsewhere, while continuing to use, produce and sell oil and gas. Some environmentalists and policy makers are critical of this approach, as it does not cut a company’s absolute emissions. In addition, the scale and quality of offsets required for all companies to meet their targets looks like being extremely difficult to achieve.
As more oil, gas and other companies adopt net zero targets, the demand for voluntary carbon offsetting is surging. In theory, a voluntary credit – which is meant to absorb CO2 from the atmosphere or prevent emission – can be set against an actual emission from fossil fuel use. This includes emissions from finding and producing oil and gas, as well as from actually consuming it. Voluntary credits differ from mandatory emissions credit systems, such as the EU’s Emissions Trading System (ETS), which focus on taxing an ever-shrinking pool of permitted emissions. Recently, they have been much cheaper (see below) than both mandatory systems and most other options for carbon reduction – and so provide an attractive alternative to tackling emissions head on, although they are expected to rise in price over time.
Some environmental groups, investors and politicians believe these voluntary carbon offsets fall short of what is required to tackle climate change and have labelled almost all credits as a form of greenwashing. This means, if relied on too much, offsets could leave companies open to reputational risk. And if environmental concerns evolve further – possibly spurred by regular extreme climate events – plans to rely on offsets could become unacceptable, largely because they fail to tackle absolute emissions, but also because they may themselves become vulnerable to the impact of climate change. The UN IPCC and more recently the IEA have adopted net zero targets because of the difficulty of aiming for absolute zero, but many environmentalists insist voluntary credits should only be a small part of the climate solution and only for emissions that absolutely cannot be avoided. Companies instead should focus on cutting fossil fuel output, or by capturing emissions from fossil fuel use using carbon capture and storage (CCS), as well as reducing operational emissions through electrification or the use of sustainable fuels. In this case, several large oil and gas companies, including Shell and Total, would have to completely review their energy transition strategies, which are currently heavily dependent on voluntary offset credits.
The credits themselves fall into four main categories: (1) avoided nature loss, such as deforestation; (2) avoidance of emissions, such as methane from landfills or renewable energy; (3) nature-based sequestration or capture, such as reforestation; and (4) the direct removal of CO2 from the atmosphere. The first two avoidance categories currently make up the bulk of offsets, although are considered less robust than the capture-type offsets (3&4). This is leading the more environmentally ambitious companies to seek the latter category out, which may push up prices overtime. Users and advocates of voluntary credits argue that they are the most cost-effective, and therefore the most efficient way of reducing emissions – and could not only produce carbon neutral, but carbon negative fossil fuel use (when more carbon is captured/avoided than emitted) more cheaply than replacing the fossil fuel use itself. They also note that in much of the world there is still little effort to reduce greenhouse gas emissions, which makes cross-border voluntary offsets a crucial means of making a difference in these countries.
Concerns over scale and verification
Beyond questions over their use generally, carbon offset markets need to show they can be relied on, and that they can scale up effectively – McKinsey & Co. estimates the voluntary offset market could be worth $50 billion by 2030, up from just $300 million in 2018. Other estimates go as high as $100 billion by 2030. But it is questionable whether supply can grow quickly enough to meet this growth, without sacrificing quality.
To start with, there are questions over the feasibility of planting the huge number of trees that would be needed to match the needs of major off-setters seeking the more robust capture offsets – estimates suggest vast areas would have to be reforested to meet oil and gas company needs alone. Shell, for example, wants to offset 120mn t/CO2e/yr in this way by 2030, compared to a market of less than 40mn tCO2e of forestry and land-use offsets available worldwide in 2019, according to Ecosystem Marketplace and EIG. Shell and Total each plan to spend about $100mn/yr on nature-based carbon offsets, and both are relying heavily on them to meet their 2050 net-zero targets. Eni sees forestry credits as crucial for achieving its net-zero target and plans to offset 20mn tCO2e/yr by 2030. As demand for this type of offset rises, so will prices, which should increase the incentive to reduce actual emissions.
There are also questions over the environmental integrity of projects and their accounting mechanisms. Monitoring and maintaining reforestation projects can be tricky, and open to manipulation. A newly planted tree can take up to 20 years to capture the amount of CO2 that a carbon-offset scheme promises, with growing risks from fire and extreme weather events. Carbon credit certifiers such as the US-based Verra, the world’s biggest issuer, claim their pools of “buffer credits” can be cashed in when emission reversals occur, effectively insuring against such events. But the buffer credits are untested long-term, and face the same increasing climate risks.
Carbon abatement and avoidance credits are particularly difficult to verify, especially when it comes to booking credits over the lifetime of projects. For example, it is not always clear if a forest would have been cut down anyway, or that renewable power plants would not have been built in any case without the credits. Moreover, the offsets generated do not actually take any carbon out of the atmosphere, but just (probably) avoid more entering it. Credits based on avoiding emissions represented 96% of all contracts issued in 20201.
Another concern is that carbon offsets will not become as commodifiable other markets, mainly because they are so varied, which prevents transparency and price discovery. The more robust the project, and the longer a tonne of CO₂ can be stored away or avoided, the more expensive the carbon offset should be and is, which makes it hard to set a standardized price. “Today’s [voluntary carbon] market is fragmented and complex,” said McKinsey in January2. “Some credits have turned out to represent emissions reductions that were questionable at best.”
Tackling the issues
There are a number of existing international standards, including the Gold Standard and Verified Carbon Standard, but many feel these are insufficient, and calls for greater scrutiny over the accuracy and accountability of voluntary carbon offsets are growing as the market expands. Leading this is the UN-backed Taskforce on Scaling Voluntary Carbon Markets (TSVCM), which has been set up by a group of 400 parties keen to oversee an ever-larger over-the-counter voluntary credit market. But the group has faced internal disagreement and is yet to complete its recommendations. In the meantime, some commodity exchanges are going ahead under existing standards. Chicago’s CME launched earlier this year, including those issued by Verified Carbon Standard, American Carbon Registry, and Climate Action Reserve. The first trade took place in March involving trading companies Vitol and Mercuria.
Currently less than $1 billion of voluntary offsets are traded annually, and most of these are low-cost ones that are unlikely to meet TSVCM’s standards. But TSVCM believes a large-scale voluntary carbon market is critical to hitting the Paris Agreement targets. In January it issued blueprints to establish “core principals” in carbon offset markets to boost governance and pricing transparency, and it is moving ahead in other areas too. The group is also expected to insist on a global regulator to ensure verification.
Some companies, such as BP, Shell and Total, are also developing their own carbon offsets. BP recently invested in Finite Carbon, the biggest US producer of carbon offset credits, which operates based on a model that helps landowners sell their forests as carbon sinks. In these cases, any process of internal verification would need some form of external oversight to satisfy most investors and emissions verification bodies.
Prices stay low (Box?).
The pricing agency, S&P Platts, began publishing daily assessments for voluntary carbon offsets in January3, with prices rising to $2.34/mt in March, before easing back to around $2.00/mt at the time of writing. Platts is involved with TSVCM, and longer term it could bring the benchmark quote into line with the group’s recommendations. Other types of offsets could potentially be traded at a differential to this benchmark price. There are also deals taking place all the time away from this market, with recent reports of prices as low as $1.5/tCO2e involving leading producers in the US. The cost for nature-based carbon offsets (capture and avoidance), which tend to be more expensive, averaged $3.76/tCO2e in 2019, according to Ecosystem Marketplace, and very few of these offsets cost more than $5/tCO2e. Renewables-based avoidance credits tend to be less expensive.
Compared to carbon compliance markets like the EU ETS, which has recently seen prices at over €50/t, the cost of buying these voluntary carbon credits is low. And if they are to be used to offset a cargo of crude or LNG, any premium gained for the low carbon option would help pay for the offset. Voluntary offset prices are also much lower than the cost of operational electrification, or zero carbon fuel alternatives, such as Sustainable Aviation Fuel (SAF), and so significant price rises many be required to push companies and others into more fundamental changes in behaviour that actually cut absolute emissions.
Carbon neutral oil and gas
Despite the criticism, trade in oil and gas cargoes that have had their emissions offset with voluntary credits is growing quickly, although numbers remain relatively small. In the case of LNG, the first ever carbon-neutral cargo was received by Tokyo Gas and GS Energy from Shell in 2019, and many similar deals have followed since then. The market has become liquid enough for S&P Platts to launch a carbon-neutral LNG assessment in June this year (to go alongside its voluntary carbon price assessment), which is based on nature-based voluntary carbon offsets for 0.068-mt LNG cargoes from Australia to the northeast Asian market. Improved transparency about climate-warming emissions from LNG will be a key component of developing a “robust and trusted” market, according to a new study from Columbia University’s Center on Global Energy Policy4. To date, most cargoes have been sold to Asian buyers, rather than European, which is thought to be mostly due to Europe’s established ETS for power and industrial sectors, which reduces the incentive for further voluntary offsetting. There is no similar ETS market in Asia, making carbon-neutral LNG supplies more attractive.
In the case of carbon-neutral oil, Occidental Petroleum claimed the world’s first carbon-neutral crude transaction in January this year. The trade involved the delivery of two million barrels of US crude from Occidental to India’s Reliance Industries, which were offset in part by pulling CO2 out of the air and storing it using Oxy’s flagship Direct Air Capture (DAC) technology. Big oil companies are keen to sell carbon neutral fuels as it draws their customers into the decarbonisation process, and can leverage potential new business areas such as CCS and DAC. Other oil offsetting still involves nature-based options. For example, BP and Shell have integrated carbon offsetting optionality into their fleet fuel card and consumer loyalty schemes in Europe, allowing drivers to help offset the emissions produced from their fuel use. Non-oil companies are also getting in on the game, especially airlines and other transport companies. For example, in June, Norwegian Cruise Line Holdings committed to buying three million carbon offset credits as part of a strategy to decarbonize its activities and reach carbon neutrality. The company said it was a measurable step that could be taken today, bridging the gap in its decarbonization efforts until new technology becomes available.
Given that the impact of climate change will increasingly be felt through extreme weather events, including this summer’s record temperatures, it is likely that voluntary offsets will come under ever-increasing scrutiny. Whether they can prove themselves to be effective at scale, and contribute cheaply and meaningfully to tackling global CO2 and methane emissions, should become apparent within the next 5-10 years.
Notes and references
1. According to the Taskforce on Scaling Voluntary Carbon Markets (TSVCM).
3. https://www.prnewswire.com/news-releases/sp-global-platts-to-publish-first-voluntary-carbon-credit-price-assessments-301193861.html