Introduction to the Series
In 2021, the Task Force on Scaling Voluntary Carbon Markets suggested that a 10x to 100x increase in the use of carbon offsets is needed to deploy the “climate capital” around the world to meet global climate targets. Under this scenario, between tens and hundreds of billions of dollars would be spent annually on carbon offsets.
Not surprisingly, this forecast generated considerable investor interest. But investors should recall that carbon offsets have been a controversial and volatile commodity since the first carbon offset in 1988. Realistically, there are BIG uncertainties about whether the carbon market can live up to “offset-optimist” expectations.
Given the stakes when it comes both to investors and climate change, and what seems like growing confusion regarding how companies, investors, and even the general public should think about carbon offsets, I’ve structured this 3-part blog series as a brief “due diligence” into the future of offset markets. The three parts are:
- Part 1: A Historical Review
- Part 2: The Challenges of Building a Market Around an Intangible Commodity
- Part 3: Anticipating Carbon Offset Futures
Because carbon offsets have become so polarized in climate change mitigation circles, I’ll include a somewhat detailed personal “offsets bio” below, so you as a reader will know my background in the area and can decide how much credence to give my thinking and conclusions.
Part 1: A Review of Offsets History
In 1988, independent energy producer Applied Energy Services (AES) was planning to build a series of coal- and gas-fired powerplants around the United States. AES’ CEO Roger Sant noted at the time that he would have preferred to construct wind farms or solar arrays, but the economics just didn’t work. Instead, with the support of the World Resources Institute in Washington, DC, AES committed to funding a carbon offset project for each of its proposed power plants. The first offset project, based on expanding an agroforestry program in the uplands of Guatemala operated by the nongovernmental organization CARE, was matched to AES’ first powerplant in Thames, Connecticut.
Since then, the impacts of climate change have become increasingly obvious and the pace of change has accelerated. The urgency of tackling the climate crisis has grown. At the same time, public policies needed to tackle climate change by radically accelerating a low carbon transition are “missing in action.” This has broadened expectations regarding the climate change mitigation role for carbon offsets. In effect, offset optimists now see offsets as the “hammer” that can drive several of the “nails” needed to build a low carbon transition. From generating and deploying needed “climate capital,” to technology innovation and commercialization, to protecting and restoring natural systems, and to promoting “climate justice,” carbon offsets are seen as the go-to solution.
The principle behind carbon offsets is simple. All kinds of opportunities exist around the world to avoid the emission of greenhouse gases (GHGs) to the atmosphere or to remove GHGs from the atmosphere. Because GHGs mix well in the atmosphere, climate outcomes aren’t affected by the location of GHG emissions, avoided emissions, or removals. Nor does the atmosphere care whether the emission of a ton of GHG to the atmosphere is avoided or whether a ton of GHG is (permanently) removed from the atmosphere.
This means that mitigating climate change can be made more economically efficient by focusing on the lowest-cost options first. Carbon offsets are based on this idea, and this has allowed construction of the accounting structure needed to implement it. It’s important to note that this description of how carbon offsets work represents a small world model view of carbon offsets. As discussed in John Kay and Mervyn King’s 2021 book Radical Uncertainty: Decision-Making Beyond the Numbers, however, relying on small world models can be dangerous because reality is inevitably more complex.
One reflection of that reality is that offsets have been controversial almost since the first offset project in 1988. Chief among the concerns is the “quality” of offsets sold to consumers and businesses, a concern that has spanned voluntary and compliance offset markets. Studies of the Kyoto Protocol’s Clean Development Mechanism (CDM), a regulated carbon offset market, suggested that as many as 80% of the Certified Emissions Reductions (CERs) issued under the CDM probably should not have qualified as carbon offsets.
More recent studies of avoided deforestation and clean cookstove projects in voluntary offset markets concluded that offsets were over-estimated by 600%, resulting in millions of tons of offset "hot air." A recent exploration by the New Yorker magazine into the single most “sold” carbon offset project, the Kariba project in Zimbabwe (from which more than $100 million of offsets were sold to buyers including Porsche and Gucci), concludes that the project has been characterized by rampant fraud, self-dealing, and incompetence, and that relatively few of the offsets sold to buyers were “real.”
But the environmental integrity of offsets has not been the only bone of contention. Some observers see offsets as an example of “carbon colonialism,” or as nothing more than a “license to pollute.” Others see offsets as the equivalent of “indulgences” in the Catholic church (have you seen the hilarious video touting “infidelity offsets"?). Other critics suggest that offsets do actual harm to local communities and ecosystems. Most broadly, some critics suggest that offsets are little more than a ploy by the fossil-fuel industry to distract from what’s really needed to tackle climate change.
Given these concerns, it should not be a surprise that offset markets have been volatile. The voluntary carbon market that got underway in 1988 grew steadily for years. It expanded rapidly after the world’s first binding emissions reductions came into force with the Kyoto Protocol in 2005. But the market effectively collapsed in the years following 2009, the result of factors including a global financial crisis and seemingly daily front-page offset scandals. The Kyoto Protocol’s compliance-based CDM carbon offset market also collapsed after a few years, in part because in 2015 countries transitioned from the Kyoto Protocol to the Paris Agreement, and in part because evaluations of the CDM’s environmental integrity were so poor. Some observers thought that these developments signaled the end for of offset-optimism; it turned out that this was only the end of Offsets Round 1.
Offsets Round 2 didn’t take long to get underway. New aviation sector targets, corporate net zero targets, and national targets under the Paris Agreement, all premised on the ability to leverage carbon offsets, caused offset markets to regain considerable ground.
This brings us to the opening of this blog post; market expectations exploded when the Task Force on Scaling Voluntary Carbon Markets suggested in 2021 that a 10x to 100x increase in the use of carbon offsets would be needed to achieve climate objectives due to inadequate public policies.
In the last two years, however, and in the face of seemingly non-stop reports and news stories critiquing carbon offsets, voluntary markets have again declined substantially. Offset optimists have responded that these are just normal growing pains for a new market, and that as long as buyers choose “quality offsets” everything will be fine. But offsets are an entirely intangible commodity that can't be observed or empirically evaluated, and buyers have little ability to judge the “quality” of the offsets they’re buying.
The intangibility of the offset commodity lies at the heart of the radical uncertainty facing the future of offset markets. Notwithstanding the industry’s aggressive growth expectations, anyone with a material interest in the future of carbon offsets should want to understand the answers to questions that include:
These questions in one way or another all come back to the intangibility of carbon offsets and the failure of offset markets to effectively adapt offset markets to that intangibility. That is what I’ll explore in Part 2 of this series.
Dr. Mark C. Trexler was hired by the World Resources Institute (WRI) in 1988 to work on the first carbon offset. At WRI, he also carried out some of the first studies of “nature-based climate solutions,” work he continued as a Lead Author for the Intergovernmental Panel on Climate Change’s (IPCC) Second Assessment Report, and as the Editor for the carbon offsets chapter of the IPCC’s Special Report on Land Use and Land Use Change in 1996. Mark left WRI in 1991 to found the first climate advisory firm focused on business risk assessment and management, later acquired by EcoSecurities, an international carbon trading firm based in Oxford, England.
In these roles he worked extensively on carbon offset projects around the world, and was responsible for developing carbon offset methodologies including coal-mine methane recovery and ocean fertilization.
Mark is widely published on the topic of carbon offset markets and the importance of “additionality” in determining the integrity of offset markets. In 2008, while at EcoSecurities, Mark’s team developed the first sophisticated carbon offsets rating system, based on a 0-1000 score representing how confident buyers should be in the quality of specific offsets. The ratings system was shelved due to fears it would undermine EcoSecurities’ business model and disrupt voluntary carbon markets. The most innovative element of the scoring system, an “inverse weighting” algorithm that makes it impossible for an offset to be rated highly without performing well against all three core criteria of additionality, permanence, and the lack of leakage, was eventually incorporated into the Carbon Credit Quality Initiative.
Today, Mark’s focus is primarily climate risk under-estimation and climate risk knowledge management. The Climatographers’ Climate Web knowledge solution is the closest thing to a collective intelligence for business as well as societal climate risk assessment and management. He continues to track carbon offsets and markets, but other than offering “due diligence” advisory services to projects and companies trying to understand and anticipate carbon markets, he has no financial interests in those markets. Mark is reachable at firstname.lastname@example.org.