Part 2: The Challenges of Creating Quality Offset Markets

Albert Einstein once noted that "If I had an hour to solve a problem, I'd spend 55 minutes understanding the problem, and five minutes working on solutions." Comparing that statement to the contentiousness of carbon offsets over the 35 years since the first offset project, Einstein would most likely suggest spending 55 minutes exploring the challenges of creating quality offset markets, and only five minutes actually coming up with solutions.  

The answer to “why are offsets so hard” is deceptively simple: their intangibility. As British journalist Dan Welch put it: “Offsets are an imaginary commodity created by deducting what you hope happens from what you guess would have happened.” While presumably intended as tongue-in-cheek, at heart it’s an accurate representation of the challenge.

This immediately raises the question: “what could possibly go wrong?” Or probably more accurately, “what could possibly go right?” Here are a just a few of the relevant questions:

Point #1: A Balancing Act

The whole purpose of carbon offsets is to advance two competing goals: cost-effectiveness and environmental integrity. There is no set of market rules that can simultaneously maximize for offset market cost-effectiveness as well as quality. And absent adequate environmental integrity, carbon offsets serve no public interest. Market rules will, explicitly or implicitly, determine how those two competing goals are balanced; the rules will establish the “burden of proof” for offset evaluations and approvals. Rules and outcomes for a “low cost” offset market will look entirely different than the rules for a “high integrity” market.

As such, we should actively decide on what the balance should be, and then write the rules. This is particularly true given the reality that powerful financial interests will push for an inclusive, low cost offset market, while few active market participants are likely to push for a high integrity market.

The situation facing offsets is analogous to the U.S. judicial system, in which juries are entrusted with the task of determining whether a defendant is innocent or guilty. Setting aside cases where DNA evidence is dispositive, juries are charged with evaluating the hypothesis that “this defendant is guilty.” Certainty is usually not on offer, so it is inevitable that some guilty people will go free and some innocent people will be convicted.

But juries are guided by a burden of proof that has been established beforehand, which they are obligated to follow. In the case of a criminal trial, for example, the standard “beyond a reasonable doubt” requires a unanimous jury to reach a verdict of guilty. That’s a high burden of proof – representing a societal decision that we’re willing to see more guilty people be acquitted than we are willing to see innocent people be convicted.

Coming back to carbon offsets, offset market rulemaking has never been preceded by a policy-based decision on how to balance cost-effectiveness and environmental integrity in the evaluation process. That means that there is no agreed-upon “burden of proof” for offset quality. This helps explain why so many non-qualifying projects might make it into the offset pool, and why the overall performance of offset markets to date has been so questionable.

Point #2: The Implications of Intangibility

Carbon offsets are an intangible commodity; it should be easy to recognize that, as a result, offsets cannot be empirically observed or measured. But it’s also not possible to empirically evaluate the quality of a proposed carbon offset project. Market participants often believe that it’s at least theoretically possible to have an offset market in which 100% of the offsets have passed rigorous testing for quality, and that their performance as offsets is effectively guaranteed. Klima DAO, for example, has stated in promotional materials that a review carried out by VERRA (a well-known offset standards organization) “guarantees” the resulting offsets. Really? Nothing could be further from the truth when you’re dealing with an intangible commodity.

The three most fundamental criteria commonly associated with offsets are additionality, permanence, and avoiding leakage. These criteria have been accepted as fundamental ever since the first offset project. But since then, we’ve learned much more about the challenges of applying them to an intangible commodity like carbon offsets. Because there is no way to “test” for these criteria in the conventional sense, the goal of achieving a quality offset market becomes enormously complicated. I’ll briefly explore why this is the case in the text and graphics below.

The Additionality Criterion

“Additional” tons are directly attributable to incentives created by the workings of the offset market. This is true whether the emission of those tons is “avoided” or the tons are “removed” from the atmosphere. Offsets cannot represent tons of CO2e that would not have been emitted to the atmosphere, or that would have been removed from the atmosphere, in the absence of the offset market.

Certainty regarding whether a proposed offset project is the result of the workings and incentives of the offset market -- as opposed to the many other potential drivers or motivations that might be in play -- is rare at best. There will always be at least some degree of uncertainty about a project’s “additionality,” making a binary “yes/no” determination impossible. Thus, we have to come up with ways to evaluate “additionality,” without ever knowing whether that project actually was additional. Imagine trying to design a pregnancy test kit without ever actually knowing whether a woman was or was not pregnant. We can only be more or less confident about a project’s additionality, never absolutely certain. 

With no empirical way to test for additionality, some proportion of non-additional tons will be approved as offsets even under the best of circumstances (and even with the best written rules). Many observers may expect offset markets to be comprised of 100% legitimate offsets, but it’s an impossible objective. Note also that even under the best written rules, some proportion of legitimately additional tons will be mistakenly assessed as non-additional and denied offset status. Each of these outcomes represents an error; the size of each error depends on how the rules are written in balancing cost-effectiveness and environmental integrity. Unfortunately, the two errors are inversely related, and can’t be simultaneously minimized for. That’s why prioritizing an offset market’s inclusivity and cost-effectiveness by definition reduces its environmental integrity (and vice versa).

The challenge of keeping non-additional tons out of offset markets is complicated because the number of “naturally” avoided or removed tons vastly exceeds the number of tons likely to be attributable to the existence of offset markets. Numerous public policies (from energy efficiency standards to renewable energy mandates) cause billions of tons of emissions to be “avoided,” and the natural carbon cycle removes hundreds of billions of tons of CO2 from the atmosphere every year. Virtually all of these “naturally” avoided or removed tons need to be kept out of carbon markets if their environmental integrity is going to be maintained.

The Permanence Criterion

The warming impact associated with CO2 emissions lasts for a long time; the equivalent cooling impact of offsets should last just as long. That may seem obvious, but applying the dictionary definition of ”permanence” would dramatically constrain the scope (and cost-effectiveness) of offset markets. Some offset categories (e.g. nature-based solutions) are almost inherently non-permanent, for example, in contrast to the goal of expanding the scope of offset markets. Thus, the real question has become how long is long enough? Given the pressures for inclusivity and cost-effectiveness, ”permanence” has lost much of its practical relevance. Some offset standards and methodologies commit to keeping carbon out of the atmosphere for just a few years, whereas the emissions supposedly being “offset” will persist in the atmosphere for centuries.

The (Lack of) Leakage Criterion

Market or behavioral feedbacks following the implementation of offset projects can undermine their cooling impact, and need to be netted out. As with additionality, however, there is no empirical way to measure the potential leakage associated with different kinds of offset projects. We might know to be more or less concerned about leakage depending on the category of project, but quantifying that leakage is almost always subjective.

At the end of the day, as I’ve already noted, one can only be more or less confident in the hypothesis that any given offset is a “quality” offset. And as illustrated below, there is a “needle in the haystack” element to the challenge, since such a small fraction of the tons market participants might try to introduce to the market actually belong there as legitimate offsets.

Point #3: The Challenge of Quantification

Once an offset project is qualified for the offset market, how does one quantify the number of offsets awarded to that project? You’ll recall Dan Welch’s characterization of offsets as “deducting what you hope happens from what you guess would have happened.” What we guess would have happened is called the project baseline, and it is counter-factual -- it’s a “but for the project” prediction that cannot be empirically validated. Recent studies have suggested, however, that the baselines used in some types of projects, including avoided deforestation and cooking stoves, have been wildly off, resulting in an estimated 600% over-issuance of offsets.

Point #4: Managing Gaming of the Rules

The gaming of offset rules will occur on two fronts, the first a reflection of the fact that offset providers face an inherent conflict of interest when it comes to bringing quality offsets to market. Even if they are motivated by the goal of tackling climate change, identifying and launching high quality offset projects is costly and risky. What if buyers end up not buying the offsets?

The most obvious way to manage this business risk is to find ways to game the system. The more non-additional, impermanent, or leakage-prone a project, the lower its business risks – at least for the offset developer. I’m not even suggesting that this is gaming is done intentionally; project developers might not even realize they’re gaming the system if they’ve convinced themselves of a project’s “quality.” As Margaret Heffernan noted: “In failing to address climate change, all the forces of willful blindness come together like synchronized swimmers in a spectacular water ballet.”

But there is another source of likely gaming, namely that associated with outright corruption and fraud. We might like to think that no one involved in offset markets would resort to such gaming, but that would be exceedingly naïve.  

Conclusion

Bringing an entirely intangible commodity to market will always be challenging. But if you ignore the implications of that intangibility, as offset markets have in the past (see Part 1 of this series) the market is probably doomed. If you tackle the implications of that intangibility, you might succeed -- but it’s not clear that offsets will ever be fit-for-purpose against today’s market expectations. I’ll talk about this further in Part 3.