Offsetting emissions: It’s not just the cost of carbon that matters to businesses

30 kilometres off the north-western coast of Malaysia, in the Langkawi archipelago, French cement giant Lafarge has made a radical change. The coal-fired kilns are now powered by palm nut shells left over from the manufacture of palm oil.

The result is a saving of thousands of tons of carbon dioxide that is no longer emitted into the atmosphere each year. It also means that Lafarge can meet its obligations to cut emissions at a lower cost than they could in Europe.

This is just one project that’s part of the UNFCCC’s Clean Development Mechanism (CDM). CDM works by allowing companies to claim carbon credits when they invest in projects that reduce developing countries’ greenhouse gas emissions. The credits on offer are known as Certified Emissions Reductions (CERs) and are part of the European Union Emissions Trading System (EU ETS). This means that credits earned by cutting emissions in developing countries can be used to offset emissions inside the EU. A sister scheme called ‘Joint Implementation’ allows firms to earn credits for use in the EU by offsetting in Eastern Europe, Russia and Ukraine.

CDM and Joint Implementation projects offer EU emitters the opportunity to get involved in cutting emissions around the world. Multinational companies can take up offset opportunities through their subsidiaries, just as Lafarge did with the cement plant in Langkawi, in order to meet their commitments to the EU ETS.

Offsetting makes sense for companies because permits are currently cheaper outside of Europe. Take the cost of permits in the CDM scheme – it has for a long time been considerably cheaper to earn permits through this scheme than through the EU ETS directly. So why are more companies not making use of this opportunity?

Key drivers: Cost of carbon, attitudes, subsidiaries

In our recent paper, we use firm-level data and interviews with key actors to better understand what drives companies to engage in offset markets. We test to see whether certain types of firms are more or less likely to use offsets, for instance, if companies with  in CDM or Joint Implementation countries use more offsets.

We find that offsetting in the EU ETS using credits from around the world depends on a number of factors.

Firstly, a company’s exposure to the cost of carbon matters. Firms with greater emissions relative to their revenue are more exposed to higher carbon prices. We found that these companies are more likely to offset their emissions through the CDM and Joint Implementation schemes.

Secondly, institutional factors within a company play an important role too. Their use of offsetting can depend heavily on individual decision makers, on attitudes towards emissions trading and on whether they had subsidiaries located in countries covered by the CDM and Joint Implementation schemes.

Finally, the location of a company’s subsidiaries affects how likely a company is to offset emissions, and using what scheme – whether CDM or Joint Implementation. We found that a company with a subsidiary in Russia was more likely to offset emissions with Joint Implementation than a company with a subsidiary in China was to use CDM.

This could be because getting credits out of Joint Implementation is more complex than CDM. A whole industry has developed to help companies develop, manage and buy credits from CDM projects. The smaller Joint Implementation scheme hasn’t developed in the same way and therefore firms needed to rely more on their own knowledge, and experience on the ground in particular countries – hence the importance of a subsidiary in determining uptake of the scheme.

A lesson for policymakers

We are starting to understand why some companies offset their emissions outside of Europe and why others don’t.

Even though offsetting emissions outside the EU makes financial sense, it is not guaranteed that a company will act accordingly. This is an important lesson for emerging emissions trading schemes such as those in China that include offsets into their design. Figures of predicted carbon reduction could be grossly inaccurate depending on whether firms actually engage in such programmes.

Policy makers would do well to remember that companies will offset emissions based on factors other than price.