Because most countries, institutions, companies and individuals will continue to generate greenhouse gas emissions through their activities even as the world decarbonises, many choose to compensate for these ‘residual’ emissions. The most common approach for doing so is to purchase carbon credits. This is commonly known as ‘offsetting’ emissions, with the terms ‘offsets’ and ‘carbon credits’ often used interchangeably.

However, disagreements over technical details and the principle of compensation – exacerbated by loose terminology – have fuelled controversy over the degree to which carbon credits should be used to allocate resources for decarbonisation. (Offsetting involves the exchange of credits within voluntary markets, and is similar to but distinct from legal emissions trading schemes, where participating firms face a legal requirement to cover their emissions with a corresponding volume of permits.) 

What are carbon credits and where do they come from?

A carbon credit is a token representing the avoidance or removal of greenhouse gas emissions, measured in tonnes of carbon dioxide equivalent (tCO2e). Projects or institutions can register the impact of their activities on reducing or removing emissions and issue an equivalent volume of carbon credits for sale, provided their purportedly climate-positive activities adhere to certain standards (see below). Many offsetting activities take place in emerging markets or developing countries, whereas buyers of offsets are typically located in higher-income countries. In theory, this should provide additional resources to invest in sustainable development around the world, while also enabling recipients to decarbonise more quickly than planned.

The difference between avoided emissions (or ‘reductions’), and the removal of emissions is important from the perspective of atmospheric accounting. Projects like renewable energy farms, energy efficiency measures in industrial plants, or protecting forests from being cut down reduce the flow of emissions into the atmosphere, compared with a hypothetical (‘baseline’) scenario in which a higher-emissions alternative would have taken place (i.e. burning more fossil fuels or cutting down trees). Carbon removal and storage, whether achieved through natural solutions (planting trees on new or previously forested land – afforestation or reforestation) or technological ones (such as direct air capture) extract emissions from the atmosphere. The vast majority of credits sold today are for reductions (approximately 90% in the first half of 2021).

What are the rules governing carbon offsets?

In 1997, the Kyoto Protocol established an international marketplace for carbon and the practice of pricing emissions by creating norms and rules for countries and private actors to trade. The Clean Development Mechanism (CDM) allowed countries to fund projects abroad and claim the resultant emissions reductions towards their own decarbonisation targets. The Paris Agreement replaced the Kyoto-era provisions with new rules, mainly grouped under its Article 6. These rules define high-level expectations that any actors – countries or private institutions – must meet if they buy and sell carbon credits through one of the official mechanisms created by the Agreement. Although negotiations on the main ‘rulebook’ have concluded, work to get these new markets operational is ongoing.

In parallel to gradual progress in the official domain, a variety of private organisations, known as programs, define and administer their own standards and compile a registry of past and existing projects that have issued credits. Leading bodies include Verra (which hosts the Verified Carbon Standard), Gold Standard, the American Carbon Registry, and the Climate Action Reserve. Projects must be certified by an independent organisation before they can sell credits through one of these programs. When another (usually private) entity buys a credit, it owns the right to claim responsibility for the avoidance or removal of emissions. To use the credit to offset emissions, the buyer must ‘retire’ it, meaning that it can no longer be sold or transferred.

When governments exchange credits under the Paris Agreement’s mechanisms, the country where the activity took place should make a ‘corresponding adjustment’ in the figures for its emissions that it reports to the UNFCCC, showing that they no longer claim those emission savings as their own and that they now accrue to the buyer country, since another entity now claims responsibility for the savings. There is a complex debate over whether countries should make such an adjustment even when the buyer of the credit is a private actor, like a multinational company, and not another country.

The act of compensating for emissions remains purely voluntary for most companies – there are no laws governing whether they offset or not – hence the term ‘voluntary carbon market’. However, there are many initiatives drawing up guidelines and rules, as the market is set to grow rapidly as the need to transition to net-zero emissions becomes more widely accepted. The Oxford Principles for Offsetting were released in 2020. The Science-Based Targets Initiative (SBTi), which encourages companies to set near-term and long-term emissions reduction goals that align with the Paris Agreement, leaves space for offsetting in its advice on ‘beyond value chain mitigation’. Both groups highlight that actors seeking to compensate for their emissions should first make every effort to reduce their own emissions – throughout their supply chain, in the case of companies – before turning to offsets. They also recommend a gradual shift from avoidance/reduction credits towards carbon removal credits as we progress towards 2050.

High-level coalitions have been formed to define consensus-based standards that ensure the ‘integrity’ of the carbon credit market, in terms of ensuring positive impacts on the environment and on people. The Integrity Council for the Voluntary Carbon Market (ICVCM) is designing a benchmark for the integrity of credits themselves, via guidelines for projects and programs – in other words, to address the supply side of the market. On the demand side, the Voluntary Carbon Market Integrity Initiative (VCMI) is developing guidance for non-state actors seeking to make claims based on their use of offsets (for example, “we are a carbon-neutral business”). In summer 2022, both groups are soliciting feedback on their draft outputs via a public consultation (see ICVCM; VCMI). Despite the absence of legal requirements, the resulting standards for credits and claims could become widely adopted, given increasing public, consumer and investor interest in institutions’ efforts to compensate for their emissions.

What role should offsets have in the world’s response to climate change?

The concept of offsetting has attracted criticism by major non-governmental organisations, such as Greenpeace. Critics claim that the purchase of carbon credits is used as an excuse not to decarbonise (encouraged by the low prevailing market price per tCO2e), incentivises the commodification of nature, and harms vulnerable communities by depriving them of their land. The ICVCM and VCMI can be seen as efforts to respond to and rectify these problems. If companies follow the SBTi or Oxford guidance, offsetting will be additional to, not a substitute for, their own action. VCMI aims to entrench this practice by making science-based targets a prerequisite for claims based on offsetting. Meanwhile, the ICVCM’s draft core carbon principles are partly intended to ensure all projects are undertaken with full respect for human rights, including for those of Indigenous Peoples (via the UN Declaration on the Rights of Indigenous Peoples), and that the benefits for local communities associated with carbon credits are visible to market participants. However, both processes are ongoing, and a lot depends on their successful implementation.

Alternatives to offsetting do exist (encapsulated in the vagueness of ‘beyond-value chain mitigation’, in the SBTi’s terminology). Institutions could talk about their ‘contribution’ to global decarbonisation or ‘impact’ on global emissions, rather than claiming to have ‘offset’ their emissions or to be ‘carbon neutral’. Setting an internal carbon price and charging a material fee, the proceeds of which can be used to make investments, would allow companies to raise funds for full compensation in a way that reflects the ‘social cost of carbon’. Institutional alternatives to the carbon market that challenge the market logic of cost minimisation and the pitfalls of a low market price for carbon are also being considered and developed.

This Explainer was written by Rob Macquarie.

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