Businesses are responding to increasingly ambitious investor expectations by committing to becoming net zero, carbon neutral often under Climate Active or carbon positive. Implementation plans for these claims typically remain high-level, and often feature a heavy reliance on carbon offsets[1] to “bridge the gap”. Yet business understanding of the roles and risks of offsets in decarbonisation is fragmented. We have found that companies may believe that offsets:

• are essentially interchangeable
• will be cheap and plentiful into the future
• offer an easy way to satisfy decarbonisation obligations.

None of these is entirely true. In this article we explain how offsets could be used and some of the factors that could make the future of offsets very different from the present.

Not all offsets are equal

Offsets can be bought for less than $1 per tonne CO₂-e avoided or sequestered – or for more than $20 per tonne CO₂-e. However, there are often trade-offs between price and quality. Quality includes consideration of an offset’s credibility: fundamentally, the strength of its promise to represent ‘genuine, additional’ carbon avoidance or sequestration. Credibility is a fairly objective aspect but one that may require some digging to ascertain – different certification frameworks offer different standards for ensuring additionality; further different offset generation activities come with different risks. Purchasers also consider more subjective aspects of quality, for example, alignment with corporate stakeholders or priorities.

Offsets could become scarce and expensive

Current prices may not persist. Finalisation of the rules of the Paris Agreement will probably reduce availability of the cheapest offsets, although this will not be clarified before November 2021. The Agreement’s Article 6 will determine how countries account for the offsets they produce and trade, and these rules are likely to filter through into the eligibility criteria of voluntary programs.

This is not to say that low-cost offsets will shortly cease to exist – if the Paris rules encourage more international trading under credible mechanisms, Australian companies could potentially take advantage of lower costs of offsets produced in other countries.

However, in the longer term, increasing demand driven by country and corporate net zero targets – as well as from hard-to-abate sectors like aviation and international shipping – is likely to drive up offset prices across the board. Modelling used by a global group of central bankers and regulators shows carbon prices (and, hence, offset values) of around US$100/tonne by 2030 for Paris-consistent decarbonisation – and much higher prices shortly thereafter if this decarbonisation is delayed. In this environment, governments may choose to restrict access to domestic offsets to preserve their priority industries. How this could all play out, however, remains deeply uncertain.

Offsets satisfy some decarbonisation obligations, but not others

The flurry of emissions reduction targets announced by Australian companies has been matched by the emergence of multiple frameworks to guide these commitments. A key difference between the frameworks is the approach each takes to the role of carbon offsets. The main decarbonisation frameworks in use in Australia are:

• Climate Active – the federal government’s certification of carbon neutrality claims. Over 150 certifications have been approved through Climate Active[2] – including Energetics as an organisation and for our services
• science based targets (SBTs) – a global NGO-led scheme to define emissions reduction targets in line with the goals of the Paris Agreement; globally, 1,199 companies have committed to SBTs, and 586 have set verified targets[3]. Among the latter are Woolworths, Dexus, Transurban and Origin Energy
• the emerging trend for net zero targets, for which best practice is not yet established, companies with recently released net zero commitments include Santos, AGL and a slew of superannuation funds.

Climate Active recommends that offsets are used only after a company has made efforts to reduce its emissions but does not require any specific reductions to be achieved. The scheme accepts many offset types, including Certified Emissions Reductions (CERs), offsets produced through the Clean Development Mechanism (CDM) of the Kyoto Protocol of the UNFCCC, which can be purchased for less than $1 per tonne. At this price companies could choose to buy and cancel offsets rather than invest in any but the lowest-cost abatement options.

By contrast, science based target (SBT) methodologies define decarbonisation trajectories aligned with the Paris Agreement temperature goals. Companies must set targets along these trajectories and, crucially, meet them without using any carbon offsets. The SBT Initiative (SBTi) argues that, as set out by the IPCC, total global emissions need to fall by around 90% by 2050 to have a 2/3 chance of achieving limiting global warming to 1.5°C[4]. Allowing for emissions offsets as a substitute for abatement is inconsistent with that goal.

However, SBT methodologies apply only to medium-term emissions reductions (i.e. for a 5-15 year time period). The SBTi recently outlined foundational principles for science based net zero targets, which include some circumstances within which offsets can be used, in the main for scope 3 emission sources only.

A fundamental requirement is that over time companies reduce their value chain emissions in line with the abatement required for the 1.5°C goal – as with SBTs. The SBTi outlines two acceptable approaches:

• Emissions abatement in line with science – this requires a company to reduce gross emissions across its value chain to as close to zero as is technically achievable. Offsets may only then be used to neutralize residual emissions and achieve net zero
• Climate positive approach – as above, but in addition the company may use offsets to compensate for all emissions released into the atmosphere while the company transitions towards a state of net zero emissions.

Key insights

Two points to take away from all of this are:

1. If you must use offsets to achieve your targets, pay close attention to their quality.

Ascertaining offsets quality involves both investigation of their paper trail – the project’s technical specifications, thoroughness of audit processes and documentation – and your own judgment: which offset types best satisfy your needs and risk preferences?

In the past Energetics has bought VERs[5] and CERs to satisfy our carbon neutral commitments. We review project reports and audit reports in detail to assess the validity of the offsets we buy. We will buy offsets that have been produced within 24 months of our emissions. We await the outcomes of the COP26 in Glasgow in November 2021 to determine whether we will still be able to use offsets purchased in international markets.

2. You may need a longer-term offsets procurement strategy

For how many years are you likely to continue to need offsets? What do current commitments imply for your future offset liabilities? Bearing in mind the potential for prices to rise significantly, and/or availability to decline, you may want to consider procurement options that provide longer-term price or quantity stability.

Energetics advises many of our clients on offsets strategy development, and we believe offset strategies will become an essential part of the corporate climate response toolkit in coming years.

References

[1] We note that, under a strict definition of offsets, Energetics does not consider renewable energy generation certificates (e.g. LGCs) to be offsets, we do however recognise them as a tradeable unit which can be used to reduce emissions associated with consumed electricity. They can be used to reduce emissions from electricity under most programs, notably Climate Active, SBTi, and RE100.

[2] Climate Active as at 9 December 2020

[3] Science Based Targets as at 18 February 2021

[4] IPCC | Global Warming of 1.5 ºC | special report

[5] In the past, Energetics bought Gold Standard from the Drinking Straw® project in Kenya because of the social co-benefits of these offsets. We buy offsets that align with our business and what we do, mainly renewable energy and some energy efficiency.  This year we purchased VERs from renewable energy projects and some locally sourced ACCUs from a savanna burning project. Sourcing robust offsets that align with our corporate mission and visions is posing an increasingly complex challenge.