Have carbon offsets outlived their value proposition? Carbon credits and offsets date back more than 25 years to the Kyoto Protocol in 1997. However, their evolution has been marred by controversies, scandals and politicking, which has resulted in increasing complications and a lack of consensus. With each passing year, carbon offsets are further from delivering the desired outcome.
Carbon credits are being seen as culprits or delaying tactics, rather than incentives, in the formation of a comprehensive decarbonisation strategy. A business-as-usual or do-nothing approach has simply increased the amount of carbon emissions. While the Paris Agreement has superseded the Kyoto Protocol, the modality lacks new market approaches and key issues remain unresolved. There needs to be a mindset shift and G20 dialogue on the usefulness of carbon credits.
Are there also structural flaws? Except for aiding carbon price discovery, critics cite the lack of regulation and audit trails, multiple counting, questionable integrity and quality, and non-existent carbon trading infrastructure in developing countries as some of the limitations of such an approach. In addition, government involvement in the mechanism seems to be missing.
What is the intent behind a customer’s decision to buy carbon credits? The purchaser may not be tied to any reduction in carbon emissions. Put simply, the mechanism helps the purchaser maintain the status quo, undermining decarbonisation. Some view the practice as toxic, giving rise to a moral hazard. Many businesses have been able to increase their turnover, profits and carbon emission volumes by buying carbon credits.
This practice raises the thorny issue of climate governance. Developing economies have been vocal about the minuscule fraction of carbon offsets that is trickling down to the target beneficiaries. Instead, carbon middlemen, brokers and agents are the ones who are profiting.
In addition, the industry remains unregulated. For some, this amounts to sophisticated greenwashing. Many consider the levy of a carbon tax as a better option than carbon offsets, citing the fact that the amount of carbon released into the atmosphere has not gone down.
Optimism fades
Investor optimism and the goodwill associated with the mechanism is fading. Private equity (PE) firms and banks are becoming reluctant to deploy capital not just in businesses buying carbon offsets, but increasingly in sellers of carbon offsets, unless they are meant for a group entity of same parent. These financiers are even shying away from investing in renewables, clean energy, electric vehicles, or forestry projects that sell carbon credits.
Investors are under pressure to report net carbon reduction impacts from their investments. Many are regularly screening portfolios deploying sustainable underwriting standards, to divest from businesses selling carbon credits.
With regulators’ crackdown on greenwashing, penalties are rising for deceptive advertisements. Even bond markets and banks are not exempt, and pricing in stock markets have started reflecting premium for decarbonisation efforts.
So the question is: have carbon credits hindered green transition? Investors, lenders and PE players are increasingly looking at carbon neutrality outcomes alongside profit on investment, and environment, social and governance (ESG) considerations. Getting ‘Paris-aligned’ is the new goal shaping ESG reforms.
Recently, the EU passed legislation banning carbon-neutral claims based on carbon offsetting schemes. Some countries are considering caps on voluntary carbon trading. As such, European brands have commenced dropping carbon neutrality claims.
Central banks and financial regulators are getting involved to address systemic risks and pushing for adequate reporting of nature-related disclosures. The path to net-zero emissions with an audit trail is important. This is a hot topic in corporate boardrooms amid fear of reputational risk, because the board has a fiduciary responsibility. Boards are analysing finance options with rising decarbonisation and interest costs.
The path to deep decarbonisation needs rethinking to make way for innovations and credible solutions. Modality needs to be structured such that the resultant impact on the environment is not detrimental. Should rich nations support developing countries using carbon offset mechanism under their climate finance pledge?
With government and possibly multilateral banks, namely the World Bank and Asian Development Bank, getting involved, the mechanism has the potential to become a game changer. Proceeds could be used to subsidise thoughtful energy transition, climate technology, grid-scale battery storage for renewables, speedy closure of fossil fuel-fired plants, as well as make the climate transition affordable. Accessibility to all – reflecting principles of equity and natural justice – will help support the affected poor and vulnerable communities, without compromising their basic living conditions.