One of Panarchy Partners’ achievements is our summer internship program which has seen 43 interns participate to date. These young and passionate change makers come from universities in Singapore and across the globe, and they share their time and minds with the Panarchy team. A main aspect of the program requires the individual or group to work on a specific project with relevance to sustainability in finance (follow this link to all previous projects). This year, three among the cohort - Leo, Maheen and Marcus, chose to investigate the voluntary carbon market and the world of carbon offsets.
In today’s ARCUS, we share their learnings (this is intentionally not the views of Panarchy Partners).
In today’s global race to decarbonize, carbon offsets are increasingly considered as a tool to help achieve GHG emissions reduction and/or avoidance. These credits can be bought through a multitude of channels which have risen in prominence, including voluntary carbon markets, direct investments in offset projects, and signing contracts for delivery as examples. Given the intricate ecosystem in which a variety of players operate in, complexities prevail and are hindering wider adoption and understanding.
Our intern cohort undertook a comprehensive analysis of carbon offsets and voluntary carbon markets (this paper is available on request). The interns also crafted an FAQ below comprising fundamental questions for companies as potential credit buyers to consider before purchasing and effectively using carbon offsets for their operations. This is not meant to be exhaustive, and we note that the landscape of carbon offsets continues to evolve rapidly with impending policies and regulations, enhancements in standards and accounting, and robustness of projects. Panarchy Partners will continue to track these developments as we seek continuous understanding of its advantages and limitations. At our upcoming 3rd Global Panvest Forum titled "Climate Investing - Opportunity of a Lifetime?", the workings of voluntary carbon markets is one of the areas that we will be exploring in addition to how listed companies can benefit from each country’s nationally determined contributions, climate impact checks and balances and investors’ contribution to their portfolios’ impact. A synopsis of the Forum’s main findings will be presented in our next ARCUS. FAQ Q: What does a company need to do before buying carbon credits? Companies who wish to purchase carbon credits would first need to determine their carbon footprint. There are several frameworks that can be used to calculate greenhouse gas emissions, including: UNE-ISO 14064, the GHG Protocol, etc. The most simplistic method for calculating emissions would be through the use of the basic formula below [1]: Carbon footprint = Activity data X Emissions factor Where activity data is separated into Scope 1, 2 and 3 emissions. Q: What are the different types of underlying carbon credit projects a company can invest in? There are currently two main categories of projects that companies can invest in: removal and avoidance projects. Simply put, avoidance offsets are generated from projects that focus on preventing greenhouse gas emissions from being released into the atmosphere. On the other hand, removal offsets are generated from products that work to actively pull out or remove greenhouse gases that are already present in the atmosphere. In recent years, there have been some debate around the efficacy of avoidance projects versus removal projects on the basis of permanence and additionality. One of the issues surrounding avoidance projects is weak additionality claims. This is becoming pertinent to renewable energy projects in particular. The combination of higher fossil fuel prices as well as new technological advancements and scale benefits has led to renewable energy becoming increasingly cost competitive when compared to traditional fossil fuel energy. This means that many of these projects are financially attractive even without the support of the revenue generated from the carbon offset market. Projects that are financially attractive already are likely to have been conducted even without the voluntary carbon market’s involvement, thus making some renewable projects non-additional. Q: What are the different types of avoidance and removal projects? While avoidance and removal are one way to classify offsets, we can also look at splitting offsets into categories based on what technology or methodology the particular project is employing. More specifically, the three project categories that are most widely recognized are nature-based projects, renewable energy projects and technology-based projects (the latter two fall under the umbrella term of non-nature-based projects). Nature-based projects are focused on the reduction or removal of greenhouse gas emissions through the protection, management or restoration of natural ecosystems. They are the most common project category with up to 43% of carbon offset projects being classified as nature-based in 2022. Common subtypes are forestry, agriculture, grasslands, and oceans and coasts. All renewable energy projects are classified as avoidance projects. In 2022, these projects made up around 31% of all projects in the offset market [2]. Technology-based solutions made up the remaining 26% of the offset market in 2022 [2]. These solutions can be split up into four main categories: direct air capture, carbon capture utilization and storage, elimination of methane emissions from oil and gas wells, and finally, clean cooking projects. Q: What are some of the advantages and disadvantages of these projects? One of the biggest advantages of nature based projects are the additional side benefits that arise from their operations. By protecting or restoring these natural environments, not only are we removing or reducing greenhouse gas emissions, but we are also maintaining and preserving the biodiversity of natural ecosystems. These projects can also protect local communities, as they are less likely to be as affected by natural disasters like flooding when deforestation is prevented. In contrast, one of the biggest obstacles to the scalability of these solutions is the vast amount of land required. There are also issues related to additionality (would a forest be cut down in the absence of carbon credits?), and permanence (forest fires?). For now, technology-based solutions can suffer from scale and financial viability. This is likely to change with greater adoption. Q: What are the ways to obtain carbon credits? Companies can obtain carbon credits via several methods:
Purchase carbon offsets directly from a voluntary carbon market. This includes purchases through retailers, brokers and carbon exchanges. Carbon exchanges like Climate Impact X (CIX), Air Carbon Exchange (ACX) and Carbon Trade Exchange (CTX) tend to deal with larger volumes of offsets. In comparison, retailers tend to handle low volume transactions.
Directly investing in one’s own projects. Some companies with diverse operations implement internal projects focused on reducing emissions within their own operations or supply chains. These efforts can generate internal carbon offsets and can thus contribute to the company's overall carbon neutrality goals. Companies can invest in or develop projects that reduce greenhouse gas emissions, such as renewable energy projects (solar, wind, hydropower), afforestation or reforestation initiatives, and methane capture from landfills or agricultural activities.
Direct investment in a pooled investment vehicle where a third party undertakes the investment in the underlying carbon reduction projects. Examples of this include the Livelihoods Carbon Fund or LEAF Coalition’s carbon fund.
Q: What are the pros and cons of each purchasing method stated above?
Purchasing from retailers, brokers and exchanges is the most seamless approach to obtaining offsets and shares similar steps as purchasing other financial products. Additionally, there are no long-term commitments as emissions reduction are likely to have already occurred and so offsets can be used immediately on purchase. Companies can decide the volume they wish to purchase and have access to a myriad of carbon offset projects. On the other hand, purchasing via these sources often means higher prices due to intermediary fees.
Creating a project from scratch can ensure that the offsets generated are of a high quality. Additionally, companies receive their offsets at exactly the cost price and do not have to pay additional intermediary fees. However, one downside is that there is a requirement for a larger upfront capital investment by the company. It may also take a significant amount of time for the project to go from getting verified to generating carbon offsets, resulting in a lack of efficiency.
The research paper includes an analysis of Panarchy Partners’ portfolio companies that have directly invested in carbon offset funds. One of the primary reasons many of these companies chose to do so was to have greater influence over the quality of the offset generated as well as have at cost access to offsets. While companies choosing this method are more involved than those who purchase credits through method 1, unlike method 2 they are not required to undertake the whole process of launching and maintaining a project. Thus, they get the benefit of higher quality offsets and greater influence over projects, while also not having to incur the high capital costs of setting up the project. On the negative side, the issue with this method is that the projects supported by these funds often generate offsets over time. Because of this, there has to be a long-term commitment by the company to the project.
Q: Do I only want projects that are focused on environmental goals or do I also want the same projects to have social benefits? Ultimately, this is dependent on individual company’s priorities when purchasing credits. Companies that just want to focus on having an environmental impact or currently only have the funds to help improve one form of capital may choose projects that focus entirely on environmental objectives. Carbon Standards like Verra tend to verify projects that focus solely on environmental impact, and specifically, emissions reduction. In contrast, if a company is looking to create a social impact along with offsetting their emissions, purchasing offsets verified by standards like Gold Standard is more likely to help them achieve their goals. Q: How can I ensure that the carbon offsets are of high quality and integrity? Companies should make sure that the carbon offset projects that they invest in are verified and certified by reputable organizations. The four biggest carbon standards as of today are Verra, Gold Standard, Climate Action Reserve and American Carbon Registry. Carbon Standards have three primary responsibilities. The first responsibility of these organizations is checking accounting standards and more specifically ensuring offsets are “real, additional, and permanent”. Their second role involves monitoring, verifying and certifying standards in order to ensure that offset projects perform as predicted during the project design. Finally, their third primary responsibility is the running of registration and enforcement systems to ensure that carbon offsets are only sold once, clarify ownership of the offsets and enable trading of offsets. In 2022 Verra’s Verified Carbon Standard Program made up about 72% of total credit issuance [3]. The Gold Standard is differentiated from the other standards in that it contributes in a measurable way to the UN Sustainable Development Goals in its verification methodology. They aim to work with projects that provide a socio-economic impact alongside the primary environmental impact. Q: How do I assess the appropriate price to pay? As of now, the price system of the voluntary carbon market is one of the market factors with the least publicly distributed knowledge. Not only is it often hard to find the actual price of a singular credit, it is also hard to distinguish the factors that are most influential to the price. Experts remain divided on the components that yield the most significant impact on the value of an offset. In saying that, some characteristics that are widely considered noteworthy are vintage, quality, certifications, negotiating power, and risk. Similar to other commodities and products it is likely that pricing transparency will increase as carbon credits become more readily available and traded. Happy Panvesting! Leo, Maheen and Marcus Panarchy Partners 2023 Interns
Sources
[1] Selectra Climate Consulting, 22 May 2023
[2] Carbon Offsets: Rapid Growth and Product Evolution, Morgan Stanley Research, 21 Feb 2023
[3] 2022 Overview: Voluntary Carbon Market, Climate Focus, 2022