Meeting the demand for voluntary offsetting
We are all increasingly aware of the threats of climate change and of the clear gap between the ambition of many governments and what is required for achieving the goals of the Paris Agreement. This awareness has motivated individuals, businesses, and public and civil society institutions to both reduce their carbon footprint and voluntarily offset their remaining greenhouse gas (GHG) emissions.
So far, voluntary offsetting has occurred almost exclusively through the purchase and cancellation of credits generated by emission reduction projects under baseline-and-credit programmes. Most well-known among these are the Gold Standard, the Verified Carbon Standard, and the Clean Development Mechanism. The issuance of credits under these and similar programmes have increased significantly over the last decade.
A lesser-known alternative is the purchase and cancellation of allowances from emissions trading systems (ETSs), such as the European Union Emissions Trading System (EU ETS) or the California Cap-and-Trade Program. This option has also attracted attention recently, in part because the credit programmes face new challenges as the Paris Agreement is coming into force.
How do credit and allowance cancellations work?
Voluntary offsetting involves cancelling carbon units to compensate for GHG emissions by the buyer. Our study assesses two types of units: “credits” and “allowances”.
“Credits” from baseline-and-credit programmes correspond to one unit of GHG, i.e. a tonne of CO2 equivalent or tCO2e, that was either removed from the atmosphere or whose release into the atmosphere was prevented by an activity. The activities that generate such credits go through an approval process that aims to ensure that the claim embodied in the credit is genuine – that is, that emission reductions are additional to what would have otherwise occurred, that they are appropriately quantified, are permanent and accounted for. The new context of the Paris Agreement – in which all countries have mitigation targets – brings much new complexity to crediting programmes, which now need new approaches for additionality, baselines and accounting.
An “allowance” is the unit transacted in emissions trading systems and gives its holder the right to emit 1 tCO2e into the atmosphere. Since the government limits the total number of allowances it uses, there is a cap on the total volume of emissions from the activities and sources covered in an ETS. In principle, cancelling one allowance tightens the cap – thus inducing facilities in the ETS to further reduce their emissions by 1 tCO2e.
For this to happen, the main requirement is that the ETS cap should induce “scarcity”, which means that the supply of allowances should be lower than the demand for them without an ETS. Scarcity depends on several conditions, including the stringency of the cap over time and how market stability instruments (MSIs) and linking with other ETSs or carbon credit programmes influence scarcity.
Voluntary offsetting with allowances may require addressing complexities from MSIs
Even when allowances used for voluntary offsetting come from an ETS with significant scarcity, the system’s MSI can diminish the environmental impact of voluntary offsetting. MSIs are policy tools that aim to reduce excess market variability due to unexpected events such as economic downturns and technological breakthroughs. Most existing ETSs have some form of MSI. Of particular relevance to the environmental impact of voluntary offsetting with allowances is whether the MSI alters the total quantity of emissions allowed under the ETS. This is the case, for example, of the Market Stability Reserve (MSR) of the EU ETS, which has a provision for invalidating (i.e. automatically cancelling) allowances under specific conditions. In such a situation, cancelling an EU ETS allowance for the purpose of voluntary offsetting today would lead to less than one tCO2e of reductions under the EU ETS – because the MSR would have invalidated (part of) the allowance anyway.
Voluntary offsetting with allowances may thus require addressing such complexities arising due to MSIs. In the specific context of the EU ETS, the report finds that voluntary buyers aiming to purchase allowances could adopt a ‘buy-and-hold’ approach, where the buyer (or a service provider representing the buyer) acquiring allowances for voluntary offsetting purposes would purchase an allowance today, but rather than cancelling now would hold the allowance until the MSR no longer effects invalidations. This would restore the full desired environmental impact of the allowance cancellation. Legal and contractual measures, however, could be required to ensure that allowances purchased for voluntary cancellation are not brought back to the market at a future date.
An important finding of the study is that accounting (through so-called corresponding adjustments) needs to be carried out to reflect cancellations from voluntary buyers for both credits and allowances, irrespective of where they are generated. This is an important component of environmental integrity of voluntary offsetting, and more attention would be warranted.
Credits, allowances: there is room for both!
On the one hand, offset purchasers with a strong focus on international cooperation, the generation of co-benefits in developing countries, communicability with a clearer narrative, and a preference for the promotion of certain technologies may find credits more attractive. Credits often have the advantage of having lower prices, but may carry integrity risks due to uncertainty in the establishment of additionality and crediting baselines, which may in turn also create reputational risks.
On the other hand, actors in the voluntary market who prefer the greater certainty of the direct emission impact may favour allowances from established emission trading systems. Allowances may also be favoured by buyers who are mostly located in developed countries, to promote innovation or drive emissions reductions ‘at home’. The main challenges of using allowances for voluntary offsetting are that continued scarcity in the system cannot be taken for granted and that due consideration must be given to the potential impact of MSIs which muddles the communication of a clear narrative.
Ultimately, the differing interests and priorities of buyers, alongside the various (and often complementary) benefits and risks of these units, provide space for both credits and allowances in voluntary offsetting.
You can download the full report here.