Voluntary carbon offsets: deal or no deal?

It’s estimated that the overall market for carbon credits could be worth up to $50 billion in 2030¹, a 15-fold increase from today. In terms of CO2 volumes, the same report estimates that demand for carbon credit markets will reach up to 1.5-2.0 gigatons of CO2 by 2030 and 7-13 gigatons by 2050.

By way of comparison, the oil and gas industry extracts about four gigatons of oil each year, less than half the midpoint of this range.

Creating a market the size of the oil and gas industry will require standards, regulations and significant investor capital.

Regulated versus voluntary markets

In a previous blog, I covered regulated carbon markets such as the European Union’s Emissions Trading System (ETS). Regulated carbon markets, such as cap and trade, provide economic incentives for companies to reduce their carbon emissions through the adoption of new technology to drive emissions efficiency. It sends clear, long-term capital deployment signals to investors as companies must either lower their emissions or buy credits in a regulated market. The higher the carbon price, the more companies will seek out efficiency improvements.

This is an important distinction from voluntary carbon markets. Within the voluntary market, companies willingly purchase emissions offsets to claim the ‘good corporate citizen’ accolade. Companies with self-determined net zero climate goals and expensive emission reduction options are increasingly turning to the voluntary carbon market to buy offsets.

And therein lies the challenge with the voluntary market: arguably, it can incentivise questionable corporate behaviour. Offsets could distract companies from pursuing new technologies to drive down real-world emissions, instead encouraging them to purchase offsets that may not permanently reduce emissions.

‘Carbon-compensated’ petrol aptly makes this point. Burning fossil fuels is fundamentally not equivalent to planting trees or conserving forests.

Quality over price

Voluntary carbon offsets are typically far cheaper than regulated markets or decarbonisation capital expenditure. The World Bank estimates² that the average cost of voluntary offsets was $2.49 per ton in 2020 and $3.82 per ton in 2021. By comparison, the EU ETS (regulated carbon market) is currently pricing at around €90 per ton.

Voluntary offset prices are driven by a multitude of factors including sector, location, verification strength and ‘additionality’ – the claim that decarbonisation wouldn’t have happened without carbon offset revenue.

Integrity is critical 

Leading carbon credit registries 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 programmes.

The Integrity Council on Scaling the Voluntary Carbon Market (ICVCM) provides a framework for higher-quality carbon markets. It aims to bring market structure principles of transparency and validity to the voluntary market. Principles and an assessment framework form a benchmark, which ensures creation and trading of offsets meets a minimum standard.

Looking to the future

If verification integrity is executed well, the prize will be a sizable liquid voluntary carbon market channelling huge amounts of investment into credible, higher-quality offset projects.

Conversely, though, the downside is that it could obfuscate the measurement and attainment of a true net zero economy – disrupting the flow of capital to industrial decarbonisation efforts.

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.

1. Source: Taskforce on Scaling Voluntary Carbon Markets, sponsored by the Institute of International Finance. Page 1 of McKinsey report ‘A blueprint for scaling voluntary carbon markets to meet the climate challenge’

2. Source: https://www.worldbank.org/en/news/press-release/2022/05/24/global-carbon-pricing-generates-record-84-billion-in-revenue