Due diligence for carbon offsets
As more companies around the world set climate targets and take action towards reducing their emissions, the demand for carbon credits has skyrocketed. In 2021 alone, the voluntary carbon credit markets roughly tripled in size.
But voluntary carbon markets (VCMs) are unregulated, which makes it difficult for organizations to verify the legitimacy and impact of individual credits. And that’s important, because investing in low-quality offsets doesn’t just undermine your climate goals; it could end up causing significant harm to the environment and making a serious mark on your corporate reputation.
In this article, we’ll explore the seven key factors to consider when performing due diligence on carbon credits.
1. Follow the mitigation hierarchy
Offsetting is just one piece of an effective climate strategy. Although carbon neutrality can be achieved simply by offsetting existing greenhouse gas emissions, net zero (an increasingly popular goal) requires that a company first reduce emissions as much as possible before offsetting.
At Sylvera, we recommend companies follow the mitigation hierarchy. First, avoid creating additional carbon emissions (for example, if you’re hosting an event for the first time, consider doing so online). Second, reduce the emissions you’re already producing (for example, invest in energy-saving appliances, switch to providers offering renewable energy, and upgrade to electric vehicles). Finally, when you’ve done as much as possible to avoid and reduce your company’s emissions, look for high quality carbon credits to offset the difference.
“Absolute emissions reduction has to come first,” said Margaret Mistry, VP Carbon Markets at Equinor, during our 2022 Carbon Markets Summit. “We have a target to reduce our scope 1 and 2 emissions by 50% by 2030, and 90% of that must be absolute reductions. So we’re following a mitigation hierarchy: first we avoid, and then we reduce, and only offset when other measures have been prioritized.”
2. Quality over quantity
For more meaningful climate impact, we recommend investing in high quality carbon credits rather than opting for a larger quantity of cheaper, low-quality offsets. There are four key factors to consider when evaluating the quality of carbon credits:
It’s important to know whether the carbon project reports accurately on its carbon-avoiding or carbon-removing activities. Make sure that the number of credits a project developer issues reflects the same amount of carbon avoided or removed by the project.
Additionality ensures that the emissions you are avoiding or removing through a particular project would not have been avoided or removed without your investment.
Permanence refers to how long the carbon will remain out of the atmosphere.
Some carbon projects offer more than emissions mitigation — they also promote biodiversity and the health of local communities. Look for co-benefits wherever possible.
Each of these factors are extremely difficult to quantify independently, and most firms won’t have the tools, infrastructure, or access to the right data to do so in-house. Consider using a third-party verification tool to perform comprehensive due diligence on your carbon credit investment options. This will also make it easier to present your options in a clear, actionable, rated format (think: credit ratings), which makes conversations with financial and C-suite stakeholders much more effective.
3. Know your project
When buying carbon credits, it’s important to understand what exactly you’re buying. For example, if you’re looking into nature-based solutions, learn about the different types of projects available, the impact each can have, and the concerns that can arise with each of them.
When you’re evaluating individual projects, learn as much as you can about where and how the project is run, who is behind it, and the project’s plans for the future.
Finally, when you decide on a particular carbon project, don’t keep it a secret. Share your offsetting partnerships with consumers, stakeholders, and employees, and educate them on the benefits and impact of the project. One again, this is where rigorous due diligence will serve you well; if you publicize an investment that turns out poorly, your firm runs the risk of being called out for greenwashing.
The best way to find high quality carbon offsets is through trusted industry registries. Registries improve transparency around quality carbon offset quality by ensuring that projects have been designed according to rigorous methodologies.
Verra is one of the world’s leading carbon offset registries, and it has developed a number of frameworks for offsetting projects.
Other notable carbon registries include:
- Gold Standard Impact Registry
- Climate Action Reserve (CAR)
- American Carbon Registry (ACR)
5. Understand legislation and policy implications
Although VCMs are currently unregulated, certain climate-related policy and regulation updates can impact the way companies purchase and report on their voluntary carbon credits. For example, Japan recently released a new draft code of conduct that would require greater transparency around methodologies from ESG data research firms, which could impact the way carbon credit investments are evaluated. Some upcoming changes to consider include:
- The SEC’s new climate disclosure rule, which, if accepted, would require companies with climate targets to disclose significantly more information on the carbon credits they purchase
- The Integrity Council for Voluntary Carbon Markets (IC-VCM) and the Voluntary Carbon Markets Integrity Initiative (VCMI) are issuing potentially market-shaping recommendations later this year, including high-level identifiers for credit quality, and considering the claims companies can make based on their use of carbon credits.
- The International Sustainability Standards Board (ISSB), created in 2021, is expected to issue market guidance on sustainability reporting, which could include how carbon credits should be accounted for
- A new Taskforce on Nature-related Financial Disclosures (TNFD), inspired by the success of the Task Force on Climate-related Financial Disclosures (TCDF), aims to direct capital into nature-positive investment, which could push more companies toward nature-based offset solutions
Learn more about the different initiatives here, including IC-VCM’s draft Core Carbon Principles.
6. Cost and supply
In the world of carbon credits, cheaper does not typically mean bad and expensive doesn’t necessarily mean high quality. For example, there are high quality REDD+ credits that are relatively low cost. But when it comes to ARR projects, prices are generally higher due to market trends, for example the demand for removals credits.
Although the price of carbon credits varies widely, voluntary carbon credits have typically been available at significantly lower costs than their compliance counterparts. But this could be changing.
As we reported in our 2022 Carbon Credit Crunch report, carbon prices are predicted to continue rising, despite the dip in prices in the first half of 2022. And because legitimate offsetting projects can take 3-5 years to get off the ground and require significant expertise, supply is not keeping up with demand — inventory of voluntary carbon credits fell by some 50% in 2021. Additionally, many of the cheaper energy-based credits are no longer available, meaning that buyers are increasingly relying on credits from agriculture, forestry, and other land use (AFOLU) projects, which typically trade at 2-4 times the price of energy credits.
The disconnect between supply and demand has three implications for firms looking to purchase offsets. First, firms need to accept that the credit prices they’ve paid in the past may no longer reflect the credit prices they will purchase today. Second, firms should consider locking in long-term purchase agreements with high quality carbon projects. This helps carbon partners forecast and deliver on their promises, but it can also become a strategic asset for firms as carbon prices rise, and reflect positively on your brand. Third, smart firms will realize that quality comes at a premium, and be willing to invest accordingly. Doing so will also help them price carbon internally, and in the long run, carbon prices reaching significant levels will incentivize companies to focus on reducing over offsetting.
As concern about the legitimacy of carbon credits rises, due diligence on carbon offsets becomes a form of risk management. Any poor behavior or illegitimacy from your offsetting partners will reflect poorly on your company and its environmental claims and could result in your firm being criticized for greenwashing. With more climate-related regulations appearing, such as the SEC’s new climate disclosure rule, this could eventually result in financial consequences such as fines.
“We fully expect to be scrutinized thoroughly on the offsets that we might use,” says Margaret. “As such, we have very high thresholds for quality in terms of what kind of offsets we will use. The thresholds include: how are the offsets verified, what type of projects they relate to, and whether — in addition to addressing carbon — they are including community co-benefits like biodiversity. Not least, the ratings are integrated into our quality filters. We expect this framework to be interrogated by stakeholders and that’s why we’ve put it in place.”
Utilize third-party due diligence tools such as Sylvera to evaluate the quality of your offsets within your budget.
A final word on carbon credit evaluation
Carbon offsetting is occasionally painted as ‘greenwashing’, but this is not the case as long as organizations are using carbon credits for what they’re designed for (mitigating truly unavoidable emissions) and not as a scapegoat to carry on with business as usual or ‘buy their way out’ of an emissions problem.
Ultimately, as carbon credits become integral parts of corporate climate strategies, it can help to think of offsetting projects and partners as suppliers in your value chain. Just as you currently evaluate potential vendors for risks and opportunities, so too should you carefully evaluate offsetting partners. Do your due diligence and be willing to spend as much as you can on high quality projects. In the end, a quality first strategy will make the most impact towards your firm’s — and the world’s — climate goals.
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