It’s time for a shift in approach to carbon credits

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Four years ago this month, former Bank of England governor Mark Carney issued a rallying cry for investment in carbon credits, through which companies could offset their emissions in pursuit of net zero targets. “This needs to be a $50-100bn per annum market,” Carney said.

For a year or so after Carney’s remarks, it looked as if his vision could become reality. Volumes surged from a low base as corporations jostled to announce eye-catching green pledges. But now the market has gone into reverse. Last year was the second consecutive year of decline, with the total value of credits sold amounting to $723mn, according to Ecosystem Marketplace — down from $2.1bn in 2021. Data from MSCI shows no rebound this year.

What went wrong? The first key problem concerns what’s known in the field as “integrity” — the extent to which these projects actually deliver what they claim. The vast majority of carbon credit projects do not set out to suck carbon dioxide from the atmosphere. Rather, they promise to prevent emissions that would otherwise have occurred. For example, I might buy an area of forest, and estimate the amount of deforestation it would have faced without my intervention. If the forest loss under my ownership is below that “baseline” estimate, then I can sell credits corresponding to the difference. Each credit signifies a tonne of avoided carbon dioxide emissions from forest that would have been destroyed, but wasn’t.

The scope for problems has attracted increasingly heavy scrutiny. If a government lowers overall deforestation rates through policy moves, then project developers may get to claim credit — and issue credits — for improvements that had nothing to do with their efforts. Developers could flatter their performance estimates by comparing their project with a “control” area that they know is likely to be deforested. Then there’s the so-called leakage problem: by protecting one area, you may just displace loggers to an unprotected zone.

The bodies that come up with methodologies to generate credits have now embarked on an overhaul, creating frameworks they say are more rigorous. A non-profit body that Carney helped to create — the Integrity Council for the Voluntary Carbon Market — has published quality standards, and started giving a seal of approval to methodologies deemed to meet them. Separately, last month’s COP29 climate summit in Baku approved a UN framework for a carbon trading mechanism.

Yet, even if these entities can restore confidence in the integrity of the projects — a very big “if” indeed — we are still left with the second big problem: incentives. Corporations are not required to buy carbon credits, and those that do risk accusations of greenwashing from environmental groups and of woke capitalism from the right.

But changes in policy and regulation may yet dramatically change the story on incentives. A paper from Harvard academics suggests that the EU should allow the use of carbon credits to reduce levies on imports under its new carbon border tax regime. It says this would drive investment in carbon projects in developing countries, mitigating their unhappiness with the tariffs.

Analysts at Morgan Stanley predict that the EU, and other jurisdictions, will at some point allow companies to use carbon credits to meet their obligations under domestic emissions trading and carbon tax regimes. Importantly, they argue that this would probably apply only to credits from removal projects that suck carbon from the air — not to the avoidance-based schemes.

This would make sense. Corporate funding for nature conservation has a useful role to play — but as a contribution to the public good, not for use in tonne-for-tonne emissions offsetting calculations. An expansion of the nascent carbon dioxide removal industry is crucial, according to the Intergovernmental Panel on Climate Change, which says that at least 100bn tonnes of carbon dioxide must be removed from the atmosphere this century if the world is to have a chance of limiting global warming to target levels.

Carbon removal companies such as Switzerland-based Climeworks have been growing, backed by purchases from the likes of Microsoft and JPMorgan Chase, but the sector is far from the scale that the IPCC says is needed. By integrating removal credits with mandatory carbon pricing schemes, governments could unlock a surge of investment. If carbon credit markets are to make a major impact on climate change, such steps will be needed.

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