Private-sector firms have demonstrated increasing interest in offsets to help mitigate their carbon footprints. Voluntary carbon markets can provide the outlet firms need, but the success of these markets will depend on how some open questions get resolved.
Net-zero targets are proliferating across the private sector in markets as diverse as auto manufacturing, big tech, retail, and integrated oil and gas. Among the largest 2,000 publicly traded firms, 703 have some type of net-zero target. But while these emissions targets vary substantially in their details (that is, if any details outline the path to a given emissions target at all), only a fraction of these companies has committed to achieving their goal without the use of carbon offsets, which effectively replace direct reductions in a firm’s emissions and instead serve as credits that are granted when the emitter engages with an emissions-reducing or sequestration project somewhere else in the world. Offsets can come from carbon removal projects, such as afforestation or direct air capture, or through emissions-avoidance projects such as building up renewable energy in developing countries. While offset markets present an opportunity to efficiently reduce net global emissions, several big-picture questions about their viability are important to consider.
Two kinds of carbon offset markets currently exist: compliance markets and voluntary carbon markets. Compliance markets emerge when firms are allowed to use offsets to comply with a regulatory program; California’s cap-and-trade market, which allows for limited offset use, is one prominent example. Voluntary markets, on the other hand, provide offsets to firms that are not obligated to offset their emissions. When voluntary carbon markets emerged in the mid-2000s, much of the activity resulted from speculation about future compliance markets, rather than from a goal to help firms reduce their greenhouse gas footprint. Voluntary markets have grown, however, and are here to stay, with the market expected to expand considerably in the next three decades as firms attempt to meet net-zero targets; by some estimates, the market needs to grow by a factor of 15–100 to help meet Paris Agreement goals.
But not all carbon offsets are of the same quality, which poses tremendous challenges to these markets. Some offsets may only temporarily reduce emissions (so, the offsets do not have “permanence”), while some offsets may not motivate emissions reductions because the project would have happened regardless (which means the offsets lack “additionality”). How can investors and firms verify the quality of the carbon offsets they purchase?
Third parties do provide guidelines and rules, but another question is whether those guidelines are sufficient to prevent a race to the bottom for cheap offsets that are neither permanent nor additional, known as “hot air” offsets, or to prevent an extremely fragmented market with huge variation in the price of offsets and a prevalence of cheap, low-quality offsets. Naturally, this question signals a potential role for government regulators and, by extension, an increasing interest in understanding how governments might regulate these markets. Should governments certify offset credits or establish tiered levels of offset quality (e.g., platinum, gold, silver)? Can the marketplace converge on the technical details without government protocols in place?
The establishment of Article 6 at COP26 in Glasgow in late 2021 prompts even more questions about voluntary carbon markets. Article 6 allows for international trading markets, so that countries can exchange offset credits to help each other achieve their nationally determined contributions. While Article 6 does not regulate voluntary offset markets, significant questions arise about how Article 6 will interact with voluntary markets, or whether Article 6 will simply “swallow up” these markets if countries buy up the world’s supply of offsets.
Further questions about voluntary carbon offset markets have become apparent due to a newly proposed rule on climate financial risk from the US Securities and Exchange Commission, something RFF experts and other scholars have examined recently. So that investors can make accurate assessments based on a firm’s climate record, the proposed rule on climate financial risk would require firms to disclose details about the tons, price, and type of offsets they purchase. If this rule is finalized, will investors reward firms that purchase lots of offsets, even if questions arise about the quality of the offsets? Will investors support firms that invest in more expensive but high-quality offsets, such as those provided by nascent technologies like direct air capture, which pulls carbon dioxide from the air and permanently stores it?
Over the next decade, the emergence of negative-emissions technologies such as direct air capture will highlight the importance of investing in high-quality offsets. High-cost investments in the near term potentially will bring down future costs and help bring these types of technologies beyond their current niche market and into the broader voluntary carbon markets.
The role of voluntary carbon markets in financing these technologies also is an open question. In March 2022, for example, the oil and gas firm Occidental partnered with Carbon Engineering to announce that it pre-sold a portion of its anticipated offsets to Airbus for an undisclosed amount.
Climate-aware firms increasingly have demonstrated a willingness to pay for offsets, with the aim of reducing their overall greenhouse gas footprint. This willingness to pay is expected to increase as firms grapple with how to meet their net-zero targets. As a result, voluntary carbon markets are expected to expand significantly over the next few decades. Yet, as illustrated here, many open questions need to be resolved for these voluntary offset markets to provide maximal benefits to society.