By Michael J. Walsh, Managing Director of Research & Public Policy, IncubEx
The shift toward “net zero” is on. Reaching aspirational goals to stave off the worst of global warming requires a multifaceted approach that includes one critical pathway that is sometimes mentioned but often underestimated- carbon offsets.
The good news is the design and use of offsets has been proven over the past nearly 20 years, providing a host of benefits that complement, not substitute for a company’s efforts to cut emissions internally. Actions such as stopping deforestation and restoring agricultural soils are not optional but a requirement to stabilize the climate.
In developed economies with strong regulatory systems, offsets expand the menu of cost-savings and offer flexibility regarding when, where and how greenhouse gases are cut.
As mandates and initiatives have been adopted to rein in industrial and transport emissions, multi-benefit climate solutions have been growing, particularly in agriculture and forestry. Offsets then foster economic development, employment and help increase climate resilience of farms and forests and enhanced biodiversity, wildlife and recreation.
Offsets also enable organizations to make emission cuts in sectors and locations where regulation doesn’t make sense or won’t be forthcoming soon. For example, technology companies may have relatively low carbon footprints yet strive for deeper carbon reductions. Offsets are a useful instrument to help achieve those targets.
We’ve seen first-hand the upside of engaging diverse GHG solution providers. In 2003, we launched the first legally binding pilot carbon cap-and-trade program – the Chicago Climate Exchange (CCX) – which attracted a broad group of participants from manufacturers, utilities and agricultural entities to governments, universities and even a brewery. CCX’s rules first included a few offset activities in the methane, soil and forest space, which led to the development of 13 “protocols” to define and prescribe verification processes for offset projects.
To expand participation throughout the US and Canada, the rules encouraged aggregating large numbers of participants through farm organizations such as the North Dakota Farmers Union. Central elements of those offset protocols have been adopted by numerous offset programs and are still used today. The answers we found for the tricky questions of: “What gets credited and why? How much credit, how long, and how to document?” have largely been incorporated into newer programs. Generally, the rules allow crediting for activities that are a combination of rare, recent and beyond regulation.
While offsets were only one aspect of the program for CCX (accounting for less than 10% total mitigation), methane cuts from landfills and livestock, tree and grass planting, and soil best management practices, spurred interesting solutions and participants. By the time the program reached its scheduled end date, more than 15,000 farmers, ranchers and foresters had enrolled 25 million acres, an area bigger than Maine.
Some of the success of the CCX pilot is reflected in practices used today by regulated exchanges including: clear rules, open governance, low fees and dispute resolution processes. Essentially, we implemented the best of markets where participants knew the rules, knew what they were buying and selling, all in a totally transparent and low transaction fee structure to foster participation and liquidity. In short, CCX and our market participants practiced what works.
Ironically, despite the advances in technology and data, international carbon offsets markets evolved and moved in a somewhat opposite direction. It is difficult enough to establish comfort that an offset credit is valid and appropriate to the buyer’s needs but that’s not the least of it. The opacity of the offsets market and the huge markups we’ve observed, reminds us that prudent action in new markets demands caution and preparation. To protect themselves, offset buyers should have a clear understanding of the business model, mark-ups and pricing structures offered by intermediaries they engage with. Sadly, but not surprising, almost every environmental credit market has seen abuses from tax frauds, gross misrepresentation of assets bought, registry account phishing and so on. In many respects, the growth and maturation process of offset markets is no different than what we’ve seen in many other commodities and financial markets over time.
The recent stampede of new participants into the offset markets can forge a truly valuable externality: price and process transparency, which penalize bad actors and reward good ones.
Now, the re-emergence of a robust offset market is a vitally important piece of the global climate change solution. Sound, well-structured and regulated offset markets promise diverse ecological and local economic benefits, plus carry the promise of delivering the goods in a way that is fair to all involved. The blueprint for offsets is there and has been proven with failures and successes just as the global appetite for climate action seems stronger than ever.
The question now isn’t how, but how fast can we scale up and deliver a market that makes “net zero” a reality instead of a goal?
Dr. Michael J. Walsh is Managing Director of Public Policy & Research at IncubEx and a leader in the design and implementation of environmental markets. As a co-founder of the Chicago Climate Exchange, he directed new product R&D and played a central role in building the market-leading Chicago Climate Futures Exchange and European Climate Exchange. While at the Chicago Board of Trade, he directed the first three auctions of SO2 emission allowances for the U.S. EPA acid rain reduction program. Earlier, Walsh served in the U.S. Department of Treasury’s Office of Tax Policy and was an instructor at the University of Notre Dame. He earned a Ph.D. in Economics at Michigan State University.