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Climate, energy and net-zero

Corporates must learn to navigate carbon markets' quality issues


Carbon credits have a credibility problem. The value of carbon credits backed by avoided deforestation projects was called into question last month when the Guardian claimed that 94 per cent of credits verified by leading standards body Verra do not represent real emissions reductions, and could be “phantom credits”.

Avoided deforestation projects – also known as Reducing Emissions from Deforestation and Forest Degradation (REDD) projects – are one of the largest recipients of funding from the voluntary carbon market (VCM) through the sale of credits. The Guardian’s accusations are especially grave, when 72 per cent of all carbon credits issued in 2022 were certified by Verra.

Verra has disputed the Guardian’s findings, arguing that the baselines chosen by journalists to measure the impact of REDD projects led them to incorrect conclusions. But even as political support to scale up the VCM has grown, similar concerns over credit quality have repeatedly been raised.

Given the lack of policy guidance over whether and how the VCM should be regulated, corporates need to stay alert to how norms and expectations are evolving, in order to avoid being stranded with worthless credits or being accused of greenwashing.

Nature-based solutions

In recent years, interest in so-called “nature-based” carbon credits has boomed, after researchers claimed that nature-based solutions can provide up to 37 per cent of the emissions cuts needed by 2030 to keep global temperature increases under 2 degrees Celsius, while simultaneously supporting biodiversity and other co-benefits. Oil majors Shell, BP and Total are big investors in nature-based solutions. South-east Asia – a land rich in rainforests, peatlands and mangroves – has been identified as a lucrative source of nature-based carbon credits.

It must be noted, however, that there is no formally agreed definition of “nature-based solutions”, so the term is used by VCM participants to refer to two very different types of activities. On the one hand are avoided deforestation projects – which dominate the credit supply of REDD+ projects (the “+” indicates that these REDD projects also offer other co-benefits). On the other are carbon removal projects – a much smaller category that includes afforestation, reforestation, wetland restoration, carbon sequestration in agriculture, and improved forest management projects. 

The distinction is an important one to make, given that avoidance credits are more vulnerable to quality issues than removal or nature restoration credits, owing to the flaws in REDD architecture described by the Guardian.

Avoidance credits

One reason that avoided deforestation projects are so controversial has to do with how baselines are calculated. The Guardian claimed that Verra-certified REDD+ projects have been using inflated baselines to get credit for more emissions reductions than they deserve. The negative media campaign has since widened, with Dutch publisher Follow The Money alleging that South Pole – a globally recognised climate consultancy – had seriously overestimated the avoided emissions from its flagship Kariba REDD+ project in Zimbabwe, and then failed to notify clients that it had oversold 27 million tonnes of carbon credits to them when the mistake was discovered last year. South Pole has said that the report presented information out of context, but is now reviewing all its REDD+ projects.

It is notoriously difficult to reliably predict how much deforestation has been avoided. Political risk, for example, can result in unpredictable local changes that impact baseline deforestation rates, as Verra itself noted. During Jair Bolsonaro’s four-year term as president of Brazil, average annual deforestation in the Brazilian Amazon rose by 59.5 per cent from the previous four years, and by 75.5 per cent from the previous decade. To make baselines more responsive to unseen risks, Verra-certified REDD project baselines are now reassessed every six years, instead of every 10 years. Other risks, such as poor land rights governance, local corruption and indigenous rights issues, can also cut across all project types.

One particularly tricky problem, even for carbon removal projects, is the question of permanence. In principle, the impact of emissions avoidance or removal should be permanent, and not subject to reversal at the end of a project’s life. Given that carbon dioxide remains in the atmosphere for 1,000 years once it is introduced, the Science Based Targets initiative (SBTi), the standard-setter for corporate net-zero pledges, has come under pressure from the carbon removal industry to define “permanent carbon removal” as those practices that keep carbon dioxide out of the atmosphere for at least 1,000 years. This would mean that carbon removal projects would have to anticipate political, climactic, geological changes over 1,000 years, and have suitable insurance or buffer systems in place to pass the permanence test – which many do not currently have.

Gaps in quality

The wide variability in credit quality is already being reflected in a sharper differentiation between REDD+ credits (which are largely avoidance credits) and nature restoration credits in the VCM. Prices of nature restoration credits hit an all-time high in 2022 and continue to trade at a premium to REDD+ projects in 2023, whereas prices of REDD+ credits fell in 2022, according to data tracked by Trove Research.

Yet, it would be simplistic to generalise about the quality of carbon credits by reducing them to project types alone. According to analysis published recently by carbon credit rating firm Sylvera, 31 per cent of REDD+ credits are considered high-quality, scoring strongly across the key metrics of additionality and permanence. Another 29 per cent of REDD+ credits may be overstating their project claims, but only 25 per cent of REDD+ credits are “effectively junk”, said Sylvera – so the troubles with REDD+ projects may not be as rampant as the media has portrayed.

Buyers in the VCM must therefore expect projects under any sub-category to be of mixed quality. They should seek to identify credible project developers that are transparent with project information, and that are able to demonstrate that carbon finance flows back to their projects and participating communities. In the case of South Pole, one carbon credit rating firm has acknowledged that there is evidence to suggest that the developer “has been trying to act in good faith”. South Pole has voluntarily ceased issuing additional carbon credits to the Kariba project until the real observed deforestation catches up with the previously modelled baseline.

Buyers should also consider how shifts in national and international environmental politics might impact the long-term viability of VCM projects. As the market digests the recent clamour concerning major players in the VCM, buyer confidence is as fragile as ever, with nature-based offset prices tumbling to their lowest in more than two years on Feb 2. But despite its flaws, the VCM is still widely recognised to be one of the best tools available to incentivise the conservation, sustainable management, and restoration of ecosystems on a large scale.

As the carbon rush pauses to take a sceptical breath, efforts are already ongoing to improve crediting methodologies, while advancements in measurement, reporting and verification technologies are raising the bar for transparency and integrity. These factors, combined with greater public scrutiny, are expected to drive better price discovery in the VCM in 2023, and a gradual flight to quality.

This article was first published in The Business Times on 6 Feb 2023.

    The views expressed in this research can be attributed to the named author(s) only.