A Radical Proposal for Fixing Carbon Credits and Offsets

Like many people coming to climate from tech or finance, I was at first very enthusiastic about the idea of carbon offsets. Here’s an instrument designed to fund climate action from emissions reductions to nature restoration. If only we could channel more capital here, we could quickly make a difference.

So I watched videos, read thousands of pages of white paper upon white paper (a partial list is here), talked to people in the offsets market, and even co-authored a paper on the voluntary carbon offsets market.

Which got me increasingly disillusioned.

Try as I might, I couldn’t find anybody to tell me what made a carbon offset valid. Sure, there are many organizations which publish standards and certified carbon projects, but their rules and methodologies differ significantly. Some require separate auditors for the issuance of the credits versus follow up monitoring, while others were fine using the same auditor for both. Some would issue offsets for renewable energy projects, some would not. Some require biodiversity for forestry projects, while others would issue offsets for commercial timber farms. Thus, offsets blessed by one organization’s criteria might not satisfy another’s, or vice versa.

So who is to really say which offsets are truly valid? Nobody could tell me. Instead I got answers like “Offsets are just bought for marketing, to show that you’re a sustainable brand.” or “In the end, who have you hurt by buying an offset?”

Then there was the absolute lack of transparency. Buyers, sellers, and brokers did not want to disclose the actual prices carbon offsets traded for. Rating services did not want to disclose their methodologies or ratings of the offsets. Finally, companies which claimed carbon neutrality with offsets did not even want to disclose what those offsets actually are.

Everybody justified their actions as some form of “We’re trying to help the market.” “It’s hard enough to get people to buy offsets, let’s not make it tougher for them.” “The prices are slow it would give people the wrong idea.” “We don’t want to get criticized for buying offsets.”

Doubt started to creep into my mind. I went to see for myself by reading through the documents and public comments for a few carbon offset projects. I found perfunctory, copy-and-paste material and summary dismissals when questions of additionality or lack of biodiversity came up.

Then it got a lot worse.

After I started to write The Open Climate Investing Book, people asked me about carbon offsets as an investment. So I decided to write a sequel to the voluntary carbon offsets paper and cover both voluntary and compliance carbon markets. It started out as a “how to” guide for investing in carbon projects. Inspired by Ray Dalio’s tomes, I decided also to indulge my own love of history and study several carbon markets from the Kyoto Protocol in 1997 to COP26.

Guess what I found?

The whole twenty five year history of carbon credits has been a series of markets with oversupply of dubious and nearly worthless credits and offsets. It happened with the Clean Development Mechanism. Then it happened to European Union’s Emissions Trading Scheme. It’s also happening in the voluntary carbon offsets market. And, thanks to the agreement at COP26 to carry over old Clean Development Mechanism credits, it’ll probably happen to the Paris Agreement Article 6 carbon markets.

By now I’ve almost turned a full 180 degrees, from believing that carbon offsets were the instrument that could catalyze climate finance to almost agreeing with Project Drawdown and Greenpeace calling them a “shell game” and “a bookkeeping trick.” When I heard about people talking about using carbon offsets to “offset blockchain emissions,” it sounded like greenwashing to me. When I started to work on supply chain decarbonization and studied the heavy transportation and aviation industries, I saw that they could very well be delaying real decarbonization.

I was pretty much done with offsets. Then a graduate student at a seminar I gave about climate change and financial markets for petroleum engineering majors (yes, really) reminded me of something. He asked, “What do you think of developing countries like the one I come from, who feel that the developed countries are holding back our progress with climate change?”

He reminded me of what it was like to grow up in a “developing” country. It means living in a place where you know there’s a world somewhere with cars, air conditioned houses full of beautiful things, and elegantly dressed people. You’ve seen it on TV and through social media, but you’ve never experienced any of it.

People in those countries aspire to a better life. They also see climate change as a problem the wealthy countries caused, but one that will cause them hardships. So why should our mistakes prevent them from getting at least a taste of the good life now? And if their country didn’t become wealthier, how could they possibly cope with climate change?

International carbon credit markets were invented to solve this problem. They’re designed to help those countries develop without making our mistakes, while providing the wealthy countries ways to meet their climate targets at lower costs. They’re also the glue that holds international climate cooperation together. Without them, the developing countries would simply try to develop as quickly as possible using whatever means available, while the wealthy countires would be even less willing to pay the higher costs for emissions reductions.

So as despite repeated failures, we need carbon markets, or we’ll never achieve our climate goals. We just need carbon markets that actually work.

Now comes the good part: Fixing this is not complicated. It doesn’t require new technology. It’s not satellites or digital MRV or blockchain/web3/DeFi/ReFi. Nor is it another rating service or standard–there are plenty of those already.

Instead, it just requires treating carbon credits as a serious asset rather than a marketing nice-to-have. An asset, such as a loan, is something that is either performing or not performing based on objective criteria–i.e., is the borrower paying? When it is not performing, such as when the borrower stops paying, the holder of the asset suffers an economic loss.

This has never happened with carbon credits. Despite evidence that some (many?) CDM credits, EU ETS allowances, and voluntary carbon offsets are not really valid, they have not been invalidated. Instead, while some groups categorically deny their validity, standards organizations continue to stand behind them, and buyers try to secretly buy them for as little as possible. As a result, carbon credits have become a shadowy world of zombies.

So here’s a proposal for something that has never existed with carbon credits but exists with every other asset out there:

  1. There must be an objective, neutral standard for determining whether a carbon credit is valid or not.
  2. If a carbon credit is determined to be invalid, it must be voided.
  3. If you use carbon credits, for example to meet a compliance target or claim carbon neutrality, and your carbon credit is voided, you must write it off and pay to replace it.

In other words, the buck must stop with, well, whoever spent it. The buyers of the carbon credits must be serious enough about their “carbon asset” to stand behind them with real money. Their investors must insist on it. Together, they must then insist that project developers stand behind the credits they create.

And here’s the best part: You could make money doing this, at least if you owned good credits. Because if we could clear the market of all the oversupply of dubious credits, then the value of the remaining credits should rise in value.

Of course, it would be take a long time for the current carbon credit buyers and sellers, standards organizations, not to mention government and international agencies to do this. But it doesn’t require them. It just requires you. And me. Do you buy carbon offsets or do business with any companies that do? If so, just stand behind the offsets you buy. Tell yourself that they must be valid under neutral, objective review, or you’ll pay to replace them. Ask the companies you do business to do the same.

There are a lot of details to be worked out. More on how to do this later. Meanwhile, here’s a link to the full chapter on investing in carbon assets.