OPINION: Will we fix offsets? It's harder than you think

Quantum Commodity Intelligence – Mark Trexler is currently part of the Climatographers and a curator of the Climate Web knowledge portal

Carbon offsets have become integral to global climate change mitigation efforts, and the Task Force on Scaling Voluntary Carbon Markets estimated in 2021 that a 10x to 100x increase in the use of offsets will be needed to meet global climate targets.

But offsets have been contentious throughout their history. The voluntary carbon market effectively collapsed after 2009, a combination of scandals on top of the financial crisis, and the Kyoto Protocol's compliance-based offset market collapsed a few years later when countries abandoned it in favour of the Paris Agreement. More recently, after regaining considerable ground, voluntary markets have stumbled again over the last two years in the face of non-stop criticism.

Why so much trouble?

Albert Einstein once said that "If I had an hour to solve a problem, I'd spend 55 minutes understanding the problem, and five minutes working on solutions." So, why have offset markets had so much trouble delivering a consistently quality "product" after 35 years of practice? And how likely is it that the proposed Assessment Framework of the Integrity Council for the Voluntary Carbon Market (IC-VCM) finally turns the corner toward a quality market?

So what is the problem? The answer is deceptively simple: the intangibility of offsets as a commodity. As British journalist Dan Welch puts it: "Offsets are an imaginary commodity created by deducting what you hope happens from what you guess would have happened." What could possibly go wrong? Here are a few of the challenges.

First, how do we balance the key objectives of carbon offsets, cost-effectiveness and environmental integrity, when they are inherently at odds with each other?

Second, how do we address the fact that one can't empirically test for the quality of an intangible commodity? At best one can be more or less confident in the hypothesis that "this is a quality offset."

Third, how reliably can we quantify an intangible commodity like offsets based on a counter-factual prediction of the future?

Fourth, can we adequately preserve the "quality" of an intangible commodity market when project developers are incentivised to game the rules?

There is no shortage of useful information and literature by which to explore these and other questions, and I can just scratch the surface here.

Point one – Carbon offsets are based on advancing two competing goals: cost-effectiveness and climate change mitigation. There is no set of market rules that can simultaneously maximise for cost-effectiveness and environmental integrity. Rather than just ignoring this fact, we should decide on what the balance should be, since market rules depend on that decision.

Point two – There are a number of qualifying criteria commonly discussed in the context of offsets, with the three fundamental criteria being: additionality, permanence, and avoiding leakage. These criteria have been around since the first offset projects, but we've seen since then how challenging it is to apply these criteria to a commodity that can't be empirically observed or measured. There is no way to "test" for these criteria in the conventional sense, which complicates the goal of a delivering a quality offset market.

Regarding additionality

On additionality, "additional" avoided or removed tonnes of carbon dioxide (CO2) are directly attributable to the demand created by the offset market. Offsets cannot represent tonnes of CO2 or its equivalent that would not have been emitted to the atmosphere, or that would have been removed from the atmosphere, regardless of the existence of the offset market.

Certainty regarding whether a proposed offset project is the result of offset market demand, as opposed to the many other potential drivers or motivations that might be in play, is rare at best. It's analogous to the US judicial system in which juries are entrusted with the task of evaluating the hypothesis that "this defendant is guilty". Certainty is usually not on offer. Which makes "additionality testing" a misnomer. Imagine trying to design a pregnancy test kit without being certain that a woman was or was not pregnant.

With no empirical way to test for additionality, some proportion of non-additional tonnes will be approved as offsets even under the best of circumstances. The inverse is also true. The size of each "error" depends on how strictly the rules are written. Unfortunately, the two "errors" are inversely related. That's why prioritising offset market inclusivity and cost-effectiveness reduces the market's environmental integrity.

The challenge of keeping non-additional tonnes out of offset markets is complicated by the fact that the number of "naturally" avoided or removed tonnes vastly exceeds the number of tonnes likely to be attributable to the existence of offset markets. A plethora of public policies cause billions of tonnes of emissions to be "avoided," and the natural carbon cycle removes hundreds of billions of tonnes of CO2 from the atmosphere every year.

On permanence, the warming impact associated with CO2 emissions lasts for a long time, and the equivalent cooling impact of offset should last just as long. But how long is long enough to be permanent? Applying the Oxford dictionary's definition of permanence would dramatically constrain the scope and cost-effectiveness of offset markets.

Avoiding leakage

On avoiding leakage, market or behavioural feedbacks following the implementation of offset projects can undermine their cooling impact, and need to be netted out. As with additionality, there is no empirical way to do so.

Point three – Once qualified, how does the number of offsets get quantified? Dan Welch characterised the answer as "deducting what you hope happens from what you guess would have happened". What we guess would have happened is called the project baseline, and it is counter-factual in the sense that it's a prediction that cannot be empirically validated.

Point four – Offset providers face an inherent conflict of interest. Identifying and launching high-quality offset projects is costly and risky. What if buyers end up not buying the offsets you've spent a lot of money bringing to market? The most obvious way to manage this business risk is to find ways to game the system. The more non-additional, impermanent, or leakage-prone a project, the lower its business risks.

Building a market around an intangible commodity is never going to be easy. But, absent the explicit recognition of the implications of offset intangibility during market design, a gamed and low-quality market is to be expected. As one carbon offset expert puts it: "At the project level, everyone kind of has an incentive to see how much they can get away with without raising alarm bells among buyers – but the systemic outcome is a crash".

The potentially good news is that it's not really that hard to identify steps that would help "fix" how offset markets work. Deciding how the goals of cost-effectiveness and environmental integrity will be balanced when it comes to market design. Deciding "how good is good enough?" Would a 90/10 ratio of "high confidence" to "low confidence" offsets be acceptable? About how 80/20? 70/30?

The answer has big implications for offset rulemaking. Explicitly consider the reality that gaming or at least attempted gaming will be pervasive when designing market rules. Carry out third-party due diligence on offset quality to better inform buyers.

Could these and other steps be implemented to promote a quality offset commodity? Sure. In fact, the relatively recent launch of multiple ratings agencies is an important step in this direction.

That said, an offset market designed for high quality would look very different from today's market. This would include: more business risk; smaller size, with less growth potential; fewer categories of qualifying projects due to stricter permanence rules; fewer qualifying projects in each category due to stricter additionality rules; and substantially higher offset prices. That's why efforts to "fix" offset markets tend to nibble around the edges, the equivalent of trying to build a slightly better mousetrap.

IC-VCM framework

The IC-VCM's proposed Assessment Framework could substantially tighten prevailing offset rules, and substantially disrupt the market for existing offsets. But the IC-VCM makes no mention of the challenges of an intangible commodity, of the reality that we can only be more or less confident in an offset's quality, or the need to explicitly balance the objectives of cost-effectiveness and environmental integrity.

Because the IC-VCM is in effect trying to improve the existing mousetrap, it seems likely to fall well short of what a complete quality re-think of the "offset quality mousetrap" would deliver.

Are carbon offsets even plausibly "fit for purpose" when it comes to being massively scaled for climate change mitigation efforts? It's a question we should be thinking more about. Indeed, many observers would like to move away from carbon "offsets" and toward carbon "contribution claims."

The future of offset markets is uncertain and they could evolve in different ways, of which the "explosive growth" scenario we started with is probably the most risky. These markets have collapsed before, and if we don't structurally reform them in favour of delivering a quality product, they probably will again.