Finding the right way to offset carbon

Policymakers and investors, having delayed serious action on climate change long after the science was well established, now have a gargantuan task in achieving net zero by 2050. There are still many industries where the path to decarbonisation is far from clear. The International Energy Agency reports that over one-third of emissions reductions by 2050 will need to come from technologies that are not yet commercially available.

But net zero does not mean zero carbon. Some emissions will continue long after 2050. This means that a key part of achieving net zero involves finding ways to enhance the removal of carbon – so that the amount of carbon added to the atmosphere is less than, or equal to, the amount being removed.

Infrastructure investors and their portfolio companies, like other investors and corporates throughout the global economy, therefore need to think through their approach to offsetting. This is particularly the case for investors that hold assets with high direct or indirect emissions that cannot be easily abated, such as airports.

Yet to say offsetting is complicated would be an understatement. For a start, there are key differences between compliance markets – which generally function through emissions trading schemes that cover the most carbon-intensive industries – and the voluntary carbon markets. The latter rely on companies voluntarily purchasing ‘offsets’ as a way of compensating for their emissions.

None of the approaches to offsetting is without its challenges and drawbacks. Many critics argue that offsetting simply serves as a ‘permit to pollute’. In approaching the voluntary carbon markets, therefore, investors could be forgiven for feeling they are walking onto a minefield.

Growing pains

Bernadett Papp, head of market analysis at Pact Capital, an environmental commodities trading firm that advises companies on carbon offsetting, says the voluntary carbon market puts companies in a “challenging situation”. She points out that there are multiple different standards that can be used to verify carbon offsets that are offered to the market.

These offsets are available at widely varying price points, partly depending on the method used to remove carbon. “No wonder that companies get lost in this plethora of information,” she says.

Papp suggests that investors need to begin by deciding their priorities for what they want to achieve with carbon offsetting. In theory, carbon offsetting can contribute to other sustainability goals. For example, planting trees could remove carbon while also boosting biodiversity, and even providing an income to forest communities through fruit cultivation.

In practice, however, these goals can contradict each other. Research published in October in the journal Trends in Ecology and Evolution warned that monoculture tree planting schemes involving non-native species in tropical regions are actually harming biodiversity, while also damaging soils and increasing wildfire risks.

“It is important that the selected projects and the credits originated by them represent real emission reductions”

Bernadett Papp
Pact Capital

And a series of massive land deals involving the United Arab Emirates-based investor Blue Carbon have drawn scrutiny over the company’s apparent failure to consult local communities. In Liberia, the company is negotiating a concession for forest carbon projects that would cover almost one-tenth of the country’s land area.

Papp says that investors can mitigate the risks of purchasing credits that are found to be inadequate or controversial through ensuring credits are verified by industry bodies and assessed by specialist rating agencies. “It is important that the selected projects and the credits originated by them represent real emission reductions, that they cannot be double counted and that they are additional, quantified, verified and permanent.”

Yet a series of media reports into seemingly ‘worthless’ carbon credit schemes throughout 2023 may well have dampened demand for carbon credits. Some investors appear to be in ‘wait-and-see’ mode, as regulators consider their approach to the voluntary carbon market.

Still, Papp argues that the work of bodies such as the Integrity Council for the Voluntary Carbon Market to produce common standards for carbon credits will be instrumental in helping the market regain momentum. “The future looks brighter”, she says, while acknowledging there is some way to go until “the end of the tunnel”.

A carbon opportunity?

Private markets funds are in the privileged position of potentially being able to find opportunity in the carbon markets quagmire by investing in companies developing solutions for carbon capture and storage. The most common methods of CCS involve capturing carbon at the source, and then storing it in places such as depleted oil fields.

But at Hellisheiði Power Station in southwest Iceland, Swiss company Climeworks opened the world’s first commercial direct air capture (DAC) facility in 2021. CO2 is filtered directly from the air at the site, before going through a process where it is mineralised and stored permanently in basaltic rock.

In a sign of investor excitement around the company’s technology, Climeworks raised $650 million in an equity round led by Partners Group and GIC in January 2023. Daniel Nathan, chief project development officer at Climeworks, notes that estimates on the amounts of carbon that will need to be removed from the atmosphere run into gigatonnes every year.

He says that a key advantage behind technical methods of CCS is that “you can verify that they are permanent”. By contrast, a purchaser of credits from a forestry-based scheme cannot be as certain about the volume of carbon removed from the atmosphere. A forest is also vulnerable to destruction, which would then re-release the carbon it had absorbed.

This advantage, literally, comes at a price. Carbon credits sold through DAC are significantly higher than those available from forestry schemes. Nathan acknowledges that Climeworks’ model is still driven by “pioneer” customers at this stage – but he believes that it will eventually generate revenues from a broader client base.

“What drives our business now is the fact that we need to scale quickly,” says Nathan. Climeworks is currently building larger facilities in Iceland, while also exploring sites in countries such as Kenya. “That brings us into a territory where we unlock the next band of customers.”