Reduce climate-related financial risk with offsets: Nature-based carbon offset considerations
December 30, 2020
The corporate desire to purchase carbon offsets is being driven by a fundamental reshaping of finance [1] where asset managers are requiring that publicly listed companies report on their climate-related financial risk, set GHG (greenhouse gas) emissions reduction targets, and show progress against these targets [2]. One of the ways that corporations can take action to address climate-related financial risk and reduce GHG emissions is through the purchase of carbon offsets.
In our last post, we provided an overview of the basic criteria for offset project eligibility and how these relate to the unique characteristics of forest carbon offsets [3]. Forest carbon offsets are particularly attractive to corporate purchasers given their secondary environmental benefits. In this blog post, we dive deeper into the unique characteristics of carbon offsets from forestry projects. Corporations that understand these issues can avoid the potential reputational pitfalls associated with purchasing low-quality carbon offset credit.
Unique characteristics of forest carbon offsets
Some of the unique characteristics of carbon offsets are identified in a report entitled A Framework for Forest Management Offset Protocols [4] that was prepared by the Canadian Council of Forest Ministers. In our discussion, we do not suggest a preferred policy approach to address these unique characteristics, but simply intend to highlight the complexity that offset project developers and purchasers must consider. For organizations looking to source forestry carbon offsets, the approach to dealing with each of these issues must be considered and addressed. Addressing these issues in a way that aligns with basic offset project criteria helps to ensure that the emission reduction is viewed as credible and valid by external stakeholders.
Project baseline and additionality
The project baseline is the business-as-usual condition against which the project should be measured. For the project activity to be considered additional, it must reduce or remove carbon in excess of the business-as-usual scenario. The concept of additionality is a key concept of offset project eligibility. The business-as-usual scenario for the project activity is usually defined in the protocol. As such, the project baseline underpins the basis for the GHG emission reduction claim. There are several different ways that a baseline can be established for forest carbon offsets. These include the following:
- projection;
- historical baseline;
- average carbon stock;
- performance standard; or adjusted/normalized.
Another consideration for project baselines is whether they should be static or change over time. Regardless of how the project baseline is established, it must support the offset project eligibility criteria of being real, quantifiable, and additional.
Permanence
Project activities undertaken to increase the volume of carbon dioxide sequestered in forests can eventually be reversed. These reversals can be a result of human activities or natural disturbances. If credits are issued for forest carbon activities, how should the risk of carbon sequestration reversal be addressed and measured? Who is liable if a reversal is to occur? How can the risk of reversal be managed (e.g. insurance, reserves/buffers, discount on credits)? How is the issue of permanence addressed once the project ends (e.g. perpetual commitment, 100-year commitment, flexible contracts, temporary credits)? The answer to each of these questions must balance proper risk management with an approach that is not so onerous that it prevents the development of forest carbon sequestration offsets.
Measurement and monitoring
An offset credit is based on accurately measuring and monitoring changes in carbon stock. Offset protocols must balance the need to accurately measure carbon changes in forests with economic feasibility. What pools of carbon should qualify for credits? (i.e. Does this include live trees only? Or should carbon sequestration in soil matter and harvested wood products be included?) How will carbon sequestration be measured? Options for measurement include prescriptive sampling, modeling, or use of biomass expansion factors. Most forest management activities rely on estimates given the large land base and cost of producing detailed information, but this increases measurement uncertainty and is often met with increased conservatism in the estimate of biomass gains (e.g. discount factors).
Leakage
The issues of carbon leakage are not unique to forest management activities. Leakage is the decrease or increase in GHG benefits outside the project’s accounting boundary. For example, if a forest conservation project shifts timber harvesting to another location there may be no net benefit in global forest carbon stocks and global carbon dioxide levels. The United Nations Clean Development Mechanism (CDM) identifies two main types of leakage: 1) activity shifting – when previous forest harvesting activities are shifted elsewhere; or 2) market effects – when emissions reductions are countered by emissions created by shifts in supply and demand of projects and services affected by the project [5]. The most challenging aspect of market leakage is determining how it should be measured. Effective monitoring of leakage requires the project proponent to identify all controlled, associated, and affected carbon sources, sinks, and reservoirs (SSR). For instance, in an elastic timber market, a forest conservation activity may create a timber supply shortage that is immediately filled by a competitor, thereby nullifying the climate benefits induced by the forest conservation activity in the first place. Policy options to deal with leakage include eligibility criteria that require projects to maintain optimal timber yields and modelling of market leakage and applying a project offset discount factor.
Crediting
Issues associated with crediting are closely linked to additionality and permanence. Crediting typically occurs ex-post when an offset system administrator issues offsets following verification and certification. Given that forest carbon removals are temporary, two different types of non-permanent credits have been developed for forestry projects: temporary credits and long-term credits. Some offset protocols also allow for credits to be developed on an ex-ante basis. This allows project proponents to receive credits before GHG reductions occur. The credits awarded are based on the expected potential of the project. This helps project developers by providing a shorter payback period but requires the offset program administrator to assume higher risk as it may be liable for ensuring that reductions occur. A third issue related to crediting periods is the duration for which a project can claim credits. The length of the crediting period determines how long the baseline scenario is valid for. A shorter crediting period allows the baseline to be more easily adapted, making the emission reduction claim more credible. A longer crediting period is more economically attractive to project developers but may be less environmentally robust unless there are periodic revisions to the baseline scenario.
Ownership
A clear, legal claim to the reductions generated by a project is required to reduce investment risk and provide the certainty necessary to manage offsets. In Canada, several competing claims to title of removals and associated offset credits can arise on private and Crown land. At the protocol level, there is typically a requirement for clear ownership. The question of offset ownership is complicated for projects where harvested wood products are within the project scope. In these cases, forest owners, timber purchasers, or end consumers may have competing ownership claims that would need to be resolved (e.g. contractual agreements between potential claimants). Potential reversals of carbon stock outside the defined forest would also need to be monitored and accounted for.
Conclusion
Given the complexity outlined here, corporations need to determine if forestry carbon offsets are the best project type to pursue. Forest carbon is probably the most complicated offset project type with respect to setting a baseline, establishment of ownership, measurement, and monitoring. However, these drawbacks should be weighed against the potential benefits. Forest carbon offsets have a high reputational benefit as a result of the secondary environmental benefits that forests provide (e.g. clean water, biodiversity, etc.). For some companies, forest carbon offsets have the added benefit of being in the same jurisdiction as the company headquarters. This proximity can help to foster local community relationship benefits. We believe that the benefits associated with forest carbon offsets outweigh the risk so long the corporate purchasers conduct the proper due diligence. Corporations that successfully navigate this complex space can not only achieve emissions reductions at a low cost but gain an outsized reputational benefit.
References
[1] https://mailchi.mp/a409e3edfd48/sustainability-in-the-spotlight-is-your-company-ready
[2] https://mailchi.mp/daf7e0a1514b/sustainability-in-the-spotlight-the-tcfd-has-arrived
[4] https://www.ccfm.org/pdf/FFMOP_e.pdf
[5] Henders, S., & Ostwald, M. (2012). Forest carbon leakage quantification methods and their suitability for assessing leakage in REDD. Forests, 3(1), 33-58.