The Benefits and Drawbacks of Carbon Offsets

The Benefits and Drawbacks of Carbon Offsets

One of the most common announcements one hears from companies looking to improve their environmental impact is the decision to become carbon neutral, often through carbon offsets. It's an appealing idea, but one that can be inordinately complicated, as any company that has undergone this process can attest.

If your firm pays to offset its annual greenhouse gas emissions, you may think that the money makes possible an immediate greenhouse gas reduction equal to your emissions. That is, your company is "carbon neutral" in the sense that its actions have no net impact on the amount of carbon in the atmosphere. However, given the way that offsets are structured it is likely that even after buying offsets your firm is on balance adding carbon to the atmosphere.

What Happens to the Money You Spend on Offsets?

Much of the media discussion about offsets has focused on offsetting as a form of greenwashing, how the carbon reductions offered for sale are measured and whether offset providers really do what they say they do. Those are all important questions, but there are even more fundamental questions about what carbon offset purchases accomplish.

An analogy is useful here. Think of a bathtub; a gallon of water in the bathtub represents a ton of carbon in the atmosphere. The average American is responsible for about 20 tons of carbon emissions each year; in the bathtub analogy the carbon would be represented by 20 gallons of water. The amount of carbon in the atmosphere depends on the total amount of water in all of the world's bathtubs.

Without any offsets, the level of water in your bathtub rises by 20 gallons a year. If you buy offsets you may think that your purchase takes 20 gallons of water out of the bathtub, so that the level of water in the bathtub is the same as it was last year. This is what most people have in mind when they think of "carbon neutrality."

The truth is not so simple. You may be buying credits that have been generated by past actions; someone else has removed some water from their bathtub, and you're compensating them for the actions they've taken. In a sense, you're paying them to take some water out of your bathtub, but that water doesn't disappear. Instead it goes into someone else's bathtub.

Alternatively, you might be providing funds for greenhouse gas reductions that will happen in the future. If all goes well the offsets will reduce the amount of water in your bathtub by 20 gallons, but it will take a long time, and in the meantime you're still adding water at a rate of 20 gallons a year.

The reason for the confusion is not that offset providers are ethically challenged. Rather, most carbon-reducing investments involve large up-front costs and reduced greenhouse gases over ten, twenty or even fifty or more years. The vast majority of greenhouse gas reductions that take place this year result from investments that were made in the past. And actions taken today to reduce greenhouse gases will reduce greenhouse gases long into the future.

Many different "products" are offered for sale as offsets, with different retail offset providers offering different product mixes. Some offset providers allow you to choose what kind of offsets you buy. To understand what you get (and what you don't get) when you buy offsets it's useful to take a look at the different kinds of offsets offered on the retail market.

Carbon Reductions Resulting from Past Actions

Some carbon credits are traded in what is essentially a financial market. In the U.S. there are two types of tradable carbon credits, Renewable Energy Certificates (RECs or "Green Tags") and credits on the Chicago Climate Exchange (CCX). Firms earn these credits by reducing their carbon emissions beyond established goals (see sidebar). After the credits have been earned they can be sold, either to firms that haven't met their carbon reduction goals or to offset buyers.

What your purchase does: When you buy CCX credits or RECs though an offset provider, your purchase reduces the number of credits available to firms that have not met their carbon-reduction obligations and consequently increases their price. The higher price provides a larger payoff for firms that exceed their obligations, and increases the costs for those that don't meet their requirements. That means your offset purchase increases the incentive for firms participating in the CCX and REC markets to reduce their carbon emissions. This incentive can be an important component in firms' decisions to invest in carbon-saving technologies; many firms participating in these markets rely on the sales of credits to make their investments pay off.

Tradable Carbon Credits In the U.S. there are two types of tradable carbon credits, Renewable Energy Certificates (RECs or "Green Tags") and credits on the Chicago Climate Exchange (CCX). Firms earn these credits by reducing their carbon emissions beyond established goals. Firms that do not meet their carbon reduction goals can meet their obligations by purchasing credits.

Chicago Climate Exchange
The Chicago Climate Exchange (CCX) has about 300 participating members who have entered into a voluntary but legally binding agreement to reduce their greenhouse gas emissions by 6 percent between 2000 and 2010. Members who joined more recently have prorated emissions goals. CCX members who exceed the emissions goals for a particular year earn credits, which they can sell to CCX members who haven't met their emissions goals.

CCX credits take the form of Carbon Financial Instrument contracts, each of which represents 100 metric tons of CO2 equivalent for a particular year. Credits offered for sale on the CCX have already been generated and verified using standard CCX procedures. When CCX credits are purchased as offsets those credits are retired so they are no longer available to CCX members who have not met their emissions goals.

Membership in the CCX is voluntary. The organizations that choose to participate are motivated to reduce their carbon emissions, so the demand for credits is low compared with credit supply. As a result, credits available on the CCX carry a lower price than many other credits -- currently about $5 per metric ton of carbon dioxide equivalent, compared with $10-$12 for most other offset types.

Renewable Energy Certificates
Like CCX credits, RECs (also known as "Green Tags") are essentially financial instruments that firms earn by exceeding their emission reduction goals. Some states (including California) require electric utilities to generate a certain amount of electricity using eligible renewable energy sources. Utilities can meet the requirement either by generating their own electricity using renewable energy sources, or by purchasing RECs from utilities that exceed the required generation of renewable electricity.

Each REC represents one megawatt hour (Mwh) of electricity produced using an eligible renewable energy source. Eligible sources include solar, wind, biomass, and hydropower. One important difference between the CCX market and the REC market is that, while membership in the CCX is voluntary, many utilities are required to hold RECs. As a result there is more demand for RECs, and their prices are higher.

What's happening to your bathtub? You are compensating someone else for reductions that have already taken place. The level of water in your bathtub falls by the amount of credits you buy, but the water doesn't disappear. Rather, it goes into another bathtub. Although your purchase may be instrumental in reducing the amount of water in the world's bathtubs, your purchase does not directly cause the overall amount of water to fall.

Carbon Reductions in the Future

Some offset providers use your funds to invest in projects that will reduce greenhouse gases in the future. Projects vary widely, but include wind and solar power, methane capture, biomass, and tree planting.

What your purchase does: Your money goes toward projects that should, when completed, reduce the amount of greenhouse gases in the atmosphere. Since many projects that reduce greenhouse gases require large up-front expenditures, financing is often a significant constraint. Funds from offset sales can put clean projects in the pipeline more quickly. Forests provide important "carbon sinks" that mitigate the carbon we humans put into the atmosphere, so if your money goes toward a tree-planting project it has the potential to remove carbon dioxide from the atmosphere over long periods of time.

However, when you buy 20 tons of offsets, there will not be an immediate, 20-ton reduction in greenhouse gases. For a renewable energy project with an expected life of 20 years, the 20 tons of carbon savings would typically be spread over the life of the project -- meaning that the carbon reduction would be 1 ton per year over 20 years. Moreover, the reduction doesn't start until the project is completed, which could be a year or more after your purchase.

If the funds are used to plant trees, your purchase doesn't reduce greenhouse gases immediately because the amount of carbon that trees absorb is directly related to their size. Small saplings have little effect on greenhouse gases; the effect grows as the tree does. If you buy 20 tons of offsets that go toward a tree-planting project, it's possible that atmospheric carbon would fall by less than 5 tons in the first 25 years of the trees' lives.

When your offset purchase goes toward projects aimed at reducing greenhouse gases in the future, it can be hard to tell whether the projects really generate the greenhouse gas reductions that they claim. Many offset providers include information on their websites about the projects they invest in, and most have a third-party auditing or verification process. However, the types of information provided and the verification and auditing procedures vary significantly from one offset provider to another. Moreover, calculations of the carbon reductions depend critically on how much carbon would have been emitted without the project, and there are no standard procedures for calculating either the baseline emissions or the carbon reductions. With tree-planting projects, there is also a risk that the trees may die of disease, or that the forest may burn. Calculations of the carbon impacts of the forest should account for these risks.

What's happening to your bathtub? Your investment removes water from the bathtub, but the level of water in the bathtub continues to rise. That's because your investment removes a little bit of water over a long period of time. Over the course of a year, you add more water to the bathtub (through your normal business operations) than your offset purchase removes.

Additionality

Many offset buyers want their money to make the difference between whether a carbon-reduction project happens or not. In the language of carbon offsets, this feature is known as "additionality." Determining whether a particular project is "additional" can be tricky. Investments in renewable energy, energy efficiency and reforestation may be additional, but it can be hard to tell. Projects are undertaken for a host of reasons, and project managers have an incentive to make their projects seem "additional" so that they can attract offset investors. If additionality is important to you, read the claims carefully. Some are more compelling than others.

What's a Business to Do?

If your company wants to put money toward reducing the amount of carbon in the atmosphere, look first to make changes that reduce your own carbon footprint. Often, such investments are not only good for the planet; they'll also save you money over time. Replacing incandescent light bulbs with compact fluorescents, using hybrid vehicles for the company's fleet, and installing building control systems to reduce energy waste can reduce your carbon footprint and improve the bottom line.

If you want to do more, offset purchases are worth considering. Revenues generated by offset purchases provide critical funding for many projects that reduce greenhouse gases. If you do decide to buy offsets, take the time to research the various offset providers. Look for details on their websites. The more transparent they're willing to be, the more likely that their projects and their calculations can stand up to scrutiny.

Carolyn Sherwood Call provides economic consulting and research services regarding climate change policies. She was a regional economist at the Federal Reserve Bank of San Francisco for 10 years and has taught a wide range of economics courses at Mills College and Saint Mary's College. She holds a Ph.D. in economics from the University of California, Berkeley and a B.A. from Pomona College.

Windmill photo licensed under the Creative Commons by andrijbulba.