Voluntary Carbon Offsetting - the forest through the trees?
Vienna, 11.01.2008 - Marianne Osterkorn
In November 2007, the little country of Guyana, slotted between Venezuela and Brazil, proposed one of the world’s largest and neatest offset projects: it would place its rainforest under the protection of the UK government in return for development aid and the technical help needed to make the transition to an environmentally-friendly economy. The million-acre Iwokrama reserve in this former British colony is larger than the size of England and acts as a carbon sink for 120 million tonnes of carbon dioxide (CO2), equivalent to the UK’s annual direct emissions. Cutting down the trees would release tonnes of CO2.
The move echoed earlier statements made at the Montreal COP/MOP discussions in 2005 concerning the potential for avoided deforestation, through which developing countries could be paid not to cut down their forests by developed economies via the carbon markets. Two years down the line, the issue has permeated the whole international arena as forestry projects, once dismissed as unworkable, now climb once again to the top of the carbon agenda and were fought over at the 2007 Bali talks.
Like many carbon issues, forestry not only splits the planet along compliance (Clean Development Mechanism) and voluntary market lines but splits the voluntary market itself, valued at US$91 million in 2006 by market information provider Ecosystem Marketplace, based in California. Greg Janetos, director of carbon programmes at Sustainable Forestry Management (SFM), a company building a global portfolio of forest-based enterprises, believes:
“For avoided deforestation, the voluntary market is the only outlet at the moment. For afforestation and reforestation, it’s also easier to go through the voluntary market because rules written into the CDM are very restrictive in terms of credits you can get,” while admitting that compliance markets would be the preferable option in principle.
Seeing the wood for the trees
A clear irony has emerged: while deforestation contributes to at least 18% of global CO2 emissions, placing Indonesia and Brazil among the top four emitting countries, very few projects have been accepted by the CDM. This is primarily because of tricky technical issues surrounding the definition of additionality - the criterion that shows that a project would not have occurred under a business as usual scenario and that validates the payment for the credits - in forestry. The length of time over which a company must bear the carbon credit liability – fifty years or more as the forests grow – is another reason for caution, and there are a number of other problems too: for instance, it is hard to prove that a tree saved will not justify another tree felled somewhere else.
At the same time, many people view the voluntary market as completely untrustworthy, and certainly not a suitable vehicle for forestry projects because it is full of legal loopholes. The end result is that there have been efforts to shut out forestry projects altogether. Yet Janetos contends that they are essential: “Forestry is part of the problem, so forestry should be part of the solution,” he asserts. According to Ecosystem Marketplace, forestry credits account for 36% of the total over-the-counter voluntary carbon market and only 1% of the CDM market.
There is a second irony: partly as a result of the CDM’s restrictions on forestry, projects in Africa have been limited in number (23 out of a registered total of 864), despite the recognised requirement that the CDM should promote the role of development within the carbon market. Of all continents, Africa is still the most in need of development. “The CDM methodology would have to be based on avoided deforestation in order to deal with Africa,” argues Geoff Sinclair, head of carbon finance and trading at Standard Bank, an organisation which focuses on emerging markets and natural resources, and which works within the voluntary carbon market alongside other markets.
This, Sinclair reasons, is because of the scale of deforestation in Africa, where charcoal is the most significant fuel source. However, it would be untrue to claim that this is the only reason for the low number of African projects. Unusually high risk levels and a relatively low skills base and networking in this area are just two other reasons.
Forestry can be managed if it is done carefully, he indicates, for instance by only focusing on obviously threatened zones rather than random remote locations. He quotes two projects in which his own organisation has invested in Africa. One is located at Sofala, Mozambique, through which participants are paid for carbon stored by the trees they plant, forest they manage and fire they prevent. The project has sold over half a million tonnes of CO2 credits within the voluntary carbon market to organisations like the Creative Artists Agency of Los Angeles the MAN Group, a financial institution, and the London-based International Institute for Environment and Development.
It is also investing in 185,000 new cooking systems in Lusaka, Zambia, that will replace charcoal use. Through this investment, the project will generate 1.8 million voluntary emissions reduction (VER) certificates each year and cut emissions by 15-18 million tonnes of CO2e over ten years.
As a result of this situation and other problems Sinclair suggests that “Corporate Social Responsibility [CSR]-driven investment is not going into the CDM but into alternative mechanisms,” of which the voluntary carbon market is one.
By investing in the voluntary market, some of those corporations may however be finding themselves moving into difficult waters as the market continues to shift, not just in relation to forestry but in relation to financial, validation and verification issues, as well as additionality and a number of other criteria. Several voluntary market organisations recognise forestry projects while others reject them. Most have embraced certain industry standards in order to back up the validity of their projects and align themselves along particular principles and project types, including forestry.
Fragmentation
The forestry issue well illustrates the fragmentation within the voluntary carbon market. Organisations that accept forestry include a coalition of the North-Eastern US states called the Regional Greenhouse Gas Initiative (RGGI) which accepts reforestation, a trading forum called the Chicago Climate Exchange that accepts both reforestation and avoided deforestation as well as offset project developers in the broader voluntary emissions reduction (VER) market that adopt particular standards.
These standards include a revised Voluntary Carbon Standard (VCS), launched in November by the Climate Group, the International Emissions Trading Association (IETA) and other partners, that does accept forestry. On the other hand, the Gold Standard in the voluntary market only accepts clean energy projects (renewable energy and energy efficiency) while the Voluntary Offset Standard, launched by financial institutions in summer 2007, adheres closely to the CDM.
The ambiguities in the market are reflected in the policy of the Carbon Neutral Company, a retail carbon offset provider headquartered in the UK and formerly called Future Forests. The company renamed itself after deciding to cut down on its forestry projects. “In principle we would like to support forestry, but we can’t if we’re taking all the commercial risk ourselves,” says Bill Sneyd, operations director. However, the organisation supports a range of standards, including some that accept forestry.
These problems within both the compliance and voluntary carbon markets have pitted the purists who want to push the standards as high as possible against the go-getters who want to move the market forward, and in doing so are willing to accept that not all projects will be perfect in the early years. The voluntary market, they say, is the most fertile ground for the most innovative technologies and ideas that can not be easily included in the CDM process. The enterprising initiatives of these organisations to grow the market, however, have inadvertently let in a number of fraudsters who have given parts of the voluntary carbon market a dubious reputation, which in turn has generated the whole brace of standards behind which people take their positions.
Private property
Claude Brown, a partner specialising in this area at the legal firm Clifford Chance, likens the carbon market to road use. “A VER is rather like driving on private land. If I want to drive on the vast estates of your private manor, I don't need a tax disc. However as it’s your land, I do need your permission and we could enter into a contract under which you give me permission to drive across your fields and I agree to pay you for it. There is no statute that governs this agreement, it is merely a private contract,” he explains.
Similarly, the contract between offset buyer and seller is valid, but an international statute does not cover the activities carried out by the offsetter. Hence a flawed international trading system has developed. For instance, an offset project developer can sell the same credit to two different buyers because no international project registry exists as yet, while critics say additionality definitions are sometimes not rigorous enough. The lack of transparency has itself led to low liquidity levels and a system that is not fully tradable, unlike the regulated carbon market.
Arguably, the market became even messier in 2007 than the previous year as different groups took sides as to how to assess and run projects, sought to distance themselves from particular organisations, and blurred even further any consistency that may have existed beforehand. At the same time, more organisations joined in and the offset market grew. Ecosystem Marketplace reports that by July 2007, the CCX alone had traded more in that year alone (11.8 million tonnes of CO2e) than during the whole of the previous year. But by July, media criticism had become more intense.
In May 2007 Clifford Chance identified thirteen protocols or protocol categories and they estimated their market shares by counting the number of offset retailers applying for each protocol or standard. Protocols using CDM equivalent assessments amounted to 17% of the market while strict CDM followers were 9%. The Voluntary Gold Standard was estimated to represent 12% of the market. It is supported by several non-governmental organisations (NGOs) like WWF as well as the Renewable Energy and Energy Efficiency Partnership (REEEP), an international partnership that facilitates market development for renewable energy and energy efficiency projects in the developing world. The recently launched Voluntary Carbon Standard makes up 4%. The largest portion of the market (34%) is using internally developed standards, Clifford Chance found.
The Voluntary Carbon Standard is still one of the most controversial. A new version of the standard was released in November by organisations including the World Business Council for Sustainable Development (WBCSD), a big business lobby group, and the Climate Group, a board-level forum with corporate members such as Swiss Re, Google and Alcan as well as governmental organisations including the state of Massachusetts and the Greater London Authority.
WWF lashed out at the standard when it was relaunched: “Buyers beware!” it warned, claiming that it was “a minimum standard and essentially a ‘bottom of the barrel’ benchmark that offers the most basic set of rules, focused primarily on lowering transaction costs and thus carbon prices to consumers.”
The charity, which is in favour of appropriately used offsetting, said that additionality, validation and verification rules in the VCS were too relaxed and could result in potentially large numbers of non-additional carbon credits. Suggesting that the VCS waived all environmental and social safeguards, it said that it appeared to rely to a considerable degree on the goodwill and integrity of project developers and that this could carry significant potential risk for buyers.
In response, the VCS Association hit back, arguing that WWF was missing the point, and that prior to the launch of the VCS, there had been “no offset standard which covers all possible mitigation projects that has balanced environmental rigor and technology innovation – this is the value of the VCS.”
It said that the standard is designed to support other credible approaches and complement “existing niche standards” and requires that all projects demonstrate conformity with all local legislation addressing social and environmental impacts. “Our research indicates that the VCS will become the leading standard against which all voluntary offset projects are judged,” proclaimed Richard Bayou of Ecosystem Marketplace.
During the period that the VCS was brewing its revised standard in 2007, another organisation, made up mainly of investment banks, launched a new standard in July 2007. Like many of its predecessors, the International Carbon Investors & Services (INCIS) decided not to adopt an existing voluntary market standard but to develop its own.
“There was no robust standard and benchmark in the market…there was a feeling by financial players that if a group of banks adopted a robust benchmark, it would send a signal to the rest of the market. The voluntary market has rightly been criticised,” explains Imtiaz Ahmad, the executive at Morgan Stanley whose job it was to develop the protocol known as the Voluntary Offset Standard (VOS).
The VOS uses a benchmark similar to that used by the United Nations for the CDM and it incorporates the Gold Standard, but is not restricted to it. Ahmad explains that the VOS is “somewhat broader” than the Gold Standard though it excludes some project types, such as large dams. “The Gold Standard may not bring sufficient volumes into the market, and more liquidity is needed,” he says. Airline KLM and auto producer Volvo are among its customers. Commenting on the VCS, Ahmed suggests that “it is unclear what it will do to methodologies not benchmarked in the CDM. It depends who sits on the VCS board and what their agenda is.”
As each organisation claims its standard is the best in the market, an offset buyer may understandably be confused. The number of standards in existence shows that there is in fact no market benchmark on which buyers can rely. “From our point of view, we are keen to avoid a proliferation of standards. It doesn’t allow for direct comparison,” says Katherine Hunter of the British Standards Institute, which is a member of the International Standards Organisation (ISO) in Geneva, Switzerland.
“It usually takes three-five years to develop an international standard, but the offset market has moved much more quickly,” she explains, likening the diversity in offset standards to the complex development of food labelling. In the food market, certain labels have become more prominent and are associated with better quality, and this is also likely for the voluntary carbon market.
The standards might more accurately be described as brands, with the very rigorous ones perhaps akin to luxury cars, selling appropriately more expensive credits because of the time and effort taken to generate them as well as a system backbone that support registration and transparency. “Maybe we’ll see a ranking in price and credibility of standards,” suggests Imtiaz Ahmad. Janetos of SFM also remains sanguine about its future, while agreeing that there are unreliable offsets in the market. “If there are dodgy standards, the market is ruthless in rooting them out over time, the market will gravitate towards standards of the highest quality,” he predicts.
There are some positive signs. The organisation TÜV, which has created a standard of its own, has also founded a registry of projects called the Blue Book. It is only registering its own projects in this book at the moment, but may also allow other projects to be registered on it in the near future.
Business as usual
Nevertheless, plenty of businesses still think twice before investing in the carbon market, which is small in comparison to other commodities or stock markets. Martin Gibson, who is responsible for this area at venture capital fund Atlas Ventures, finds it a risky market and says he has not found a suitable project development company to invest in so far.
The company focuses on investing in businesses that find novel uses of technology (of all kinds) to generate competitive advantage. However, Gibson finds that few companies have the right combination of business acumen and passion for the climate issue. Cash flow problems, too, are common as offset developers struggle to manage the lumps of cash paying for the stock of projects with the credit sales income they are receiving.
Few markets other than the insurance market are so quirky, he says. “Normally you get something for what you buy. But in this market you just get the belief that you are offsetting something, rather like life insurance, where you trust that there will be a payout.” The lack of a global register for the voluntary market and absence of agreed standards are reasons why he has not backed any companies yet, he says.
Though the market has grown strongly, the press campaign against the offset market has hit home. Geoff Sinclair’s comment that CSR investment is avoiding the CDM is true, but not all of it will be aimed at the voluntary carbon market. Many corporations are now emphasising their commitment to renewable energy at home, partly because offsetting can be viewed as greenwash. “We’ve never said never, but we will always view offsets as a last resort,” says Chris Tuppen of telecommunications company BT, which invested in its own wind farm in October. Retailer Marks and Spencer has also initiated unusual new projects to cancel out its emissions in the UK.
While the voluntary market experience significant growth on the demand side, the supply side’s response by increasing the number of new standards has only contributed to the already fragmented and unreliable market conditions, where there is still high risk of failure. One can only hope that over time, several standards will merge together into one or two internationally accepted standards, supported by both the business and NGO worlds. One major benefit that the growth in the voluntary market has provided is a dramatic increase in the flow of finance into smaller, innovative projects that could not otherwise become viable without carbon finance.