Net-zero targets are proliferating across the private sector in markets as diverse as auto manufacturing, big tech, retail, and integrated oil and gas. Among the largest 2,000 publicly traded firms, 703 have some type of net-zero target. But while these emissions targets vary substantially in their details (that is, if any details outline the path to a given emissions target at all), only a fraction of these companies has committed to achieving their goal without the use of carbon offsets, which effectively replace direct reductions in a firm’s emissions and instead serve as credits that are granted when the emitter engages with an emissions-reducing or sequestration project somewhere else in the world. Offsets can come from carbon removal projects, such as afforestation or direct air capture, or through emissions-avoidance projects such as building up renewable energy in developing countries. While offset markets present an opportunity to efficiently reduce net global emissions, several big-picture questions about their viability are important to consider.
Two kinds of carbon offset markets currently exist: compliance markets and voluntary carbon markets. Compliance markets emerge when firms are allowed to use offsets to comply with a regulatory program; California’s cap-and-trade market, which allows for limited offset use, is one prominent example. Voluntary markets, on the other hand, provide offsets to firms that are not obligated to offset their emissions. When voluntary carbon markets emerged in the mid-2000s, much of the activity resulted from speculation about future compliance markets, rather than from a goal to help firms reduce their greenhouse gas footprint. Voluntary markets have grown, however, and are here to stay, with the market expected to expand considerably in the next three decades as firms attempt to meet net-zero targets; by some estimates, the market needs to grow by a factor of 15–100 to help meet Paris Agreement goals.
But not all carbon offsets are of the same quality, which poses tremendous challenges to these markets. Some offsets may only temporarily reduce emissions (so, the offsets do not have “permanence”), while some offsets may not motivate emissions reductions because the project would have happened regardless (which means the offsets lack “additionality”). How can investors and firms verify the quality of the carbon offsets they purchase?
Third parties do provide guidelines and rules, but another question is whether those guidelines are sufficient to prevent a race to the bottom for cheap offsets that are neither permanent nor additional, known as “hot air” offsets, or to prevent an extremely fragmented market with huge variation in the price of offsets and a prevalence of cheap, low-quality offsets. Naturally, this question signals a potential role for government regulators and, by extension, an increasing interest in understanding how governments might regulate these markets. Should governments certify offset credits or establish tiered levels of offset quality (e.g., platinum, gold, silver)? Can the marketplace converge on the technical details without government protocols in place?
The establishment of Article 6 at COP26 in Glasgow in late 2021 prompts even more questions about voluntary carbon markets. Article 6 allows for international trading markets, so that countries can exchange offset credits to help each other achieve their nationally determined contributions. While Article 6 does not regulate voluntary offset markets, significant questions arise about how Article 6 will interact with voluntary markets, or whether Article 6 will simply “swallow up” these markets if countries buy up the world’s supply of offsets.
