Voluntary Confusion:A Simple Comparison of Carbon Credits

Mar 15

More and more individuals and organizations are interested in buying carbon credits to offset some or all of their carbon emissions. Unfortunately, it is challenging to understand which credits are effective and which ones aren’t. Moreover, prices and the quality of the underlying reduction / removal processes vary considerably. With this article, we seek to bring clarity to the topic and provide guidance to potential buyers and people generally interested in the space.

Attention: This article constitutes our perspective on the topic at this point in time. But please consider that we are investors, not scientists. Our views can (and certainly will) change in the future, and they are far from being objectively correct. We merely hope to provide some added value to the general discussion on the topic and welcome constructive feedback.

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Preface

As an early-stage venture capital firm, we at Übermorgen Ventures aim to invest in startups that help to mitigate or counteract climate change. Besides technology that seeks to reduce the carbon footprint of our economy by re-thinking food, energy, fashion, transportation and the likes, we also look at companies and technologies that effectively help to draw down (i.e., capture) and store carbon from the atmosphere. We have invested in a few pioneers in the space, such as Carbo Culture, which aims to produce high-purity biochar with a novel and patented reactor, as well as in Carbonfuture, a certifier for permanence of carbon storage through biochar and a marketplace for carbon negative certificates.

In the process of investing in these companies and seeking new investment targets, we have increasingly stumbled upon the question of the effectiveness of different carbon reduction and removal pathways as well as the definition of a “good” carbon credit. Not only do the prices differ substantially between different credits on the voluntary carbon market, but so do their characteristics. Do they remove carbon or merely avoid future emissions? How energy-intensive is the process behind capture and storage technologies? How permanent is the offered solution?

Unfortunately, we struggled to find a framework that comprehensively answers these questions. While there exist frameworks that assess the effectiveness of carbon credits, none compare different reduction and removal pathways. Moreover, the inherent complexity of each pathway can inhibit understanding how they work and how they act against climate change. For these reasons, we developed a framework that strives to be highly accessible, usable, and pragmatic while still being based on current scientific foundations. By simplifying certain aspects of climate change, our framework constitutes an easy guideline on what sort of credits one should aim for when making a purchasing decision. This contribution has only been possible thanks to the excellent work of others such as Climate Tech VC, the World Economic Forum, the Carbon Brief, the CDR Primer and many others.

The case for carbon reduction and removal

If we stopped emitting global GHG emissions tomorrow, we would still need to remove CO₂ from the atmosphere to avoid catastrophic global warming. Since 1850, we have released about 2,500,000,000,000 tons of CO₂eq into the atmosphere and we continue to emit about 50bn tons of CO₂eq per year. For most 1.5° C pathways, even with drastic decarbonization (e.g., electrification of everything, H2, etc.), we will still need to remove 6-10 Gt of CO₂eq per year by 2050. That’s equal to stopping GHG emissions now and removing ~10-20% of global emissions annually. [1]

Global CO₂ emissions and emission reduction and removal scenario to reach net-zero by 2050 (bn tons of CO₂eq per year) [2]

Compliance regulated vs. voluntary carbon markets

We distinguish between two types of carbon markets: The compliance or regulated carbon markets and the voluntary carbon market.

Compliance or regulated carbon markets exist in response to laws (e.g., the EU’s ETS) requiring emission reductions, managed through emission trading systems. These cap and trade systems dwarf the size of the voluntary markets and are rife with their own set of peculiarities. Though they tend to be more stable and well regulated. [1]

The voluntary carbon market has been around for decades but grew rapidly in recent years due to corporate net-zero commitments. Governments and corporations accounting for more than USD 14trn in sales are now under net-zero targets. To net their emissions out to zero, entities will take a series of operational decarbonization actions. At a certain point, the cost of the next marginal unit of emissions abatement breaks even with the price of buying a carbon credit equivalent to doing the hard work of internally reducing emissions. [1]

In the following, we will focus only on the voluntary carbon market due to its rapid development in recent years and the lack of transparency around different carbon reduction and carbon removal pathways used to generate credits.

Carbon reduction and carbon removal pathways

In the voluntary carbon market, carbon credits are issued based on either carbon reduction or carbon removal pathways. In the following we lay out the most common pathways for both. However, please note that our list is not exhaustive.

Carbon reduction

Carbon reduction credits constitute an emission avoidance vs. a predefined baseline. Hence, the emitted CO₂ is still in the atmosphere.

There are many different types of carbon reduction credits in circulation. For simplicity, we focus on the main three types:

Community-based energy efficiency: Supporting households in developing communities to switch to more energy-efficient bio-based energy sources such as biogas and clean cooking solutions.
Renewable energy: Developing renewable energy assets such as small and low-impact hydro, solar thermal and electric, wind and geothermal energy to replace fossil energy carriers.
Forestry-based avoidance (REDD+): Conservation of forest-carbon stocks and sustainable management of forests to reduce emissions from deforestation and forest degradation. [3]

Carbon removal, on the other hand, uses biological, chemical or technological processes to draw down carbon from the atmosphere and then store it permanently or convert it to either energy or value added products. The net impact on the atmosphere is resultantly zero or even negative.

From a voluntary carbon market perspective, creating value added products (e.g., Synfuels) is usually not sufficient for carbon crediting. It depends highly on the resulting product’s expected lifetime and the related reversal risk. Most products are short-lived (e.g., Synfuels, polymers) and hence do not remove carbon long enough to qualify for carbon removal credits. Nonetheless, we include such products in our framework to provide a more comprehensive view of available carbon removal technologies.

There are basically three types of carbon removal:

Nature-based removal and storage / use: these have land and water use as major constraints to scaling.

Technological removal and storage / use: These tend to have energy and cost as barriers to scaling up.

Hybrid removal and storage / use: These have land and water alongside energy as barriers to scale.

Nature-based removal and storage / use

Afforestation and reforestation: Planting trees where there were none (afforestation) or restoring areas with cut down or degraded tees (reforestation). [3]
Soil carbon sequestration: Using measures such as regenerative agriculture methods, grassland restoration, and wetlands and ponds to reverse past soil carbon losses and sequester CO₂. [3]
“Blue carbon” habitat restoration: Conservation and restoration of degraded coastal and marine habitats such as salt marshes, mangroves, and seagrass beds, so that they can continue to draw down CO₂. [3]
Enhanced ocean productivity: Adding iron or nitrogen to the ocean to increase the rate at which tiny microscopic plants photosynthesise, thus accelerating their take up of atmospheric CO₂. [3]
Seaweed and algae cultivation and burial: Cultivating seaweed and algae and sequestering it by burying them in the ocean’s depth.

Technological removal and storage / use

Direct air capture (DAC) and storage / use: Sucking carbon dioxide out of the air and either burying it underground, binding it chemically to minerals, or using it to build products. [3]
Enhanced weathering: Spreading pulverized rocks onto soils and / or the ocean to ramp up the natural rock weathering process that takes up CO₂ from the atmosphere and eventually sees it washed into the ocean as bicarbonate. [3]
Concrete building materials: Using CO₂ to “cure” cement or in manufacturing aggregates to store CO₂ long term and displace emissions-intensive conventional cement. [3]
Hydro-carbon fuels: Combining hydrogen with CO₂ to produce hydrocarbon fuels, including methanol, synfuels, and syngas to replace fossil fuels. [5]
CO₂-enhanced oil recovery (EOR): Injecting CO₂ into oil wells to increase oil production so that more CO₂ is injected and stored than is produced on consumption of the final oil product. [5]
CO₂-chemicals: Reducing CO₂ to its constituent components using catalysts and chemical reactions to build products such as urea (used as fertilizer) or polymers. [5]

Hybrid removal and storage / use

Biochar: Biomass that has been burnt at high temperatures under low oxygen levels to create biochar that is then added to soils. [3]
Bioenergy with carbon capture and storage (BECCS): Farming bioenergy crops, which extract CO₂ from the atmosphere as they grow, then burning them for energy and sequestering the resulting emissions underground. [3]
Building with biomass: Using plant-based materials in construction, sorting carbon and preserving it for as long as the building remains standing. [3]

Evaluation criteria

To evaluate the different carbon reduction and removal pathways, we apply four qualitative evaluation criteria: Additionality, permanence, measurability and scalability.

Additionality: GHG reductions or removals are additional if they would not have occurred in the absence of a market for carbon credits. If the reductions / drawdown would have happened anyway – i.e., without any prospect for project owners to sell carbon credits – then they are not additional. Additionality is essential for the quality of carbon credits – if their associated GHG reductions are not additional, then purchasing credits in place of reducing your own emissions will worsen climate change.

Evaluating whether GHG reductions are additional can be deceptively tricky. The challenge is that GHG-reducing activities occur all the time. Sometimes this is because the activities are required by law. Landfill operators in California, for example, are required to install equipment that captures and destroys methane. In other cases, investments that reduce emissions are made simply because they are profitable, without considering carbon credits. An investment in energy-saving lighting, for example, can pay for itself through avoided energy costs. Similarly, renewable energy technologies, like wind and solar, are increasingly cost-competitive with fossil fuels, without revenue from carbon credit sales.

For an activity or project to be additional, the possibility to sell carbon credits must play a decisive (“make or break”) role in the decision to implement it. While additionality is the most essential ingredient of carbon credit quality, its determination is subjective. Determining whether an activity is additional requires comparing it to a scenario without revenue from the sale of carbon credits. Such a scenario is inherently unknowable and must be determined using educated predictions (such as future fuel, timber, or electricity prices). The determination can also fall prey to “information asymmetry”: only a project developer can say whether the prospect of selling carbon credits was truly decisive, but regardless of the truth, every project developer has an incentive to argue that it was. In light of these uncertainties, it is best to think of additionality in terms of risk: how likely is a project to be additional? [10]

For carbon removals, in particular, the concept of additionality is of lower importance at this point in time as most removal technologies, except for afforestation and reforestation, are not yet ready to scale and rely on mechanisms like carbon credits to be put in place. Hence, most removal projects have high additionality by definition.

No additionality = the project would have been realized even without the carbon credit
Low additionality likelihood = the likelihood that the project would have been realized without the credit is significant
High additionality likelihood = without the carbon credit, the project would have probably not been realized

Permanence: One challenge with using carbon credits to compensate for CO₂ emissions is that the effects of CO₂ emissions are very long-lived. Most of the carbon in a ton of CO₂ emitted today will eventually be removed from the atmosphere. However, around 25% remains in the atmosphere for hundreds to thousands of years.

To compensate for this, carbon credits must be associated with GHG reductions that are similarly permanent. If a carbon reduction or removal is “reversed” (i.e., GHGs are subsequently emitted so that no net reduction occurs), then it no longer serves a compensatory function. The greatest risk occurs with projects that store carbon in “leaky” reservoirs. The classic example is a forestry project that keeps carbon in trees and soils (and adds to those carbon stores over time, as the forest grows). Such a project will reduce CO₂ emissions – and increase removals – if the trees would have been cut down otherwise. But, if a fire later burns down the project’s trees, some or all of the carbon may be (re)emitted, leading to a reversal. The permanence of CO₂ removal differs across pathways, ranging from temporary (e.g., forests, soil) to effectively permanent (e.g., mineralization, geological). [8]

Temporary = less than 100 years, high risk of leakage
Permanent = more than 100 years, moderate risk of leakage
Highly permanent = more than 100 years, low / no risk of leakage

Measurability: Suppose that, for every 50 additional tons of CO₂ that are reduced by a reduction or removal project, the project developer reports reducing 100 tons, and 100 carbon credits are then issued to the project. Half of these credits would have no effect in mitigating climate change, and using them in lieu of reducing your own emissions would make climate change worse.

Overestimation of GHG reductions can occur in several ways:

Overestimating baseline emissions. The first and most subtle way GHG reductions can be overestimated is if a project’s baseline emissions are overestimated. Baseline emissions are the reference against which GHG reductions are calculated and are closely tied to additionality: they are the emissions that would have occurred in the absence of demand for credits. Baselines are easier to determine for some types of projects than others. [9] For carbon removals, the baseline is usually business as usual, i.e., no removal occurs.

Underestimating actual emissions. Many kinds of carbon reduction projects reduce but do not remove GHG emissions. A project’s GHG reductions are quantified by comparing the actual emissions produced to the predicted baseline emissions. In the same way that baseline emissions can be overestimated, actual emissions can be underestimated – with both contributing to an overestimation of GHG reductions. [9]

Failing to account for the indirect effects of a project on GHG emissions. To quantify GHG reductions, actual and baseline emissions are determined for sources (or sinks) affected by a project. However, a project will often have both intended and unintended effects on GHG emissions. If quantification methods fail to account for GHG emission increases caused by the project at some sources (even indirectly), then the total net GHG reductions will be overestimated. Unintended increases in GHG emissions caused by a project outside of its boundaries are referred to as “leakage.” [9]

Credits may be issued for GHG reductions that a project developer expects to achieve in the future – so called “forward crediting”. Such practice is usually problematic because it can lead to an over-issuance of carbon credits if a project fails to perform as expected. It can also pose issues if future events (e.g., regulatory changes) lead to additionality or emission reduction ownership concerns. [9]

To control for all these possible overestimation causes, it is crucial to monitor and verify a project’s performance. It is essential for measurement and data collection procedures – and for any calculations or estimates derived from these data – to be scientifically sound and methodologically robust. Verification entails assessing the veracity of data provided by project developers, often through an audit of selected data samples. Carbon reduction or removal project developers have an incentive to report data that maximize the number of carbon credits they can sell. Verification helps to assure that reported data are accurate and do not overstate GHG emission reductions. [9]

Poor measurability (no verification) = no project data available and hence no verification of carbon impact
Moderate measurability (no verification) = while some project data is available, no generally accepted verification protocols are in place
Good measurability (verified) = high-quality project data is widely available and verified through renowned and standardized processes

Scalability: Whether we can scale carbon reduction and removal solutions depends on a variety of factors, including the potential a given pathway has to remove CO₂ from the atmosphere, cost-effectiveness, level of readiness to be deployed, and how quickly the carbon sink reaches capacity.

Nature-based solutions, while not without challenges, are largely affordable, readily available, and have an important role to play in both the near- and long-term. For example, afforestation projects have a significant potential to draw down CO₂ from the atmosphere already today, and the technology is ready to scale. However, in the longer run, afforestation might run into land-availability problems. Technological solutions like direct air capture, on the other hand, may not be constrained by land availability, and might even offer more permanent storage. Yet, they are energy-intensive, are technologically not yet ready to implement at scale, and require further development to reach commercial viability.

Scalable in the short-run only = Scalable in the short-term due to availability of natural resources and readiness of technology
Scalable in the long-run = Not scalable in the short-term but once in the medium and long-run
Highly scalable = Scalable short and long-run

For convenience, we give each carbon reduction and removal pathway a subjective overall quality score. We based on the individual performance of each pathway’s additionality, permanence, measurability, and scalability. We use the following scores:

A = Premium quality (i.e., high additionality, permanence, measurability, and scalability)
B = High quality (i.e., high to moderate additionality, permanence, measurability, and scalability)
C = Moderate quality (i.e., performs poorly in either additionality, permanence, measurability, or scalability)
D = Low quality (i.e., performs poorly on several of additionality, permanence, measurability, or scalability)

Lastly, we look at price as an evaluation criterion for carbon credits. In the voluntary carbon market, there is no one price per ton of CO₂eq reduced or removed like in the compliance or regulated carbon markets. Price is driven by the underlying project costs of the specific carbon reduction or removal pathway, alongside the pathway's associated value chain. Mostly, the value chain can be broken down into project developers (e.g., regenerative farmers, reforestation projects), verification and validation agencies (e.g., measurement standards like the Gold Standard or Verra) and market intermediaries (e.g., banks, traders, insurers) and lastly the buyer. For example, costs of a typical afforestation carbon removal project are usually allocated accordingly: 40% to the project developer, 30% to the verification and validation agencies, and 30% to intermediaries. Moreover, demand and supply dynamics play a pivotal role in pricing. Currently, demand for carbon removal credits exceeds supply and hence, prices tend to be rather high especially for high quality credits (i.e., high additionality, high permanence removals).

Evaluation of carbon reduction and removal pathways

Based on the above-mentioned evaluation criteria, we evaluate each carbon reduction and removal pathway and summarize this in the table below. Please note that this high-level evaluation simplifies and may not consider all aspects of individual projects within a specific carbon reduction or removal pathway. Also, a comparison between carbon reduction and carbon removal is problematic for various reasons. Firstly, the reduction has to happen regardless and needs to be subsidized if not affordable. Hence, the carbon reduction credits are paramount and need to be scaled. Secondly, carbon removal has to be scaled on top and not in place of carbon reduction. Therefore, we hope this comparison is not misleading and would like to remind the reader that reduction and removal have to be similarly scaled to achieve net-zero targets.

As shown in the table, the quality of a carbon reduction or removal credit correlates strongly with the price of the credit. Especially the additionality and permanence of a given carbon removal pathway have a high impact on price.

Carbon reduction credits are, on average, the cheapest credits in the market. While they have a relatively low additionality likelihood and permanence does not apply as they do not remove carbon, they are already quite established. As well, mechanisms exist to measure and validate the credits generated by the underlying projects. Moreover, as mentioned above, carbon reduction needs to happen anyways on top of carbon removal. Such credits should thus not be understood as inferior to carbon removals, even if our valuation might give that impression.

Within nature-based removal and storage / use pathways, ocean-based pathways could provide solutions to remove carbon in a highly additional and permanent way from the atmosphere. Since limitations for nature-based pathways are constrained mainly by land and water availability, those technologies allow for up-scaling in the short to long-run while still being affordable.

Technological removal and storage / use together with hybrid removal and storage / use are on average the most permanent way to remove carbon while still being highly additional (except for enhanced oil recovery). While prices are still relatively high for these pathways, it is essential to invest in the underlying technologies to improve energy efficiencies and drive the cost-curves down to increase economic scalability in the medium and long term.

Conclusion

Our assessment of carbon reduction and removal pathways focused primarily on different quality criteria and the price of carbon credits for each pathway. As expected, the quality of carbon credits correlates highly with the price. However, when building a carbon reduction and removal portfolio, corporations and individuals may consider a multitude of decision criteria reaching beyond the trade-off between the chosen quality criteria and price, including:

Credit availability: Due to the high number of net-zero pledges made during COP26 and even before, the voluntary carbon market currently has more demand than supply for credits, particularly for high-quality credits. As a result, buyers often need to offset most of their emissions with higher supply credits such as afforestation, reforestation or forestry-based avoidance (REDD+).
Long-term technology development: Some carbon removal pathways (particularly technical carbon removals) may be sold at a higher-than-cost price to enable technological innovation to bring down the future costs of such technologies. This is often made transparent to buyers and may motivate them to offset their own emissions and support a specific technology to scale in the longer term.
Other impact considerations: Some pathways may have other positive impacts beyond just GHG emission reduction or carbon-dioxide removal, such as biodiversity protection, freshwater resource protection, improvements in soil health, and provision of livelihoods for local communities.
Own emission reduction: Corporations and individuals may aim to reduce their own emissions wherever possible and hence, make investments to improve their carbon footprint and therefore diverting budget away from external carbon reduction and removals. This should be prioritized before exploring opportunities within the voluntary carbon market to help move the entire economy towards net-zero.
Story-telling: Corporations, in particular, are often driven by the underlying story of a specific carbon reduction or removal pathway and use that story for marketing purposes.

Given the multitude of relevant considerations, there is not one but many ways to put together an effective carbon reduction and removal portfolio. Also, it is critical to keep in mind that all pathways are needed to reach net-zero. To provide corporations and individuals with some input and inspiration, we share examples.

Let’s start with corporate carbon reduction and removal portfolios. Most corporations begin with assessing their current carbon footprint and then either approach their credit purchasing with a financial imperative (to spend as little per credit as possible but purchase the full volume of carbon credits) or with a marketing imperative (to support technological development or support local communities). Moreover, credibility of credits is important for many corporations to minimize reputation risks for their net-zero strategy.

An example is Microsoft, a pioneer offsetting its emissions and publicly sharing its portfolio and expertise to catalyze discussions and collaborations, leading to a more robust global market for corporate procurement of carbon removal solutions.

Microsoft’s carbon reduction and removal portfolio [12]

Microsoft’s portfolio consists of mainly nature-based removal credits, which allow for carbon removal at a relatively low cost. However, Microsoft also has a significant allocation to technological removal and storage / use (esp. DAC) and hybrid removal and storage / use, which is significantly more expensive than nature-based pathways. Even though such an allocation may not be cost-efficient, it poses higher additionality and permanence of the carbon removed.

On the other hand, individuals may be driven by all kinds of influencing factors in portfolio construction, including factual drivers (e.g, price, quality, etc.) alongside emotional drivers (e.g., moral concerns). For example, an individual living in Switzerland may want to compensate for their yearly footprint, which we estimate to be about 20t CO2eq (factoring in the indirect emissions we all produce). If that individual has a spending limit of about CHF 2’000 p.a. (i.e., CHF 100 per ton) a potential distribution could look as outlined in the figure below.

Example of an individual's carbon reduction and removal portfolio

This example portfolio considers the before-mentioned budget whilst maximizing additionality, permanence, measurability, and scalability. Therefore, cost-efficient credits such as afforestation make up a large share of such a hypothetical portfolio. Since biochar is rather cost-efficient while still highly permanent and has relatively high additionality, we have allocated a large part of the budget to this pathway. Moreover, we have added DAC and soil carbon sequestration to the portfolio to support emerging removal technologies. For individuals, multiple services for calculating the personal carbon footprint and then offsetting emissions through reduction and removal credits exist. Examples for such services include myclimate, NativeEnergy, Clear, and atmosfair (specialized in air traffic emissions).

With this article, we hope to provide practical guidance for navigating the complex and vast jungle of voluntary carbon reduction and removal credits based on our current market understanding. We hope that we can contribute to supporting everyone interested in the space to make better purchasing and investment decisions. Moreover, we see this article as an opener for discussions and potential future collaborations – so please don’t hesitate to reach out and share your thoughts and feedback.

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About the authors

Alexander Langguth is a co-founder and managing partner at Übermorgen Ventures. After multiple years at the leading strategy consultancy McKinsey & Company, where Alex primarily worked with clients in the energy, industrial and technology sectors, he has worked exclusively with companies, investors, and governments in the climate tech and sustainability space. Alex is also closely associated with the Center for Sustainable Finance and Private Wealth at the University of Zurich and the Chair of Sustainability and Technology at ETH Zurich.

Adrian Bührer is a co-founder and managing partner at Übermorgen Ventures. Already at the age of 22, Adrian co-founded the largest student portal in Switzerland and successfully sold it to Axel Springer in 2007. Since then he has invested in or co-founded more than 20 ventures. He is co-founding investor and chairman of farmy.ch, one of Europe’s most successful sustainable food tech startups.