Greenhouse Update (National)

Carbon offsets

Offsetting generally involves an organisation investing in an external abatement project through the purchase of offset credits and acquitting or retiring those credits so as to offset or neutralise its own emissions. For example, a company that emits 10,000 tonnes of carbon dioxide equivalent (tCO2e) per year could neutralise its emissions by purchasing and retiring offset credits from a forestry project that absorbs 10,000 tCO2e per year. By compensating for its annual carbon emissions through offset projects, the company is said to become 'carbon neutral'.

Companies invest in offset credits for a variety of reasons including, increasingly, the desire to market their company or products as being 'carbon neutral' or carbon 'friendly'.

The growth of voluntary markets

Voluntary carbon markets essentially consist of all those trades of offset credits that are not required by regulation. They can be divided into two main segments: the voluntary, but legally binding, Chicago Climate Exchange (CCX), and the broader over-the-counter (OTC) offset market comprised largely of bilateral trades outside of a central exchange.

Voluntary carbon markets have grown dramatically in the last 5 years. There is now a wide variety of sellers, buyers and abatement projects. A recent study has found that between 2006 and 2007, voluntary carbon markets globally more than tripled in value to US$331 million (up from $96 million in 2006), accounting for a total volume of 65 tCO2e (see Ecosystem Marketplace and New Carbon Finance, State of the Voluntary Carbon Markets 2008 ). Even larger increases are predicted for 2008.

A whole industry has developed for the provision of voluntary offset credits and services. In Australia alone, there are now over 50 carbon offset providers offering different types of offset products, up 40% in the 3 months between March and June 2008 ( Carbon Offset Guide Australia - Summary of Providers ).

Although voluntary carbon markets remain only a fraction of the size of the regulatory carbon markets globally, they have experienced a higher growth rate in recent years. The question is whether such growth will continue, in the face of increasing government regulation and the introduction of mandatory carbon trading schemes by governments around the world.

The future of the voluntary carbon market in Australia 

The voluntary carbon market in Australia is likely to face significant changes in the next few years as a result of:

• calls for greater regulation of the voluntary market; and
• the introduction of a regulatory carbon market under the Carbon Pollution Reduction Scheme (CPRS).

The impact of these changes is discussed below.

Increasing standardisation and regulation

One factor likely to influence the development of the voluntary carbon market is the need to address issues surrounding the credibility of particular offset products. Concerns about the 'wild west' nature of the voluntary carbon market, and recent negative press coverage about some offset schemes and marketing claims, has lead to some scepticism about the validity of voluntary emission reduction initiatives.

Accreditation standards

To help address concerns about the unregulated nature of the voluntary carbon market, offset providers are increasingly using third party accreditation standards to demonstrate the credibility of their credits. These standards often draw on regulatory market methodologies (such as those under the Kyoto Protocol's Clean Development Mechanism) and seek to address the issues of additionality, of verification and monitoring, of the permanence of the emission reduction, of possible 'carbon leakage', and the potential for double counting.

 In 2007, it is estimated that as much as 50% of transactions in voluntary markets involved credits verified to a specific third party standard (see Ecosystem Marketplace and New Carbon Finance, State of the Voluntary Carbon Markets 2008). Sellers are increasingly using these standards as a means of proving their legitimacy, and buyers are increasingly requesting certified credits as one means of assessing credibility.

The most frequently used standards internationally are:

• The Voluntary Carbon Standard;
• The Gold Standard for voluntary offsets;
• VER+; and
• the standards of the Chicago Climate Exchange for offset projects.

In Australia, the most recognised certification scheme is Greenhouse Friendly™, run by the Commonwealth Government. The scheme provides for Greenhouse Friendly™ certification of approved abatement projects, following a life cycle assessment and independent verification of emissions reductions. Abatement projects must occur in Australia and must generate additional, permanent and verifiable emissions reductions or sequestration.

Government regulation

For buyers, however, the proliferation of standards is perhaps creating more confusion than clarity in the market. Governments are now starting to intervene in this area to provide greater clarity for buyers.

For example, in early 2008, the United Kingdom's Department for Environment and Rural Affairs (DEFRA) launched a Code of Best Practice for Offset Providers based in the UK, which is designed to provide consumers clarity and confidence when they choose to offset. It currently endorses only Kyoto-based offset credits.

In Australia, the Rudd Government has promised to introduce a single national standard for offset credits by the end of 2008. The Australian Carbon Offset Standard is expected to :

• require all offset products on the market to be accredited;
• specify minimum standards for offsets;
• include verification and validation protocols and standard methods of calculating carbon neutrality;
• require credits to be cancelled when used to provide an offset;
• require ongoing management where necessary to ensure integrity;
• provide a nationally consistent approach to offsets, building on existing schemes like the Commonwealth's Greenhouse Friendly Program; and
• take account of international developments.

This standard is due to be completed at the end of 2008, but little information had been publicly released about its development or requirements. Carbon offset providers in Australia will be particularly keen to know whether offset credits which are already accredited under a recognised international or national standard will be automatically accredited under the new Australian standard.

Issues to consider when purchasing and marketing credits

In the meantime, businesses which plan to acquire offset credits as part of a voluntary carbon reduction strategy need to do adequate due diligence on the nature of credits being acquired and take care to ensure the purchase contract accurately defines their expectations. Our article 'Going carbon neutral - real green or just green wash?' in Greenhouse Update 17 May 2007 explains in more detail some of the issues which companies need to consider.

In addition, businesses which intend to use offset credits to make claims about the carbon footprint of the organisation or one of its products should be aware that the Australian Competition and Consumer Commission (ACCC) has ramped up its scrutiny of carbon claims and is acting on its warnings to take enforcement action with respect to claims that mislead consumers. For more guidance on this issue, see the ACCC's guidelines on Carbon claims and the Trade Practices Act and our Greenhouse Update 11 July 2008.

The impact of the CPRS

The introduction of the CPRS is also likely to have a significant impact on the voluntary market, but the extent of that impact will not be fully known until the design of the scheme is finalised and trading commences in 2010.

Overview of CPRS design

As discussed in our Greenhouse Update 17 July 2008 , the Federal Government's Carbon Pollution Reduction Scheme Green Paper (Green Paper) proposes that the CPRS will commence in 2010 and be a broad-based, cap-and-trade scheme requiring liable companies to surrender at the end of each year eligible carbon permits to account for their GHG emissions. The scheme will cover GHG emissions from stationary energy, transport, fugitive emissions, industrial processes, waste and forestry sectors. Agriculture will be initially excluded from scheme coverage, but the Government will consider covering this sector from 2015, with a decision to be made in 2013.

One design feature suggested for the CPRS by previous working groups was the creation of a regulated offsets regime for sectors not covered by the scheme. Under such a regime, eligible abatement projects in uncovered sectors could generate scheme credits which could be sold in the market and be acquitted to satisfy scheme obligations.

However, the Federal government sees little scope for the introduction of a regulated offsets regime, at least initially, given the broad coverage of the Scheme. The Green Paper indicates that the Government does not propose to introduce a regulated offsets regime for uncovered sectors during the initial period of the Scheme's operation (2010-2013). It will, however, consider in 2013 the scope for offsets from emissions sources that cannot be included in the Scheme, following final decisions on coverage of agriculture emissions.

Implications of the CPRS for the voluntary carbon market in Australia

It seems likely that there will be less demand for offset credits in the voluntary market from companies in sectors covered under the CPRS. The carbon strategies of these companies are likely to focus on reducing actual emissions or acquiring eligible carbon permits to satisfy their scheme obligations. According to the Green Paper, voluntary offset credits will not be able to be converted into eligible carbon permits under the Scheme. As a result, it seems likely that there will be less demand for credits in the voluntary market from the 1000 or so firms with activities covered by the scheme.

Given that the CPRS is likely to cover about 75% of Australia's emissions, the reduction in demand for voluntary credits from covered sectors could well be significant. In the Draft Report of the Garnaut Climate Change Review , Professor Garnaut suggests that the introduction of the CPRS is likely to 'cannibalise' the market for voluntary credits, but he acknowledges that the nature and pace of impacts are uncertain at this time.

On the other hand, demand for credits in the voluntary market will probably continue from those companies (including companies in covered sectors) wishing to acquire credits to support marketing claims about carbon neutrality or the carbon benefits of their products. One of the underlying concepts of offsetting is that the carbon abatement should be 'additional' to what would have occurred under existing regulatory requirements. This principle is unlikely to be satisfied by a company claiming as an 'offset' the value of carbon pollution permits acquitted in accordance with regulatory requirements under the Scheme. Accordingly, even companies in the covered sectors may continue to seek voluntary credits to support particular green marketing claims.

On the supply-side, there may be a shift in the volume and type of credits offered in the voluntary market. Whilst the Government does not propose to create an offsets regime for uncovered sectors at this stage, it does propose that certain forestry projects will be eligible to earn carbon permits under the Scheme for carbon sequestered in Kyoto-compliant forests. As a result, we may see some forestry credits flow from the voluntary sector to the compliance market.

In the future, the Government may also recognise other abatement or sequestration activities as being eligible to earn carbon permits under the Scheme. This could include sequestration in the agricultural sector (once a decision in made in 2013 about whether agriculture should be included in scheme coverage) and abatement as a result of avoided deforestation (depending on the outcome of international negotiations). If this occurs, credits from projects in these sectors may also flow to the compliance market.

As a result of the introduction of the CPRS, there may also be a change in the nature of credits offered in the voluntary market in Australia. Offset providers are increasingly offering voluntary market buyers regulatory or 'compliance-grade' credits as a means of establishing the credibility of their products. For example, a number of offset providers in the Australian market currently offer offset products in the form of Abatement Certificates under the New South Wales Greenhouse Gas Abatement Scheme (GGAS) or Renewable Energy Certificates under the Mandatory Renewable Energy Target Scheme (MRET).

The introduction of the CPRS will see a new type of regulatory credit come into existence in Australia: a carbon pollution permit known as an "Australian emission unit" (AEU).The Government proposes not to place restrictions on who may purchase AEUs. It also intends to allow AEUs to be voluntarily surrendered to the regulator, which would be noted in the central electronic register.

This means that voluntary carbon market buyers will be able to purchase, track and voluntarily surrender AEUs as a means of voluntarily offsetting their emissions. As AEUs are likely to be regarded as "highly credible" credits, supported by mandatory measurement, reporting and verification requirements, there is likely to be considerable demand for these credits in the voluntary market (depending on their relative price).

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