Carbon Insetting: Doing More Good Than Less Bad

July 15 2024 Hussein Gouda

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Carbon Insetting: Doing More Good Than Less Bad

Following the 1997 Kyoto Protocol, the first binding climate change agreement by the United Nations, which laid the foundations for new climate policies, and as part of the evolution of carbon offsetting, several countries started adopting carbon trading, more formally known as the Clean Development Mechanism. The UK was the first to roll out the scheme in 2002, and it was soon followed by the EU’s similar cap-and-trade Emissions Trading System in 2005. In the years that followed, carbon trading gained global traction. By 2021, the global compliance carbon market size had reached a whopping $850 billion—almost 2.5 times its value in 2020—while the voluntary carbon market quadrupled to reach $2 billion. The voluntary market is also expected to grow five times by 2030. Amidst these developments, carbon insetting emerged as a superior approach, focusing on doing more good rather than just doing less bad.

Table of Contents

The Clean Development Mechanism essentially allows countries to fund greenhouse gas emission-reduction projects in developing countries to offset their own emissions and reach their net zero targets through carbon credits. These carbon credits could then be sold and bought by companies and individuals wishing to compensate for their own emissions. Put simply, a factory in Europe can emit 100 tons of carbon dioxide into the atmosphere if it plants enough trees in a developing country to offset those 100 tons. However, once implemented and studied, the mechanism proved to be flawed on several fronts, even perpetuating the crisis at times, according to multiple studies.

The Problematic Trinity: A Flawed Mechanism

The Homogeneity Problem

The mechanism is based on a set of flawed assumptions; it assumes that emissions and climate change have a linear relationship, that a one-on-one tradeoff is present between emissions and offsets, and that all carbon credits are equally valuable regardless of the timing and location of the emissions. The assumption of emissions and climate change being linear is questionable because climate change reaches a threshold beyond which it becomes irreversible. Losing the Greenland and West Antarctica ice sheets, for example, could result in glacial collapses, methane escaping from permafrost, and sea level rise. Land and forests also store different amounts of carbon based on a host of factors, and, of course, deforestation activities then lead to the release of the trapped carbon dioxide into the atmosphere, a single ton of which could last anywhere between a thousand and 35,000 years.

Offsetting and emitting also do not share a one-to-one relationship because offsetting just one ton of carbon dioxide usually requires sequestering more than that one ton. In fact, a lot of carbon sequestering projects pose a threat to nature – you can only inject so much carbon into the soil. Even when specific plantations are set up to sink carbon, they usually entail replacing native forests, displacing local communities. They also pose a risk to the environment in cases of natural disasters, turning these projects from carbon sinks to carbon sources. The final assumption—all carbon credits are of the same value—is also incorrect because a plane traveling during the day, for example, has a different effect on the climate than a plane traveling during the night. Research has also shown that while carbon dioxide produced locally can form “domes” that trap emissions near the initial source, the effects of carbon dioxide and how it interacts with the atmosphere are also specific to each region.

The Injustice Problem

Given the mechanism’s competitive nature, carbon offsetting projects tend to get set up in industrialized or industrializing countries, like China and India, often overlooking countries that are in greater need of these projects, widening the inequality gap between countries. These poorer countries are left at a disadvantage because low-carbon technologies and their property rights are concentrated in Western countries, and even if the poorer countries were to develop their own technologies instead of relying on the West for them, foreign companies would have cherry-picked the cheapest projects available. In fact, one survey found that the mechanism has prevented developing countries that host these projects from setting up their own projects due to a lack of suitable sites. It is because of these hurdles that the projects never fulfill their goals of development or emissions reduction.

The Gaming Problem

Another set of problems that come with carbon markets has to do with gaming or manipulation. Some projects’ revenues are used in the production of fossil fuels, like a coal mine in China being approved carbon credits to capture methane as part of its operations, which will later use the money coming from the production of coal. Another flaw is the fact that credits for low-sulfur coal come at a much cheaper price than credits for wind or solar energy projects.

Companies also seem to have figured out a way to abuse the mechanism by intentionally emitting greenhouse gases and then stopping them to produce carbon credits. That was the case with HFC-23-emitting companies, which emit this gas as a result of their production of air conditioners and Teflon. These businesses noticed how profitable HFC-23’s abatement can be and only started producing it to offset it further and make profit from its carbon credits, which became more valuable than its production. Another way companies started abusing the mechanism is through geographic leakage, which sees companies established in regions that impose environmental regulations wishing to escape these regulations and setting up their factories in places without regulations on emissions. Some energy-producing companies located in places that impose a cap-and-trade system on fossil fuels have opted to lower their own production and instead buy electricity from plants in places where such regulation doesn’t exist, meaning their purchase price is cheaper, then sell them for the higher prices caused by the regulations in their own regions.

Possible Solutions: The Search for the X Factor

Incentives and Taxes

Now, carbon trading might be a flawed mechanism to achieve net zero targets, but experts have proposed a multitude of alternatives over the years, some of which have even been implemented. Carbon taxes, for example, are taxes imposed on the production of greenhouse gases or on services or goods that are greenhouse gas-intensive, which, in theory, encourages businesses and consumers to look for cleaner alternatives given the higher price that comes with such a tax. Carbon taxes also somewhat overcome the information problem, since determining the cost of the tax is a lot more certain than that of a carbon credit. Governments can also introduce different incentives to encourage firms and consumers to switch to cleaner options. These incentives can come in the form of tax incentives, or they can come in the form of feebates. Under a feebate scheme, GHG-intensive products have a surcharge applied to them, and environmentally conscious products receive a rebate, which is paid for by the fees collected. The self-financing policy ultimately aims to encourage producers to constantly improve their products in terms of their environmental impact, and it encourages consumers to opt for the product with fewer negative externalities.

Carbon Insetting

However, these options explored also come with their flaws. Carbon taxes, for example, are just another form of greenwashing, and incentives and feebates require a government to implement the policy in a scenario where companies are passive. Going back to the point about information, which can be a problem, it can also be the most viable and efficient way to tackle climate change.

Recent reports by PwC indicate that while CEOs and investors might both agree that climate change requires attention and a response, investors seem to be a lot more aware of the financial risk climate change poses to companies they invest in than their CEOs. In its survey, PwC discovered that investors want to see their CEOs taking action to overcome potential climate change impacts through innovation. 44% of its survey respondents agreed that companies should make greenhouse gas (GHG) emissions reduction their top priority, but they also don’t want to see greenwashing, which 87% of the survey’s respondents believe sustainability reporting by companies contains. Some solutions recommended include implementing initiatives, innovating climate-friendly products and processes, and developing a data-driven climate strategy.

Investors have the right to be worried; according to a PwC report, the dependence of most industries on nature is inextricable. Agriculture, forestry, fishing, food, beverages, and tobacco, and construction are five industries with a high degree of dependence on nature in their supply chains and in their direct operations, and it also affects their direct customers. Other industries, like automotive and real estate, show a moderate degree of dependence on nature, both in their supply chains and their operations. Stock markets have also shown a degree of dependence on nature, with 19 stock markets estimated to exhibit a combined high and moderate degree of dependence on nature of 50%.

But CEOs aren’t exactly resistant to acting; it’s rather a problem of awareness. In a matrix created by PwC, the higher a CEO’s perception of potential climate risk to their company, the higher the company scored on the climate action index. While CEOs ought to accurately estimate their climate exposure and consult their investors, they must also communicate their supply chains. According to several experts, the most effective route to acting on climate change is through carbon insetting—taking an active inside-out approach. Carbon insetting would allow companies to mitigate potential risks while simultaneously overcoming a lot of the flaws that accompany offsetting approaches. Unlike offsetting projects, which have often harmed local communities or at least had no effect on them, carbon insetting has a positive impact on local and indigenous communities.

The first step in the insetting approach is evaluating a company’s supply chain, which includes its energy source and where its raw materials come from. A factory, for example, would substitute conventional energy produced from fossil fuels with wind or solar energy. Insetting also entails sourcing raw materials from suppliers who use climate-friendly practices, as well as companies investing in their suppliers’ businesses to ensure their efficiency and the elimination of negative externalities. As coffee plantations yield better crops in the shade, Nespresso has invested in tree planting in its coffee farms and their surrounding areas, which not only increases the plantations’ efficiency but also offers income opportunities to local communities.

Conclusion

For decades, companies and governments have been attempting a myriad of approaches to tackle climate change, from taxes to carbon credits and incentives. The worsening climate crisis, however, is proof that more serious action is needed. Research suggests that investors expect more companies to tackle the crisis and mitigate its potential risks for businesses, but it also shows that CEOs are willing to act when they’re fully aware of the adverse effects their businesses could face. A recently suggested solution to the problem seems to be the answer to the crisis; it overcomes previous flaws, it allows companies to be the first to act, and it serves its purpose.

As the World Economic Forum put it,

“Insetting focuses on doing more good rather than doing less bad.”