House of [Recycled] Cards: An Overview of the Precarious Carbon Offset Market

“Carbon Farming” is the process of developing, measuring, auditing, and monetizing CO2 sequestration initiatives (eg. sustainable farming, carbon sinks, forestry conservation) in the form of “carbon offsets”. These carbon allowances or credits are priced based on provable impact over a period of time. The base unit of measurement is generally a tonne (spelled with the “ne”, these are international projects) of deliberately sequestered greenhouse gas emissions, or tCO2e (tonne of CO2 equivalent).

In practice, one has to prove beyond reasonable doubt that one will enduringly cultivate the land using carbon-neutral practices. The completed and/or projected net carbon sequestration over a period of time is valued based on a recognized framework such as the Gold Standard. Newly branded ‘carbon consultants’ aid with these calculations, and help project developers budget their unique requirements to expand operations. This ‘offset opportunity’ is generally offered to a regional marketplace, where brokers match it with large institutional clients. Refer to this Bloomberg diagram, which excludes the FinTech/DeFi contingent.

Source: Bloomberg “Carbon Offset Trading Is Taking Off Before Any Rules Are Set”

The carbon credit market is technically split into two: Compliance to meet legal regulations, and Voluntary to follow through on social pledges or succumb to peer pressure. Either way, it is largely dominated by multinational corporations with massive carbon footprints, trendy ESG commitments, and/or financial foresight:

Source: Bloomberg “These Trees Are Not What They Seem: How the Nature Conservancy became a dealer of meaningless carbon offsets”

Since large corporations are the primary consumers of these credits, the products and exchanges are generally region-specific and business-facing.

• EU Emissions Trading System (ETS)
• CME CBL Global Emissions Offset (GEO)
• California Carbon Allowance (CCA)
• Regional Greenhouse Gas Initiative (RGGI)
• Private contracts with Projects, Conservancies, Issuers, Brokers

Climate tech, FinTech and DeFi startups have made this market more accessible from both the supply and demand side.

• Pachama: IoT, Satellite, machine vision driven validation system for growers + accessible marketplace platform for organizational consumers
• Verra: Modern registry and auditor for numerous standards
• Nori: peer-to-peer decentralized marketplace with audited Nori Carbon Removal Tonnes (NRTs using blockchain) available to any retail investor.
• KlimaDAO: newly launched crypto-native solution structured around Tokenised Carbon Tonnes (TCTs), a blockchain accounting of externally audited verified carbon units that backs the KLIMA currency.

But the carbon market is in disarray at the moment. There is fierce debate over the price of 1 tonne of time-offset CO2, and the necessity of directly inducing the environmental benefit instead of simply stewarding: “If Nature Conservancy is enrolling landowners who had no intention of cutting their trees, they’re engaged in the business of creating fake carbon offsets.” On the other hand, the Lionshead Fire in Oregon burned through one of the largest forest offset projects participating in California’s carbon market. The precedented risk intrinsic to maintaining certain regions should be priced in, potentially in partnership with parametric insurance providers like Arbol. Ultimately it comes down to valuing a projects ability to verifiably sequester CO2 in a reliable environment and sustainable manner.

And how does one do this? Documentation. Several years of land records, agricultural measurements, sensor data, weather, natural events, academic study, any information is helpful. Data availability is an important consideration for carbon-based accounting and investment. In order to trade on exchanges such as California Cap and Trade, CME:GEOV1 and EU ETS Allowance Auctions, or join a FinTech/DeFi solution such as Pachama or Nori; all projects must pass a rigorous screening process for any of the numerous certification for carbon offset products:

• REDD+ Results Units (RRUs)
• Gold Standard Certified/Verified Emission Reductions (CERs for Compliance, VERs for Voluntary)
• Verra Verified Carbon Unit (VCU)
• Nori Carbon Removal Tons (NRTs)
• KlimaDao Base Carbon Tonnes (BCTs)
• Generic “Ton of CO2 (or Equivalent) Removed” or tCO2e

Startups such as Yard Stick are developing in-ground solutions using IoT to “measure soil carbon at scale”, and Pachama is attempting a complementary system using satellite imagery and machine vision. Their goal is to lead a data-driven approach to carbon accounting and pricing, which accelerates the verification and accounting processes. More importantly, it lays the foundations for a more scalable “trustless” marketplace, where one can rely on certified sensor data and tamper-proof blockchain transactions. The upcoming convergence of the crypto and carbon worlds through Nori (NRT) and KlimaDao (KLIMA) launches is worth tracking; but we are ways away from implementing such an automated, decentralized marketplace.

Yardstick automated soil carbon measurement solution. Source

Nori’s accessible marketplace allows retail buyers to remotely offset their carbon footprint. This has the same basis of the credit model for more complex products listed on official exchanges: in theory, 1 tonne of carbon removed in Norway negates 1 ton generated in New York. I ended up buying some Nori Removal Tons (NRTs) to test this out, only to realize that suppliers and issuers can sell previously unaccounted for carbon. My NRTs represented carbon sequestered in Iowa from 2015–2016:

Source: Author’s certificate

I found that such “Vintage” credits are actually common practice: given the relatively broad time horizon of mother nature, the carbon sequestered today and +/- 5 years is somewhat equally valued. This presents a significant challenge with dubious credits such as those backdated from 2011 Chinese wind farms, as well as those issued by Nature Conservancy to the likes of JP Morgan and Disney. This led to the creation of a primary authority in this space: the “Task Force on Scaling Voluntary Carbon Markets” (TSVCM). And though I wholly support Nori’s marketplace concept, my carbon credit purchase left me feeling hollow: I simply claimed some Iowan carbon sequestered in 2015. Our goal should be to accelerate climate action, not just cash in on past credits. Investors and consumers are have become increasingly aware to this fact and expect ‘Carbon Sourcing’ reports that match the domain, such as KlimaDao’s DeFi-based report.

High-quality, forward-thinking offsets that actually remove additional carbon from the atmosphere are extremely rare. Credits based on avoiding emissions made up 96% of all contracts issued in 2020, mostly by seeking to prevent trees from being cut down or support self-sufficient renewable energy projects. Climate scientists are cautious of using such credits to erase a company’s ongoing pollution because it’s very difficult to determine how much carbon, if any, has really been saved.

So, how does a patch of land go from being a corn field in Iowa to a legitimate carbon offset/allowance/credit product? The Task Force published a comprehensive report here, and Oxford outlined a set of principles for “Net Zero Aligned Carbon Offsetting” here. Most companies have not yet adopted the ambitious scope, as the important takeaways are:

1. Additionality, meaning the project would not have happened without the offset program payments.
2. Permanence, meaning the offset project is likely to reduce emissions, or store carbon in soil/trees, for a long period of time.
3. No double counting, meaning the entity represented by an offset is only counted once
4. No leakage, meaning avoided deforestation in one area doesn’t lead to higher rates elsewhere
5. No additional social and environmental harm, meaning offset projects do not jeopardize indigenous livelihoods or local cultures/traditions

I would add one more:

6. Transparency. It is imperative that projects enable monitoring solutions to store tamper-proof digital measurements on a public ledger

These guidelines provide an excellent rubric against which the market should judge carbon sequestration initiatives, but this would devalue the bulk of currently issued carbon offsets. It is becoming clear that a carbon allowance should represent an actionable investment in a verifiable, ongoing, carbon-negative project. Proving and quantifying the authenticity and impact of such projects is the primary bottleneck, which will soon be aided by camera and sensor based solutions as well as blockchain technology. As businesses continue to postpone their “going green” efforts, there will be increasing demand for well-documented, digitally-accessible, and highly-scalable carbon sequestration opportunities.

Shoutout to Terra.do’s Climate Change for Software Engineers program!