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Fuel for Thought: Carbon offsetting goes mainstream as producers set sights on net-zero

  • Featuring
  • Robert Perkins    Frank Watson
  • Commodity
  • Energy Electric Power Energy Transition LNG Natural Gas Oil
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  • Energy Transition

In the race to hit booming net-zero emissions pledges, carbon credits are seeing a surge in interest from oil and gas producers keen to offset the climate footprint of their fossil fuels.

But with more producers using the financial instruments to market oil and gas as carbon neutral, calls for greater scrutiny over the accuracy and accountability of so-called voluntary carbon offsetting are growing.

The credits themselves fall into four main categories: avoided nature loss, such as deforestation; nature-based sequestration, such as reforestation; avoidance of emissions, such as methane from landfills; and the direct removal of CO2 from the atmosphere.

The projects generating these carbon credits fall into two main categories: the avoidance or reduction of greenhouse gases, such as renewable energy or avoided deforestation; and removal or capture projects, such as reforestation or direct-air removal.

Global carbon offset market volumes by type vs price

The purchasing of voluntary carbon credits to curb net greenhouse gas emissions is nothing new.

In 1996, US-backed carbon sequestration projects in Belize and Brazil were some of the first open to private capital through a market-based incentive program. The carbon accounting mechanism has boomed since then with a spike in interest since the 2015 Paris Agreement.

Tokyo Gas and GS Energy received the world's first carbon-neutral LNG cargo from Shell in 2019, and a raft of carbon-neutral crude and oil product deals have followed in its wake.

In January, Occidental Petroleum claimed the world's first carbon-neutral crude transaction under a deal arranged by financial services group Macquarie. The trade involved the delivery of 2 million barrels of US crude from Oxy to India's Reliance Industries that were offset in part by pulling CO2 out of the air and storing it.

In Europe, BP and Shell have integrated carbon offsetting optionality into their fleet fuel card and consumer loyalty schemes allowing drivers to help offset the emissions produced from their fuel use. BP wants in on the offset market itself and has already invested in Finite Carbon, the biggest US producer of carbon offset credits which helps landowners sell their forests as carbon sinks.

Although the value of the voluntary market is still a fraction of the compliance carbon markets, the Taskforce on Scaling Voluntary Carbon Markets (TSVCM) estimates demand for carbon credits could increase by a factor of 15 or more by 2030 when the market could be worth up to $50 billion.

Offset concerns

But the rising use of carbon offsets and "carbon sinks" to meet climate ambitions has drawn increasing fire from environmental groups which claim they are a distraction from the need to throttle absolute emissions. Skepticism over the credentials of offset credits has led some green groups to call the mechanism an "accounting trick," promoted to allow fossil fuel producers to keep polluting.

Detractors claim the climate science behind carbon abatement and avoidance is unsettled, particularly when it comes to booking outcomes over the multidecade life of many projects.

Deforestation, for example, is one of the biggest sources of anthropogenic emissions globally, making woodland conservation a low-hanging fruit. But mature forests also stop sequestering CO2 eventually and can amplify the risk of forest fires which releases CO2, according to consultants Thunder Said Energy. It's also tough to verify a carbon offset based on a counterfactual such as avoided planned deforestation.

Monitoring and maintaining reforestation projects can also be tricky. A newly planted tree can take up to 20 years to capture the amount of CO2 that a carbon-offset scheme promises, and carbon can be returned to the climate through future fires or destruction.

Carbon credit certifiers such as the US-based Verra, the world's biggest issuer, claim their pools of "buffer credits" can be cashed in when emission reversals occur, effectively insuring against such events. But the buffer credits have yet to be stressed-tested over time and some fear the growing risk of future climate-change events, such as California's wildfires, could swamp their intended utility.

Another key contention is the lack of global recognition and regulation of accreditation and legitimacy. Differing carbon accounting and performance metrics along with the lack of a global governance body leaves the market open to fraud and money laundering, according to TSVCM.

"Today's [voluntary carbon] market is fragmented and complex," McKinsey, which provided research to TSVCM, said in a January report . "Some credits have turned out to represent emissions reductions that were questionable at best."

That's an issue for companies like Shell, which is relying on nature-based solutions as the second-biggest lever in its toolbox to hit its 2050 net-zero target. The energy major is aiming to abate 120 million mt/year of CO2 using "high quality" voluntary carbon credits by 2030.

Work is underway, however, to address many of the shortcomings in the voluntary carbon market. The private sector-led TSVCM, of which S&P Global Platts is a member, in January issued blueprints to establish "core principals" in carbon offset markets to boost governance and pricing transparency. Teething problems aside, it believes a large-scale voluntary carbon market is critical to hitting Paris Agreement targets.

"While the current offset market is incredibly fragmented, there is a possibility of a general shift towards offsets from specific types of projects or environmental criteria as companies take on stricter internal standards for their own purchases and those of their counterparties," said Jeff Berman, head of emissions and clean energy transition at S&P Global Platts Analytics.

Carbon pricing

Nature-based carbon offsets are fast becoming the most popular way for energy majors to manage their emissions alongside renewable projects. While Exxon and Chevron have yet to set targets for dealing with greenhouse gases from fuels sold to customers, Shell and Total each plan to spend about $100 million a year on nature-based carbon offsets. Italy's Eni sees forestry credits as a key plank in hitting net-zero targets and plans to offset 20 million mt/CO2 by 2030, a thirteenfold jump from 2020 levels.

The range of voluntary carbon pricing is wide, depending on the project, but nature-based offsets averaged $4.3/mtCO2e in 2019, three times more than renewables-based credits, according to Ecosystem Marketplace.

Compared to carbon compliance market like the EU Emissions Trading System, however, the cost of buying carbon credits as marketing wrappers for oil and gas sales can be much cheaper than directly reducing emissions.

Exchange-traded ETS allowances, for example, rallied to an all-time high of Eur50/mt ($60.70) CO2 equivalent in early May. Oxy reportedly paid $1.3 million, or $0.65/b, to offset its 2 million barrel crude cargo to Reliance. That equates to just $1.5/mt in CO2 terms.

Growing price gap between EU emissions allowances and carbon credits

With some oil majors spending millions of dollars on nature-based carbon offsets, price discovery is also seen as key to a well-functioning secondary market in offset credits, which is characterized by low liquidity and limited data availability.

A number of platforms have gravitated toward trading based on eligibility criteria used by the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), which launched this year for airlines hoping to achieve carbon-neutral growth.

Platts in January began publishing daily assessments reflecting the CORSIA-eligible carbon credit market, called Platts CEC. After hitting a high of $2.34/mt in March, the CORSIA-eligible credits were pegged at $2.00/mt by Platts on May 5. That's up from just 80 cents/mt when first assessed at the start of the year, but still well below the cost of exchange-traded EU carbon allowances.

Producers will also be hoping that premium pricing will develop for carbon-neutral oil and LNG cargoes, mitigating or perhaps exceeding the costs of buying the original carbon credits. As carbon intensity accounting for specific producing fields evolves, an effective offsetting premium could also be integrated into future cargo prices.

But with offset credit prices still so low, producers may struggle to deflect criticism that the industry is leaning too heavily on offsetting to continue pumping oil and gas rather than as a last resort on the path to carbon neutrality.