(Editor's Note: This article, focusing on forests and soils, is the first in a series where S&P Global Ratings explores various options for reaching net-zero global emissions. Jeff Berman of S&P Global Platts Analytics, a division of S&P Global, contributed to this report.)
- Net-zero commitments by companies and countries remain critical to mitigating climate change, even though GHG emissions are falling this year, not least because they are expected to rebound.
- Capturing CO2 in forests and agricultural soils has the maximum potential to offset 32%-47% of annual CO2 emissions. Biosequestration has the potential to offset approximately 26%-37% of annual global GHG emissions. The offset values could be worth $125 billion-$150 billion for a total market of $175 billion-$250 billion a year, roughly the size of the green bond market.
- Supply for soil-related carbon offset markets could likely come from projects in Sub-Saharan Africa, where the region has larger area of agricultural land to store carbon and low national emissions. Historically, the supply has mostly come from the U.S. Demand for offsets will come from the larger emitting countries.
- However, markets for forest- and soil-based offsets face obstacles such as stagnation in the climate change negotiations, uncertainty about measuring offsets, and wildfires.
Greenhouse gas emissions are expected to dip this year due to fallout from the pandemic that has plunged economies the world over into recession. S&P Global Platts Analytics estimates global GHG emissions will drop 5.5% this year. That would be the largest drop since 1.4% in 2008 during the global financial crisis, according to the Global Carbon Project. That's significant but would still fall short of the 7.6% each year in reductions that the UN Environment Program says the planet needs to keep global warming below 1.5 degrees Celsius under the Paris Agreement. Furthermore, climate watchers expect a rebound in emissions growth once economies restart and try to make up for lost time. This means companies and countries will still need to reduce their emissions further. To be sure, many are committing to becoming "net zero" by 2050, which is in line with the agreement, but is it achievable? Can they really reduce as many emissions as they produce? Here, in this article, we assess the ability of the world's forests and soils to capture carbon and offset emissions.
Going Net Zero: A Trend In Companies' ESG Commitments
Net-zero commitments by companies typically include significant reductions in GHG based on transitioning to low-carbon technologies, with the remaining emissions "netted" through the purchase of carbon offsets. These commitments to net-zero emissions by 2050 are broadly compatible with the Paris Agreement. "Carbon offset" is a loaded term that includes several options intended to mitigate emissions. There are two main types:
- Biosequestration projects that remove carbon emissions from the atmosphere by expanding forests, for example, and
- Technology projects that avoid future CO2 emissions by funding low-carbon technologies, such as renewable energy and carbon capture and storage.
Both have the potential to contribute to annual reductions in emissions either by avoiding them in the first place or by removing CO2 from the atmosphere and storing it in the biosphere. However, to lower global GHG emissions 7.6% each year, low- or no-carbon technologies would have to rapidly replace fossil fuel technologies. (For details about carbon offsets, see the box below.)
Green technologies have been available for several decades now, and yet the demand for fossil fuels has outstripped demand for technology-based offsets and green technologies. Even with the rapid decline in the cost of renewables, global renewable energy consumption has remained largely flat for decades, although recently that picture is starting to change (see chart 1). Still, global GHG emissions have grown every year, with some exceptions and are not likely to contract. Unless there is a fundamental upward shift in the consumption of renewable energy, the world will require increased efforts that remove carbon directly from the atmosphere, such biosequestration--the capture and storage of carbon dioxide by continual or enhanced biological processes--which includes agriculture and forestry but also uptake by the world's ocean ecosystems.
Agriculture And Forestry Can't Do It All
We calculate that biosequestration has the maximum potential to offset approximately 32%-47% of annual global CO2 emissions, or 26%-37% of total GHG emissions. This is without economic constraints factored in. So, even at full deployment, there is not enough supply to create the annual surplus needed to offset historical emissions. In essence, the earth's soils and forests do not have the capacity to offset emissions by all companies. That could mean increased competition for biosequestration offsets and perhaps more of an incentive to transition to low-carbon alternatives.
Forests are not the only source of untapped potential for natural carbon storage; plants can store carbon directly in the soil. Therefore, soil-based carbon sequestration could be another frontier in flattening the emissions curve. In one effort, global commodities trader Cargill has recently announced its scheme to pay farmers in Iowa to store carbon in their soils through better management practices, and in turn will sell carbon offsets based on this practice.
The global potential for soil carbon sequestration and offsets stands at 9%-19% of annual CO2 emissions (3.3-6.8 gigatons (Gt) of CO2 per year) under improved farming management over 20 years, according to estimates from the Global Carbon Project. Practices include "addition of organic manures, cover cropping, mulching, conservation tillage, fertility management, agroforestry, and rotational grazing," according to the researchers Zomer, Bossio, Sommer, and Verchot in their article published in Nature. The potential market for soil-based offsets could be worth $50 billion-$100 billion a year, which assumes carbon offset prices hover at $15 per metric ton of CO2, the price of North American offsets before the pandemic, according to S&P Global Platts.
The maximum potential for forestry is greater and stands at 8.2-10.1 Gt of CO2 per year, or 23%-28% of annual CO2 emissions, according to a study published in Carbon Balance and Management by researcher Yuanming Ni and others. The offset values could be worth $125 billion-$150 billion for a total market of $175 billion-$250 billion a year, roughly the size of the green bond market. We commented on an increase in the issuance of land-related bonds in our article, "'Could Agriculture And Forestry Be The New Frontier For Green Bonds?" published Dec. 4, 2019, which concludes they represent just 3.3% of the green bond market, and that so far they are all forestry bonds. Yet, forestry bonds are a growing segment of environmental, social, and governance (ESG) investing.
The distribution of this potential is uneven around the world, with strong concentrations in some countries (see chart 3). Many countries in Sub-Saharan Africa could have surplus offsets to trade with major emitting nations, such as China and the U.S., due to their currently low annual emissions compared to the potential of their soil to store carbon.
|Highest Potential Sources Of Supply And Demand For Soil Offsets|
|Rank||Supply country||Supply quantity (MtCO2)||Demand country||Demand quantity (MtCO2)|
|3||Congo (Democratic Republic)||24.2||India||2,175.20|
|MtCO2--Metric tons of carbon dioxide. Sources: S&P Global Ratings; Global Carbon Project; Zomer, Bossio, Sommer and Verchot (2017).|
Countries at the top of the supply table have large land masses dedicated to agriculture where plants use photosynthesis to store carbon in the soils and have very low annual GHG emissions. Countries at the top are big GHG emitters due to their large populations, large emissions per capita, or overall reliance on using or producing fossil fuels.
Uncertainty, Double Counting, And Climate Risks
Figures for carbon offsets are notoriously difficult to calculate and measure, and uncertainties can put off some market participants. The figures in this report are taken from reputable sources, but should nonetheless be taken with caution. For example, a widely quoted study in Science put the potential for forest offsets at 205 gigatons of carbon. However, the study relies on planting trees wherever they can possibly grow, including on agricultural lands, urban areas, and in existing forests, and therefore is an overestimate.
Despite the growing carbon market, there is still slow adoption of offset trading. One reason might be a complex and expensive process of establishing such projects. Four basic criteria are commonly used and sometimes compulsory used to evaluate carbon offsets: additionality?, permanence, absence of leakage, and verification. And several different standards--such as the Verified Carbon Standard and the Gold Standard--are used by vendors to certify that particular carbon offset projects satisfy these criteria to an acceptable degree. All Clean Development Mechanism or Joint Implementation projects, where countries finance offset projects in other countries, must go through a rigorous validation process by the UN Framework Convention on Climate Change. Certification costs depend on the complexity of the project, and there are usually many other costs involved.
The next climate change conference (COP26), set for November 2021 in Glasgow, will address Article 6 of the Paris Agreement, which aims to close out the issue of double counting between nations that create offsets and those that purchase offsets for their own net-zero commitments. Double counting could occur when one nation expands its forests and uses the stored carbon to offset its national emissions, but uses funding obtained from a second nation that uses the amount of stored carbon to offset its own emissions. It is a sticking point that has spilled over from last year's negotiations and remains a risk for global offset markets. A successful conclusion to these negotiations is paramount in the global effort to meet the goals of the Paris Agreement.
Offsets require that the carbon stored in soils and forests remain in these natural assets. Last year's wildfires were an acute reminder that physical climate risks are reducing the security of using nature for carbon capture. Once burnt, the carbon returns to the atmosphere--and the offset potential literally goes up in smoke.
A development that could further dampen companies' participation in offset markets is the pandemic, whose shocks have created short-term liquidity issues for some companies. Still, the Institutional Investors Group on Climate Change (IIGCC), whose members include BlackRock and account for $30 trillion in assets under management, are calling for a green recovery in the aftermath of the pandemic. This could signal a shift in capital allocation toward the solutions needed to reach net zero. Although the current drop in global emissions is insufficient to meet the Paris Agreement, the pandemic may have provided an opportunity for investors to shift their appetite toward finding solutions to other long-term, systemic threats such as climate change.
Net-zero commitments could be considered both necessary and daunting, and companies and governments making them are not doing so lightly. It is not just a case of buying some relatively cheap trading offsets and continuing business as usual. Companies and governments wanting to achieve their net-zero commitments may need to rely on the deployment of low-carbon, carbon capture, and other technological solutions. If action is not taken quickly to mitigate annual emissions, there could be few options left. The biosequestration potential of forests and agricultural soils may not be enough to net emissions. The vulnerability of these ecosystems to climate change could be further dampening that potential. While 2050 appears to be a long way off, actions by companies and governments in the next few years are most critical to achieve these goals. While it may not be too late to take action today, it might become so very soon.
What Is A Carbon Offset?
A carbon offset, or credit, is the reduction of one metric ton of CO2 equivalent (CO2e) from a baseline--that is, the level GHG emissions would have been in the absence of the project. Often confused with a carbon allowance, which is the right to emit one ton of CO2e, the two carbon instruments facilitate global efforts to reduce carbon emissions by putting a price on carbon.
There are two markets for carbon offsets: the compliance offset market and the voluntary offset market. Though the two markets technically trade the same product--a tonne of CO2e avoided--the markets operate largely distinctly. Certified Emission Reductions (CERs) are the instrument used by entities in the world's largest carbon market, the EU's Emissions Trading System, and trade at €0.31/tCO2e. Offsets in the voluntary market, known as Voluntary Emission Reductions (VERs)--purchased by companies and individuals wishing to offset their GHG emissions, though under no regulatory obligation to do so--typically trade between US$3-US$6/tCO2e, depending on the location and type of the project generating the offset. Voluntary market participants can purchase CERs, but compliance market participants cannot purchase VERs to offset their regulated GHG emissions. Emission Reduction Units (ERU) help countries meet their treaty obligations under the Kyoto Protocol, a precursor to the Paris Agreement. The total offset market pales in comparison to global carbon emissions (see chart 4).
Offsets can be created from stand-alone projects, such as wind farms and methane capture from landfill, or from scalable projects, such as fuel-switching initiatives--clean cook stoves replacing charcoal, for example--and reforestation projects. According to Forest Trends, the voluntary offset market generates most of its offsets--on a volume tCO2e-avoided basis--through energy efficiency and fuel switching, and forestry and land use projects. Renewable energy projects generate the cheapest, and clean cooking stoves the most expensive voluntary offsets.
The common and defining feature of all offset-generating projects is that they must create a measurable, trackable, permanent, and independently verified reduction in GHG emissions that would not have occurred in the absence of the revenue generated from the offset. "Additionality" is fundamental to offset markets, which means market forces would not have created the project. For example, an offshore wind farm in the U.K. will be developed because the internal rate of return of the project has been made palatable to investors through government subsidies. That is, the project would be constructed with or without the revenue generated from offsets and so cannot claim to produce an "extra economic good." In contrast, a wind farm developed in an emerging market, where subsidies do not exist, may not be financially viable without the income generated from selling offsets. If a project does not generate an "extra economic good," then it cannot justify selling a carbon offset, as the money paid for an offset does not cause the reduction in GHG emissions. Further, having additionality as a fundamental feature of offsets acts to constrain the market, thereby giving offsets a value.
- Could Agriculture And Forestry Be The New Frontier For Green Bonds? Dec. 4, 2019
- The EU's Drive For Carbon Neutrality By 2050 Is Undeterred By COVID-19, April 29, 2020
- COP25 Special Report: Climate Finance Takes Root, Dec. 4, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Beth Burks, London (44) 20-7176-9829;|
|Secondary Contact:||Maurice Bryson, London;|
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: firstname.lastname@example.org.