What is a carbon offset and how is it different from EU Allowances (EUA)? Do retirements of EU Allowances and retirements of carbon offsets represent the same environmental benefit? Can I retire EU Allowances to compensate for my residual emissions as part of my corporate climate strategy?
Many of our clients are asking us these and similar questions so we decided to shed some light on this topic via this short summary.
EU ETS and EU Allowances
The European Union Emission Trading Scheme (EU ETS), launched in 2005, is a cap-and-trade system, which is one way the EU incentivizes emission mitigations, and puts a price on GHG emissions. As the name suggests, the EU allocates a cap on total emissions of the sectors covered by the scheme consisting of free allocation to certain entitled sectors and auctioned allowances. If a company pollutes more than its free allowances, it has to purchase the EUAs from the primary or secondary market. One EUA represents the allowance to pollute one ton of CO2e and companies only need to buy the amount of EUAs that represent tCO2 they polluted over their cap (or free allocation of EUAs).
Allowances can also be considered as a market-based tax on pollution over the limit. It is important to understand that one EU Allowance currently cannot be directly linked to the reduction of one tCO2e as the use of money the governments generate from auctioning allowances is not disclosed in detail, and might be incentivizing anything from 1tCO2 to 0.0001 tCO2 reduction. This does not mean that the EU ETS is not functioning or that the system is not helping the environment, as the companies covered by the system still use it to measure their emissions and emission reductions. EU allowances traded for many years below the marginal abatement cost of the companies as the system accumulated a huge surplus in the past. However, since the EU implemented the Market Stability Reserve, the EU ETS surplus was corrected and the cost of EUAs increased significantly, and currently provides a very high incentive for complying corporations to reduce their emissions. However, its purpose, design and underlying instrument is completely different from carbon offsets and should not be interchanged.
Voluntary Carbon Market and Carbon Offsets
On the other hand, a carbon offset (also referred to as a carbon credit) is a tradeable instrument that verifies that one ton of greenhouse gas (GHG) emissions has either been removed, reduced or avoided. To ensure and facilitate standardization regarding GHG accounting, the GHG emission reductions, avoidances and removals are expressed as one ton or one Metric ton of carbon dioxide equivalent (abbreviated as one tCO2e or MtCO2e).
As a simple overview, these credits, in what is referred to as the voluntary carbon market (hereinafter VCM) are generated by the approved GHG mitigation activities and objectives of projects and programs that are registered and certified by UN or private carbon crediting standard, such as Clean Development Mechanism, Verified Carbon Standard or Gold Standard Foundation. The registered projects and subsequent credits traded in the VCM must be verified by third party auditors. These, later need to be issued by a carbon standard and can only be so by following the rules and requirements set by this carbon standard. Example of such requirements are proofs of additionality, permanence, peer-reviewed baselines etc. One carbon offset (credit) is issued after the corresponding emission reduction, avoidance or removal occurred and is issued on a carbon registry. As such, carbon offsets represent verified reduction/removal/avoidance of 1tCO2e, whereas allowances represent a right to pollute 1tCO2e and so in reality, both instruments have a fundamentally different function.
There are several reasons for why companies participate in the voluntary carbon market and why they procure offsets. Usage of carbon offsets is something that is relevant for companies or organizations that have climate targets based on science, implemented every possible strategy to reduce their emissions inhouse and for the residual, unavoidable and hard-to-abate emissions there is no other viable reduction solution available at the time. By offsetting (compensating) their residual emissions, companies seek to demonstrate that they take responsibility for all their residual GHG emissions, contribute to innovative and additional mitigation efforts globally, channel financing to projects that verifiably reduce/remove/avoid emissions or seek support mitigation actions beyond their value chain and focus on preservation of biodiversity.
Conclusions
It is important to conclude, that if a company wants to make a claim on offsetting (compensation) of its residual emissions in tons of CO2 (or claim on carbon neutrality), it has to use an instrument that verifiably offsets (compensates) its GHG emissions in tons of CO2 removed/reduced/avoided. According to Article 12(4) of the ETS Directive it is possible to purchase and cancel EU Allowances, however, by doing so, a company cannot claim it compensated for its emissions as allowances cannot be linked to any specific verified reduction/removal/avoidance activity.
Nonetheless, at Strive, we follow and adhere to the ICROA Code of Best Practice and recommend our clients to use carbon credits from ICROA endorsed programs in order to ensure high environmental integrity of their claims.
If you would like to learn more about carbon offsets and explore if this could be suitable for your organization and your sustainability strategy, please feel free to reach out to us here to set up a meeting. We invite you to fill the form or contact us by email at hello@strive.earth.