Will the Real Carbon Credits Please Stand Up?

Last month, a couple of sentences in a nondescript document sent shockwaves through carbon markets. The offending author was the UN Framework Convention on Climate Change (UNFCCC) Article 6.4 Supervisory Body, which had been tasked with building a global carbon market under the terms of the Paris Agreement. In its draft guidance for “Removal activities under the Article 6.4 mechanism,” the Supervisory Body sought to define what, exactly, counts as a carbon credit. In one fell swoop, it ignited a firestorm. 

The document casts doubt on the future of engineering-based carbon dioxide removal (CDR) mechanisms, which it describes as “technologically and economically unproven, especially at scale, [and posing] unknown environmental and social risks.” Though nature-based solutions (NBS) get the green light, the Supervisory Board expresses concern that technological solutions “do not contribute to sustainable development, are not suitable for implementation in the developing countries, and do not contribute to reducing the global mitigation costs… ” They fail, it concludes, to “serve any of the objectives of the Article 6.4 mechanism.”

False Dichotomies and UN Discrepancies

Broadly speaking, there are two ways to sequester carbon: with nature- and engineering-based solutions. NBS (as the name suggests) leverages the former via forestry and agriculture projects, which come with co-benefits but are vulnerable to reversal risk. Engineering-based solutions, on the other hand, encapsulate a range of carbon capture and storage (CCS) technologies, such as direct air capture (DAC), bioenergy with CCS (BECCS), and enhanced weathering. Notwithstanding its criticisms of the latter, the Article 6 Supervisory Body acknowledges they have one unique benefit that eludes NBS: “… permanent net removal of carbon dioxide from the atmosphere.”  To argue about which solution is “better,” however, is to miss the point. The problem is that the mechanisms were pitted against one another in the first place. Not only is the binary distinction misleading (many projects blend both nature- and engineering-based solutions, as have argued CDR industry experts in an open letter), but supranational and national authorities have made it abundantly clear that all possible solutions are required to offset residual emissions and the soon-to-be-overshot world carbon budget. In its recent Synthesis Report, the Intergovernmental Panel on Climate Change (IPCC) — also, ironically, a UN body — warned the Earth must remove billions of tons of carbon annually to keep global warming below 2°C above pre-industrial levels.  The volume in question is staggering. To meet its net-zero commitments, the U.S. alone should capture and permanently store somewhere between 400 million and 1.8 billion tons every year between now and midcentury, according to the Department of Energy. Today, it puts away 20 million tons. Consultancy Wood Mackenzie claims that CCS accounts for 20% of the global emissions reductions needed to achieve net zero by 2050. That equates to an eye-watering eight billion tons annually. “CCS has to be made to work,” writes Wood Mackenzie. “A massive new industry, as big as today’s annual global oil and gas production capacity, must be built almost from scratch.”

If the UN reneges on IPCC guidance and declares that only NBS credits count, where does that leave the fledgling carbon-capture industry? How about corporate buyers such as JPMorgan, which just spent $200 million on credits? Does Microsoft find its extensive purchases invalidated? And if net zero depends on carbon capture, what happens to a natural world devoid of it?

Carbon-Capture Costs Must Come Down

NBS have in their favor two unique qualities beside co-benefits, according to the Article 6 Supervisory Body: They 1) “are proven and safe, have a long history of practice, and are backed by considerable experience… ” and 2) “have the potential to deliver cost-effective CO2 mitigation required by 2030.” In other words, (1) tried and tested, and (2) cost-effective. Though the former is a dubious recommendation (their relatively extensive record is littered with a relatively extensive litany of PR crises), the latter is a valid point of comparison.

“About the only thing everyone seems to be able to agree on is that there isn’t a carbon-removal technique on the market today that’s cheap and easy to do as well as durable and permanent… In essence, the world currently has two choices: pay a little money for nature-based solutions, or pay a premium for more durable removal.”

– A Major Showdown Is Brewing Over What Counts as a Carbon Credit, Bloomberg

For CCS, the crux of the issue is cost. Nascent technologies need to become more economically viable if they are to grow into a “massive new industry.” “There are around 35 commercial facilities applying CCS to industrial processes, fuel transformation and power generation,” according to the International Energy Agency, “with a total annual capture capacity of almost 45 million tons.” Project developers have announced intentions for over 200 new capture facilities by 2030, which would capture 220 million tons per year — but just 10 projects had attracted final investment decision (FID) by June 2022. Even in a best-case scenario, the pipeline of projects is well below what is required by a net-zero scenario.

There are a number of ways to reduce costs and unlock investment. Wood Mackenzie suggests that improved technology and economies of scale will lower expenses by up to 25%. Internationally coordinated carbon prices should make a significant dent, as will improved incentive structures. To reach scale and augment incentives in the first instance, however — organically, and barring political intervention — there must be a way to unleash capital flows from within the market. 

Deterring would-be buyers by casting doubt about the viability of CDR is not the answer. Insurance, on the other hand, could be immeasurably useful. By reducing the risk of upfront financing, de-risking mechanisms can secure better terms for and attract capital to CCS ventures. In turn, insurance promises to accelerate both scale and scope in carbon credit markets.

Build Your Carbon Credit Insurance Portfolio

Connect with one of our experts to secure your carbon investments.