The trading of carbon credits will take an increasing role in hydrocarbon supply chains over the next decade.
Recent years have seen a significant increase in buyer demand for carbon offsets from projects regulated under leading standards such as the Verified Carbon Standard (VCS). Coming after a long fallow period, this is welcome news for greenhouse gas (GHG) reduction or sequestration projects supporting local communities or associated bio-diversity outcomes.
Key buyer sectors include airlines and consumer-facing companies as well as energy businesses. The oil and gas sector in particular has a long involvement with climate change mitigation projects but the drivers and dynamics of the market are changing quickly. Here, we consider those drivers, look at some examples of innovative transactions and discuss some of the issues and opportunities ahead.
In many respects, the current increase in demand for carbon offsets is a rerun of market dynamics from the 2000s. At that time there was a robust market for carbon credits under the Kyoto Protocol’s Clean Development Mechanism, driven by the rollout of the EU Emissions Trading System and a widely-held expectation that other key markets such as the US would follow.
Oil and gas companies made some of the first significant investments supporting nature-based carbon climate solutions, including early VCS projects and the World Bank’s Forest Carbon Partnership Facility. However, delays in moving from the Kyoto Protocol to the more comprehensive approach of the Paris Agreement, along with a lack of significant new widespread emissions trading systems, led to a hiatus. Throughout the 2010s, long-term buyers for carbon offsets were hard to find and many GHG mitigation projects struggled.
This is unlikely to be an issue for projects in the 2020s. Multiple industry sectors are competing for volumes and prices are increasing accordingly. What is driving this new interest? The most common key driver is a broad recognition that urgent action on climate is needed this decade. In the absence of a functional international emissions trading system, more and more sectors are looking to reduce and offset emissions. Many of those are sectors are consumer facing. The oil and gas sector also recognises the need for urgent action but also understands that, as hydrocarbons are economically critical and therefore unavoidable and therefore GHG emissions need to be addressed.
With carbon capture and storage a long way off, offsetting those emissions is the only viable option for a company looking to take action in the near to medium term. Importantly, companies are increasingly also taking a more holistic view of their carbon footprint. They are looking beyond their direct emissions at those across the supply chains feeding into their direct emissions at those across the supply chains feeding into their products.
As Lisa Walker, CEO of Ecosphere+, which is one of the most active sellers of nature-based offsets, and a former senior climate expert for oil and gas companies says: “Companies in the oil and gas sector have been engaged for years, but they are getting serious now as they develop comprehensive climate strategies.”
As these market dynamics strengthen, challenges and opportunities arise. The first challenge is a supply crunch for carbon offsets from reputable carbon offset projects. If the number of industrial sectors looking to offset supply chain emissions continues to increase, the volumes required to do so will exceed near-term supply availability.
For the oil and gas sector, there is an added difficulty in the increasing occurrence of key buyers from a given project looking to prevent that project from selling to oil and gas buyers. More importantly, the role of sub-national offset projects under standards such as the VCS face challenges as host countries implement the Paris Agreement. This can involve the incorporation of the GHG mitigation actions being taken by a project into a wider regional or national plan, with an associated impact on the ability of the project owners to continue to generate and sell carbon offsets. Managing this risk in contractual arrangements is key for buyers.
However, increasing action to implement the Paris Agreement is also an opportunity for the oil and gas sector to be positively engaged in national implementation plans in their countries of operation. It is becoming clear that nature-based solutions can provide a significant near-term source for offsetting unavoidable emissions of sectors such as oil and gas while addressing the need for safeguards and the permanence of outcomes. Nature-based solutions, particularly reforestation, could deliver in the period to 2030 one-third of the emissions reductions needed to limit global warming to 2°C, according to research led by Bronson W Griscom.
Nature-based solutions also offer the potential for strong biodiversity and social development outcomes. To unlock that will require firm voluntary action that is aligned with developing countries’ implementation of their Paris Agreement commitments. There are practical ways in which the engagement of key sectors, including oil and gas, could support win-win solutions. These would involve investment flows into host country mitigation programmes to support offsetting of production emissions through nature-based solutions.
There are various public/private alliances working to unlock this, including Nature4Climate, IETA’s Markets for Natural Climate Solutions, WEF’s Natural Climate Solution Alliance and the REDD+ Business Initiative. We envisage increasing products with full offsetting of upstream supply chains, with the offsets used being generated from countrywide nature-based solutions in the country of production.
That would be implemented as a joint public-private programme aligned with the host countries’ implementation of the Paris Agreement. The oil and gas sector could act as an important bridge for the evolution of the energy sector into one aligned with global climate goals.