When to Purchase Carbon Offsets and the Importance of Blue Carbon Credits

Happy Friday!

Not only is it the end of the week, but it’s the end of the month already.

On Monday, I’ll have my monthly asset class report ready for your perusal.  I enjoy it when that report writing falls on a weekend.  It gives me more time to drink in the results.

But right now, grab your morning java, and let’s get to the last bit I’ve got for you on carbon offsets.

When To Invest in Carbon Credits

You don’t need to know the intricacies of how offset methodologies work. But you should have a high-level understanding of the entire offset lifecycle: how offsets are created, purchased, and used.

That will help you determine the type, price, and risk of investment options available – and whether or not a purchase will help companies meet their organization’s emissions reduction goals.

Each new carbon offset has five major points in its lifecycle:

    1. Development of a new offset type
    2. Selection of an offset methodology
    3. Planning of an individual project using that methodology
    4. Implementation and verification of the project, registration with a carbon authority, and the beginning of offset issuance
    5. Transfer to the purchaser and retirement of the offsets

Each phase represents an opportunity for substantial investment: in new offset technologies, in offset project creativity and development, and in offsets themselves.

To start, an investment’s price and risk begin extremely high, as there is no guarantee emissions will be removed. As the project enters the planning phase, the price falls, and terms improve to attract investment.

Prices rise again as validation, verification, and registration takes place.  This means the risk of delivery has decreased, and high-quality offsets are more likely.

Then prices level off or rise slightly as the risk of double-counting or leakage rises and brokers and retailers take their cut.

Offset purchasers should become familiar with this. It will help them maximize the ROI and other benefits their organization receives in return for offset purchases.

Offset Type Development

Dozens of offset types, such as methane capture from landfills and large hydro projects, have been established over the past thirty years. The two most popular types are currently wind and reforestation.

Fortunately, new technologies and methods of removing CO2 emissions from the atmosphere are constantly moving along. Experimental types of offsets currently in the funding and research phase include:

    • Accelerating mineral weathering in rocks using electrochemical forces.
    • Genetically engineering phytoplankton to capture CO2 in the ocean.
    • Flooding deserts to create artificial oases that phytoplankton can inhabit.
    • Developing enzymes that capture carbon.

The holy grail of offset development borders on alchemy: turning atmospheric CO2 into a usable product.

Coca-Cola has already signed a deal with a company that uses direct air capture of CO2 to make its soft drinks bubbly.

Investing in offsets at this stage is risky.  During type development, there is no guarantee that carbon offsets will be produced from the eventuating invention.

It’s also expensive.

Experimental methods of removing carbon from the atmosphere can cost hundreds of dollars per ton during development.

Offset Methodology Selection

Once a carbon offset technology is ready for a new project to be built around it, it requires creating or selecting an offset methodology, which is a complex set of rules around the creation of that offset.

The methodology provides guardrails for a project developer, outlining what they must do to establish a baseline for the project, determine additionality, calculate project emissions reductions, and monitor external parameters to calculate absolute emission reductions.

Offset Project Inception: Project Planning, Validation, and Registration

Once a methodology has been chosen, the project developers generate a project plan that assesses its feasibility, environmental impacts, and possible risks to development.

The plan is solidified into a project design document, which outlines the anticipated reduction in emissions from the project, plans for quantifying and monitoring those benefits on an ongoing basis, and proof of additionality for the project.

Independent third-party verifiers examine and approve the project design, ensuring the emissions reductions will take place. Then—and only then—can the carbon offset program be registered. This official registration sets the program up to begin issuing carbon offsets.

There are two general options for investment at this stage, both of which involve investing in the project directly:

    • Investing for the right to a specific percentage of the offsets created by the project.
    • Investing for the right to a specific number of offsets created by the project.

The former requires (and enables) much deeper engagement and a broader understanding of the mechanisms of carbon offsets than do later stages.

Investors must evaluate the strengths and weaknesses of specific projects alongside third-party verifiers to decide whether the project is likely to deliver on its plans.

The latter generally looks like an Emission Reduction Purchase Agreement (ERPA). ERPAs take risks away from project developers by letting them pre-sell a specific volume of offsets. In exchange for taking on the delivery risk, buyers or investors get to lock in below-market offset prices.

Both options have a lower cost than later in the development process, and buyers may invest in at-cost offsets. As always, that comes with a price.  The offsets will be delivered over time, not all at once.  This type of investment generally requires a long-term agreement (as with an ERPA).

Offset Project Implementation: Verification and Issuance

Projects that have become operational must be monitored over a period based on the original methodology and plan. Then, another verification audit process assesses the realness and quality of the claimed reduction in CO2 emissions; these verifications typically occur a year apart.

Once verification has been passed, the project developer can issue carbon offsets equal to the number of tons of CO2 verified to have been captured or reduced.

Those verified offsets are deposited into the project developer’s offset “bank account.” This is where the transition from “project readiness” to “pay for performance” takes place.

In other words, those offsets are no longer just theoretical; they are continually being created, and the developer can begin delivering on long-term contracts.

Offset Sale and Transfer

Any offsets that have not been pre-sold become available for direct, one-off purchases from consumers and corporations. While purchasing directly from a project developer can help avoid transaction costs, it is not without its risks—especially in terms of the quality of the offsets.

Since there is no centralized marketplace for the voluntary carbon market, finding buyers remains challenging for project developers. Identifying quality offsets is difficult for all but the most knowledgeable buyers.

Thus, three new entities have been created to facilitate the easy purchase of offsets: brokers, exchanges, and retailers.

    • Brokers have purchased credits from the project developer or exchange and can transfer them to clients or retire them on their behalf.
    • Exchanges are places for developers to sell directly to buyers (and traders to invest in carbon offsets).
    • Retailers sell off-the-shelf carbon credits (just like the old boxes of Microsoft Windows CDs), then retire them on behalf of the buyer. Retailers have physical ownership of the offset, while brokers and exchanges do not.

Offset Retirement

Offsets can be sold and resold. With each new transaction, they are transferred into a different account in the offset program’s registry. Those new buyers can hold them, transfer them to another account through a sale, or retire them.

Offsets are retired by “using” them by claiming their verified CO2 reductions against an emissions reduction target. Each carbon offset registry has a retirement process that prevents the offset from being transferred or used again—think of it like a dollar bill being removed from circulation.

Making Your Offset Investment Decision

Where you choose to invest in the carbon offset lifecycle depends on myriad factors, including:

    • The business goals and expected advantages behind your purchase.
    • How quickly you anticipate needing the offsets to be delivered.
    • The guaranteed quantity of offsets you will need.
    • The price level that can be afforded or that makes the most financial sense.
    • The amount of time and effort available to apply to the offset acquisition.

Answers to each of these questions will guide you toward options that differ in their timing, volume, and price and your ability to evaluate (or influence) their quality.

Now, let’s turn our attention to blue carbon credits.

What is Blue Carbon?

Blue carbon credits are created by the growth and conservation of carbon-absorbing plants, such as mangrove forests and their associated marine habitat.

Over the past decade, scientists have discovered that seagrass meadows, tidal marshes, and mangrove forests are among the most intensive carbon sinks in the world. This means blue carbon offsets can remove enormous amounts of greenhouse gases.

A blue carbon offset project should have its carbon credits trade at a premium.

This is because of the significant positive second-order effects such as the positive effects on corals, algae, and marine biodiversity (e.g., sharks, whales, sea turtles) that have been so negatively impacted by activities such as over-fishing and farming.

Mangroves store 10x more carbon than terrestrial forests (Source: Kauffman et al., 2018).

Yes, forests can grow in the ocean. Examples include the mangrove forests in sea bays, such as Magdalena Bay in Baja California Sur, Mexico.

Mangroves are trees (about 70 percent underwater, 30 percent above water) that have evolved to survive in flooded coastal environments where seawater meets fresh water and the resulting lack of oxygen makes life impossible for other plants.

Mangrove trees create shelter and food for numerous species such as sharks, whales, and sea turtles. Mangrove forests are a valuable marine ecosystem.

Second-Order Effects of Blue Carbon Credits

Other positive second-order effects of mangrove forests include their importance as a pollution filter, reducing coastal wave energy, and reducing the impacts from coastal storms and extreme events.

Blue carbon systems trap sediment, which supports root systems for plants. This accumulation of sediment over time can enable coastal habitats to keep pace with rising sea levels.

All this can be calculated into insurance premiums, and lower-cost premiums are suitable for businesses and residents. These are all free second-order effects.

To put it in perspective, natural disasters and extreme weather events created over $270 billion worth of economic losses in 2020. It is absolutely in the best interest of citizens and insurance companies to mitigate the effects of climate change.

Coastal wetlands and mangrove forests will become an ever-increasing sector for carbon credit generation. That is because mangrove forests and coastal wetlands sequester carbon at a rate that is up to ten times greater than mature tropical forests.

Because the carbon is sequestered and stored below water in aquatic forests and wetlands, it is stored for more than ten times longer than in tropical forests.

The significant positive second-order effects attributed to each blue carbon credit are why many investors believe it will trade at a premium to other carbon credits.

Blue Carbon and the Food Footprint

There is a land-use carbon footprint of 1440 kg CO2e for every kilogram of beef and 1603 kg CO2e for every kilogram of shrimp produced on lands formerly occupied by mangroves. A typical steak and shrimp cocktail dinner would burden the atmosphere with 816 kg CO2e.

It is estimated that over 1 billion tons of carbon dioxide are released annually from degraded coast ecosystems.

There are around fourteen million hectares of mangrove aquaforests on earth today, and they’re under attack by the deforestation practices caused by intense shrimp farming.

Are the shrimp you eat part of the problem? Soon, these shrimp will be labeled, and consumers will know and be required to cover the offset costs for the environmental damage.

To put things into perspective, 14 million acres of wetlands will absorb as much carbon out of the atmosphere as if all of California and New York State were covered in Tropical Rainforest.

Think of Blue Carbon as the “high grade” gold mine at the surface.

With the economic value of Blue Carbon credits and the technology that will enable Carbon Rangers to preserve forests and wildlife, expect entrepreneurs to expand the Carbon Ranger program to mangrove forests across the globe.

This will be a step forward and a small part of solving the climate emergency.

These are just a few examples of how carbon credits will be created to enhance stakeholder capitalism.

Oceanic Blue Carbon

In addition to coastal blue carbon mentioned above, Oceanic blue carbon is stored deep in the ocean within phytoplankton and other open ocean biotas.

Many factors influence carbon capture by blue carbon ecosystems. These include:

    • Location
    • Depth of water
    • Plant species
    • Supply of nutrients

Improving blue carbon ecosystems can significantly improve the livelihoods and cultural practices of local and traditional communities. In addition, restoring blue carbon regions provides enormous biodiversity benefits to both marine and terrestrial species.

I’ll see you on Monday.  Until then, have a great weekend!

All the best,

Sean

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