By Lasse Leipola, Climate Policy Specialist, Finnwatch

The problem with carbon offsetting as a means for companies to bear responsibility for their emissions is not the concept itself, but its current implementation. Rather than limiting the use of carbon offsetting by banning terms like “carbon neutral”, policymakers should drive forward reforms to improve the quality of the carbon market.

It is very clear – for example in the light of the most recent reporting from the IPCC – that climate change has already had serious and partly irreversible adverse human rights impacts. These impacts are only likely to intensify in the near future. To prevent and mitigate them, companies must accept in full their responsibility for their greenhouse gas emissions.

A human rights based approach to corporate climate accountability builds on the concept of human rights due diligence (HRDD) which is defined in the UN Guiding Principles on Business and Human Rights (UNGPs). According to the UNGPs, companies must take appropriate action to prevent and mitigate their adverse human rights impacts. In the context of climate change, this means effectively reducing their greenhouse gas emissions and supporting climate action. In addition to their emissions, companies should take into account their role in adaptation to changing climate as well as in participating in remedial measures.

Although international human rights treaties do not explicitly recognize the precautionary principle in the same way as international environmental law does, human rights due diligence is first and foremost also about prevention and the  responsibility to do no harm. In addition, Climate litigation cases have confirmed that the precautionary principle is also relevant to the human rights-based climate responsibility of companies.

The recently approved update to the OECD Guidelines for Multinational Enterprises further strengthens the link between responsible business conduct and emission reductions by stating that “enterprises should ensure that their greenhouse gas emissions and impact on carbon sinks are consistent with internationally agreed global temperature goals based on best available science”.

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There is an international consensus that companies are responsible not only for their own direct emissions but also for the emissions in their value chain. Key initiatives, such as the GHG Protocol and the Science-Based Targets initiative (SBTi), also adopt this approach. For companies, this means that their efforts to reduce emissions must cover the company’s own operations and their value chains.

In the light of the Paris Agreement and the most recent IPCC reports, companies must reduce their emissions to what is called “net-zero” as soon as possible and by 2050 at the latest. This means that businesses in certain industries, in which reductions are easier to make, should reach net-zero sooner than by 2050. Indeed, some companies have already announced at least their intention to do so: Out of 257 companies that have set a SBTi net-zero target, 105 companies have set their target for a year well before 2050.

In addition to the requirements for the SBTi net-zero target, the concept of net-zero corporate emissions has been adopted by the likes of International Organization for Standardization (ISO) and the UN High-Level Expert Group making it less ambiguous and controversial than claims about carbon or climate neutrality. Net-zero is a point in the future, where a company has already reduced its emissions to a minimum and offsets any residual emissions with permanent removals. In order for a net-zero target to be credible, a company must also adopt and regularly update short-term targets that are sufficient and in line with the global 1.5 degree target. Companies must also monitor and report on their progress in reducing their emissions.

In addition to implementing a net-zero plan, the direct and indirect emissions that companies cannot immediately cut must be offset. This can be seen as a way for companies to address adverse human rights impacts related to their residual emissions. This kind of an integration of international standards describing companies’ human rights responsibilities with climate responsibilities still requires definition work, but for example the updated OECD Guidelines recognise offsets as a last resort “means to address unabated emissions”.

Because the quality of many carbon offsetting projects has been poor, the concept of carbon offsetting has been a subject of well deserved scrutiny. For that reason, it is important to stress that offsetting must be done with high-quality carbon credits and in a transparent manner to be acceptable. When setting climate targets or when reporting on achieved emission reductions, the changes in actual emissions must be separated from any use of offsets.

In addition to the integrity and transparency of climate action funded through carbon credits, the companies must take into account the human rights risks of offsetting projects. Like any other suppliers, carbon credit suppliers should also be included in companies’ human rights due diligence processes. Most carbon offset projects are located in so-called risk countries, where national safeguards for human rights are inadequate. In addition, even the certified carbon offset projects have had somewhat  poor track record in ensuring that human rights risks are recognised and addressed. Thus it is important for companies to undertake human rights due diligence when choosing which projects carbon credits are being bought from.

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It is clear that the current carbon market is broken in many ways, which means that currently it cannot fulfill its role as a tool for companies to bear responsibility for the emissions that they cannot immediately reduce. The range in the quality of carbon credits currently available is huge and makes the procurement process a daunting task for companies that do not have dedicated specialists for the job.

Many of the current problems are widely recognized and there are many efforts to improve the situation ranging from certification schemes improving their own requirements to a variety of legal instruments requiring transparency of climate claims. However, fixing the carbon market to serve its purpose as a tool for corporate climate responsibility still requires a lot of work. What is needed is an improvement on both the quality of supply as well as  the quality of demand. Luckily, there is work being done on both fronts.

Firstly, there needs to be a higher standard for what is accepted as climate action worthy of being awarded carbon credits. The typical problems at the moment include uncertainty about the climate impacts of the projects which are due to setting unreliable baselines, questionable additionality, inability to ensure sufficient permanence of removals and so on. In addition to the concerns about the climate impacts, the safeguards currently in place to ensure that the projects cause no harm to the environment or to human rights are inadequate on paper and often poor in practice, too. On the demand-side, one step to address these issues is the upcoming corporate sustainability due diligence directive that could make the EU companies accountable for the human rights violations in their value chains.

The two most important processes to improve the quality of the projects where carbon credits are created are the establishment of accepted methodologies for the carbon markets under the Article 6 of the Paris Agreement at the UNFCCC and the recent core carbon principles released by the ICVCM. While these two criteria will raise the minimum requirements for the project developers, they should not be seen as the end goal but as important steps forward. Both standards must continue to be developed over time as the markets evolve and carbon removal technologies advance.

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Secondly, the quality of demand can and should be improved as well. The poor quality in the current carbon markets can be, at least in part, attributed to the fact that the buyers of the carbon credits have not been demanding quality, but rather thinking that any carbon credit will do. Critical exposés on the failures of individual projects may have improved the situation a bit, but many companies still offset their emissions blindly trusting the promises of the seller.

As the possibility to make climate-related marketing claims is an important incentive for companies to offset their emissions, the demand for better quality can be adjusted by regulating these claims. The EU is currently working on this by updating the directive on unfair commercial practices and setting a new directive on green claims. These regulatory processes target greenwashing and have implications for a wide range of environmental claims and labels. By requiring transparency and justification on all environmental claims, they will also have very direct consequences for the climate claims that companies make on the basis of offsets, such as claims to carbon neutrality.

The proposed changes to the regulation concerning unfair practices would set requirements for all environmental claims and ban some practices altogether. An example of what would be banned is making a claim “about the entire product when it actually concerns only a certain aspect of the product”. Claims such as carbon neutrality would “be prohibited whenever there is no excellent environmental performance demonstrated or whenever the specification of the claim is not provided in clear and prominent terms”. However, the European Parliament voted in May in favour of amendments to the commission proposal that would include claims about carbon neutrality on the list of practices that should be completely banned.

Whether claims like “carbon neutrality” are altogether prohibited or just defined in a way which requires transparency and justification, will be decided in the trilogue negotiations between the European Parliament, the member states, and the European Commission. The European decision-makers would be well-advised to avoid a total ban on carbon neutrality claims and take note of the upcoming ISO standard for carbon neutrality, or the recent guidance from the Finnish government on climate claims, instead. In both of these, the approach is to define carbon neutrality in a way that requires science-based emission reductions and accepts the offsets only as a complementary measure to address the remaining emissions.

Banning terms like “carbon neutral” would be counterproductive in many ways: It would disincentivise companies from using offsets to meet their human rights-based climate responsibility as they could not communicate their use of offsets by using established terminology. This, in turn, would decrease the demand for carbon credits and limit the amount of private money channelled to climate measures. Instead of banning, the EU should create robust requirements for what kind of carbon credits are accepted to justify carbon neutrality claims.

Also, it is naive to think that banning companies from making marketing claims like “carbon neutral” would be beneficial to climate. There is no reason to assume that by disincentivizing the use of carbon credits, companies would step up emissions reductions. On the contrary, two recent reviews by carbon market analysts (here and here) have estimated that companies that offset their emissions also reduce their emissions more than their non-offsetting counterparts. It seems that carrying the responsibility for one’s emissions in one way, can lead to carrying the responsibility in other ways as well. And it is not just about bearing responsibility but also about economic reasoning: offsetting corporate emissions can have a direct impact on emissions as it sets an internal price for emissions and incentivizes reductions.

The problem with carbon offsets is not in the concept itself but in its implementation. Rather than trying to ban the concept we should fix the implementation i.e. the quality issues in the current market. This is important because without offsets, it is hard for companies to bear responsibility for the adverse human rights impacts of their residual emissions. This should be taken into account when considering categorical bans on claims that could and should be fixed with strict requirements for companies making such claims.

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As a final note, the issue of double claiming needs to be addressed. In the past, most of the carbon credits that were used to offset corporate emissions were from projects in countries that did not have climate targets. So whatever was done in those countries to produce carbon credits, was on top of the sum total of other countries’ national climate targets. This has now changed as most of the countries (and emissions) are covered by climate targets.

This fundamental shift at the core of the carbon markets is largely due to the Paris Agreement, which consequently has a mechanism to address double claiming. When a carbon credit is authorized for international use by a host country, a corresponding adjustment is made so that the host country no longer counts the mitigation outcome towards its national target and the credit is free to be used to meet another country’s or a company’s target without being claimed twice.

The Paris Agreement applies to countries, but the market rules defined under it will be used by other actors as well. This has happened before, as the Clean Development Mechanism established in the Kyoto Protocol became the foundation of the current carbon market structure.

So, in the future, carbon markets will have two kinds of carbon credits: ones with authorisation (i.e. corresponding adjustment made by the host country) and ones without it. The key difference between the two is not the quality as both should meet the same requirements. What makes them different is the impact that the underlying projects have. The ones with authorization go beyond national targets and lead to climate outcomes on top of the national targets. Credits without authorization help to achieve national targets, which can be valuable for the host countries, but do not raise the level of ambition on top of the national targets.

In simple terms it can be claimed that without corresponding adjustments carbon credits help governments achieve something that they would need to achieve anyway. And as these national targets are insufficient, companies should finance climate action beyond these targets to bear responsibility for their emissions.

Most of the existing guidance on offsets and claims avoid the question of double claiming in corporate use by not taking a clear stand one way or another. One welcome exception can be found in the official Finnish guidance on climate claims. It makes a distinction between contribution claims and offsetting claims. The difference is that the latter require the use of authorized carbon credits (i.e. without double claiming towards national targets), and only by doing so a claim about carbon neutrality can be made. Such a definition, also included in the Nordic Code of Best Practice, is something that legislators in the EU and elsewhere could also adopt. This approach that strongly prefers authorized carbon credits as a stronger form of climate action has been widely accepted in Finland, and the domestic project developers on the supply side, as well as offset-buying companies on the demand side, have stated their support for it.

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If companies are required to use carbon credits that are authorised by the host countries and that meet the highest and still improving international requirements, the current carbon market will have to change. Most likely, supply will become more limited at first leading to prices that are significantly higher than current prices. This will have positive effects as it will drive demand towards emerging carbon removal technologies that urgently need finance to scale up.

Higher carbon credit prices also have the added benefit of effectively functioning as a form of internal carbon pricing. When a company is committed to  carbon neutrality and carbon credits become more expensive, making bigger emission cuts than initially planned becomes more lucrative.

Well-defined and regulated marketing claims about the use of carbon offsets, such as carbon neutral, can also help consumers to choose products and services from companies that are comprehensively doing their part by cutting their emissions and offsetting whatever remains by funding climate action elsewhere.

Carbon markets can also facilitate just transition by bringing income to those who need to adjust their livelihoods for carbon free society. For example, forms of carbon farming or growing industry of carbon removal can create new jobs to replace those that are currently in unsustainable industries.

A well-functioning and well-regulated carbon market can thus lead to increased efforts to fight climate change, including increased climate finance. Such a path forward is not, however, set in stone and will not happen without decisive action. The policymakers at all levels from the UN to national parliaments need to take action to ensure three things: gradually rising minimum quality requirements for carbon credits, clear quality and transparency requirements for making offset-based climate claims, and national policies that enable and define the practices regarding corresponding adjustments.

Companies buying and selling carbon credits are also key players. By setting higher standards, they can drive the carbon market forward towards higher quality and show the lawmakers and wider society that carbon markets can be an instrument for climate mitigation and finance.

Lasse Leipola is a climate policy specialist at Finnwatch, the Finnish civil society organisation.