Environmental commodities are a class of commodities that are taking off in popularity globally. They are of particular importance to the oil and gas industry and can be generally referred to as non-tangible environmental credits.
The value of environmental credits is keyed to the demand of market participants who are faced with imperatives to both produce and consume lower carbon forms of energy. Markets have developed for both voluntary and compliance credits in response to the demand of both consumers and governments and there is generally acceptance to describe the products as either credits or offsets, depending on the specific product being described. They have become a useful means for companies to offset emissions that can’t yet be reduced or eliminated – residual emissions.
The voluntary carbon market is actually three decades old and was developed in 1989 to enable companies in many industries – such as air travel, banking or energy, to offset their CO2 emissions. It’s been promoted by figures like Mark Carney, the former Governor of the Banks of Canada and England as a means to encourage emissions reduction.
The adage quoted by traders is that the creation of carbon markets was driven by consumers but the drive for markets gained momentum from the goal of net zero GHG emissions agreed to by the leaders of 192 countries and the EU in the Paris agreement at the UN climate change conference COP 21 in 2015. The intention was to reach net zero emissions by 2050. Corporations responded by setting more formal goals across resource areas and government actions intensified with Sweden setting set a goal of net zero emissions by 2050 in 2018, followed by the UK in 2019. In 2020, China, the world’s biggest emitter, pledged it would reach “carbon neutrality” by 2060. Businesses, as well as regional governments also set similar targets.
As governments began establishing carbon pricing initiatives, the environmental products offered became increasingly diverse. Compliance environmental markets developed in response to government or jurisdiction mandated programs, which created trading opportunities. As new regulations are added, opportunities for more markets to participate increase. Some compliance markets are cap and trade programs, low carbon fuel standards – LCFS, hybrid schemes like Alberta’s TIER and renewable energy certificates or RECs. Below is a graph showing Alberta credit pricing from 2019-2021.
The voluntary environmental markets developed in concert with private sector corporate greenhouse gas target development and the development of local and international carbon offsets. As businesses reduce their GHG emissions, they utilize voluntary carbon credits to offset the emissions they have not been able to reduce. In a Sept 2022 report, McKinsey predicts growing demand for voluntary carbon credits from companies that have committed to mitigation and net-zero targets stating “Recent studies forecast a 15-fold increase in demand by 2030, to 1.5–2.0 metric gigatons of CO2 equivalent (GtCO2e) a year.”
When trying to make sense of environmental product terminology- offsets versus credits- it makes sense to look at the registries that offer them. There are currently over sixty environmental product or GHG registries globally with some recognized as more trustworthy. The website 8billiontrees.com identifies eight registries as the most trustworthy globally.
1. American Carbon Registry
2. The Climate Registry
3. Climate Action Reserve
4. Chicago Climate Exchange
5. Global Carbon Project
6. Global Atmosphere Watch
7. Carbon Trust
8. Verified Carbon Standard (Verra VCS) Formerly Voluntary Carbon Standard
The voluntary space is where you get more registry-level detail and that is where you find the four main or largest registries that most companies and corporations deal with which are – the American Carbon Registry (ACR), Climate Action Reserve (CAR), Gold Standard (GS), and Verra (VCS). These four registries form the bulk of the voluntary market, so any offsets registered and purchased within those four registries are considered sealed and delivered products. Essentially, the registries have protocols that specify what a project developer can generate an offset under, and then ensure that the project is verified. Registries certify carbon offsets and enforce specific guidelines for verification and validation for them.
Standardized offsets are verified as legitimate. The distinction between a credit and an offset is a bit blurred. “Credit” is an all-encompassing term that can either be issued by the government, or auctioned off and are developed at some benchmark. The offsets are basically climate-positive emission reduction activities that sit within a program. They’re not generated by government auction. Instead, they’re generated by projects that are able to reduce emissions and then be recognized as offsetting a ton of CO2 in the regulated market.
In Alberta, in compliance, we have emission performance credits and emission offsets. A performance credit would be, a corporation operating within an industry that is regulated in Alberta and has a benchmark. If the corporation is able to operate at a lower emission intensity than its benchmark- it would generate an emission performance credit. Essentially it indicates the corporation was better than its benchmark and was awarded a credit in recognition. On the flip side, any entity that’s operating in excess of its benchmark is issued a compliance obligation because it didn’t meet the benchmark. They will need to either pay the TIER fund price or buy an offset. Currently, under TIER, the main offsetting protocols are wind and solar generation, vent gas recovery, CO2 capture & permanent storage in deep saline aquifers, and switching to pneumatic devices that reduce methane emissions. Each protocol includes climate-positive emission reduction steps that companies can take that don’t naturally fall within the purview of what they’re operating under. The government establishes protocols that recognize emission reductions of particular activities and then determines offsets for engaging in those activities.
Credit is often used as a generic, all-encompassing term. Referring to offsets typically means a credit type which recognizes activities that would offset emissions. An offset is a way that companies engage in an activity that not only reduces emissions, but can also include activities that prevent emissions from ever being emitted, known as avoidance emissions.
Then there’s the low carbon fuel standards (LCFS) registries in BC, Oregon and California. The BC LCFS was established in 2008 and implemented in 2013. The Canadian Federal Government rolled out a federal program on June 20, 2022. The Clean Fuel Regulations under the Canadian Environmental Protection Act bring a clean fuel standard (CFS) into law. The final version of the CFS was published on July 6, 2022. California’s system was established in 2011.
“Essentially, low carbon fuels standards look at the life cycle or through the lifecycle of a fuel and the associated carbon emissions.” Matthew Marshall, Environmental Commodities Specialist at Radicle, says. “Typically, when referring to a carbon tax, you are referencing the source of the emissions- like upstream oil and gas, where the emission is coming from the actual drilling facility. What an LCFS program does is look at everything involved with drilling, refining, transporting and the actual combustion from the vehicle. Essentially the program is aiming to quantify that lifecycle in terms of grams of CO2 per megajoule. The goal is to reduce the intensity of the fuel anywhere along the lifecycle.”
If a company can find ways to extract the fuel in a less carbon-intensive way, it would help its LCFS carbon intensity score. In the refining process, for example, a company can make adjustments to the intensity of the refined product- like producing bio-diesel. Matthew Marshall suggests this would help the LCFS CI score and promote fuel switching by the end user.
“Taking a look at an internal combustion engine, you could incentivize an end user to switch to an electric vehicle which is more energy efficient. These are all activities that could reduce the lifecycle emission of a fuel. Essentially, the distinction between an LCFS program and a traditional carbon market is that the LCFS program ties in the midstream and the downstream aspects versus a traditional carbon tax system which really focuses on the upstream.”
Environmental products have names and acronyms as numerous as the products they represent. In the voluntary space, credits historically were traded over the counter, directly bilateral between counterparties and project developers worked solely with corporations, either directly or through brokers, or specialized trading shops that have emerged that help match the carbon credits between the producer and the consumer. New environmental products continue to be identified as registries and markets continuously find ways to standardize diverse products.
Matthew Marshall of Radicle identifies the challenge of product complexity. “Every carbon credit is a little bit different or has different elements. Which project is that carbon credit actually coming from? What year was the carbon credit produced in? What jurisdiction am I buying it from? What kind of project type? Is it a forestry project? Is it an industrial project? Is it a reduction? Is it a removal? And so historically, it’s been a very heterogeneous product. It’s not like a barrel of oil which has distinctions, but for all intents and purposes is still a barrel of oil. And so, GEO and NGEO and other identifications are trying to basically create a little bit of market liquidity by standardizing instruments.”
One of the many upsides of environmental products markets is that there is a myriad of financial instruments for O&G companies to access to manage carbon costs. There is also an increasing number of tech tools and analysts for companies to access, manage, trade, and analyze with increasing transparency, the products that serve their needs.
Maureen McCall is an energy professional who writes on issues affecting the energy industry.