Is the rising cost of carbon offsetting a problem?

As prices rise and regulation tightens around voluntary carbon offsets, their use by oil and gas companies to meet net zero targets will become more of a challenge.

The price of voluntary carbon offsets (VCOs), used by oil and gas companies to make oil and liquified natural gas (LNG) cargoes “carbon-neutral” and to meet their own corporate net zero targets, has been rising recently, which may encourage mitigation or reduced hydrocarbon output instead, experts have said.

The price of good quality VCOs, through which firms offset carbon from continued production and consumption, has increased this year from about $1/ton of carbon dioxide equivalent (tCO2e) to $5-8/tCO2e, according to pricing agencies.

Surging demand, tighter standards, and limited supply – in the case of nature-based offsets – could mean prices rise further, making it more expensive to get to net zero this way or to buy a carbon neutral cargo, according to energy experts. Nature based offsets involve absorbsion or retention of CO2 within recreated or preserved ecosystems.

These commercial challenges are adding to concern over VCOs on environmental grounds, as offsets allow continued investment in fossil fuels – although proponents insist it is the most efficient way of achieving net zero.

Last month’s United Nations Climate Change Conference (COP26) in Glasgow, Scotland, toughened VCO standards and insisted they should only be used as a last resort.

Stricter rules

COP26 did not directly establish a global carbon market, but modifications to Article 6 of the Paris Agreement  ­– which includes tools to encourage countries to meet their climate commitments and engage in international cooperation ­– now allows countries and companies to trade in emissions internationally in the form of offsets, and to use them towards their net zero targets.

It also established more rigorous rules on double counting – where both buyer and seller count the offset towards decarbonization targets – which was key to improving the transparency and reliability of offset markets. This validated the use of these offsets, although the COP26 final declaration emphasised they should only be used with difficult-to-remove emissions.

Wood McKenzie’s head of carbon research, Elena Belleti, said the decision to mandate international carbon markets in Article 6 meant the VCO market could be worth as much as $200 billion by 2050, especially given the more robust and transparent framework. She also noted that the elimination of double counting made “decarbonisation real.”

Kristiina Siilin, Business Development Manager at Helen, a Finnish green energy company, said that, in the past, weak regulation had discouraged investment in voluntary carbon offsets. But now “since the double calculation at a national level has been solved… it will put pressure on the projects to increase in scale.”

She added that higher offset prices would encourage developers to focus on new technologies to reduce actual emissions, such as renewables, biofuels, hydrogen and CCS.

Wood McKenzie’s Belleti and chief analyst Simon Flowers said that while it remained down to each individual country to act, COP26 developments would give countries a significant push in the direction of establishing carbon pricing, and further integration of VCOs in their compliance mechanisms.

Speeding up mitigation

Most observers expect voluntary offset prices to rise further over coming years. Helen’s Kristiina said prices were likely to reach the same level as mandated emission allowances – such as those on platforms such as the EU’s Emissions Trading System (ETS) –  which is currently at around €60/tCO2e.

Timo Huhtisaari, Director of Sustainability and Future Business at ST1, a Finnish energy firm, said that long term VCO oversupply was now reversing, and while the market would respond to the increasing demand, “it might take time due to increasing demands of standards,” which would push up prices.

Flowers and Belleti estimate that VCO prices will “rise tenfold to over $50/tCO2e by 2030, given the higher demand especially for high-quality offsets, which are more costly to develop.”

However, technological developments, expanded compliance markets such as the EU/UK ETS, energy efficiency and emissions reductions measures should all ease rising VCO demand as prices increase. More expensive direct mitigation solutions, such as carbon capture and storage (CCS), will become more attractive, they said.

Rising offsetting and mitigation costs will make hydrocarbon production more expensive, and it will also add to the premium for carbon neutral LNG and crude cargoes. “It is likely that the net effect will still be a larger price gap between a green and non-green cargo or product,” Flowers told Gas Outlook.

Belleti pointed out that VCO supply constraints and price rises would facilitate the financing of real emission reduction. “In the likely scenario where… the employment of nature-based solutions will not be sufficient, there will need to be a scaling of mechanical solutions for carbon removal, such as CCS, that allow for large volumes of removal, as well as the development of newer technologies”, such as hydrogen, she said.

ST1’s Huhtisaari said there were a rising number of initiatives to increase nature-based carbon sequestration, but to be able to scale these further, technical advances in areas such as biochar carbon capture were required. Carbon removal using Direct Air Capture (DAC) and storage will also be needed and should become competitive as carbon prices rise and technology improves.

But even with DAC, CCS, VCO and mandated credits, Belleti and Flowers note that, given the net-zero pledges of most countries, the output of oil and gas companies will have to decrease over coming years: “In our estimates of a 1.5-2 degree scenario, most fossil fuels will reach peak demand by 2030… BP plans to reduce oil and gas production 40% by 2030; in the long run we’d expect other oil and gas companies also to shrink their production in line with demand,” they said.

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