Climate change and venture capital [part 1]: The mechanics of carbon emissions reduction
Climate change is real and increasingly pronounced. At the same time, consumers, corporates and governments around the world are ever more willing to go out of their way to take action against it.
This is the first piece of a series that will explore the nature of combating climate change and how venture capital may be part of the solution.
The US Global Change Research Program released the Fourth National Climate Assessment (NCA4) report on Nov 23, 2018. The NCA4 is a “stand-alone report of the state of science relating to climate change and its physical impacts”. Among many things, the report estimates the environmental, human and economic implications of climate change in scenarios where green house gas (GHG) emissions targets are not met.
For example, annual economic losses in the USA due to climate change in 2090 according to the NCA4 (in 2015 $):
- Moderate warming (RCP 4.5; 1.8°C warming by y. 2100): $280 billion/yr
- Extreme warming (RCP 8.5; 3.7°C warming by y. 2100): $500 billion/yr
The OECD estimates the current global CO2 emissions rate at 40 GtCO2e/yr. In order to meet the Paris Agreement’s goal of limiting any global temperature rise to 1.5°C above pre-industrial levels, the OECD estimates global net annual emissions need to be reduced to 20 GtCO2e/yr by 2040. That is an emissions rate difference of 20 GtCO2e/yr — a 50% cut relative today.
There are two overarching ways to address this carbon emissions delta: The first is to reduce emissions and the second is to recapture CO2 from the atmosphere. In this first article I will discuss the context, opportunities and limitations surrounding the first alternative.
Carbon credits and emissions reduction
If you stop driving, recycle everything, stop eating meat, stop flying…well basically stop every action that pollutes — you’ll only reduce about a third of your personal CO2 footprint. The big problem is the big polluters. — Norwegian Meteorological Institute
Full applause to the many that skip flights, save on heating, recycle their waste and take other emission-saving action in their everyday lives. I envy their effors as I try to be self-aware in my own attempts to be one of them. Unfortunately, there is only so much that uncoordinated consumer action can achieve in terms of GHG emissions reduction. A majority of global emissions is outside of consumers’ direct control.
To address emissions from the large structural polluters — i.e. industry and commercial energy & transportation — governments and global institutions have developed and implemented certain economic tools. There are two key paradigms that outline these mechanisms:
- Carbon cap-and-trade credits
- Carbon offset certificates
We will now delve into each of these two and clarify their properties and differences.
1: Carbon cap-and-trade credits
Today, about 14% of global GHG emissions are covered by some form of penalty to entice their reduction. Many jurisdictions employ taxes that target the emission of CO2 as well as operate so-called emissions trading systems (ETSs).
ETSs operate under the authority of governmental bodies with regulatory power:
- An emissions cap is set on the total amount of certain greenhouse gases that can be emitted by installations covered by the system. The cap is reduced over time so that total emissions fall.
- Within the cap, companies receive or buy emission allowances (aka. ‘carbon credits’) which they can trade with one another as needed.
- They can also buy limited amounts of international credits from emission-saving projects around the world (see the carbon offset certificates section further down this article).
The limit on the total number of allowances available ensures that they have a value. For example, under the EU ETS the cap decreases each year by a linear reduction factor of 1.74% of the average total quantity of allowances that were issued in 2008–2012.
As the ETSs operate under market conditions, the effective price per carbon credit will vary by ETSs scheme. Credits under the EU ETS (the world’s largest operational ETS) are currently priced at USD 24.5/tCO2.
So what’s the emissions impact of ETSs? The ETS principle resides on a free market approach to reduce emissions as cost-effectively as possible across industry. The full allowance cap is typically not given out for free. For example, over the trading period of 2013–2020, 57% of the total amount of EU ETS allowances will be auctioned, while the remaining allowances are available for free allocation.
Combined with the potential for carbon leakage (the relocation of emissions to non-regulated juristictions), this means that ETS credits do not function as 1:1 carbon reduction equivalents. In other words, if you as a consumer were to buy an ETS credit and keep it to yourself you couldn’t necessarily claim that you just saved the world a tCO2 of emissions — you would more likely just have driven up the credit price a bit.
2: Carbon offset certificates
As opposed to ETS credits, carbon offset certificates are instruments that (unless fraudulent) truly do represent net reductions in CO2 emissions. Typically referred to as certified emission reductions (CERs), the certificates represent the validated net CO2 impact of specific carbon reduction projects.
Effectively, the CERs act as crowd-funding mechanisms for these carbon reduction projects: The certificate purchases is the funding for the projects. In order to achieve the highest impact per dollar, projects are generally sourced in the developing world.
Concrete projects range in method and type, from photovoltaic replacement of fossil power generation in rural Nigeria to biogas initiatives in India. Globally, the United Nations is one of the main contributors of CERs.
Because the CERs always represent concrete emissions reductions, buying and destroying the certificates equates to carbon offsetting (you funded the project but didn’t increase your emissions in response). The UN’s online platform for voluntary cancellation of certified emission reductions allows consumers and businesses to do precisely this. Climate positivity company CHOOOSE is another actor that is building a brand around CER-based CO2 offsetting via a user-friendly consumer subscription platform and corporate collaboration offerings.
You’ve made it through the first piece of the series — thank you for reading.
Tricky things these carbon instruments… In the next part we will explore the second option for net carbon emissions reduction — carbon capture — and look into what it might mean in terms of opportunities for an investor.
Feel free to share your thoughts in the comments or directly with me at philippe.klintefelt.collet@globalfounderscapital.com or on Twitter @philippekc .
