Will carbon offsetting boom after COVID-19?

Published in

MSM fund

16 min readApr 22, 2020

Carbon offsets have gained corporate momentum since 2017, sparking a new wave of startups trying to capitalize on our growing environmental awareness. If we want to form a view about how big any market or trend can become, we should start by looking at the main drivers enabling its existence in the first place. Here, this means looking at:

Global warming and why we suck at tackling it.
Why COVID-19 can drive climate change leadership.
Demystifying price — why are flight offsets cheap if they pollute so much?

Finally, a brief reflection on where founders and VCs should look at to find winners in this market: B2B startups with fixed subscription pricing models who offer offsetting as a feature, not a product.

(Note: this is the full version of our latest market scan. If you’d like to focus on our takeaways, feel free to read our TL;DR here)

History book designers will struggle to find menacing visuals for humanity’s greatest threat.

Carbon what?

The term ‘carbon offset’ was first used[1] exactly thirty years ago (yes, 1990 was thirty years ago — we can hold hands and cry together) to describe “an action or activity that compensates for the emission of carbon dioxide or other greenhouse gases to the atmosphere”.

Carbon offsetting allows companies and regular folks to neutralize our carbon footprint by buying carbon credits generated by projects that prevent or reduce greenhouse gas (GHG) emissions — typically in developing countries.

One credit usually represents one metric tonne of greenhouse gas emissions prevented or removed from the atmosphere.

Nelly was right — it’s getting hot in here.

When thinking about climate change, nothing puts global efforts like the 2016 Paris agreement into perspective as realizing the oil industry already knew[2] where we were headed since 1970. We cannot argue that industry leaders simply did not have the technology to understand the implications of a carbon-based economic boom, since a model developed by Exxon[3] back in 1982 correctly predicted atmospheric CO2 levels would reach 420ppm by 2020.

*“We can’t be sure that global warming is man-made” — people that don’t like charts*

This suggests that climate change is as much a behavioural and global governance challenge as a technical one. In order to understand why we’re not doing much to solve a problem that Citigroup estimates[4] will generate 50 trillion USD in losses even if we can keep global warming at 1.5ºC, we need to look at the incentives for industry and national leaders, which drive their (very human) decision-making.

We haven’t seen climate leadership because decision-makers didn’t get any upside beyond morality — their second marshmallow was too far off into the future.

The marshmallow test is a famous Stanford experiment on delayed gratification back in 1972. Every participating child sat down and was presented with a choice: eating the marshmallow placed on a table in front of them or resist the temptation for fifteen minutes in order to eat two. Children who successfully resisted instant gratification went on to have higher grades, educational attainment and a healthier body mass index, well into their teenage years and early adulthood.

*Timmy the Oil Exec wanted to do the right thing, but he also really really wanted a new Porsche.*

A later replication with over 10x the original sample found that the role of willpower was initially overestimated, and in fact half of the observed effect was explained by the participant’s economic background. Sweden, Denmark, Finland, Norway, Switzerland and the UK all sit on the top quartile of the Climate Change Performance Index[5] — notice the parallel.

Leaders aren’t alone here — we’ve all been hoping to shrug our way out of this.

The world was a lot different back in the 90s when offsetting became a thing. While you and I were playing outside with a Skip-it on our ankle, parents and older brothers sat down to watch the sitcom Friends for the very first time.

In the meantime, the global economy was busy meeting our increasing standards of living and releasing 22 billion tons of CO2 that same year alone, already doubling annual global emissions of the early 60s[6].

Carbon offsetting is the easiest way for citizens do their part.
The IPCC reports are clear: we can’t just skip it no’mo.

While it is not a perfect solution, carbon offsetting is among the easiest ways for individuals to reduce or neutralize a carbon footprint that is only expected to increase[7]. Up 70% since the 90s, our footprint sits at 37 billion tons for every lap around the Sun. Reducing our dependence on CO2 is effectively humanity’s biggest challenge to date, not because it requires cleantech breakthroughs[8], but because the largest polluting nations and industries need to take action and cooperate: things we simply haven’t been very good at[9].

Climate inaction and COVID-19’s fallout spell good news for a market wishing it wasn’t needed.

We’ve looked over our shoulder to understand how we got here — but what can we expect from 2020 onwards? The media’s increased climate change coverage coupled with record-breaking grassroots movements such as Fridays for Future[10] certainly are increasing the pressure for citizens, companies and political leaders to act.

Before COVID-19, recent data[11] suggested that many developed nations are barking louder but the bite was nowhere to be seen, announcing ambitious carbon neutrality targets by 2050 that rely on improvements in direct carbon capture technology that simply isn’t scalable today.

Climate research centres didn’t spare criticism when it surfaced that these targets could only be met through models that assume carbon capture technology will remove the same amount of CO2 from the atmosphere as all the oceans and forests combined.

Let’s be clear — this is simply a publicity stunt made possible by cooking the books and passing the burden to the next generation, which sadly improves market demand prospects for the offsetting industry.

COVID-19 and its different impact across developed nations is a perfect demonstration of the hard choices leaders face in times of crisis — as well as what happens when they act and cooperate before it is too late.

We’ve since entered uncharted territory, and you’re probably reading this from your living room due to the global lockdown. The parallel between COVID-19 and climate change couldn’t be more obvious as the origin[12] of the virus itself has been tied to human disruption of a tropical hotspot for biodiversity, with researchers suggesting we can expect more pandemics if we continue to interfere with nature without understanding it. Both challenges require long-term thinking, international cooperation and are sparked by the ongoing removal of natural habitats for short-term gains while overlooking medium-term losses.

*You’re looking at 2018’s 14 climate disasters, each responsible for +1b USD in damages. The NPV of climate neglect won’t look great even at high discount rates.*

Bottom-line? After the global economy and the job market recover from this baseball bat to the face, at MSM we argue that there will be a renewed sense of need for preventive measures around climate change as consumers see what happens when developed nations ignore experts and don’t take action. Increasingly pressed to do their part, they won’t just wait and see what politicians and corporate leaders do through this decade, so we expect this market to continue to grow, perhaps even during a recession — thanks to the low price points of offsetting services.

How offsetting really works, aka “Why can I offset my flight for 5 bucks?”

There are two main markets for carbon offsets. The first is the compliance market, which includes highly regulated programs such as the EU emissions trading scheme, under which big industrial polluters such as power plants are legally obliged to buy credits to cover the CO2 they produce. The second is the voluntary market (the one we’re looking at here), through which individuals and companies buy credits that fund GHG-reducing projects, such as planting forests or installing efficient cookstoves in homes that currently resort to polluting alternatives.

The big offset certifiers include American Carbon Registry, Climate Action Reserve, Gold Standard, Plan Vivo and Verra. Verra and Gold Standard alone audit and accredit about 80% of the market[13]. Any SME can open up shop and start selling offsetting credits by purchasing them from certified sources, which explains why most founders today think offsetting became a commodity.

Selecting a project to invest in and how much it’s worth has been compared to real estate. There are several variables from quality, type, size, and geographical location. Just for your reference, the Fairtrade minimum pricing model estimates 9.10€/tCO2e for renewable energy projects and 14€/tCO2e for forest management. The problem is that these price-points can be highly manipulated by changing the time-horizon chosen to estimate GHG savings from, as demonstrated below.

Let’s run through an example shared with us by Nuno Brito Jorge, founder of GoParity, an impact investment platform based in Lisbon where anyone can start investing for as little as 20€.

*Offsetting a flight between Lisbon and Barcelona costs circa 2 EUR in most airlines. If we wanted to mitigate its footprint within one year it would cost us closer to 90 EUR.*

A one-way trip between Lisbon-Barcelona takes ~2 hours and emits about 109kg of CO2 per passenger[14].
In Europe, each kWh generates an average of 0.447 kg of CO2[15].
Therefore, offsetting this trip through renewable energy means we need to buy 243.85kWh of clean energy to make up for the CO2 released by our trip.
Buying one kWh from renewables at peak efficiency (kWp) costs experienced buyers approximately €0.60. Plugging in sector-specific details, offsetting this trip in one year will end up costing the end consumer not a couple of bucks, but 88,7€.
When Nuno flies to Barcelona, he pays under 80 times this amount — around 1–3€ to offset his flight.

Time is the key variable that allows companies to change the price of carbon-reducing activities when we offset our flight.

This is because renewable energy projects typically have a guaranteed horizon of 25 years.
Our money is put to work over 25 years instead of one, so each Euro is able to generate 25x more CO2 savings than if we had a one year horizon (because the plant is guaranteed to continue to generate renewable energy for 25 years).
This brings our one-year offsetting cost of 88.7€ down 25 times, to a single payment of €3.57 that will generate GHG savings over the next 25 years.

If we’re talking about reforestation or hydroelectric dams, the horizons are even longer — this suggests consumers should be able to see the real cost and pick the time horizon offsetting.

The misleadingly low price of offsetting comes from a desire to attract consumers to the market — the jury is out on its ability to increase demand vs. enabling low-cost greenwashing.

Pricing in offsetting markets has been described[16] as a “fine line between being affordable and uncomfortable, but that can change rapidly in a competitive carbon market”.

If prices are too low, offsets won’t generate enough pressure to get an individual or government or business to change their own carbon-intensive behaviour, and in fact, may simply grant them license to keep doing what they’re doing. But if they get too expensive, few will buy them voluntarily, and we will slow down a good way to raise environmental awareness.

How big is carbon offsetting?

Total offsets from the last decade add up to a tiny 1% of the 37b tons released last year. It won’t save us alone, but it was never supposed to.

The market peaked at $790m in 2008 after the Kyoto protocol promised a global carbon market.

Sarah Leugers, communications director of the Geneva-based nonprofit Gold Standard famously stated that Donald Trump’s decision to pull the US out of the Paris agreement transformed the market, with companies and individuals all now wanting to mitigate their footprint regardless of government leadership.

Even though the International Air Transport Association (IATA) says that just 1% of passengers offset their carbon emissions through voluntary programmes, the global offsetting market is back to where it was before the Global Financial Crisis, with a total of 430 million tonnes of emission reductions generated since 2005[17] — a large number easily overshadowed by the 37 billion tonnes of GHG humans released in 2018 alone. The market for these credits, worth possibly a few tens of millions of dollars in 2005, is now (August 2019) valued at over $500m a year and growing.[18]

Perhaps unsurprisingly given the stream of public announcements, businesses are driving most recent growth after the initial hype of 2008, accounting for 75% of all transactions[19] despite initial marketing efforts towards the planet-conscious citizen. This chart by the Financial Times suggests the last financial crisis effectively killed the J-curve of the sector, as companies and consumers cut back on spending to stay afloat during harsh economic waters.

This brings back the topic of a COVID-19 fuelled recession: will it chop down a second wave of tree-hugging clients or will going green be the highest ROI marketing tool to attract younger generations because of its low cost? We argue the latter to be most likely, as with every decade consumer preferences are increasingly greener. The overall sentiment in the pre-COVID business world was positive, as by now over 177 large companies have pledged net zero emissions by 2050 and may need to use offsetting to get there. The combined GHG emissions of these 177 firms roughly equal the total CO2 emissions of the entire country of France.

Who is leading the charge and why?

Airlines show mass adoption as they seek to keep flying guilt-free: 29 airlines, including Emirates, Delta, BA, Air Canada and Gulf, now offer offsetting, and 15 are voluntarily offsetting their own emissions. This should not be surprising as a report by the Rhodium Group[20] suggests the transportation sector is leading the way as the largest source of emissions for the third year in a row. EasyJet’s 2019 committed to offsetting one year’s worth of flights was equivalent to nearly 8 per cent of the entire global market for voluntary offsets in 2018.
Large consumer-facing brands using it to meet public carbon neutrality targets: big corporate buyers [21] include energy majors BP and Shell, British Airways, French luxury goods company Kering and US ride-sharing group Lyft, whose recent pledges to cut their net carbon emissions are fuelling a fresh boom in the relatively small offsetting market.
Brands such as Disney, Amazon, Microsoft, Lyft, Apple, Aviva and Sony have pledged to become climate neutral over the next two decades and most plan to use offsets to get there.
Others have already taken action today — Google, Dell, HSBC, Etsy and others use offsetting to claim partial or full carbon neutrality[22],[23].

While green advocates raise needed awareness, going green is now good for business

A 2017 study[24] by the PR firm ConeComm found that “87% of Americans will purchase a product because a company advocated for an issue they cared about.” and “92% will be more likely to trust a company that supports social or environmental issues”. This is an area where we can be optimistic: doing good no longer relies on green champions who feel responsible for internalizing the true cost of their operations — a trend unlikely to be reversed until we reach several cleantech breakthroughs and reduce our own emissions.

How profitable are the top carbon offsetting companies?

While answering this requires a deeper dive than what we’ve done to date and cannot be forward-looking by nature, our anecdotal findings suggest that offsetting alone isn’t a massive economic opportunity for market leaders entering a new decade, as:

Established brands with significant press coverage like Atmosfair reported record-breaking revenues of merely 7 million Euros in 2017[25].
Gold Standard, a market leader in auditing and certifications, reported 4.2m in revenue and 700k in net profit in its 2018 annual report[26].
Several established players are set up as NGOs and their revenues are capped at 20% of collected funds to cover their operations.

Differentiating strategies presented further below are currently being tested by startups and may change the nature of the game, but offsetting alone will most likely not be the main driver of revenue for successful SME’s in this space.

Companies who can provide offsetting on top of a stronger value proposition may be equipped to leverage the same ‘green goodwill’ while generating more attractive revenue streams.

How do carbon offsetting companies compete on the market?

Offsetting is now a publicly recognized commodity. Startups have started using it as a “foot in the door” tactic to upsell more green goods and services to a growing customer base.

MSM talks with offsetting startups aiming to build a new client-base revealed the following competitive strategies:

Locking in customers with fixed monthly subscriptions where the offsetting fee is chosen by the user (the company markets the ability to offset a chosen percentage of a citizen’s average monthly emissions).
Bundled with samples of products from green brands who use the Company as a marketing channel.Bundled with carbon calculators, allowing users to see their footprint and GHG savings to date.

4. Minimizing friction through low price points and ultra-easy sign-up UX.

5. Marketing specifically to firms that want or need to be seen as green and cool by their own workforce.

What are the main alternatives to offsetting?

Note: Alternatives here refer to viable options for internalizing the cost of released emissions. Investments in green tech or improved consumption habits are GHG positive yet not included in this conversation.

Voluntary carbon offsetting, mandatory cap and trade schemes and a state-enforced carbon tax are the three most widely discussed methods to allow companies to internalize the cost of the GHG emissions they need to release into the atmosphere in order to operate profitably. This frames carbon offsetting as especially relevant for individuals, who at best are left with the option of using their voting power to encourage implementation of the other two strategies.

Back to the Future — our Expectations for the Offsetting Industry

Is it relevant for impact investors? Yes.

While not devoid of criticism, with The Guardian’s George Monbiot describing offsetting as “a tool to buy complacency, political apathy and self-satisfaction”, one can argue that offsetting can be part of the solution to mitigate climate change due to its ability for widespread market adoption from both citizens and corporates. That offsetting alone will never be enough should be a given — it may buy us valuable time and momentum, nevertheless. The increased consumer awareness of the need to monetize the true cost of living on a carbon economy is valuable in and of itself, facilitating further green policy, as suggested by Britain’s National Consumer Council and Sustainable Development Commission[27]: “a positive approach to offsetting could have public resonance well beyond the CO2 offset, and would help to build awareness of the need for other measures.”

Is the market opportunity interesting? Probably not from offsetting alone.

Despite strong growth since 2017 and a positive consumer sentiment towards companies who position themselves as part of the sustainability movement, the offsetting market today appears to be too small for VC funds to make bets exclusively focused in it. As B2B sales are driving 75% of market growth, consumer-facing startups focused on offsetting are trying to win in a small market worth less than 1b USD today, marketing themselves to a target customer base that appears to be more active with its physical and digital voice than their wallet — and might thus be trying to climb a hill that remains too steep for now.

Is COVID-19 likely to disrupt this market? Yes in the short-term, yet less likely in the medium-term.

Its potential to trigger an economic downturn already prophesized by experts over the last 3 years cannot be overlooked. The real question is how large corporates will ‘play the green game’ during a recession: the boom and bust of the 2009 offsetting market took place when millennials were graduating college and Gen Z was watching after-school cartoons. Climate change was further away. In this new decade, both millennials and Gen Z will see an increase in purchasing power and likely be equally or increasingly loyal to the ‘fight against climate change’.

Are founders right to bundle green services together? Yes, as it boosts conversion, impact and market size.

Startups that aim to bundle offsetting as a feature that sits on top of their core value proposition may be able to effectively satisfy customers from more than one “green market”, creating a larger baseline TAM from day 1.

Current demand for offsetting suggests that companies should continue to provide this service, as their customers will continue to demand it. This is in part possible due to increasingly “commoditized” nature of offsetting and carbon calculators, which allows companies to sell certified carbon credits through credible providers such as Gold Standard as well as reporting features so clients can track their ‘green equity’ on phones and software platforms.

VC-compatible startups are more likely to focus on the B2B space and combine complementary solutions for clients looking to go greener. Different services increase the likelihood that a potential client will have an appetite to start with one. These commodity-like revenue streams should sit on top of a differentiated value proposition which is the only real source of valuable IP.

What can we take away from this?

MSM argues that the most interesting piece of data from the offsetting market lies in the confirmation that businesses today recognize that “being green sells” because their clients care. The core motivations are not altruistic and they’ve widely been written about, spanning from PR to boosting stocks to employee engagement and talent acquisition — B2B is driving this market because companies want to say “We care about the environment”.

Startups looking to satisfy this demand can then likely play one of two strategies: a) focusing on ‘transformative impact’, or b) focusing on ‘frictionless impact’.

The first is likely to require strong sector expertise, R&D and long sales cycles — losing its appeal to VCs but commanding high price points and gross margins as well as first-mover advantages to the companies that find ways to forever change how incumbents operate.

The second will require building a ‘green stack’ of scalable offset-like services that allow companies to generate green claims across sectors at low price points, requiring a larger customer base and an efficient go-to-market strategy. Moderate VC activity will be expected in this space, as founders try to create “the next offsetting”.

Sources:

[1] https://www.merriam-webster.com/dictionary/carbon%20offset#h1

[2] https://www.theguardian.com/business/2016/apr/13/climate-change-oil-industry-environment-warning-1968

[3] https://www.theguardian.com/environment/climate-consensus-97-per-cent/2018/sep/19/shell-and-exxons-secret-1980s-climate-change-warnings

[4] https://time.com/4082328/climate-change-economic-impact/

[5] https://www.climate-change-performance-index.org/

[6] https://ourworldindata.org/grapher/annual-co-emissions-by-region

[7] https://www.varsity.co.uk/science/9086

[8] https://www.b-t.energy/wp-content/uploads/2016/10/BreakthroughEnergyCoalition_Landscape.pdf

[9] https://www.theguardian.com/environment/2019/dec/16/un-climate-talks-australia-accused-of-cheating-and-thwarting-global-deal

[10] https://en.wikipedia.org/wiki/School_strike_for_climate

[11] https://www.theguardian.com/environment/2018/feb/04/carbon-emissions-negative-emissions-technologies-capture-storage-bill-gates