The SEC Must Avoid Legitimizing Carbon Offsets

These are nothing more than financial trickery that lets polluters shirk responsibility.

BY DYLAN GYAUCH-LEWIS
MARCH 11, 2022

QUEENSLAND FIRE AND EMERGENCY SERVICES VIA AP
Record flooding inundates streets and buildings in Maryborough, Australia, on February 28, 2022.

The Revolving Door Project, a Prospect partner, scrutinizes the executive branch and presidential power. Read more from the Revolving Door Project

After months of deliberation, the Securities and Exchange Commission (SEC) is set to release their much-anticipated climate disclosure rule later this month. This first step toward measuring climate-related financial risk could be critical to setting the financial system on a more stable path through the inevitable climate transition. The financial industry, however, is likely hoping for a different outcome, one that doesn’t force it to make any fundamental changes. And, as my Revolving Door Project colleague Hannah Story Brown and I explore in a report released today, one of corporate America’s favorite mechanisms for “addressing” climate change without actually doing much is carbon offsets.

The SEC shouldn’t let them get away with that.

An offset is essentially a certificate that an entity can purchase to fund an external project which purportedly prevents or removes carbon emissions, counteracting the harm of their own carbon footprint. But there are problems. First, as many have pointed out, offsets do little to alter polluting firms’ behavior and often just dump the burden of combating climate change elsewhere. Many offset projects aim to reduce emissions in the developing world, resulting in a quasi-colonial trend of dictating natural-resource use in less industrialized countries.

Beyond ethical quagmires, there are rampant accounting problems in offset markets, such as double counting. This is when more than one entity counts an offset against their emissions. For instance, it is not uncommon for both the project’s funder and the government or entity that manages the physical location of the project to claim a reduction in their carbon footprint. Then there is the related problem of additionality: Offsets are supposed to further reduce emissions, but this can enable firms to profit from their already existing projects by promising not to change the status quo. It’s a convenient way to make money by essentially sitting on your hands. In a similar vein, some offset sellers rely on a theory of suppressed demand, where they argue that their project will reduce future pollution “based on assumed carbon emissions rather than actual carbon emissions.”

These accounting gimmicks make it possible to vastly overestimate actual emissions reductions by double-counting offsets, taking credit for existing conditions, and equating a promise to reduce in the future with addressing existing emissions today. With all of these problems, it is perhaps unsurprising that many offset projects can’t verify their emissions reductions and some actually wind up increasing carbon pollution.

These accounting problems can have a huge impact for two key reasons. First, because of the international nature of offset projects, verifying results can be difficult—especially because current carbon market registries lack basic transparency; they disclose how many offsets have been purchased, but not the identities of the buyers. Second, as the offset market grows, accounting issues become more and more difficult to police. As a result, estimates of the effectiveness of offsets can easily become inflated.

Among the many more obvious dangers resulting from a warming planet, climate change poses a dire risk to the financial system. The SEC and other financial regulators are currently developing rules to regulate (and potentially mitigate) that risk exposure. Depending on the exact shape of the framework they propose later this month, the SEC could pave the way for the carbon offset industry’s takeoff or expose its deceptions.

If the SEC’s new disclosure requirements address carbon offsets directly, it will be one of the first American financial regulations to do so. The more significant the disclosure mandated—for instance, if they require companies to report gross instead of net emissions, and to identify all specific carbon offset projects they invest in to lower their net emissions, with emissions “prevention” and emissions “reduction” qualified differently—the less likely that corporations will be able to greenwash themselves with half-baked solutions.

Corporations, unsurprisingly, are hoping for permissive standards that require only minimal disclosure of climate risk management and environmental, social, and corporate governance strategies. Additionally, polluting industries would strongly prefer that the SEC not require disclosures to distinguish investments in offsets from investments in projects that actually cut emissions or mitigate exposure to climate risks. With such rules, carbon offsets and the markets that facilitate them are more likely to become accepted and adopted as a primary mechanism for addressing the climate crisis by companies and governments alike. Knowing what we know about carbon offsets’ integrity problems, this would be disastrous. Offsets exemplify what corporatists and financiers love about unregulated financial markets: how easy they are to game.

The SEC’s climate risk disclosure rule is among the first policy moves from this administration with serious implications for the carbon offset industry, but it will not be the last. And although the administration’s domestic climate plan does not include market-based carbon trading solutions, there are reasons for concern about whether the administration will set and maintain a hard line on offsets moving forward.

Offsets have already permeated some of the government’s international development financing, with the Department of State supporting projects to generate carbon offsets in dozens of countries. As the Biden administration enacts its International Climate Finance Plan, and agencies like the Development Finance Corporation and Millennium Challenge Corporation pledge more funding for climate-related investments, it is crucial that the projects and partnerships funded by federal money go to real, equitable climate change solutions.

Right now, offset markets are still a niche industry—but that could change quickly.

Domestically, too, the opportunities for carbon offsets to secure federal funding are growing. For instance, there has been bipartisan support for heavily investing in a closely related and complementary form of greenwashing called carbon capture. Carbon capture is a fossil fuel–backed technology that the IPCC says poses a “major risk” for climate goals if relied on. It encompasses a range of techniques and equipment that can capture carbon emissions, put that carbon to use, and/or sequester it in the ground. Carbon capture is greenwashed as climate change mitigation when in fact most captured carbon is used to extract more oil, with “enhanced oil recovery.” Carbon capture is not quite the same thing as carbon offsets, but there are a number of critical connections between the two. The first, and most obvious, is that carbon capture projects can be used as offsets. Another common thread is that both carbon capture and offsets are favored fossil fuel industry “solutions” that have had abysmal returns when actually implemented.

Despite these fatal flaws, the Department of Energy poured over $1 billion into carbon capture projects in recent years, none of which have been successful. Now, carbon capture may receive $12.2 billion in funding from the infrastructure bill, and set up fossil fuel companies to make billions more in tax breaks for carbon capture.

These investments could easily continue, thanks to enthusiastic support for carbon offsets among high-ranking administration officials and legislators. Secretary of Agriculture Tom Vilsack is an ardent supporter of developing a carbon bank within his department. Vilsack’s son also works for a firm that aims to build the largest carbon capture project in the world. In the Department of Energy, both Secretary Jennifer Granholm and Assistant Secretary for Fossil Energy and Carbon Management Brad Crabtree have touted the promise of carbon capture projects. John Morton, the climate counselor to Secretary of the Treasury Janet Yellen, joined the administration from Pollination Group, a company that bills itself as a climate change investment and advisory firm and is heavily involved in nature-based investments, including carbon markets.

This makes it all the more important that the SEC’s rule proposal establishes stringent standards that undercut greenwashing from the carbon offset industry and others. With rigorous disclosure, outside organizations and investigators will be better able to pressure finance companies to put their money where their mouth is and invest in real, proven solutions and mitigation strategies, rather than questionable financial products and green PR.

This is a critical juncture not only because the SEC’s new rule will be among the first to require companies to disclose information about their emissions and management of climate risk, but also because the offset market is potentially ready to grow massively in both scale and legitimacy in the near future. Bank of America estimates that the market for offsets will grow by a factor of 50 in the next couple of decades, while BlackRock, the largest asset management company in the world, has stressed the importance of business plans that move towards “net zero” emissions. (Importantly, “net zero” pledges traditionally rely much less on actually slashing emissions than on offsetting them.)

A financial industry group is also setting up its own regulatory body for voluntary carbon markets, which can be safely dismissed out of hand. The task force is slated to include former SEC Commissioner Annette Nazareth, who has a history of supporting large banks and financial institutions over the public interest, including vocally opposing increased regulation in the wake of the Great Recession.

Right now, offset markets are still a niche industry—but that could change quickly. Strong disclosure guidelines now can help to block off the worst abuses simply by making companies back up their “net zero” pledges for the public record. But, if offset markets are allowed to continue on their current path, where they prop up projects that do more to line pockets than fight climate change, the industry may grow to the point where reining it in becomes far more difficult. And the longer that offsets are allowed to remain in the shadows, the more they will disincentivize real climate strategies.

For more on offsets and how they fit into federal regulation, see the Revolving Door Project’s Carbon Offsets Industry Agenda report.

DYLAN GYAUCH-LEWIS is a research intern at the Revolving Door Project.