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INFLUENCE: Carbon offsets … Is it time to invest?

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The recent release of the ‘carbon offsets paper’ by National Treasury raises the question of whether carbon offsets are in need of a feasibility reassessment, for the planet and the bottom line. Do they bring profit? By Gary Swartzand Zani Labuschagne

South Africa is one of the world’s top 15 greenhouse gas (GHG) emitters. In 2011 a national climate change policy was adopted on emission reduction measures and the promotion of investment in infrastructure and actions that are climate-change resilient. In line with this policy, South Africa has committed to a reduction in its GHG emissions by 34% by 2020 and 42% by 2025.

The introduction of a carbon tax is viewed as one of the key measures for achieving these goals. A GHG tax of R120 per tonne of carbon dioxide equivalent (CO2e) is proposed. This compares favourably to the current market price of carbon credits of around £5 per tonne. The implementation of the tax has been delayed by a year to provide time for a proper regime for implementation to be created.

The new tax includes an offsetting mechanism for projects where the reduction of carbon dioxide (CO2) emissions or other GHGs may be offset against emissions made elsewhere. This is one of the carbon tax’s six key elements for motivating carbon sequestration.

Other aspects of the tax include:

  • A 60% tax-free threshold
  • Further threshold adjustments intended to benefit companies that have voluntary mitigation emissions
  • Allowances for sectors with limited emissions reduction potential, and
  • Graduated relief for trade-exposed and emissions-intensive sectors

The emission threshold has a 90% limit on the tax-free elements, including offsetting. Graph 1 provides a diagrammatic representation of the thresholds for each industry sector.

CARBON OFFSETS

The recent publication of the ‘carbon offset paper’ for public comment provides more guidance about the offsetting mechanism that is linked with the carbon tax, and raises the question of the economic incentive for companies to introduce carbon projects. Offsetting is aimed at providing companies with an avenue through which their carbon tax liability can be reduced at a cost lower than that of the carbon tax. The aim of the offset mechanism is to reward firms who reduce their emissions, rather than simply raising the cost of continuing to emit. It therefore intended to be not merely a cost, but a driver of action. It also addresses other flaws of the carbon tax, such as the tax revenues generated from emitting not being ring-fenced for reducing emissions. Otherwise it could become a revenue-generating tax rather than a climate-changing solution. An additional concern about the carbon tax is that our biggest polluters – the electricity, gas and liquid industries – would, given their dominant and protected positions, be able to pass the costs of the carbon tax and carbon offsets on to their consumers, thereby negating any punitive impact on the industry itself.

GRAPH 1 (Click to enlarge)

Rep_July2015

While the carbon tax has been greeted with much circumspection, the possibility of using carbon projects which reduce GHG emissions to offset the proposed carbon tax was considered to be a step in the right direction. In total 93,5% of the respondents to the carbon offset paper felt it would promote sustainable behaviour, while they acknowledged the need and importance of a carbon offsets scheme.1 However, the questions surrounding the economic viability of offset projects still need to be answered.

In a South African context any desire to be carbon neutral, or to reduce emissions, is motivated purely on a voluntary basis at present, and the purchasing of carbon credits or for instance entering into carbon-saving projects would have little value other than a philanthropic motive or for marketing as a clean green company. However, this would change with the introduction of carbon offsets on the carbon tax, and may trigger a rise in activity in the carbon projects market.

THE ECONOMICS OF CARBON OFFSETS

National Treasury defines carbon offsets as measurable avoidances, reductions or sequestrations of CO2 or other GHG emissions. These are often described as being project based, as they typically involve specific projects or activities that reduce, avoid or sequester emissions.

According to the National Treasury discussion paper, independent studies suggested that the potential overall national demand for offsets could be up to 30 million tonnes of CO2e per year. Therefore it would be attractive for firms to cost effectively lower their carbon tax liability, using offsets, by up to 10% of actual emissions. National Treasury further suggests that carbon offsets would incentivise investment in least-cost mitigation options. ‘Such projects can also generate considerable sustainable development benefits in South Africa, including channelling capital to rural development projects, creating employment, restoring landscapes, reducing land degradation, protecting biodiversity and encouraging energy efficiency and low carbon growth,’ National Treasury stated.2

ARE CARBON PROJECTS ECONOMICALLY VIABLE?

The determination of economic viability for carbon projects is a complex and often bespoke process. Each project needs to be evaluated based on its own merits and principles. In addition, there are a number of difficult estimation aspects to each project. For instance, the determination of a baseline (status quo), measurement of emissions, determination of the project scope (including all impacts), and concepts such as additionality need to be taken into account in the estimation of economic feasibility. Furthermore, because so many of these aspects are subject to measurement manipulation, they will require careful management.

The following are the main issues that need to be considered and quantified:

• Adverse selection and moral hazard in offset markets:

  • Adverse selection involves firms actively taking steps to inflate their baselines.
  • Moral hazard entails paying companies with already low emissions too much.

• Current regulatory focus on additionality, which tends to paint projects with a broad brush without proper consideration of context and implications:

    • Additionality requires that the reduction would not have happened anyway, or was not based on a normal business decision. Thus, if a cheaper fuel is used in a furnace, and it just happens to have lower emissions, the additionality criterion will not have been satisfied. If it thus is stems from business as usual, there will have been no additionality.

• Determination of a baseline or starting point from which emission level reduction can be measured (the emissions in the absence of an offset). This is not easy to define and measure, and is often subject to manipulation.

• Cradle-to-grave analysis of all emissions, or cradle-to-cradle analysis if the item is recycled:

    • Material and service inputs (suppliers)
    • Manufacturing process
    • Packaging
    • Distribution
    • Transportation
    • Usage
    • Disposal
    • Recycling

• Qualitative factors that have other non-monetary benefits should also be considered.

The carbon tax and carbon-offsetting scheme will add to these considerations, for any carbon tax savings, as well as the market price of carbon credits which could be sold, could result in project or technology viability – which was not possible before.

The carbon project is a complex undertaking, and the application process and viability considerations can range from half a million to many million rands, depending on the project size and its complexities. A large part of this entails assessing the strategies, accumulating data, determining baselines, and calculating the carbon footprints of the various activities.

Ultimately, perhaps, the implementation of triple bottom line reporting will be the more important driver than mere economic feasibility.

Graph 2pg46_july2015
Graph 3Graph 3

NOTES

1. Republic of South Africa, National Treasury, Carbon offsets policy paper – April 2014: summary of public comments & initial feedback: economic tax analysis, October 2014, http://www.ecometrix.co.za/wp-content/uploads/downloads/2014/12/141002-Carbon-Offsets-Public-Comments-Response.pdf

2. Republic of South Africa, National Treasury, Carbon offsets policy paper, April 2014, 7, http://www.treasury.gov.za/public%20comments/CarbonOffsets/2014042901%20-%20Carbon%20Offsets%20Paper.pdf

AUTHORS: Professor Gary Swartz CA(SA) is institute head of the Institute of Accounting Science and Zani Labuschagne CA(SA) is a sustainability consultant at the institute