ESG » From millions to billions: The shocking rise in carbon offset costs

From millions to billions: The shocking rise in carbon offset costs

The same volume of voluntary carbon offsets purchased in 2022 by FTSE350 businesses for £38 million could cost £438 million by 2030

From millions to billions: The shocking rise in carbon offset costs

A new report from PwC suggests that the cost of carbon offsetting for corporations could double by the end of the decade, and increase by a factor of thousands under a carbon capture scenario by 2050.

This surge in cost comes as businesses race to meet net-zero targets. PwC’s analysis, published May 30, shows that in 2022, FTSE 350 companies publicly reported purchases of voluntary carbon offsets totalling £38 million.

However, based on current pricing models, PwC has calculated that by 2030, this same volume of offsets would cost companies more than £135 million (a 256% increase).

This trend is expected to continue until 2050, when the cost of the same volume of offsets may peak at £365 million.

“Companies across all sectors must consider the potential financial impacts of rising offset prices as part of their Net Zero planning,” says Ian Milborrow, sustainability partner at PwC UK.

“If we get to that stage where the use of offsetting to reach net-zero targets becomes sufficiently expensive so as to become unviable, and in the absence of other strategies, companies will be unable to meet their net-zero commitments in the timeframes they have published.”

Although not a new concept, the prevalence of voluntary carbon offsets is growing as businesses become increasingly conscious and more proactive in relation to their responsibilities to tackle climate change.

The energy sector reported the highest purchases of voluntary offsets in 2022, amounting to £27 million.

However, the report also highlights that 80% of the volume of offsets reported to have been purchased in 2022 were classed as ‘avoidance offsets’.

Carbon offsets can be issued by projects which either reduce emissions through activities that prevent or avoid emissions that would have otherwise occurred (known as avoidance offsets), or through activities which actively remove and store greenhouse gases (GHGs) from the atmosphere (known as removal offsets).

Purchasing avoidance offsets should reduce GHG emissions in the future while purchasing removal offsets removes GHGs that have already been emitted from the atmosphere. There is growing momentum that only removal offsets should be permitted.

In such a scenario, PwC has calculated that the same volume of voluntary offsets purchased in 2022 for £38 million would cost £438 million by 2030 (a 1,051% increase), with prices expected to peak in 2037, where the cost of the current FTSE 350 purchases would reach £2.6 billion.

What is causing the price increase?

While the exact magnitude of the increase remains uncertain, there are several demand and supply fundamentals that could underpin this price rise.

One factor is increased pressure from customers and investors for businesses to set net-zero commitments. Almost 40% of the Fortune Global 500 have already set a net-zero target, and this number is rising every year.

Moreover, the agreement at COP26 on guidelines for the implementation of Article 6 of the Paris Agreement could lead to a significant increase in demand for carbon offsets from governments and non-state actors.

The cheapest forms of offsets currently in use could also be retired over the next few years, forcing businesses to shift to more expensive carbon offset project types.

A combination of these factors could lead to a material increase in the price of voluntary carbon offset purchases in the future. Accordingly, businesses may need to provision accordingly and take on more price exposure related to offsets.

CFOs should be aware of the potential financial implications, potential reputational damage, and regulatory scrutiny associated with carbon offsetting and take steps to mitigate these risks.

Impact on the bottom line

However, PwC’s research hints at a glaring reluctance to act. The purchase volume of offsets varies by industry and, therefore, so does a business’s exposure to potential offset price variation.

While many companies mention carbon offsets in their annual or sustainability report in 2022, only 19 out of 118 (16%) refer to their price/cost and only seven companies discuss potential price rises. PwC analysis also found that no companies in the FTSE 350 currently report voluntary purchases of carbon capture offsets, or removal projects, and the majority of offsets purchased are avoidance offsets.

As the cost of offsetting carbon emissions continues to rise, it can impact a company’s bottom line and profitability. Additionally, if a company is not adequately prepared to manage the cost of carbon offsetting, it may face reputational damage and increased regulatory scrutiny.

CFOs need to be aware of the potential financial risks associated with carbon offsetting and take steps to mitigate those risks.

Carbon offsetting is often used to buy time to invest in the technologies and operational changes needed for full internal transformation. Significant increases in the price of carbon offsets will make buying time more expensive.

This should drive investment into low-carbon technologies and operational changes sooner as they become more cost competitive and could shift business spending away from offsets.

Businesses should focus on reducing their emissions now rather than relying on voluntary carbon offsets to minimise their exposure to financial risks.

PwC’s report recommends that transparency, longer-term offset purchasing agreements, and decarbonisation strategies should be central to a sector’s plans to avoid exposure to offset price rises.

The bigger picture

Price increases in the voluntary carbon market must be considered as part of companies’ wider decarbonisation strategies.

“There are a number of steps that companies can take to address these challenges, including making longer-term offset purchase agreements, developing internal carbon pricing mechanisms and, wherever possible, focusing on decarbonisation to reduce their exposure to future offset price rises,” says Milborrow.

Disclosing approaches to offsetting and any considerations of changing prices would improve transparency between businesses and investors and provide them with a better understanding of the risks or lack thereof from price rises in the voluntary carbon offset market.

Companies should make their voluntary carbon offset purchasing strategy clear and transparent for investors so they can assess the extent of potential risks from offset price rises.

The Oxford Principles for Net Zero Aligned Carbon offsetting and the recommendations from the United Nations on how to use carbon offsetting to achieve Net Zero commitments can support businesses in improving their reporting.

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