Carbon offsets vs carbon reduction – which is the better investment?

Carbon prices are at an all time low.  What does this mean – and should a business thinking of buying carbon offsets be worried about investing in them?

Carbon offsets are purchased by individuals or firms to offset the emissions they produce in their activities.  The emissions aren’t being taken away of course; the idea here is that somewhere in the world, a project to reduce emissions by the equivalent amount will go forward because this money has been granted to it.  That is supposed to put the project into the black – the UN will only approve offsets if the project would not be financially viable without the money the offset brings in.

Offsets can include landfill methane power generation. Photo: D'Arcy Norman /
Creative commons

The problem right now is that offsets are in low demand, at least partly as a result of the recession.  At the same time, supply of offsets is rising, as more and more projects are approved by the UN.  There is no shortage of companies willing to propose projects, but at current prices, most of these will barely cover their costs.   High supply and low demand have made this one of the worst performing commodities this year.

However, this is not a problem for the buyers of offsets.  In fact, if you are buying in order to become carbon neutral, it has never been cheaper to do so.  So should every firm that aims for carbon neutrality start focussing on offsets to accomplish this?

This is not necessarily wise.  Carbon offsets cost money, and provide no direct return – you have to buy them again next year.  Carbon reductions – for instance reducing waste, energy consumption, and so on – does provide a return, as the cost reductions come year after year.  Like offsets, they may cost money, though many are free or have a payback period of months.  However, even the costly investments do at least have a return, which carbon offsets do not.

On the other hand, some environmental investments will never be profitable.  To take an extreme example, solar panels on a north-facing roof in the UK are unlikely to turn a profit.  How can a firm decide which investments to make, and whether to pursue offsets as well?

A popular tool for selecting green investments is the marginal abatement cost curve.  The vertical axis shows the net present value or cost of the project per Kg of emissions reduced, while the horzontal axis has the total amount of abatement per year.  Investments are ordered by value, with those that create the greatest financial benefit per unit of carbon reduction on the left.

Those projects with a positive net present value are the obvious priority. As for the projects with negative net value, some will be attractive to firms that will gain sufficient indirect value from carbon reductions (morale, reputation, etc).  Those opportunities with a net cost lower than carbon offsets should clearly be favoured next. For projects with a greater net cost than offsets, the strategy should switch to purchasing these instruments instead.  The chart on the right summarises the decision process.

Offsetting is most valuable to firms that have already have a powerful programme of continuing carbon reductions, and who will benefit from the reputation effects of achieving full carbon neutral status.  However, if a firm’s emissions per unit of sales or output are not falling, then there are almost certainly direct carbon reduction options waiting to be uncovered.  In addition to being environmentally sound, these projects are financially more sustainable than offsets.