Carbon offsets - how do they work, and who sets the rules?

Could carbon offsets help reduce emissions? Or are they just one more tool for greenwashing?

Carbon offsets occur when a polluting company buys a carbon credit to make up for the greenhouse gas it has emitted. The money should be used to fund action somewhere in the world that remove the same amount of carbon out of the air, or to prevent carbon emissions.

Detractors say that offsetting is ‘greenwash’, allowing companies to avoid cutting their emissions while still being able to claim they are, or will be, carbon neutral.

Proponents say offsetting, if done properly, can help channel funds to conservation and sustainable development projects that will reduce emissions, giving companies time to work towards zero emissions.

On the latest episode of the Radio Davos podcast, we hear from Rachel Kyte, co-chair of the Voluntary Carbon Markets Integrity Initiative which is building a rulebook that aims to ensure carbon offsetting does what it claims to do.

And we hear from Dharsono Hartono, UpLink Top Innovator, and CEO of Rimba Makmur Utama, an Indonesian company that manages the Katingan Mentaya Project, a forest in Borneo, Indonesia, that generates carbon credits. The transcript is below.

This transcript has been generated using speech recognition software and may contain errors. Please check its accuracy against the audio.

Robin Pomeroy: You're co-chair of something called the Voluntary Carbon Markets Integrity Initiative. Could you tell us what that is?

Rachel Kyte, co-chair of the Voluntary Carbon Markets Integrity Initiative: Yeah. So VCMI was created in 2021. It's a multistakeholder initiative and it's focussed on integrity as the golden thread of voluntary carbon markets in that without integrity, and I'll explain what we mean by that, it's going to be very difficult for the voluntary markets to achieve their dual purpose. And their dual purpose is to channel funds into nature and natural resources, into countries that have a wealth of natural resources and a potential to produce carbon credits.

This could be a stream of financing into countries that desperately need financing through an adaptation for the protection of nature and for their own resilience and their own green growth in the face of this climate emergency.

The second purpose is to actually reduce emissions, and that by using market mechanisms, in this case, voluntary markets, those companies that are emitting and need to find a way to get to their net zero obligations can use voluntary markets as a potential tool to do so.

This multi-stakeholder initiative came together last year to try to develop some guardrails, in fact a rule book, for how companies can make claims when they claim that they are net zero using the voluntary carbon markets and using as one part of that potentially offsets.

As you will have seen over recent years, there's been more and more and more companies making net zero claims. There's been lots of consternation about whether those claims are legitimate, whether they're science based. And there's been a lot of concern that very large global companies are doing deals with small developing countries where they're trying to use the sequestration capability of the nature in those countries to offset their carbon emissions from their continuing business plans. And that's the accusation of greenwash that we've heard so articulately put forward by, in particular, the youth movement around the world.

So real need for companies to meet the net zero claims, real need for finance to flow to protect nature. Can we make it work so that we reduce carbon emissions and that the finance flows? Or are we just creating an awful lot of hot air? Or are we just delaying action and are we actually not solving the problem? So that was the question that VCMI was set up to look at, together with many others that were from the issues of the voluntary carbon markets.

Robin Pomeroy: Who's behind VCMI, then? Who put this together?

Rachel Kyte: VCMI was funded by the British government and the Children's Investment Fund Foundation, initially. In the next phase we'll be funded by a broader set of governments and philanthropic actors.

The steering committee, which I co-chair together with Tariye Gbadegesin from Nigeria, is made up of people who have standing in the business world, in the government world, in the civil society and scientific worlds. And there's an expert advisory group that provides the sort of scientific basis upon which we are developing our codes of conduct. And we've been consulting with the private sector, with companies, with civil society, with indigenous peoples and local communities, and with regulators and with governments. So the United Nations Development Programme is part of this as well, importantly, because it provides a lot of the support and advice to governments on how they can produce credits that could then be potentially active in voluntary carbon markets.

So multi-stakeholder, funded by governments, philanthropy, basically one of the initiatives set up to try to make sure that voluntary carbon markets, if they are going to operate, operate for good.

Robin Pomeroy: You set out perfectly what the battle lines are. Let's imagine a world where carbon offsetting worked perfectly. What would it look like? Explain in theory how carbon offsetting works.

Rachel Kyte: So carbon offsetting is the idea that a party that has excess credits, that has an excess of carbon capacity, as it were, and a party that needs credits can trade or can have a relationship whereby the excess credits offset the excess emissions of the other actor.

Obviously, there are regulated carbon markets. So in this case, we're talking about voluntary carbon markets and we're talking about companies and countries in different jurisdictions - there can be voluntary carbon markets within a national jurisdiction - but I think the piece of this which causes so much concern and which offers so much opportunity is the idea that a series of companies in, say, western Europe, could channel resources into the mangroves of Central America, for example, mangroves being very, very important part of our natural resilience to climate change, having many, many benefits, including an important benefit of carbon sequestration, and that funding will then help those mangroves be protected, could extend them. You would then have jobs. You would have the kinds of economic activity. You would have pristine natural barriers for storms, etc., and you would have a flow of revenue into that country or into that local community or into the indigenous peoples who would claim those mangroves as their own.

So that's the idea, that you've got excess and you've got a need and that you come together. The detail of this is how you account for it, and also. importantly, when you could actually use the voluntary carbon market, that's where the issues come.

So the issue is can a company go to the voluntary carbon market before it has done everything it can to reduce its own emissions? And should it ever actually go to the carbon market in a world where we're running out of the carbon budget? So wouldn't we only want to see companies reducing their emissions, and in fact, reducing carbon?

The big issue which we have focussed on at VCMI is what do you need to do before you could use the voluntary carbon markets? You cannot go to the voluntary carbon markets and offset emissions before you have done everything you can to reduce your emissions from your business model, before you have clearly understood how you are going to get to your net zero targets, before you've done everything that you can, leaving you only with residual emissions. And then if those residual emissions can be considered in a voluntary carbon market, then potentially that could be a use of the voluntary carbon markets.

I think what many observers are afraid of is that companies are using carbon offsets as part of a sort of generic net zero or carbon neutrality pledge before they have taken the necessary steps to reduce their emissions. And of course, some companies, while at an enterprise level, aren't clear how they're going to get to net zero, are offering carbon neutral products as well. So you can buy 'carbon neutral, motor oil', etc. And I think some of the product branding remains highly dubious.

Robin Pomeroy: So companies at the moment, without these guardrails in place, a company is free to kind of write its own rules on this, say, I've done something, this product is now, therefore, carbon neutral. Is that what's happening in some cases.

Rachel Kyte: Yes. You've got companies saying that they're going to be net zero by whichever date and that they are then implying that they are carbon neutral now or implying that because they've got a pledge that that's okay now. And I think the important thing to remember is that we're in transition. So there's almost no company today that is carbon neutral. I mean, there may be a few, but there are very few. Most companies have a pledge to get there at a certain date, and they've got milestones. There are a number of countries, more than 200, that have science based targets. Those perhaps are the sort of most rigorous and most transparently vetted plans on how to get to carbon neutrality.

So at the moment, we're in a voluntary market where there's no rules, there's no governance. And what you're seeing is these sort of voluntary initiatives, ours, another private sector-led initiative which is looking at the rules for the quality of credits, with the international Integrity Council for the Voluntary Carbon Market (ICVCM), the Science Based Targets initiative. So you got all these different groups coming together and trying to build parts of the scaffold of a voluntary market that actually achieves its purpose.

Meanwhile, there's extraordinary demand for high quality, or high integrity, credits. There's extraordinary demand for credits writ large. As more and more companies have made their net zero pledges, they need to be able to show how they're going to get there.

And you've seen the good, the bad and the ugly. You've seen very careful. constructive activity. Companies that have done a lot of legwork on understanding how this is going to be part of the strategy. And you can also go into the markets and find somebody who will sell you credits, whether it's from a forest in Siberia that burnt down three years ago.

So everything is there. But I think what we're seeing is just this extraordinary pressure on the demand side as the business and financial community has understood the imperative of decarbonisation.

Robin Pomeroy: So how do you envisage this all working out? There seem to be a lot of initiatives. Lots of people are working on this. I mean, I suppose at the end, if this is going to work, there's going to need to be some kind of guarantee. Do you imagine that's ever going to be feasible and how would it work?

Rachel Kyte: Well, I think we're in this sort of very necessary but difficult moment where the rules are not in place, there is no oversight of those rules. And I think the consequences of not operating with integrity will emerge. But they haven't quite emerged yet. And so for many private companies, this is extremely discombobulating. You are entering into a voluntary, and you have no guarantee that the trade that you're engaging in is one that's going to be considered high-integrity down the line.

And yes, there are many, many private actors that will help you with your monitoring verification. There are many companies now springing up that will use satellites and machine learning and AI to give you a sense of whether or not you can claim what you're claiming.

Robin Pomeroy: So those will be able to do things like, 'here's a forest that's been planted or protected and it's still there'. It's not this forest in Siberia that burned down.

Rachel Kyte: Right. But these are private and these are all voluntary. And at the same time, the United Nations is moving along at its pace on regulated carbon markets. And you've got the [UN] secretary-general leaning in as well, having established a high level taskforce to look at issues of integrity in net zero claims across all non-state actors.

I think he was very alarmed last year because there is so much activity and there is so much sort of buy-in to getting to net zero at the required time frame. And yet a lot of that action is well outside a state or a country's jurisdiction, and it is in the voluntary sector.

And if cities or companies or asset owners or banks or whatever are making net zero claims, as the secretary-general. his responsibility is is to know if you add it all up, are we on track or not. And so he's put a group together that is looking at principles for how we think about net zero.

But back to the position that an ordinary company finds itself in, there is no escaping the fact that you need to have a transition plan and that needs to be science based, because eventually this will get regulated one way or the other. All your activities will end up in some sort of advertising standards authorities. All your activities will end up in front of consumer protection bureaus, all of whom I think will start to get involved.

But I think for companies now, the difficulty is just picking your way through that, which means that while VCMI can set a rulebook for claims that companies make and ICVCM will come up with principles for high quality credit, at the end of the day the integrity starts in the boardroom and starts in the C-suite. And so as a company, there is there is no way around that. You can't engage in activity and then hope that somebody is going to give you a pass down the road if you know that that activity is not legitimately helping you get to your science-based targets quickly and isn't going to help the country by producing a steady stream of revenue.

Robin Pomeroy: So if I was a company now, I'm doing all they can to reduce emissions. I'm putting a plan in place, but I want to invest in a project, in a mangrove swamp somewhere that's going to do good out there, that's going to suck carbon out of the air. And I've got some budget to do that, what would be my best route to doing that now?

Rachel Kyte: What we put out into the public domain in June, the rule book on claims, it's a sort of laddered approach, right? So we've called them VCMI gold, silver and bronze. And it basically describes what you would need to do in order to be considered to be a gold calibre participant in the voluntary carbon markets, silver or bronze.

And this is to allow for the fact that many companies are at different stages of their development or in different jurisdictions. It's to allow for the fact that different sectors of the economy have different emissions profiles. And it's also based on the assessment that we're in transition and so companies are going to have to get better, and that rule books and qualities of credits will improve over time and that the market could work for good.

And so what I would suggest is you go look at that. It will operate also as advice to management consultants, to accounting bodies and to the other acronyms and NGOs that are in the space that offer support to companies in terms of trying to think through what their strategy of using voluntary carbon markets is.

But basically you're going to have to reduce emissions. And then if you've got residual emissions, at a certain point, there's a legitimate use of the voluntary carbon market. And what we've tried to do in the gold, silver and bronze is sort of give you some guardrails around that.

Now, at the moment we're beta testing it. So the other thing we're really interested in is companies taking it, looking at it, working with it in their own scenarios and then coming back saying actually this would have a perverse impact or this doesn't work or this is too complicated or this is only going to work under certain circumstances.

We've got a number of very big firms and small firms from all over the world taking the first iteration of the rule book and giving us the feedback. And so hopefully by the time we get to November, certainly before we get to the next meeting in Davos, we will have a newer version based on the feedback from companies that have tried to use it.

Robin Pomeroy: This is such a fraught area in the ways you've pointed out. Wouldn't it be simpler to scrap all of this, tax carbon emissions or greenhouse gas emissions, use that money then to invest in projects such as the mangrove swamp or whatever these projects that need to happen. Would that simplify it? Why are we making life so complicated for ourselves?

Rachel Kyte: Well, yes and no. I mean, if we had a magic wand, we would have effective carbon pricing worldwide. We would be investing the proceeds from those carbon taxes into protecting the vulnerable and into natural assets, etc. Yes. Well, we don't have that wand and it hasn't happened and we can't even in critical markets actually have a sensible conversation around effective carbon pricing, still, even on a day when 125 million people are living under extreme heat.

So, yes, it would be easier, but we don't have that. Doesn't mean to say we haven't got to keep pushing for regulated carbon markets and for also the regulation of companies, etc., to take on these issues of carbon risk fully.

But in the meantime, market mechanisms give you speed for sure, and there is a legitimate use of voluntary carbon markets for firms. You see, even within some global conglomerates, basically an internal voluntary market between different divisions, between different operations in different parts of the world. And it's perfectly okay, I think, for a company, even outside of any obligation it feels it needs to make towards its regulator in terms of its ability to meet net zero, for it to want to be involved in projects around the world or projects even in local communities where you're investing in the carbon sequestration or the carbon impact of a resource.

So I think you can't sort of say voluntary markets shouldn't exist or whatever. Yes, it would be much more efficient if we had effective pricing everywhere tomorrow, but we've singularly failed to get to that over the last 20 to 30 years. And so we are where we are.

In the way in which we're constructing these markets, we're thinking of carbon as an asset, which the sequestration capability of a forest or a mangrove is an extraordinary asset which should be able to attract investment. But for a company that is emitting, and emitting over and above a plan to get to net zero, that's actually a liability. But at the moment, the markets are constructed as assets on both sides.

So I think there are some fairly fundamental discussions that we need to have if we're going to continue to build these markets out. And of course, the subtext here is where are the regulators? There's been extraordinary progress in regulators and financial supervisory bodies getting their arms around the climate crisis over the last 7 to 8 years. But really, we need express lane action if we are to make these kinds of market opportunities work for everybody, which at the end of the day is part of that purpose for voluntary carbon markets. The purpose is to help people protect their natural assets and to reduce emissions. And so there is much for government regulators to do here.

Robin Pomeroy: To get an idea of what carbon offset projects look like on the ground, I'm joined now by Dharsono Hartono. He's the chief executive of an Indonesian company that manages forests in Borneo in Indonesia that generate carbon credits. Dharsono, thanks for joining us. Your company manages a piece of land in Borneo, a tropical forest. Could you describe what that forest looks like? Just give us an idea. If I was to walk in there, what would I see?

Dharsono Hartono, Chief Executive Officer, Rimba Makmur Utama: So 15 years ago, my business partner Rezal Kusumaatmadja, who is our COO, actually gave me a proposition. He said, 'Dharsono, you can save and restore peatland forests, which is a wetland forest, typical forest in Indonesia, provide sustainable livelihood for the people, and, finally, make profit.'

The area of Katingan Mentaya Project is about 157,000 hectares. To give a comparison, the island of Singapore is about 60,000 hectares, so it's twice the size of the island of Singapore. So it is a huge area.

This is a pristine forest, rich in biodiversity, you can find animals as part of the population here. The area is 100 kilometres from north to south. It's about 30 kilometres from west to east. It's bounded by two rivers. So if you look at it flying from above, you probably look at it as if it's a typical tropical forest.

But what makes this forest special it is a peatland forest. If some of you are not familiar with peatland, peatlands store a lot of carbon below ground. Unlike a typical forest where the soil is just mineral, in peatland forest, the soil is predominantly carbon. So some people think that after 10,000 or 20,000 years, peatland forests become coal mines. So I think that's the context. Hence, you know, this project, while we are not the largest in size, only 157,000 hectares, which is still humungous, we produce on average 7 million tonnes of carbon credit, which makes us the largest project in the world today registered in the voluntary market for the amount of carbon that we produce, because of the peatland that stores so much carbon

Robin Pomeroy: So for managing this forest, what kind of conservation measures are you using there and what would happen if you weren't managing and conserving this forest?

Dharsono Hartono: The proposition is if we were not here, because we were granted a licence called ecosystem restoration licence, a company would have opened this area and converted it into pulp and paper. Basically, all this conservation would not happen.

Robin Pomeroy: So what you're saying is if you weren't there, effectively being paid to manage this and conserve this forest, it would be chopped down to make timber and paper.

Dharsono Hartono: That's correct. So this area, you know, 157,000 hectares, historically, this area would have been converted into what we call a plantation forest, which is a single monoculture forest. But prior to opening and prior to planting those trees, the area has to be drained. Hence all this emission would have happened. And we are actually avoiding that to happen.

Robin Pomeroy: So the emission would have come out of the trees and would have come out, probably even more importantly, from the soil, from this peat soil where all the carbon's stored. Tell me, how do the locals feel about this? I mean, the people who live in and around these forests, what's life like for them?

Dharsono Hartono: If you look at our area, all the locals who live surrounded our area, one thing that they do frequently is actually they are farmers. Sometimes they do activities like slash and burn. So causing all this deforestation to happen.

So what we're doing is we are trying to help them to become more productive. So the core activities of Katingan Mentaya Project is about how we can change behaviour for the communities so that they become more productive by not deforesting.

I can tell you, Robin, it's easier said than done because even for myself to change behaviour when you are 40 some years old, it's not easy. I'll share with you a small experience that I had. When I went to visit the village in 2015-16, I remember, during the early years, we actually tried to convince the farmers of no burning, no chemical practice.

Majority of them produce rice because rice has a long shelf life. They don't produce horticulture or vegetables because if they cannot find a market to buy it then it's going to be rotten quickly. And during the dry season, all this wheat will grow and they will just burn the area. They do slash and burn and then they'll plant again.

So in 2015, when we tried to introduce the no burning, no chemical activities, I spoke to about 500 farmers. And guess how many farmers were interested in our programme? Only two. So I think it takes a lot of effort to change this behaviour. Of course now a few years later we see that all the changes happen. Now we have a school, what we call a agro-ecology school, that we teach farmers, where they exchange ideas, and they do all this farming organically and the productivity is even higher than before. So I think it's not easy to change behaviour when you're so used to doing something for a long time.

Robin Pomeroy: One of the criticisms of carbon offsets is that how can we be sure that the carbon that is there in the trees and in the soil will stay there? What is keeping this permanent? How do we know that in five years time it won't be slashed and burned and all that carbon will be released anyway.

Dharsono Hartono: Our company, PT Rimba Makmur Utama (RMU), was granted a licence to operate this area for 60 years. So the licence is actually not allowing us to cut the forests. We have to restore it and we have to conserve. I mean, that's the sort of like the permanence of what we believe in.

But of course, this permanence can only be sustainable if there's sustainable financing and benefits coming to the people. I mean, it's not fair to keep us to be permanent all the time, but there's no benefit on the ground, particularly for the communities, because they depend on the forest for their livelihood.

So that's why we try to transform this in our work with communities in terms of how we can try to change their behaviour, that burning and doing deforestation into something more productive.

I share with you a small example that we are looking to do. In one of the small villages we're going to invest quite a significant amount of money. Instead of just traditionally having fish farming activities, we are actually building a processing fish, which is a snakehead fish, into a very high quality albumin, which is a pharmaceutical product coming out. So I think that's what we want to be.

The good news is with this carbon financing that we receive by selling carbon credit, we will be able to do that. We will be able to build business or sustainable livelihood programmes, leapfrogging just traditional farming, bringing into much higher quality products that can be produced. And not only that, it will generate income for the communities, but also building the capacity of this community, in the way that they have the the ownership that they think that they can also do more productive activities.

So I think the good news is Katingan Mentaya Project, we always welcome experiment, we always welcome innovation and creativity, and I think that's how we survive.

Robin Pomeroy: Isn't there an element of colonialism about this? We've got countries in the West polluting, emitting carbon, and they're basically paying an area like yours to solve the problem for them to some extent. That's what one of the many criticisms of carbon offsetting would be - there's a kind of colonial aspect to this. So tell us how to how do Indonesians and people you work with feel about this?

Dharsono Hartono: One thing, as the largest project in the world, we're also being framed that we are such a large company, we manage such a big plan. So I think what people framed us 15 years ago is like 'this is a new neo-colonialism'. What's different this time, I feel, is when you look into this business, particularly because the fact is this business is producing environmental services in terms of certificate or carbon credit, it needs a lot of credibility. It needs a lot of transparency. I mean, you need a strong certification. But more importantly for us is it's about how we can transparently work with communities and give the best.

So I think it's totally the opposite of colonialism because this is a business where not only we are protecting the environment. Most importantly, we have to be inclusive and transparent about it. I mean, unlike in other sectors where you do coal mining and oil and gas, sometimes the physical delivery of that product makes people close their eyes if anything happened on the ground. So I think our product is totally different. Hence, throughout this transformation of 15 years as the largest project in the world, people can see that we are doing all the things that is totally anti-colonialism because we are giving everything for the community.

But the question becomes if people are buying credit from us, are they also a colonialism system? But I think it has to go back to the whole idea of developed countries and developing countries how we can have common or different responsibility. I think by buying offsets from developed country into developing country, you can see the benefit that you're doing not only for the environment but more importantly for community.

So I would say that this is totally not colonialism. I think this is a new way of doing business to a point where if we want to solve the climate change issue and the inequality issue, this is the way to go.

Robin Pomeroy: That's very interesting. So what you're saying is this isn't the West or the global North paying emerging economies to stay underdeveloped. You're saying actually this money can help develop an area like yours, but in a sustainable way?

Dharsono Hartono: Absolutely. I think particularly if you look into a type of forest that we have, it's better to be conserved rather than being cultivated. So, of course, you know, the argument is not as easy as you totally stop development in a developing country. But I think you can identify what are the natural resources that can be kept. What are the natural resources that are better to be stored and being cultivated and part of development.

But I think development doesn't necessarily believe in industrialisation anymore, that we believe that it has to be producing coal. I mean, a lot of the things that we produce nowadays, you know, you can see renewable energies, actually keeping all this natural resources intact. You give yourself room for development. It's just that the ways to develop are different than before.

Hence we need a lot of financing from the developed world to help us. I mean, a country like Indonesia, we need a lot of help in terms of financing us through this transition of decarbonisation.

So it is, in the way you can frame it as colonialism if you are not helping us. But I think if you are helping us and really make us in the way that we can decarbonise, we can still have our development with clean energy, for example. I don't see that as a colonialism like you frame it, Robin.

Find all our podcasts here.

Subscribe: Radio Davos; Meet the Leader; Book Club; Agenda Dialogues.

Join the World Economic Forum Podcast Club on Facebook.