Nowadays, you would be hard-pressed to find a global company in any sector that has yet to declare a goal to reach net-zero, net-neutral or net-negative in the coming decades. Whether all these companies have a comprehensive environmental, social and governance (ESG) strategy in place remains to be seen. But as an experienced climate tech investor and observer, one thing is clear to me: Carbon offsets are not the answer.
Even as companies around the world continue to struggle with the impacts of the pandemic on global supply chains, there is another challenge looming: new environmental regulations that promise to change how shipping companies operate many transoceanic and regional routes.
New rules from the International Maritime Organization (IMO), the United Nations agency responsible for regulating global shipping, will have significant implications for how container lines design their services and will have consequences for production location choices that underpin global supply chains. Plus, European Union regulations that are likely to be passed before the end of 2022 and whose initial phase would begin in 2023 promise to add additional costs and complexity. Managers in supply chain and sourcing need to start planning for these changes.
A Major Generator of Greenhouse Gases
Maritime transport is the backbone of international trade. It is the most cost-effective way to move large volumes of goods such as oil, mineral ores, grains, and containerized cargo over long distances. But it has also attracted attention for its environmental impact: It accounts for 3% of global greenhouse gas (GHG) emissions.
Most ship engines burn heavy marine fuel oil, which produces not only carbon dioxide (CO2) but other pollutants as well. In a study published in 2015, the IMO projected that CO2 emissions associated with the sector could increase as much as 250% between 2014 and 2050 if abatement steps were not taken. Moreover, emissions are difficult to eliminate because of the need to consume large amounts of energy over long distances without the opportunity to refuel. Maritime assets have very long lifetimes — typically 25 years — so getting to net zero by 2050 will require substantial investments in near-zero fuels and propulsion technologies deployed as soon as 2030.
The IMO Rules
Beginning in January, the new IMO rules will require individual ships to measure and report a carbon intensity index in the form of an annual efficiency ratio (AER). The AER is a function of a ship’s deadweight tonnage (DWT) — how much weight it can carry in cargo, fuel, crew, fresh water, passengers, supplies, etc. — plus how much and what type of fuel it consumed and how far it traveled in the previous year. This data has been part of an IMO mandatory annual submission since 2019 for ships over 5,000 DWT.
The AER is used to grade the ship A, B, C, D, or E. Vessels that receive a grade of A, B, or C will be deemed compliant that year. Vessels graded D have a three-year grace period during which the owner will have to somehow get back into compliance. Those graded E will have one year to do so. Importantly, the grading criteria will become tougher every year: The IMO is mandating a 2% annual improvement in AER from 2023 through 2030. Thus, a ship may start with a B grade in 2023, but if no changes are made after as few as six years, it could automatically become a D. If the owner cannot comply, the vessel will have to be removed from service and likely scrapped.
The impact on container shipping, the backbone of the global merchandise trade, will be substantial. A significant number of ships will not be compliant. Most of these are older, smaller ships with less than 8,000 TEU capacity (TEU stands for 20-foot equivalent unit and is a standard container size), but the implications are serious.
Options for Achieving a Better Grade
Shipping companies have three options to improve a ship’s grade:
Switch to fuels that generate less CO2.
The fuel choice is challenging because not many fuels have the necessary energy density. Maersk, the second-largest container line by capacity, is focusing on biomethanol and has ordered 12 16,000 TEU methanol-powered ships. It has also signed agreements with several companies to produce methanol from renewable energy. CMA CGM, the third-largest container line, has made a big bet on liquified natural gas (LNG) as an interim transition fuel and plans ultimately go to some form of hydrogen. It has already put 12 LNG-powered vessels into service and will have 44 operating by 2024. Mitsui OSK Lines plans to launch 90 LNG-powered ships by 2030, and Ocean Network Express (ONE) recently ordered 10 13,700 TEU ships that could run on either ammonia or methanol. All these companies will be looking to bio-based marine fuel oil as well.
For all these strategies, a key dependency is how fast suppliers can scale up production of the massive quantities of fuel that will be needed. Originally, it was thought that LNG would have a significant advantage over the near term because it is already available in many geographies, and it is easier to handle than methanol and ammonia. But the skyrocketing prices of LNG and questions about Russian supplies due to the Ukraine war could significantly alter that equation. New LNG-powered ships will be comfortably below IMO targets for the first decade of their lifetime, but beyond that other measures will likely have to be taken such as blending with bio-based LNG or transitioning to some form of hydrogen fuel.
Change how a ship is operated.
This option is the least expensive way to keep many existing ships in compliance. Because the carbon-intensity measure is tied to how much weight is moved per unit of distance, larger vessels sailing long routes with fewer port calls will earn higher grades than smaller ships making lots of port calls. Newer and larger ships, even if not completely full, will score better than smaller ones.
Ships can slow-steam to reduce fuel consumption and hence emissions, but this also reduces the annual cargo hauling capacity of what are expensive assets and crews. Ship operators have been reducing speeds for the last decade, but the 2% annual improvement mandate means this technique will eventually reach its practical limits and older ships will have to be replaced sooner rather than later. Ports and trade lanes that cannot support high volumes may see less frequent service or the elimination of service altogether as it becomes progressively harder to serve them and remain compliant.
Make technical refinements.
These include upgrading engines and emission controls. It might include actions such as retrofitting the engine so that the ship can use alternative fuels, making changes to optimize the flow of water around the hull, or polishing or upgrading propellers.
These changes will also be expensive. Jeremy Nixon, the CEO of Ocean Network Express, a global container shipping company, estimated at a conference in January that the global container shipping industry will have to invest $1.5 trillion over the next 20 to 30 years to meet IMO targets. Even though the industry booked record profits last year, the investments it faces are enormous.
The EU’s Emissions Trading Scheme
Adding to costs, the European Union (EU) is planning to bring shipping into it’s Emissions Trading Scheme (ETS) in 2023. Shipping lines will have to purchase allowances for 50% of emissions for voyages connecting EU and non-EU ports. Maersk has already announced surcharges for its Asia to North Europe and North Europe to U.S. trade lanes, and others will have to follow. While a looming recession is already driving shipping costs lower, they will likely not return to their pre-pandemic levels over the longer term as the added costs ultimately have to be paid for.
The ETS is central to the EU’s climate policy and covers 40% of emissions of firms in energy-intensive sectors. It seeks to reduce GHG emissions by 61% by 2030 compared to 2005 levels. The EU’s proposed Carbon Border Adjustment Mechanism (CBAM), slated to become fully operational in 2026, will put a tax on imported products in designated sectors where production-related emissions have not been taxed at the same level by the exporter’s country. This is designed to prevent the circumvention of the EU’s GHG-reduction efforts by imports from countries with less ambitious climate policies. It will also be a critical part of phasing out of free allowances for EU producers.
While imports into Europe of products covered by the CBAM will likely decrease, exports will be impacted as well. EU-made goods that use EU ETS products as inputs will become more expensive, whether they are imported or produced in Europe. As other countries implement carbon pricing, they will need to set up similar mechanisms.
The Implications for Companies
For managers planning their supply chains, there are several important things to pay attention to:
The cost of decarbonization in ocean shipping is going to change the calculus of where goods are sourced.
Although spot market rates have declined recently, it is probably unrealistic to think that costs will return to their pre-pandemic level. While carriers plan to add a substantial amount of new capacity in the next few years, it’s tricky to forecast shipping rates because the retirement of old capacity that will have trouble meeting IMO rules will likely balance out the additions. Much will depend on whether U.S. import demand drops and carriers choose to idle ships. Other segments like bulk carriers and vessels for transporting motor vehicles may face significant challenges because there isn’t as strong an order book for new more efficient ships to replace older ones that will need to be taken out of service. High-volume trade lanes where container lines can deploy newer, larger, and more efficient assets will fare better, but all in all it may make less sense to produce many goods far away from where they are consumed even if the production costs are lower.
Lower-volume trade lanes will likely see less-frequent and higher-cost services.
This was foreshadowed during the height of the supply chain crisis in 2021, when Japan lost some direct eastbound services to North America as container lines tried to juggle capacity shortages and delays by dropping port calls from their schedule rotations. (It was a more efficient way to operate the vessels.) The IMO rules will favor efficiency: larger ships, fewer port calls, and less-frequent service with maximum capacity utilization per ship.
Managers should anticipate that other countries outside the EU will take similar actions. For example, U.S. managers should pay attention to Canada, which has set a large increase in carbon pricing for 2030. There may be pressure for similar border adjustment measures in heavy-GHG-emitting industries such as steel.
Companies that export to Europe or have European suppliers should plan for the higher costs that CBAM, ETS, and similar actions by other countries will produce.
Policies and regulations to help mitigate climate change promise to have a major impact on how supply chains are designed. Increased costs as well as the practicalities of shipping logistics are on a course for change. They will alter the way supply chains are designed and how shipping will work. Now is the time to start planning for this new era.
REDD stands for “reducing emissions from deforestation and forest degradation”. It is a crucial part of any climate change mitigation strategy, as Greenhouse gas emissions due to deforestation and forest degradation account for nearly 20% of global GHG emissions.
As global understanding of climate change has evolved, however, so have the strategies to combat it.
This leads us to the comprehensive REDD+.
The “plus” goes beyond deforestation and acknowledges the “role of conservation, sustainable management of forests and enhancement of forest carbon stocks in developing countries”.
Who Started REDD+?
The framework, first introduced in 2013, was created by the UNFCCC Conference of the Parties (COP) to help guide activities in the forest sector. The Paris Agreement advanced it further, linking individual forestry projects to the REDD+ strategies of their host countries.
The Paris Agreement codified the contribution of forests to mitigating climate change. It became the duty of all rainforest nations to give REDD+ due importance by supporting its implementation in line with all UNFCCC decisions.
Implementing REDD+, however, has been challenging. As a large-scale funding mechanism, it needs hundreds of billions of dollars of investments to carry out REDD+ strategies and to pay rainforest countries and communities for avoided forest emissions. The activities behind REDD+ are voluntary and vary based on the circumstances and capabilities of any given nation.
What are REDD+ Strategies?
REDD+ strategies refer to a set of policies and programs meant to reduce emissions from deforestation and forest degradation while enhancing carbon uptake from other forest protection activities.
- Direct and indirect drivers of deforestation
- Baselines and forest monitoring systems
- Reference emissions levels
- Social and environmental safeguards
These strategies have become a catalyst to help countries analyze and reform wider forestry, land tenure and sustainable development policies. It has boosted the engagement of a wide range of stakeholder groups in forest and land management and community leadership, including indigenous peoples, women and other forest-dependent communities.
But there’s another important question that stakeholders demand an answer – is REDD+ sustainable?
Sustainability of REDD+ Programs
REDD+ relies on incentives for altering the way forest resources are used and managed, cutting carbon emissions by incentivizing actions that avoid forest loss or degradation.
These transfer mechanisms often include payments via carbon offsets. These offsets are paid for both by preserving forests as well as lowering the historical amount of emissions.
Some studies showed that outcomes from REDD+ programs are even more competitive than what logging provides.
REDD+ attaches benefits to cutting carbon emissions that support communities in other ways, increasing overall quality of life.
Where logging primarily brings income to companies and their owners, REDD+ projects contribute directly to achieving the UN Sustainable Development Goals (SDGs). This means tackling climate change as a way to reduce poverty, improve health, alleviate hunger, and strengthen institutions.
Technology has advanced forest monitoring tremendously, bringing hard data to REDD+ goals. Teams can now produce exact forest carbon stock data, keep track and respond to risks, and show the forest regeneration rates. This has mitigated uncertainties in calculating carbon offsets from forestry projects.
As countries adapt REDD+ strategies to fit their needs, there’s a shared underlying principle. The strategies must result in measurable and long-term benefits mitigating climate change while aligning with the national development strategies of those countries.
What are REDD+ Countries?
REDD+ countries are developing nations located in a subtropical or tropical area that have signed a Participation Agreement to participate in the Readiness Fund. Together they form the Forest Carbon Partnership Facility or FCPF.
There are 47 developing countries that were initially selected to join the FCPF – 18 are in Africa, 18 in Latin America, and 11 in the Asia-Pacific region.
The FCPF created a framework and processes for REDD+ readiness. This helps countries understand the requirements behind REDD+. At the readiness stage, that means formulating national strategies that prioritize key drivers of deforestation and degradation. It also involves proposing realistic means to fix barriers to become a REDD+ country.
- Their ultimate goal is to build investment packages that will produce emissions reductions and results-based finance.
Carbon markets have been recognized as a good source of finance where REDD+ carbon offsets come in.
As of 1st quarter of 2022, more than 398 million REDD+ offsets have been issued on the voluntary carbon market (VCM). That amount represents a quarter of total voluntary carbon offsets issued.
When it comes to its performance, here’s how REDD+ carbon offsets price has grown. It’s part of the nature-based avoidance offsets .
Given the high potential of REDD+ in avoiding emissions and delivering other impacts, governments and companies are interested in investing in REDD+ strategies. But how can they help fund these projects?
How REDD+ is Funded?
There’s a national REDD+ mechanism that serves as a fund coordination and distribution platform for those who are willing to financially support the implementation of REDD+ strategies. Donors or contributors can commit resources that support everything from technical assistance to capacity building to executing REDD+ strategies on the ground.
While there are many channels for the funds to support forestry projects, carbon offsets have been among the most popular tools..
To date, REDD+ offsets on the VCMs are from individual projects. This is when REDD+ activities are focused on a specific area of forest where a baseline of deforestation is established. The reference data covers only the nearby forested areas, not the national level.
The number of offsets issued depends on how much deforestation has reduced relative to the baseline. So far, individual projects are the successful approach in getting REDD+ carbon offsets to the VCM.
Analysis shows that REDD+ projects yield many offsets with verifiable, additional, and long-term carbon emission reductions, as well as measurable co-benefits.
However, there are a couple of challenges to individual project-level REDD+. These include:
- inflated baselines,
- underreporting of deforestation,
- forest loss causing permanence risk, and
- risks caused by land tenure and rights
No matter the type of REDD+ program, and no matter the challenges, a unified, financially legitimate approach to fighting climate change can undoubtedly bring other benefits. Carbon offsets still need to be of quality. The factors that determine quality are diverse and can be complex, whether you approach them at the local, national, or intentional level. As a buyer of the offsets , you should perform due diligence on any offsets you buy, and collaborate with institutions you can trust.
Conversations around sustainability, regenerative agriculture, and a financially incentivized carbon offset market have grown louder in the world of agriculture. Private industry, farmers, universities, and governments want to take full advantage of agricultural practices that can benefit the climate and industry simultaneously.
To date, a lot of the focus has been on practices such as including cover crops in cropping rotations or switching from conventional tillage to strip tillage or no-till.
However, many of these conversations have overlooked a substantial but quiet success story – perennial forages, and in particular, alfalfa.
In the table above, we see that alfalfa has huge potential in achieving different sustainability goals. Taken together with traditional cover crops, alfalfa can help realize key benefits to soil health and sustainability. We highlight a few of these major strengths below.
To start, let’s talk about carbon sequestration. A recent Stanford publication found forests, widely thought of as one of the best carbon sinks, may be a less effective sequestration solution than grasslands (i.e. perennial forages) in certain situations.
As CO2 levels rise, many plants have a concurrent increase in CO2 sequestration, whereas forests largely remain unchanged. Results can vary based on things like geography, precipitation, soil type, management, etc., so many findings are going to be generalized. However, this research demonstrates that crops like alfalfa, typically grown over a period of several years, enable maximum carbon sequestration per acre.
Including alfalfa in carbon sequestration models is no small feat. Annual crops like corn and soy are easier to model because management is more predictable and management impacts can be attributed to a single year because they are annual crops.
Despite this challenge, to alfalfa’s impact on carbon sequestration – a perennial, deeply rooting plant – is tremendous. While crops like corn and soy often have a net neutral or negative impact on carbon sequestration, we see documented improvements in soil carbon levels when alfalfa is included as in the rotation. These improvements go beneath the topsoil layers, where cover crops stop, deep into the soil.
Alfalfa’s best known benefit is its ability to fix nitrogen and pass it on to the next crop for utilization, which has tremendous implications for overall greenhouse gas emissions. Alfalfa’s nitrogen contribution to subsequent crops allows us to decrease our synthetic nitrogen needs when rotating to something like corn or wheat. This can reduce the need for nitrogen fertilizer the first year in corn or wheat, and may even extend into year two.
Farmers can reduce their fertilizer bill and the carbon footprint all at once.
Using its deep root structure, alfalfa can help decrease nutrient leaching in deep soil, making it a perfect ally for cover crops that protect the upper soil levels. This benefit has been shown in mine reclamation sites, where it is being planted to reduce toxic metal concentrations in the soils, as well as near groundwater sources, where it can help to soak up potential contaminants such as nitrates.
We are learning in real time how to best measure carbon sequestration practices, while both building and maintaining soil health. Our toolkit is growing and creativity will only help. Innovative agriculture practices and even overlooked crops, like Alfalfa, can drive conversations that support soil health, ecosystem services, and overall sustainability.
For organizations that prioritize decarbonization and environmental stewardship, carbon offsetting has been a popular tool to balance out emissions and elevate sustainability efforts.
A newer concept, however, gives companies a framework to pursue these goals internally. Carbon insetting helps companies consider their own structure and work climate considerations into the fabric of the supply chains they work with.
What is Carbon Insetting?
Carbon insetting suggests companies should mitigate their avoidable emissions before offsetting the unavoidable ones. This approach, the critical net zero strategy, takes a comprehensive view of how companies operate in modern supply chains.
An organization can take action within its own value chain, both upstream and downstream, to fight climate change. Inset emissions are directly avoided, reduced, or sequestered.
Carbon insetting also means investing in sustainable practices that prevent emissions from happening in the first place. Once an organization successfully avoids and sequesters carbon as normal practice, the next step is actively protecting biodiversity and restoring ecosystems.
Carbon Insets Vs. Carbon Offsets
Taken together, both carbon measures are powerful tools to mitigate emissions.
The key difference between carbon insets and offsets is the way an entity invests to reduce its carbon footprint. Carbon insetting focuses on projects related to a company’s products; carbon offsetting involves projects that are not related to a firm’s products.
Besides the environmental considerations, investing in carbon inset projects can help make a firm’s supply chain more resilient and improve the quality of its raw materials.
Carbon offsetting, on the other hand, lets organizations reduce their carbon footprint by paying money to another entity, reducing overall carbon emissions.
The focus of carbon offsets is on the tonnes of carbon avoided/removed, while the focus of carbon insets is creating carbon emissions reduction capacity.
Besides their characteristic differences, there are key technical differences when pursuing carbon insetting and offsetting.
Methodology and standards: a third party like a registry (Verra, Gold Standard) or rating agency (Sylvera) set the certification standard for carbon offsets. In carbon insets, many parties involved agree on the standard used.
Intended project purpose: carbon offset projects are for the voluntary carbon market. Whereas inset projects are for specific businesses’ supply chains.
Accounting requirements: offsets are a negation of emissions already dumped into the atmosphere so they must meet rigorous standards (fungibility, additionality, durability, etc.).
Overall, carbon inset represents indirect but embedded emissions reduction activities within a firm’s supply chain. Insetting activities include upstream (fuel and energy-related activities) and downstream (sold product processing).
Carbon offset represents direct but outsourced emissions reduction efforts. An entity buys an offset and outsources it to another entity that takes the project into effect.
Real-world Examples of Carbon Insetting
Carbon insets are relevant across a wide variety of industries. But they’re most significant in the food and agricultural supply chains due to these agriculture-specific conditions.
Ag regenerative practices exist for decarbonizing food supply chains with nature-based, scalable climate solutions. Decarbonization in this sector has a lower cost compared to new carbon removal technologies.
Readily available financial systems:
There are existing financial mechanisms already in place that incentivize farmers to adopt ag regenerative practices. It doesn’t need to put up new payment systems.
Agricultural soils are by far the world’s largest carbon sink.
Decarbonizing food supply chains also result in other positive impacts like biodiversity, improved water and air quality, and nutritious food.
There is no one solution for the climate challenges facing people, companies, and governments.