Calculating an NPV for Climate Innovation Emissions Reduction
Carbon Offsets Are an Important But Flawed Tool
In the ongoing battle against climate change, carbon offsets have emerged as a “go-to” tool for companies to meet sustainability targets when it is too difficult to directly reduce their own emissions. The concept of carbon offsets is simple and, on the surface, a reasonable approach to mitigating environmental impact. Yet, as Joe Romm bluntly puts it, the current carbon offsets market is “mostly junk.” This sentiment echoes a growing skepticism towards a system that some perceive as merely an engineered loophole for polluting companies.
Carbon offsets have many challenges. Two major challenges are additionality—how can we be sure that the emissions reduction or forest preservation would not have occurred without the financed offset?—and avoidance—how can we be sure that the action prevents the activity from happening? Dave Roberts wittily sums up this predicament: “Nice forest, shame if something happened to it!” This tongue-in-cheek comment highlights the difficulty of determining whether an offset project genuinely contributes additional environmental benefits, e.g., in the case of the forest, whether it would have been cut down in the absence of a carbon offset to keep it standing.
The industry also faces a pricing challenge in that offset quality is rarely tied to price. Cost + pricing is currently the industry standard, which makes sense to ensure that the action covers cost and then some. Unfortunately, that means that price cannot be a signal on which buyers can depend, and raises additional questions about the true value and effectiveness of any particular offset.
As Ben Silton wrote, other issues include permanence (e.g., will protected sites still be standing years later?) and double-counting (e.g., if a foreign company purchases a credit to help achieve its Net Zero pledge, and that credit is also within the scope of the host country’s contribution to the Paris pledge, are multiple buyers claiming credit for the same ton?).
However, it's not all doom and gloom. Coalitions like Frontier, through Advanced Market Commitments, are nobly shelling out over $500/ton to pave the way for cost-effective CCUS methods, hoping to eventually bring their costs down to less than $100/ton. The companies that are part of Frontier are providing this catalytic capital because these projects many of these companies are still way from the Nth of a kind deployment that makes projects bankable through traditional project finance. This represents a serious commitment to ensuring the quality of carbon credits with a long-term view.
Technology Partnerships and Other Climate Interventions Do Not Currently Qualify as Quality Offsets
Now, let's consider an alternative path: what if we could achieve high-quality CO2e emissions reductions at low or no cost while also deploying novel technologies and meeting corporations’ broader strategic objectives? Such unproven technology investments with the potential to reduce emissions might not immediately qualify as reductions according to the GHG Protocol or SBTI, but their impact would be strategically aligned with business interests and more cost-effective in the long run by avoiding carbon offset purchase volumes.
Let’s explore a few representative examples of the beneficial activities that may not currently qualify as carbon offsets today:
A chemicals company collaborates with academics to explore new chemistries for Long-Duration Energy Storage, using abundant materials, with outcomes to be determined. To this end, it sponsors a green steel innovation prize and offers conditional purchase orders to innovators who meet its specifications.
A utility hosts an innovation summit and pitch fest to enhance infrastructure integration with carbon-free energy sources (as PG&E did in 2023), aiming to avoid the need for additional transmission and distribution through improved distributed resource management.
An oil and gas company establishes an Advance Market Commitment to incentivize the development of ambient air methane capture technology. While the end result of captured methane emissions may not manifest for 10+ years, establishing and running the initiative has a current cost.
A company offers a warranty for cost overruns associated with expanding an existing nuclear plant to include a new Small Modular Reactor intended for hydrogen production.
An electric vehicle manufacturer introduces a guaranteed buy-back program for recycled batteries, encouraging circular economy practices and limiting long-term resource depletion for battery manufacturing.
A utility supports the development and implementation of an insurance product for climate-resilient infrastructure within its service area.
How Do You Make it Count?
The crucial question remains: how do we make these innovative efforts "count"? To be recognized as legitimate carbon offset projects, they must adhere to criteria like additionality, permanence, verifiability, and quantifiability. Developing custom protocols that establish clear emissions reduction metrics could be a solution, requiring a registry for tracking and integrating them into carbon markets.
Or Does It Need to “Count” According to Today’s Formulation?
However, we must ask whether these activities need to formally count as carbon offsets to be valuable in combating climate change. If, as Joe Romm suggests, existing offsets are “mostly junk,” wouldn’t it be better to simply create a new system that allows corporations to claim credit for anticipated emissions reductions resulting from a portfolio of climate-related R&D investments and initiatives?
Proposing an NPV of Climate Innovation Emissions Reduction
At Realize2050, we propose evaluating the climate impact of corporate investments through a “Net Present Value (NPV) of Climate Innovation Emissions Reduction” approach. This method involves calculating the anticipated GHG emissions reductions against the investment costs, adjusting for the likelihood of success and the urgency of emissions reductions due to climate change feedback loops.
By comparing the NPV of emissions reductions against the NPV of cash flows, corporations can derive a more accurate cost per ton of GHG emissions reductions. This approach necessitates balancing financial calculations and strategic business considerations.
This approach is not without its risks and unanswered questions. If offsets are “mostly junk”, there is certainly a risk that companies would create their NPV of Climate Innovation Emissions Reduction calculation in a fashion that suffers many of the same shortcomings.
Open questions range from big questions - will companies care about this calculation if they can’t claim emissions reductions for the Carbon Disclosure Project or other disclosures? - to more tactical questions - how should we establish a discount rate for emissions reductions, effectively valuing a ton of GHG emissions today more than one 20 years from now?
Given the number of high-quality climate technologies that have not yet been deployed, we suspect that the cost per ton for Climate Innovation Emissions Reductions should often be well less expensive than the $50-100/ton social cost of an avoided ton of CO2e emissions. Over the long term, many of these portfolios could have a negative cost per ton of CO2e emissions, i.e., companies will make money on each ton avoided or sequestered.
Call for Collaboration
Collaboration is key to refining and implementing this concept. We need experts in traditional carbon offsets, corporate innovators, and those willing to invest in novel climate technology partnerships. By advancing such a methodology, we can hope to foster technology partnerships that potentially reduce emissions more effectively than many current offset projects while aligning closely with corporate strategy.
While the path is fraught with challenges, the potential for innovation in carbon reduction is immense. It's time to rethink our approach, not just to make it “count” according to the existing protocols for carbon offsets, but to make a real difference in the climate fight.
