Carbon offsets — purchased to compensate for carbon dioxide emissions — are an increasingly popular tool for companies seeking to achieve their climate goals. However, increasing public scrutiny and evolving standards mean legal and compliance teams must stay on top of changing regulatory requirements, say Kirkland partner Alexandra Farmer and associates Michael Mahoney and Donna Ni in this article for Law360.
Despite the COVID-19 pandemic, companies such as Microsoft Corp., Unilever PLC and Kimberly-Clark Corp. are continuing to make climate commitments — and carbon offsets are an increasingly popular tool for companies seeking to achieve these ambitious goals. But carbon offset transactions have become more complex as public scrutiny of offset quality heightens, regulatory markets and voluntary standards evolve, and some companies seek to invest in longer-term arrangements.
In the first part of this two-part series, we discussed how in-house compliance and legal teams can ensure that corporations' climate commitments are appropriately messaged, and that proper governance programs are in place to support their achievement.
In this installment, we focus on the role these teams can play in carbon offset transactions to maximize the benefits that carbon offset projects can pose for a company, and to minimize the risk.
Carbon Offset Markets and Agreements
Carbon offsets are bought and sold in two types of markets. In the larger, compliance market, governments, companies or other entities buy carbon offsets to comply with caps on the total amount of carbon dioxide they are allowed to emit, such as under the EU Emission Trading Scheme; the cap-and-trade programs of California, Ontario or Quebec; or the Regional Greenhouse Gas Initiative in the eastern U.S.
In the smaller, voluntary market, companies, governments and individuals purchase carbon offsets on a voluntary basis to mitigate their own greenhouse gas emissions from transportation, electricity use and other sources.
Carbon offsets are often purchased through emission reduction purchase agreements. ERPAs define the commercial terms of the project, including price, volume and delivery schedule of emission reductions, and identify the rights, responsibilities and obligations of the parties to manage project risks.
Generally, the seller is responsible for carrying out verification and certification; implementing the monitoring plan; handling general project operations; and delivering emission reductions. The buyer must set up an account to receive delivery of emission reductions; pay for the emission reductions; and communicate with the relevant regulatory bodies.
There are three main types of ERPAs: (1) spot agreements; (2) future delivery agreements; and (3) options.
- Spot agreements are made when emission reductions have been issued to the seller and are ready for delivery to the buyer. Consequently, there is very little risk either to the buyer or seller in terms of nondelivery or nonpayment.
- Future delivery agreements, the most common type of ERPA, are made when emission reductions have not yet been issued but will be in the future. Payment is made either on delivery of emission reductions or in advance. The timing and delivery aspects, coupled with the possibility that the seller provides a guarantee of emission reduction quantities, can pose different levels of risk to the buyer and the seller.
- There are two different types of ERPA options transactions: (1) a call option, where the buyer has the right, but no obligation, to buy emission reductions at a certain point in the future for a fixed price; and (2) a put option, where the seller has the right, but no obligation, to sell at a certain point in the future for a fixed price.
Achieving Goals Beyond Carbon Footprint Reductions Through Offset Projects
Companies can creatively leverage participation in carbon offset projects to support their broader social impact and sustainability goals, such as by layering attributes or participating in project development as a direct manager or investor. Offset projects may have attributes that generate value beyond carbon reductions.
For example, projects may preserve ecosystem services and habitat. Projects may also benefit local communities through employment and education, which can make the projects more reliable and less at risk of public opposition in the long term.
Additional attributes require third-party oversight and verification, such as through dual verification under the Climate, Community and Biodiversity Standards, which evaluate land management projects from the early stages of development through implementation. Offset providers such as Ecosphere and Second Nature offer products with dual verification.
To achieve their particular social impact and sustainability goals, companies can also participate in project development as a direct manager or investor, and not just as an end buyer. Occupying a direct manager or investor role can help a company have more say in the design, construction and operation of a carbon offset project, which the company can use to tailor the project to its specific goals.
Carbon Offsets Tied to Specific Conservation Projects
Companies that have made climate commitments are increasingly investing in specific conservation projects to achieve carbon offsets. Some prominent examples include:
- Amazon.com Inc. announced a commitment to restore and conserve four million acres of forest in the U.S. as part of its climate pledge in April 2020. Amazon will initially fund projects in Pennsylvania and Vermont that will help family forest owners sequester carbon, and then support the expansion of the program to the Appalachians and other U.S. regions.
- Nike Inc. has been offsetting carbon emissions by planting trees in the Atlantic Forest in Brazil. Since 2016, Nike has partnered with WeForest as part of a commitment to plant at least one million trees; currently, over 813,000 trees have been funded.
- In honor of Earth Day 2019, Delta Air Lines Inc. offset the carbon impact of more than 300,000 passengers' flights through purchasing offsets to benefit Conservation Coast, a project that provides environmental protection and sustainable economic opportunities for communities in Guatemala.
Continuing Carbon Offset Commitments During the COVID-19 Pandemic
While the COVID-19 pandemic has presented new challenges for achieving climate commitments, companies are continuing to make climate commitments, many of which depend on carbon offsets for the companies to achieve their goals. Some recent examples of such climate action include:
- In June, Unilever announced that it will invest €1 billion in a new climate and nature fund to help the company reduce to net zero greenhouse gas emissions from all its products by 2039. The fund will invest in projects including reforestation, water preservation and carbon sequestration over the next 10 years.
- Also in June, Kimberly-Clark, the company behind Kleenex, Cottonelle and Scott, announced a new 2030 climate commitment to reduce direct emissions by 50% against baseline year 2015. The company's plan to meet its climate commitment includes offsetting electricity purchased by its U.S. manufacturing sites by entering into virtual power purchase agreements with wind projects in Texas and Oklahoma.
- In July, Microsoft provided an update on its commitment to be carbon negative by 2030, and remove from the environment more carbon than Microsoft has emitted since its founding by 2050. Microsoft plans to issue a request for proposal for nature- and technology-based carbon removal solutions, with the goal of removing 1 million metric tons of carbon through such solutions.
Due Diligence of Carbon Offset Quality
Project developers can employ a variety of activities to produce offsets, including improving energy efficiency or switching to cleaner fuel sources; managing forests, soil, grasslands and other land types to avoid releasing carbon and/or increasing the amount of carbon the land absorbs; and installing solar, wind and other forms of renewable energy production.
While carbon offsets can be generated in a number of ways, there are certain features that distinguish a quality carbon offset from a lesser one.
- First, there must be a baseline and system of measurement. A company must calculate its carbon footprint, determine what emissions would occur in the absence of a proposed project, and figure out how the emissions that occur after the project is performed will be measured.
- Second, there must be additionality. A carbon offset project only has value if it would not have happened without the investment.
- Third, there must be no carbon leakage. The carbon offset project must not, inadvertently or otherwise, lead to displacement or other problems that create more carbon emissions.
- Fourth, there must be permanence. The benefits of the carbon offset project must not be reversible. A classic example is forestry projects, where trees planted to sequester carbon could potentially be cut down in the future.
- Fifth, there must be third-party oversight and verification. There are a variety of third-party verification programs, including the Verified Carbon Standard, the Climate Action Reserve, the Gold Standard and the American Carbon Registry. The Verified Carbon Standard, which aligns with the Kyoto Protocol's Clean Development Mechanism, is the most widely used standard in global voluntary markets. Certain offset providers may choose to exceed the requirements of their third-party certifications, such as through more robust reporting. Projects may also be verified by more than one third-party.
The Role of Counsel and Compliance Teams in Carbon Offset Investments
The days of buying generic carbon offsets appear to be numbered. As consumers become more sophisticated and better able to scrutinize corporate climate commitments, companies are increasingly under pressure to invest in high-quality offsets.
In-house compliance and legal teams have a natural role to play in carbon offset transactions in order to maximize the benefits that carbon offset projects can pose for a company, and to minimize the downside risk.
Companies should seek to clearly define their goals with respect to a carbon offsetting program in order to ensure that it is consistent with their longer-term climate and other environmental, social and governance commitments. Investing in higher-quality or longer-term commitments is a key way to maximize those goals.
Conduct Robust Due Diligence
It is important for carbon offset quality to be thoroughly vetted, particularly for any project in which a company will be publicly identified.
Facilitate Effective Negotiations
A company's leverage in negotiating ERPA terms is commensurate with the term and size of its investment. Counsel has a clear role to play in ensuring that negotiations focus on priority issues and mitigate potential risks.
Ensure Accurate Statements
With respect to any public announcement about the purchase of carbon offsets, including in a press release or an annual sustainability report, counsel should ensure that such statements are accurate, not misleading and meet regulatory requirements. For example, the U.S. Federal Trade Commission's Green Guides contain helpful guidance on how to describe offset programs.
While it is increasingly common for companies to engage skilled outside counsel to advise in connection with climate commitments, it is often the role of in-house counsel and compliance teams to raise these considerations at the outset and to monitor evolving regulatory requirements. Accordingly, these teams should stay up to date on the carbon offset market and the frequently changing regulatory landscape.
Alexandra Farmer is a partner, and Michael Mahoney and Donna Ni are associates, at Kirkland & Ellis LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 While not referred to as a carbon offset, carbon removal or sequestration projects could fall within the broader category of offsets. Carbon offsets as a whole can include a broader set of activities, such as energy efficiency projects, which do not remove carbon from the atmosphere but instead reduce future emissions.