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Carbon credits

Seeing the wood for the trees

As governments and companies strive to reduce carbon emissions and achieve net zero, questions are being asked about the role of natural climate solutions. We analyse differing approaches to offsetting and their impact on forest management.

Imagine an area of forest with a rich canopy, running 100 metres along each edge of a square. Take a slow walk around the perimeter, put a match to it and watch it burn. Replicate this 10 million times, and you have an idea of the amount of forest cover being lost around the world each year.1 An area the size of Iceland is being cleared, with ecosystems altered to make way for human activities – for settlements, agriculture and mining.

This is not new; humans have disrupted the carbon cycle for millennia. The issue is the scale.

Humans have cleared nearly one third of the planet’s forests since the 1750s, triggering profound changes in the environment and reducing carbon dioxide (CO2) drawn from the atmosphere to the land. Meanwhile, the increased level of commercial activity creeping into formerly forested areas is often not attractive from carbon or biodiversity perspectives either.

Does it matter? Absolutely.

We are currently damaging the natural world so profoundly that many of its natural systems are now on the verge of breakdown

“We are totally dependent upon the natural world,” wrote the legendary broadcaster and natural historian Sir David Attenborough in the foreword to The Economics of Biodiversity: The Dasgupta Review, an independent, global review commissioned by the UK Treasury in 2019.2 “It supplies us with every oxygen-laden breath we take and every mouthful of food we eat. But we are currently damaging it so profoundly that many of its natural systems are now on the verge of breakdown.” 

Forests sequester around a third of man-made carbon emissions (see Figure 1 for forest flux) and cool through transpiration. Acting “like giant air conditioning units”,3 they are an essential part of the hydrological cycle, helping groundwater recharge and drawing it up to form clouds. As if that were not enough, primary forests host such astonishing biological diversity that destroying them has been described “like burning a Renaissance painting to cook a meal”.4

This raises critical questions. Will offset schemes (where companies and investors purchase certificates to compensate for man-made emissions elsewhere) prove effective mechanisms for carbon sequestration? And can investors ever be sure the carbon lock-in they expect takes place, while being sensitive of wider ecosystem concerns?

Figure 1: Forest carbon flux estimate
Forest carbon flux estimate
Source: ‘Global Forest Watch’, January 2021

A ‘natural’ pathway?

There is now a flood of initiatives calling for forest protection and mass-scale nature restoration from governments and non-governmental organisations around the world. The World Economic Forum’s initiative to get one trillion trees in the ground by 2030 includes a 5,000-mile ‘Great Green Wall’ in the Sahel in Africa as well as reinvigorating forests in the US. It is part of a wider vision that has catapulted natural climate solutions (NCS) onto the front line; schemes explicitly designed to reduce carbon emissions and improve resilience to climate extremes.

Figure 2: NCS carbon offsets - questions of scale
NCS carbon offsets - questions of scale
Source: ‘Carbon Offsetting: A Piece of the Decarbonisation Puzzle?’, Morgan Stanley, February 2020

These nature-based projects are getting attention from companies committed to net zero but aware their emissions will be difficult or impossible to trim. Voluntarily buying offset certificates offers a fast track to shrink carbon footprints, removing carbon at low cost (US $3 to $5 per tonne) with one click.5 (This is separate to the compliance offset schemes that exist to constrain large emitters in regulated markets, managed under the European Emissions Trading Scheme (EU ETS), California’s Cap-and-Trade System and so on).

While offsets allow individuals and companies to weigh environmental gains against their own footprints, the projects are often unrelated to the activities that produce carbon in the first place. In addition to certificates from projects that generate carbon sinks (for example in forestry, the largest sector by certificate value)6, there are also offsets available from those that avoid emissions (including renewable energy projects) or slow them (such as peatland restoration). See Environmental offsets in all shapes and sizes for more detail.

We know it will be very difficult for many businesses to get all the way to net zero

“We know it will be very difficult for many businesses to get all the way to net zero, much less carbon negative, without tapping into the offset market,” said Bill Winters, CEO of Standard Chartered Bank, chair of the taskforce on scaling voluntary carbon markets initiated by Mark Carney, UN special envoy on climate action. “The offsets are the most convenient and efficient way to migrate tens of billions of dollars that need to move from banks like mine into the hands of those who can actually remove carbon from the environment.”7

In 2020, the flow of corporate funds into voluntary offsets continued, despite COVID-19 affecting aviation and tourism, according to Ecosystem Marketplace8 (full year data is yet to be released). That follows a record year in 2019, when corporate pledges reached 104 million tonnes of CO2 equivalent.

Now companies in multiple sectors are taking part; from EasyJet (accessing credits from forestry regeneration schemes in South America and Africa)9 to Microsoft (mainly funding forestry, as well as soil carbon sequestration, bioenergy, biochar and direct air capture).10 Doing so will allow them to stretch towards ambitious carbon targets, faster.  

Fast track or off track?

But the question from those concerned with environmental, social and governance (ESG) risks is whether the fast track will ultimately prove the best track. The recommended pathway set out in the Oxford Principles for Net Zero Aligned Carbon Offsetting advocates focusing on emissions reduction first, then carbon removal, then long-lived storage; leaving offsets as a last resort.11 The concern is that in the rush to present a green face to the world, many companies are simply leapfrogging to the final phase.

It’s incredibly important that the offset is credible, verifiable, transparent

Then there is the question of quality. “It’s incredibly important that the offset is credible, verifiable, transparent and is preserving that precious and very limited carbon budget,” Carney said,12 but there is a patchy history of trust.

It is a problem Scott Kirby, CEO of United Airlines, has been brutally frank about. “Today, basically everyone that says they're going to get to net zero uses carbon offsets,” he said in a recent interview.13 “And the truth is that carbon offsets, most of them aren't even real.”

In the past, there have been problems ensuring environmental criteria are met. A damning analysis by the Institute for Applied Ecology in 2016 assessed a number of carbon projects under the Kyoto Protocol and concluded the majority fell short.14 Only two per cent had a high chance of delivering “real, measurable and additional” emission reductions; the prospects were low for 85 per cent.  

“There are still lots of issues around verification and governance,” says Stanley Kwong, Aviva Investors’ associate director of ESG for real assets. “That’s partly because carbon is so difficult to measure. Imagine you buy 10,000 carbon certificates; you think you will remove 10,000 tonnes of CO2. It sounds straightforward, but if you drill down into these projects, you need to check what the underlying assets are. The key question is whether you are really contributing to long-term changes that will make a difference,” he adds.

Carney’s taskforce is keenly aware of this, suggesting the way to ensure credibility is to get more eyes on the issue. “Think about the people that are watching this time, who were not watching before,” Winters said. “Our owners are watching. Our regulators are watching. To the extent these commitments make their way into financial reports, auditors are watching….”

Insetting involves a different philosophy and effectively brings carbon management in-house

One option is for companies to address carbon management themselves through insetting (see Figure 3). This involves a different philosophy, taking full ownership of carbon-generating activities, seeking to reduce them and then balancing residual emissions right across the value chain. Effectively, it brings carbon management in-house. It is less popular than offsetting, although a lack of official data makes it difficult to scale. It is slower and more difficult to administer, but it ensures emissions are addressed head on. Long-term leasing or buying assets with potential to generate offsets brings greater control, but resource scarcity is an issue.

Figure 3: Offset or inset? Assessing responsibility for carbon management
Offset or inset? Assessing responsibility for carbon management
Source: Aviva Investors, May 2021

For those that choose to inset, there may be financial implications as carbon markets evolve. “Carbon offsets have a price,” says Kwong. “If we are to meet the targets of the Paris Agreement, the current price is too low. If carbon offset certificates become credible units of exchange in achieving net zero, the price could rise, but no one knows how soon or by how much. If you invest in natural capital in a form where you can generate offset certificates, you have some protection from that, because you are locking in your own capacity to generate offset certificates in the future.”

Current evidence suggests offset certificates from projects that offer other benefits as well as sequestration may have higher value. People pay more for ‘charismatic carbon’; benefits that can be experienced directly or as part of a positive environmental narrative. Assets that can be accessed for recreation or used for flood management, for example, might have additional appeal.

Investing in outcome-oriented forestry

For real asset investors, forestry is one of the few established commercial areas to invest within NCS. Although there are still measurement challenges, the majority have been addressed. Valuing land, monitoring carbon sequestration and anticipating cashflows can all be carried out with a reasonable degree of accuracy.

Demand for wood products is growing in both emerging and developed markets

Wood products are needed for construction and packaging, particularly with the recent move away from plastics. There is new demand coming onstream for wood pellets for use in the energy sector, too. With demand growing in both emerging and developed markets, conditions are in place for long-term return generation in an asset class that is not closely correlated with mainstream investments. There are risks attached, but the investment is asset-backed, and hazards like fire can be mitigated through careful management. 

To put this in context, the S&P Global Timber & Forestry Index has seen annualised returns of 7.6 per cent over the past ten years,15 around two per cent less per year than the S&P Global Broad Market Index. But for those with an eye on sustainability and net-zero targets, the total return may be less important than wider environmental and sequestration considerations.  

“If you are planning a forestry investment, you need to be absolutely clear about what your objective is at the outset,” Kwong says. “Are you purely carbon driven? Are you return driven – do you plan to sequester the carbon and sell the certificates? And how will you manage biodiversity?”

Reference to frameworks like the one designed by the Forest Stewardship Council (FSC), an international, non-profit organisation, should help ensure best practice, whatever the approach.

FSC certification gives independent assurance that high standards of responsible forest management are being met

“FSC certification gives independent assurance that high standards of responsible forest management are being met,” says Amy Willox, forestry outreach manager at the FSC. “Forest managers need to focus on specific high conservation values, including species diversity, ecosystems and habitats, community needs and cultural values. They need to show how these factors will be maintained or enhanced.”

Existing commercial planting can generate positive cashflows from the outset, for the simple reason the trees are already there. But a better carbon outcome can be achieved through afforestation – establishing a forest or area of trees where previously there was none (although there is still a need to show planting is genuinely additional – i.e. it would not have taken place without further carbon finance.)

“Remember you won’t be able to access the carbon certificates straight away,” Kwong explains. “It is very different from buying an offset, which is an immediate one-time transaction. The whole approach means you need to be very long term in your thinking, because trees take time to grow. The volume of sequestration depends on local factors as well as the species mix and will not step up until about year 15 after planting.“

Figure 4: Indicative natural sequestration rates (tCO2e)
Indicative natural sequestration rates
Source: WCC, May 2021

The land managers held up by the Woodland Carbon Code (WCC), the body responsible for verification and transparent record keeping in the UK, highlight a 40 to 100-year timeframe, rather longer than most farmers or investors usually have in mind.

You won’t solve the climate crisis by buying a woodland

“Forestry is a long-term business,” says Dr Vicky West, UK WCC manager at Scottish Forestry, the government agency responsible for forestry policy, support and regulation. “It is inevitably a challenge to make such a long-term commitment. You are permanently changing from something where you might make an annual decision to something agreed and set out years in advance.

“Buyers need to be realistic too. You won’t solve the climate crisis by buying a woodland. Things do not happen as soon as you put trees in the ground. It takes time, and there is growing understanding about the timescales and how soon you can expect carbon credits to be delivered, and how you might align that with any net-zero strategy,” she adds. 

Under the WCC framework, verified units can be stored and accumulated, which may be helpful if there are specific target dates in mind.

Asking the Earth?

One issue to consider with NCS is how external factors could impact yield. As the Institute for Applied Ecology’s assessments clearly show, many factors (including natural hazards such as fire and human effects like poor land management) could mean a shortfall between sequestration forecasts and what is achieved. There are several different frameworks for measuring carbon lock-in; the WCC’s framework is specifically designed to address this uncertainty. 

Decades of data collection are fed into our model to create a forecast which is then reduced by 20 per cent

“Our sequestration predictions are conservative,” explains West. “Decades of data collection by Forest Research, the government research agency, are fed into our model to create a forecast, which is then reduced by 20 per cent. We allow the sale of 80 per cent of what remains and direct the remaining 20 per cent into a buffer. Effectively, what somebody can on-sell in advance is only about 60 per cent of what the model originally said would be sequestered. The buffer ensures a verified unit of carbon can be guaranteed. If there is an unexpected loss, the project can claim from the buffer and have an arrangement put in place to pay back into it over time.”

Details like this are reassuring for the buyers of verified units and should ultimately drive conviction in the voluntary market.

Figure 5: Cumulative sequestration (tCo2e)
Cumulative sequestration
Note: tCo2e = tonnes (t) of carbon dioxide (CO2) equivalent. Source: Vicky West, ‘Using the WCC carbon calculation spreadsheet: Version 2.4’, Woodland Carbon Code, March 2021

Assigning value to carbon – albeit at levels too low to achieve anything close to the Paris target – is already bringing important changes. More focus is now needed on carbon metrics, the detail of sequestration schemes, offsets and insets, and land management. With the carbon cycle out of kilter, there is a window of opportunity to use natural pathways better and keep carbon leakage in check.

Environmental offsets in all shapes and sizes

The idea that custodians of the land might be compensated for locking away carbon is gaining traction. Russia, the world’s most forested country, is the latest to see the opportunity to become “a massive carbon capture hub," putting its enormous sequestration potential to use.16

Nevertheless, there are still vast challenges to overcome to ensure schemes in Russia and elsewhere deliver the long-term environmental benefits investors seek. Although drones and LiDAR (Light Detection and Ranging, remote sensing using a pulsed laser) are being tested for data gathering, monitoring remote and sometimes inaccessible areas of the globe is a challenge.

At a country level, the US and India led the issuance of carbon offset certificates in the first quarter this year, followed by Turkey and Cambodia.17 The largest project issuers included the Rimba Raya biodiversity project in Indonesia and Fresh Breeze afforestation project in Mexico. But the most striking trend was the jump in the number of offset certificates that were retired (formally taken out of circulation, to claim against carbon targets), suggesting voluntary carbon constraints are starting to bite.


  1. ‘The state of the World’s forests (SOFO)’, Food and Agriculture Organization of the United Nations, 2020
  2. ‘Final report: The Economics of Biodiversity: The Dasgupta Review’, HM Treasury, February 2, 2021
  3. ‘Why the Amazon doesn’t really produce 20% of the world’s oxygen’, National Geographic, August 28, 2019
  4. R.Z. Sheppard, ‘Nature: Splendor in The Grass', Time, September 3, 1990
  5. ‘The offset shop: Gold Standard offers 'one click' access to carbon credits’, edie, October 13, 2017
  6. Stephen Donofrio, et al., ‘State of the Voluntary Carbon Markets 2020: Second installment’, Ecosystem Marketplace, December 2020
  7. ‘Davos 2021 - Carbon markets: A Conversation with Bill Gates, Mark Carney, Annette Nazareth and Bill Winters’, World Economic Forum, January 27, 2021
  8. Stephen Donofrio, et al., ‘State of the Voluntary Carbon Markets 2020: Second installment’, Ecosystem Marketplace, December 2020
  9. ‘Sustainability’, Easyjet
  10. ‘Microsoft buys 1.3 million carbon offsets in 2021 portfolio’, S&P Global, January 29, 2021
  11. ‘The Oxford Principles for Net Zero Aligned Carbon Offsetting’, University of Oxford, September 2020
  12. ‘Mark Carney oversees blueprint for scaling up carbon market as offset demand soars’, Climate Change News, November 10, 2020
  13. ‘United’s Kirby: Carbon offsets “a fig leaf for a CEO to write a check”’, CAPA, March 21, 2021
  14. ‘How additional is the Clean Development Mechanism?’, Institute for Applied Ecology, March 2016
  15. ‘S&P Global Forestry & Timber Index’, S&P Dow Jones Indices, March 2021
  16. Dina Khrennikova, Laura Millan Lombrana, and Ilya Arkhipov, ‘Russia wants to use a forest bigger than India to offset carbon emissions’, Bloomberg, March 25, 2021
  17. ‘EM insights brief: Closing the carbon offsets issuances & retirements gap’, Ecosystem Marketplace, April 2021

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