Offsetting cannot always be the answer

Over-reliance introduces systemic risk that investors need to take proactive steps to reduce

Those early to decarbonise face numerous challenges beyond their direct control in their pursuit of achieving this objective; ranging from the embedded emissions in the energy system they operate within, to exposures within the supply chain, to selling products and services that have no proven pathway to net zero.

Consequently, companies have turned to offsetting as a means to reduce their carbon footprint. But offsetting cannot always be the answer.

In simple terms, the amount of land required globally for nature-based offsetting (e.g. forestry) to offset current emissions is many multiples the actual land available; while technological alternatives to nature-based solutions are still far from being viable. Insufficient land will therefore result in offsets becoming scarce, inevitably leading to rising prices.

Companies reliant on offsetting will therefore see these higher prices impact profitability. However, failure to meet net-zero targets could result in reputational, financial, regulatory and share price consequences.

These companies therefore face Hobson’s choice; either purchase increasingly expensive offsets for reduced profitability, or fail to achieve net zero and face the financial ramifications.

Introducing risk

Over-reliance on offsetting therefore introduces systemic risk. Universal owners of these companies face financial downside whatever route the company takes. It is not a stretch, therefore, to suggest that over reliance on offsets could, and most likely will, introduce systemic risk into financial markets.

Investors need to take proactive steps to reduce this systemic risk. But where should they start?

First, investors should look at measures to support and enable companies to reduce their reliance on carbon offsets. These could include:

  • Engaging with policymakers to create a net-zero environment (for example, the energy system) in which companies can operate;
  • Prioritising long-term investment over near-term returns, to provide companies with the capital and time required to innovate lower-carbon products; and
  • Using stewardship processes to engage with high-emission companies that form a vital part of global supply chains.

But these actions need to be pre-emptive and start immediately. We are currently looking at just the tip of the iceberg. The vast majority of global emissions are not covered by regulated carbon frameworks or under scientifically verified decarbonisation plans.

It is not a stretch to assume that in order to meet their own legislative targets, governments around the world will need to enact policy change to force these currently unregulated entities to decarbonise.

As things currently stand, this wave of additional emissions looking for offsets to decarbonise would result in an even greater increase in offset pricing; increasing the systemic risk. Near-term action is therefore crucial and early investor action can help to drive early policy change.

Private sector action can, and hopefully will, bring forward policy change, creating a virtuous cycle where more ambitious climate policies from governments will incentivise and facilitate further decarbonisation efforts from the private sector.

The time to act and drive real-world decarbonisation is therefore now; to insulate our world from the effects of climatic change and to mitigate the impacts to our financial markets.