Digging in to Net Zero Part 3: Offsets

In this three-part series, we consider how the mining industry can achieve its net zero commitments. In this final instalment – how an effective offset market can further the sector’s efforts.

The drive towards net zero has focused the mining sector’s attention on reducing its carbon footprint, but some emissions either can’t be eliminated or doing so is too costly. That’s where the offsets market comes in.

Mining majors have made commitments to cut emissions from mining activity and the energy that powers it by 30-40 per cent in the next 10-15 years, achievable mainly through operational improvement and adopting a cleaner power mix. Which leaves the challenge of tackling the remaining ~60 per cent required to reach net zero.

Turning carbon into a commodity could be a solution. There are two carbon markets operating today, a ‘compliance’ market enforced by regulators and another ‘voluntary’ one, in which sectors like mining and metals can offset emissions that they are unable to reduce directly.

This article looks at the voluntary carbon market and its potential in helping the mining industry to reduce its global carbon footprint.

A voluntary strategy?

The compliance market grew out of the Kyoto Protocol as a ‘cap and trade’ system, in which companies are allocated a quota of carbon credits that acts as a cap on their emissions. Using a Regulated Emissions Trading System (ETS), companies can sell any unused capacity – an incentive to reduce emissions – or buy available credits if they exceed their cap. Failure to comply could result in a fine.

The absence of a uniform global compliance market or ETS framework has given rise to fragmented systems operating in different regions, such as the EU, China and the state of California. Further, the focus of the compliance market is to gradually reduce total industry emissions. This does not, at present, provide an effective mechanism to support a move to net zero.

A second carbon market operates on a voluntary basis. Sectors like metals and mining can choose to offset hard-to-abate emissions or those too costly to combat directly. Here, ESG commitments or the drive to net zero are the motivation, rather than compliance with emissions regulations.

It’s an opportunity for private companies, cities or governments to purchase carbon credits from projects that either avoid or reduce emissions or remove greenhouse gases directly from the atmosphere1. Think planting forests or wilding areas to increase natural carbon sequestration, projects that avoid nature loss, or those deploying technologies like direct air capture. The credits can then be used to offset the credit purchaser’s own carbon emissions.

While this sounds encouraging, the voluntary offset market is in its infancy, lacking scale, a formal framework and the governance necessary to turn it into a credible tool to help the drive towards net zero. There is work being done to respond to these challenges – and this needs to occur urgently as we expect the demand for voluntary offsets to materially increase in the coming years.

Increasing demand for credits

A snapshot of today’s carbon market shows the number of credits purchased and retired over the past decade. Last year, 181 metric tons of CO2 equivalent (Mt CO2e) worth of carbon credits were issued (shown by the grey line on Chart 1). While this suggests an oversupply today, demand for credits is increasing fast and the picture could look very different by mid-century.

Meeting the net zero commitments made so far by energy majors like BHP, Vale and Rio, combined with the projected aggregate sum of carbon emissions, would require double the voluntary credits issued in 2020. And the metals and mining sector is one industry among many, accounting for a tiny proportion of potential future demand for offset credits.

Global net zero commitments doubled in the last year, reaching more than 1,500, according to the United Nations. Total emissions of companies and cities with these commitments is estimated at 3.5 GTCO2e.

To remain on a 1.5oC pathway, today’s voluntary offset market needs to increase by more than 15 times in the next decade, and by up to 100 times by 2050, a TSVCM report predicts.

A formal framework is needed

There are multiple pain points in today’s voluntary market. Integrity and quality concerns have led to a lack of confidence in the system. Structurally, it is difficult for buyers to navigate and identify credible offset projects, plus there are limited finance opportunities for suppliers and risk management tools for buyers.

To overcome these and other issues, the TSVCM’s 2021 report sets out a blueprint for action, prioritising the need for ‘core carbon principles’ and universal quality control measures for carbon credits to help unify different systems.

Source: Taskforce on Scaling Voluntary Carbon Markets Report, January 20212

As Chart 2 shows, the measures aim to provide a formal framework for voluntary carbon offset schemes and ensure high levels of environmental and market integrity by establishing a ‘core carbon reference contract’.

While curbing direct emissions remains the priority, offsetting has an important role to play in accelerating climate action. A liquid voluntary offsets market could transfer flows of capital from heavy emitters to players committed to reducing or removing carbon, either through technology or nature-based climate programmes.

Voluntary carbon markets and the mining sector

“The world emits approximately 51 billion tons of greenhouse gases each year... We need to reduce that number to zero during the next 30 years and the private sector has an essential role to play,” says Bill Gates in the foreword of the TSVCM 2021 report.

While the voluntary offset market is an important tool in this challenge, it should be complementary, says Bill Winters, Chair of the TSVCM and Group Chief Executive of Standard Chartered. It is important that miners consider how a voluntary carbon market strategy supports broader net zero commitments and aligns with company values.

“The TSVCM is working on improving the integrity of the voluntary carbon market through the development of core carbon principles, core carbon reference contracts, and exchange and clearing infrastructure,” he explains.

This would allow miners to purchase core carbon contracts through a trusted exchange, ensuring a high degree of market integrity. Trust in the system would also encourage more capital to flow into voluntary markets, which has already started happening as public and private sector commitments to net zero increase.

“For the voluntary market to become established, complementing the framework build- out with early adoption and liquidity is going to be critical,” Winters says.
“I would encourage the mining sector to engage with the voluntary carbon market and explore how it can complement its emission reduction strategy. The sector produces many of the metals and minerals critical for the energy transition, and the TSVCM would welcome the industry’s participation in the development of the market,” he explains.

Digging in to Net Zero: Concluding our series

It goes without saying that there are costs associated with the road to net zero, but it is a vital journey every industry must make. Embracing cleaner power options, researching and developing clean-tech solutions and establishing new markets are just a few of the factors shaping the landscape ahead.

Tough decisions will need to be made to select the right assets and limit the risk of assets becoming stranded through swings of public and investor sentiment, such as the move away from coal in recent years.

The boom in sustainable finance leaves the banking sector with an appetite to support efforts by miners to reduce their carbon footprint. That said, increasingly, investment and lending decisions hinge on more than creditworthiness, including factors like emissions intensity, climate risk and the credibility of transition plans.

For mining and other sectors, continued efforts to get closer to net zero are essential to maintain access to capital. Mined materials are at the heart of many energy transition technologies and solutions, but mining valuation multiples lag behind the industries that rely on these materials.

Lower carbon footprints and better data on the importance of mined materials would provide a future platform to develop mining’s brand and investor potential, which could help close the valuation gap in the coming years.

https://www.whitecase.com/publications/alert/voluntary-carbon-markets-blueprint

2 https://www.iif.com/Portals/1/Files/TSVCM_Report.pdf

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