The Role of Carbon Offsets in the Energy Sector

The increase in companies committing to net-zero carbon emissions by 2050 has given rise to a new and growing industry: financing voluntary carbon offsets.

Carbon offsets provide a mechanism to smooth the transition to a decarbonized economy by linking sectors that face challenges in fully abating emissions with activities that avoid or reduce emissions. While compliance carbon markets are focused on the transfer of credits to meet national emission reduction commitments, voluntary carbon markets provide an avenue for individual actors or companies to acquire offsets in support of their emission reduction targets.

As the energy sector continues to evolve, the use of voluntary carbon offsets was featured in a panel presentation at the 20th edition of our Calgary Energy Conference, a two-day event featuring insights from leaders across the energy and related sectors.

Aaron MacNeil, Director, Equity Research, shares insights from the panel on the voluntary carbon market through the energy sector lens:

Climate change is the biggest challenge we'll face in our lifetimes, requiring urgent and immediate action. Every day we delay, it compounds the problem. While many companies in the energy sector have set their net zero focus on reducing scope 1 and 2 emissions, industry leaders have been participating in the voluntary carbon market for years and will continue to pull ahead.

With the world now watching, companies and asset managers are making major investments in positive climate action. Investors and stakeholders are recognizing that companies who are acting now to reach net-zero – rather than wait and attempt to reposition their business at the last minute – are poised for long-term success.

Energy companies have gotten up to speed and are making participation a priority. Carbon markets are not only here to stay but are getting bigger by the day: Two years ago, the voluntary market was about $300M and in 2021 it more than tripled to $1B, with some forecasts indicating that the market could grow to $30-50B by the end of the decade.

With a strong regulatory push, it is also becoming an integral and required part of many investment mandates. From a climate disclosure perspective, the Securities and Exchange Commission is making climate and carbon offset strategy disclosure a requirement.

Energy companies are inherently built around corporate social responsibility and ESG with surficial considerations, minimizing carbon footprint and Indigenous relations. The carbon market is a natural evolution.

"Carbon credits are important tools on the path to decarbonization for energy companies who have emissions that are difficult to reduce or eliminate," says Aaron. "It can often be challenging to source capital for carbon offset projects, so we are seeing a rise in companies entering the space to finance projects applying the proven streaming model used in mining and energy to carbon credits. TD Securities intends on being a thought leader in this area and we are expanding our team and capabilities to better serve our clients in the energy and other emissions intensive sectors."

The panelists evaluate an investment in new carbon streams by considering three overarching themes: financial, risk and attractiveness. From a financial perspective, the project needs to make returns for shareholders – they must be cashflow generating assets, especially in the near term. From a risk standpoint, the credibility of the project developer is essential – consider how many projects they have completed, whether they are reputable and how this information is verified. On the attractiveness side, consider how many co-benefits arise from the project – benefits in addition to reduced emissions. These co-benefits are typically evaluated through the lens of the UN Sustainable Development Goals (SDGs), with higher SDGs typically attracting a premium. The final step in due diligence should also involve a site visit as the variety of project types, from forestation to carbon capture, requires a boots-on-the-ground approach.

As the industry is still young, it faces growing pains. With increasing demand and limited supply of credits, one of the main challenges the market's current infrastructure will face is keeping up with demand. Firstly, carbon credit registries are inundated with requests to review the legitimacy of projects, and the number of qualified professionals in the field are limited. Secondly, there are still few developers who are reputable and experienced. Lastly, pricing in the carbon markets can often seem like a black box – all credits are not treated alike so there is significant variability in benchmark pricing. When considering a project, the best way to get price transparency is to pay for services reporting on a bi-lateral basis in the OTC market.