Making Net-Zero Add-Up: From Nothing to Everything
by Julia Sekula with support from the Stanford Sustainable Finance Initiative
With the equivalent of 90% of global GDP committed to net-zero targets, demand for initiatives promising to measure and remove carbon has surged dramatically; each, in their own ways, seeking to do something about the climate crisis. These efforts couldn’t be more important. After all, it was Churchill who claimed that in times of crisis,
“it is better to do something than to do nothing while waiting to do everything.”
We are certainly in times of crisis. However, systems change, unlike Churchill’s 20th-century warfare, is a battle fought on an infinite number of axes. For systems to change, contemplating the proverbial everything becomes just as important as solving for a single something; Everything may just be a precondition to something. Today, the everything elephant in the room are the foundational principles governing how to transact and account for the carbon we are so zealously seeking to remove. These foundational principles largely don’t exist, and yet without them, we risk erecting a climate future on fragile foundations upon which laudable corporate pledges and the flurry of start-up solutions, could risk amounting to, well, nothing. And nothing, in the face of imminent climate timelines, is ultimately catastrophic.
Transacting Carbon
Week after week, the carbon markets have made front-page news. While scrutiny is important, news coverage has missed a fundamental point: today’s Voluntary Carbon Market (VCM) lacks basic regulation, definition of property rights and insurance offerings; all necessary elements for any market to align incentives and function effectively. Overemphasizing the personalities or the carbon registries, as has been the case, distracts from the discussions on the structure and principles that necessarily precede the improvement of a rapidly growing market; a market that, it is worth remembering, remains our only meaningful mechanism to transact carbon, today.
As a result, overwhelming expectations have been put on the not-for-profit carbon registries as arbiters of some carbon storage guarantee. Carbon registries operate with technologies and methodologies from a pre-digital and pre-carbon-market-growth era. They are also transfer agents: they track transactions but do not control them, meaning that (contrary to what many believe) carbon registries provide no recourse to buyers for non-performance of the removal project. How would a transfer agent also provide this type of guarantee anyway; a guarantee that in other industries is enabled, in practice, with associated insurance products or government guarantees? Without mechanisms to ensure and remediate non-performance, transactions in the VCM today are incomplete not because carbon registries are a lost cause (as much of the press would lead us to believe), but because the market itself is lacking component parts to align incentives and provide effective carbon outcomes.
While buyers have no recourse if projects don’t perform, they also have no corresponding legal responsibility to restate their removal efforts if carbon storage reversal has occurred. Considering Zimbabwe’s recent nationalization of carbon credits, will companies that purchased removals in those regions restate their progress to net-zero pathways? And what about less publicized cases? It remains to be seen. Certainly, there are no regulations or accounting mechanisms that force corporations to reflect reversals, reminiscent of the old adage: “If a tree falls in a forest and no one is around to hear it, does it make a sound?" The current VCM structure doesn’t incentivize accountability on either end of the transaction; resulting in a whole lot of something that may just add up to nothing if we do not start to address the foundations of everything.
Counting and Accounting Carbon
One of the few ways to overcome the challenges regarding net-zero claims and their corresponding carbon credit purchases in the VCM is to re-imagine how we think about carbon in the first place. If collectively we’ve agreed that carbon is important, then our systems must reflect this, too. Today, they don’t.
Carbon largely operates within a closed natural system on our planet and so the way we measure and account for carbon should reflect a closed system too. We are, after all, seeking to reconcile the carbon capacities of the planet, and how these capacities are divided between the atmosphere, ocean and land; amongst nations, corporations and maybe even individuals. Carbon somewhere must be accounted for everywhere.
Today, the GHG Protocol (the standard most companies use to count carbon) does not allow us to reconcile carbon comprehensively. Scope 1 captures all carbon emissions. Scope 2 and 3 capture someone else’s Scope 1 emissions, again. This creates a scenario where emissions (and efficiencies) can be arbitrarily doubled, tripled, or even as much as 10 times over-counted, depending on the number of nodes in a supply chain. A carbon accounting system needs to count everything, and importantly, count everything only once. The concept of emissions liability, by Kaplan and Ramana offers a possible solution to this. As long as double-counting remains unaddressed, corporate net-zero pledges will lack clarity (and attract lawsuits), supranational climate efforts will struggle to balance national carbon ledgers, and ultimately, planetary pathways to 1.5’C will be difficult to measure and predict.
These challenges associated with counting carbon increasingly also point to the necessity of incorporating carbon into accounting frameworks. Accounting forms the basis of how we take stock of our global capitalist system; it is the agreed-upon ledger to measure, transact, and compare economic performance. Accounting is the global equalizing tool of “money in somewhere must mean money out elsewhere.” This logic could be applied to carbon too. Important initiatives like the TCFD and GFANZ are anticipating some of these movements and the past few years have seen a rise in S&P 500 companies explicitly mentioning climate risk or greenhouse gasses in their annual filing notes.
However, filing notes mean little if carbon does not migrate to the balance sheet. Today, emissions are not tied to the costs of goods and services sold and emissions are not being treated in the same categories as other relevant liabilities like debt or pensions. As a result, a company’s emissions have no impact on consequential metrics like gross margin or balance sheet leverage that define a company’s performance to the market and cost of capital. As long as carbon is not on the balance sheet, the challenges associated with distinguishing greenwashing from corporate climate heroism, for consumers and investors alike, will further slow the alignment of market outcomes with climate outcomes.
To use Churchill’s words, trusting that something is always better than nothing, ignores how given climate timelines, we have to get it mostly right the first time. To do that, we have to build something with a vigilant eye on the foundations of everything. As long as carbon accounting and carbon transactions are not clearly defined, the foundations upon which a net-zero world is erected may be fragile at best, and redundant at worst. And redundancy that costs climate runway is catastrophic. In the face of these odds, going after everything, by adequately defining the principles and structures that govern carbon may be the only net-zero pathway to getting from something to everything, effectively, all at once.
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💰 In Jason’s Capital Series, we heard from Vikram Raju, Head of Climate Investing for the private credit and equity division of Morgan Stanley. We cover Morgan Stanley's 1GT Platform, Vikram's journey to doing the work that he does, the energy transition generally, barriers holding it back, and changes that could unlock faster progress. Tune in to the Capital Series here.
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