The recent disastrous fires, which occurred a week ago in California, provide us with the opportunity to discuss climate change and the remedies that finance can offer to address it. Lombard Odier, in a recent report, declares that these fires are no longer manageable or controllable, meaning they have already surpassed our capacity to contain them and, unfortunately, are destined to increase in severity.
So, how can we intervene? The report suggests investments based on the “Circular Bioeconomy,” which include – among others – investments in reforestation (even pushing us to design landscapes resistant to fires) or water recovery, to cite two clear examples. These are the typical projects financed with carbon offsets/removal or green bonds. These are those “voluntary” green products that, in a previous post, we had promised to explore further.
When a company subject to the “cap and trade” system exceeds the permitted CO2 emission limit into the atmosphere, it can only do two things to comply with its carbon footprint: 1) purchase additional credits (EUA, to be clear); 2) purchase offsets to compensate for the excess CO2 equivalent emitted. Unlike the “mandatory” market, the “voluntary” market is not characterized by an issuing and supervisory authority and is not linked to a specific jurisdiction but relies on an internationally recognized registry system (Verra and Gold Standard for offsets and UNFCCC for removals). These registries are responsible for evaluating a project’s environmental benefit and issuing the corresponding carbon credits to be attributed to the project. Any organization (public, private, governmental, etc.) can choose to engage in carbon emission reduction projects, either because their leaders believe it is the right thing to do or because they wish to generate carbon offsets, which can in turn be monetized on the relevant markets (scope 1 of the Greenhouse Gas Protocol – GHGP). Here, we plant an important stake regarding the classification of voluntary green credits. We prefer to categorize them based on the nature of the project: those of a natural basis, which aim to remove already present CO2 equivalent from the atmosphere, and those of a technological nature, which aim to prevent CO2 emissions. Among the former, reforestation certainly stands out; among the latter, green energy production.
However, all voluntary green credits are subject to some important issues:
– Multiple counting of the same amount of CO2 removed or saved, meaning when two or more distinct entities claim the same environmental benefit;
– Multiple sales of the same voluntary environmental credit;
– Circulation of voluntary green credits based on nonexistent projects or on estimates of the represented environmental benefit that are entirely incorrect (generally overestimated);
– Traceability of the environmental credit.
Ideally, these issues should be eliminated by the registries, which should analyze projects, ensure they produce reliable and truthful estimates of environmental benefits, and trace every transaction of the voluntary green certificate so that removal from the registry corresponds to the actual use in compensation for the acquired right by the last (single and clearly identified) registered entity. However, numerous and well-documented cases of greenwashing testify that registries do not always operate optimally. Greenwashing is the fraudulent practice of recording nonexistent positive environmental impacts or hiding real negative impacts from an entity’s sustainability report.
The “cap and trade” system is less prone to manipulation because it involves supervision and participation by state or para-state entities dedicated to the system’s operation (including trading). But there is another system designed to address GHGP scope 2, conceived and successfully tested by the European community to mitigate the above-mentioned issues: we are talking about the system of Guarantees of Origin (GO).
GOs are electronic certificates that certify that a certain amount of energy has been produced from renewable sources. For every MWh of renewable energy generated, a GO certificate is issued. The issuance is carried out by an issuing body designated by each member state and regulated at the community level by the European Energy Certificate System (EECS). The issuer is responsible for monitoring, using specific instrumentation installed at production plants, the amount of renewable energy produced: based on this monitoring, a corresponding number of GOs is issued. The issuer is also responsible for maintaining the register to record every transaction. Being in digital form, several platforms for electronic trading of these certificates have emerged, along with specialized operators such as brokers and dealers who ensure liquidity.
This mechanism allows tracing and verifying the origin of energy, guaranteeing end consumers that the electricity they purchase actually comes from clean sources such as the sun, wind, or water. Electricity retailers who claim to buyers that they inject a certain amount of green energy into the grid are required to purchase a corresponding amount of GOs that certifies the renewable source.
Internationally, GOs are called RECs (Renewable Energy Certificates) or I-RECs (International RECs) and seek to replicate the European model, which currently appears the most comprehensive and efficient. Given the significant risks related to the traceability and evaluation of voluntary environmental benefit credits, it seems advisable to leave these markets to expert professionals and to subject their use, as a means of financing the interventions suggested by Lombard Odier, to reconsideration and improvements.
Disclaimer: This article expresses the personal opinion of the contributors of Custodia Wealth Management who drafted it. It does not constitute investment advice or recommendations, personalized consultancy, and should not be considered as an invitation to carry out transactions on financial instruments.
