The tangled web of companies buying and selling ‘credit’ to reduce carbon emissions

In a world of climate-change worries, where investors increasingly look at environmental sustainability, companies scramble to improve their carbon footprint—and their reputations.

Microsoft said it will be carbon negative by 2030. JetBlue wants to be carbon neutral on all domestic flights by July 2020. Starbucks looks to be “resource-positive” by 2030, including storing more carbon than it emits.

Even Barclays announced it aimed to be net-zero on carbon and to “align all of its financing activities with the goals and timelines of the Paris Agreement”—after years of pressure by U.K. nonprofit ShareAction to reduce its financing of the fossil fuel industry.

These are all great goals, and some might have an easier time than others. For example, a company that could kick most of a fossil fuel habit and switch to complete renewable power without much trouble can make a big dent in its carbon load. But other companies might not have easy choices. In general, though, companies don’t become carbon neutral or even negative in a single move. It takes a mix of conservation, smarter operations, and carbon allowances and offsets to achieve success. And the balance varies a lot, depending on the individual business.

And sometimes it takes multiple companies working together to share reductions and reduce overall carbon levels.

If carbon reduction were a game of Monopoly, carbon allowances and offsets would be like a get-out-of-jail-free card—except more like time off for good behavior. Company A, which has reduced its carbon footprint, has credits in one of two forms: An allowance is a reduction of ongoing and future carbon emissions into the atmosphere—for example, moving to renewable energy or reducing emissions from smokestacks or vehicle fleets. An offset refers to removal from the environment of previously released carbon, a popular approach being planting trees that pull carbon dioxide from the air and emit oxygen.

Although it’s not a term used by industry experts, it’s easier to understand all this by grouping both together as carbon credits. Company A can sell its credits—those time-off-for-good-behavior cards—to Company B, which wants credit for reducing its own carbon footprint but is having trouble doing so.

To the uninitiated, it can sound like a scam. One business buys another’s efforts and pretends to lower its own carbon footprint? There are ways to make it work so everyone benefits, but if not done carefully, investors, the public, and companies themselves can take an unintended green-carpet ride.

Flooring company Interface claims to have cut its carbon footprint by 69% over the past quarter-century by changing its raw materials and manufacturing. That doesn’t cover transportation, installation, and ultimate disposal—factors outside of the company’s control.

“To make carbon neutral products, the greatest impact is in the raw materials sourcing,” said Erin Meezan, Interface’s chief sustainability officer. “That’s out of our total control. We have to convince our suppliers to make the shift.” If the vendors don’t reduce their own carbon footprint, their dirtier operations get applied to the products that Interface produces and sells. So, in the meantime, Interface uses credits to reduce its carbon use.

But are these credits nothing more than paper shuffling? The net amount of carbon between the two companies seems to stay constant. And what’s to prevent the credit owner from making money by selling them over and over?

“I think that level of skepticism is probably both well-placed and well-earned,” said Kenneth Richards, associate professor of public and environmental affairs and affiliated associate professor of law at Indiana University. “That’s different from saying every project or even every developer is severely flawed.”

It is possible for credit trading to actually help reduce the overall amount of carbon that’s impacting the climate. Companies that can reduce carbon emissions are motivated to because they can sell the credits, and companies who need to buy them are helping to finance the goal.

To make ecological sense, credit mechanisms need to incorporate three aspects that experts call additionality, leakage, and permanence, noted Alex Leff, a principal at environmental law firm Sive Paget & Riesel. Additionality recognizes that projects that would have happened anyway aren’t increasing carbon reduction, like the company that was ordered to reduce emissions from its smokestack. The lack of additionality can create a false impression of additional action.

Leakage means a project done in one place could be countered elsewhere. “Let’s say I have crop land, and I’m growing corn, and I say I’m going to convert that to forest,” Richards said. Because there’s a net increase in carbon capture with the change, farmers have offsets they can sell to make the shift economically viable. However, the demand for corn remains, and other farmers might cut down trees to plant the crop.

Or a project prevents trees from being harvested in Belize for lumber and again creates credits. Loggers who found themselves stopped may take their saws to another area. “In drug enforcement, they call it the push-down, pop-up effect,” Richards said. “Others refer to it as the whack-a-mole.”

In permanence, the intent is to ensure that the benefits are long-lasting—a term that is slippery. How many years after a new forest is planted would be reasonable to allow logging? Ten years? Twenty-five? Never?

Credits are voluntary systems that companies have tried. That might sound terrific as companies need to reduce carbon, either on principle, as a promotional tool, or to address public pressure. But the absence of oversight enables multiple problems.

One company might decide to buy credits for something that would happen anyway, like a company forced by a court order to reduce carbon emissions from a smokestack. Should the company be allowed to sell credits when the choice to change was made for it?

There is also the potential for carbon credit fraud. The Justice Department at times has prosecuted companies for selling credits that didn’t really exist. Or there can be potential mismanagement, as British Steel found when it reportedly sold excess credits it thought were not needed to meet EU commitments, according to the Financial Times. Additionally, buyers might not have a way to check that the promised reductions actually happen.

For these reasons and others, experts emphasize third-party oversight and certification. There are various government regulatory structures using so-called cap-and-trade—in which the government sets a limit on total carbon emissions in a geographic region and then lowers the limit each year while controlling the issuance of credits and their use.

“Every year you’re reducing the cap, and they have to find alternative ways [to lower their emissions],” said Jeremy Firestone, a professor in the College of Earth, Ocean, and Environment and director of the Center for Research in Wind at the University of Delaware.

Some examples of these government structures are the EU Emissions Trading System, California’s Cap-and-Trade Program, and the Regional Greenhouse Gas Initiative of nine states, including all of New England, New York, New Jersey, Delaware, and Maryland. The overall cap comes down on a regular basis, requiring more innovation and action for offsets or credits to continue.

Paired with the cap is a credit system. “If you produce CO2, you have to have [a credit] for each metric ton of carbon that you release into the atmosphere,” Firestone explained. Companies that are efficient in reducing their own emissions can have excess credits, which they can sell.

The result is a transparent market-based system that doesn’t care how companies reduce and which ones are better. The important thing is that the overall carbon footprint keeps shrinking.

Or, instead of a government framework, companies seeking to generate credits that can be sold and monitored might work with some of the NGOs, like the Gold Standard Foundation or Winrock International, that run voluntarily verified and controlled programs.

Before joining his current law firm, Leff worked for the Gold Standard Foundation. Participating companies at times would get upset because it typically took years to get a project accredited. “You could feel pretty comfortable that the carbon [credit] project wasn’t a sham,” he said.

Without some kind of third-party framework, whether government or NGO, companies are much less likely to have a successful program. Businesses buying credits won’t have any way to verify the actual carbon reduction. “When it doesn’t have accreditation, immediately it seems like it’s a load of bull,” said Leff.

“Anybody who’s serious about participating in the market makes sure they are buying certified and verified offsets from a number of entities that meet tracking and reporting protocols,” said Aurora Sharrard, director of sustainability at the University of Pittsburgh.

Finally, if a company can’t point to some solid strategies beyond offsets or allowance, there is something wrong.

“Carbon offsets should not and will not be the sole feature of companies taking climate action,” said Marcus Krembs, head of sustainability for renewable-energy operator Enel North America. Expecting other businesses to provide all the effort and innovation and then to depend only on credits might work for a while. But caps will get tighter, and credits will become more costly as the easy ones have already been sold, and the price of lowering a carbon footprint gets far more expensive.

More must-read energy sector coverage from Fortune:

The oil sector is quickly running out of storage for its unprecedented surplus
—The great African air conditioning boom is about to begin—and it could strain the planet
—Coronavirus fight could prove fatal for addressing climate change
—Business is finally starting to reckon with climate change

—Listen to Leadership Next, a Fortune podcast examining the evolving role of CEO
—WATCH: PSEG CEO on climate change action: “It should have been done yesterday”

Subscribe to The Loop, a weekly look at the revolutions in energy, tech, and sustainability.

Subscribe to Well Adjusted, our newsletter full of simple strategies to work smarter and live better, from the Fortune Well team. Sign up today.

Read More

Path to ZeroEnergyClimate ChangeElectric VehiclesSupply Chains