The transition to a low carbon economy is on every CEO's agenda nowadays. The impacts of climate change and responses to it will transform every business sector in the coming decades. Although Climate change will affect a majority of companies, all will be expected to contribute to its solution.
Nevertheless, it is challenging for most companies to devise and implement a credible decarbonisation strategy. The transition requires new ways of doing business, including new ways of displaying capabilities and resources and new ways of thinking. But despite the challenges, companies around the world are scaling up their decarbonisation commitments.
We can see this trend with the number of companies committing to reducing emissions. More than 2000 companies have confirmed emissions reduction targets under the Science Based Target initiative (SBTi). Additionally, more than 370 have committed to The Climate Pledge, pledging to achieve net zero emissions by mid-century or sooner.
For most companies and investors, carbon credits play a crucial role in their Net-Zero strategy. They allow companies to make earlier and more ambitious commitments. Credits allow companies to reduce their current emissions through offsets, while taking cost-effective steps to reduce future emissions through asset rotation and business model development. In the long term, credits can play an essential role in offsetting difficult-to-avoid emissions from products for which no low- or zero-emission options exist.
The growing interest in recent years is also reflected in the Voluntary Carbon Market (VCM), which organises the pledging and trading of carbon credits. In 2022, the demand for carbon credits is at its peak. Prices have increased by more than 140% since 2021 and forecasts assume that demand for credits will increase 15-fold by 2030, to $50 billion per year.
But the voluntary carbon market has a problem. It cannot cope with demand. Access, which plays a crucial role in the global effort to combat climate change, is often limited to large organisations and is characterised by opaque pricing and market inefficiencies. Furthermore, due to a lack of transparency and credibility, it has faced a number of problems in recent years.
This report examines the key role for on-chain carbon credits as part of net zero strategies and the VCM. It was prepared by senken to help business decision makers identify and understand the best use of credits for their business.
What is a Buffer Pool?
Buffer pools act to provide projects with a safety net, acting in a similar manner to an insurance policy, by holding onto a specified amount of carbon credits to not be sold. The primary role of buffer pools is to offset any unforeseen losses or damage to the project’s carbon stocks, such as those caused by natural disasters or unexpected environmental changes. By doing so, buffer pools ensure the integrity and reliability of carbon credits, ensuring that each credit represents a genuine reduction in carbon emissions.
How Does the Buffer Work?
Fundamentally, the operational mechanism of buffer pools is triggered if a loss occurs that affects the project's carbon stock. However, not every loss leads to credits being withdrawn from the pool. It largely depends on the net emissions reductions achieved by the project. If the project experiences a net loss of carbon stock, as verified, measures such as the cancellation of an equivalent number of credits from the buffer pool are taken. This is to ensure that the overall environmental impact of the project remains positive.
What Happens to Credits in a Buffer Pool if Nothing Goes Wrong?
If a carbon credit project proceeds successfully without any significant loss of carbon stock, the credits held in the buffer simply pool remain unused. Over time, if the project continues to perform well and demonstrates reduced risks, a portion of these buffer credits can sometimes be released and sold. This incentivises project developers to maintain high standards of operation and risk management.
Determining Buffer Pool Contributions
Determining the size of contributions to buffer pools is a nuanced process, influenced by a range of risk factors that differ from project to project. These factors can include environmental threats (like the likelihood of fires or floods), the project's management efficiency, and its financial stability. The contribution size needs to strike a balance between keeping sufficient reserves for comprehensive risk coverage while also maintaining the economic viability of the project.
Implications for Sustainability Leaders
Sustainability leaders looking to purchase carbon credits need to understand how buffer pools work. When evaluating carbon credit projects, it is important to assess both the size of their buffer pools, along with how they are managed. These factors are indicative of the project's long-term resilience to environmental risks as well as the reliability of the emission reduction or removal claims. This is why assessing project buffer pools is a significant step in Senken’s due diligence process, ensuring a selection of projects that align with long-term sustainability goals and genuine contribution to climate change mitigation.