Reducing carbon footprints and mitigating climate change are increasingly crucial for all businesses. With escalating regulations, growing consumer demand for environmentally friendly products and services, and persistent shareholder pressure, there is an escalating need for companies to deliver on their climate ambitions. This article explains the basics of Carbon Credits, outlines how to craft credit portfolios tailored to your customer base, and discusses how to generate a competitive advantage by managing downstream climate actions.
Meeting customers' climate demands
Enterprises must take measurable action to fulfill these demands in order to maintain their competitiveness and profitability, e.g., by improving energy efficiency, investing in renewable energy sources, and matching their net-zero targets. For most, procuring carbon credits is a crucial component of that effort. Especially the optimization of enterprises’ engagement strategies in the voluntary credit market (VCM) and their carbon credit portfolios are substantial to counteract emissions that cannot be reduced internally.
So far, most enterprises have created their carbon credit portfolios with the primary objective of reducing and removing unavoidable emissions from their operations. Increasingly, credits are also the mode of choice to reduce emissions outside the company's control, i.e., the upstream supply chain. This means that many businesses ask their suppliers to compensate for emissions as a contribution to their climate targets. With many companies still in the process of setting up their own (Scope 1+2) portfolios, setting up compensation for downstream customers requires even more care. Companies must not only navigate the still complex and volatile carbon market but also comply with their customers' compensation requirements.
More often than not, the question arises whether suppliers' compensation matches the buyers' climate ambition.
Carbon Credits 101 - covering the basics
A carbon credit represents one verified ton of greenhouse gas (GHG) emissions reduction or removal. It complements other market mechanisms like compliance allowances by enabling companies to reduce emissions in addition to policy-set targets. The original mechanism was established under the United Nations Framework Convention on climate change to combat climate change. Since then, it has evolved. Even though every credit is equal to one ton of reduced GHG equivalents, they differ in fundamental characteristics.
- Removal vs. avoidance. The difference between the two credit types is that removal credit removes one metric ton of GHG emissions from the atmosphere. Avoidance credits represent an emissions reduction achieved by avoiding releasing GHG emissions into the atmosphere through measures such as energy efficiency improvements.
- Additionality refers to the fact that certified emission reduction or removal would not have occurred in a baseline scenario, i.e., it only happens because of the credit being issued. Additionality is analyzed along three dimensions: financial, political, and environmental. For example, financial additionality is only given if the project would not have been viable without the sale of credits.
- Leakage occurs if the removed or reduced emission by the project leads to a rebound effect, which increases the emissions up or downstream of the mitigation activity. Therefore, leakage identifies the project's impact on the environment outside the project's boundaries. A typical example is increased deforestation outside an area protected by a climate project.
- Permanence of credits is the duration of the project’s climate impact. While some avoidance categories have technically no permanence (i.e., the effect is only viable at the time it is realized), most removal and storage credits have a measurable permanence in years.
- Vintage year of carbon credits indicates when the removal or avoidance occurred.
The price of carbon credits is increasingly linked to these fundamental characteristics, but in practice, buyers and "users" of credits often have precise requirements, may it be specific geographical coverage or additional contributions to social benefits. This, in turn, requires companies to build sub-portfolios for particular customer groups to be able to deliver products with accompanying compensation. Read our "How to build a portfolio of carbon credits" white paper to learn more about the distinctions between various credits.
Crafting credit portfolios for your customer base
Ideally, companies build distinct sub-portfolios for specific customers or segments. Building a sub-portfolio requires analyzing and identifying the different customers' requirements regarding climate action. Typically, these include some of the following dimensions:
- Customers’ public environmental commitment. Companies show a different level of consciousness and prioritization of sustainability in their company strategy. An indicator to differentiate between clients is their historical, present, and future engagements and commitments, e.g., SBTi and net zero commitments. Companies committed to SBTi criteria can use only removal credits to offset their emission, which means that suppliers also need to use SBTi-compliant credits to make sure the customer can account for their contribution. With detailed guidance of SBTi requirements for outside-of-supply-chain emissions still missing, this requires special care in crafting a portfolio. That said, customers with SBTi targets are, on average, more willing to pay for quality and permanent removal.
- Consumer claims. Many companies that ask suppliers to compensate for goods and services use the purchase of credits to claim “net-zero” or “carbon neutrality” toward consumers. While this practice is fading for a number of reasons, including the often hard-to-proof nature of these claims, portfolios for this purpose require additional scrutiny. B2B2C portfolios must minimize the reputational and legal risk associated with the credits used. Usually, this signifies an exclusive focus on ex-ante credits from large certification bodies. In many jurisdictions, the safest option is using credits from ICROA-certified standards, such as Gold Standard. ICROA is a sub-part of the international emissions trading association and is frequently cited as a de facto quality assurance by courts and legislators. This, interestingly, makes it hard for B2C companies to use removal credits that are mostly certified under newer standards. Moreover, controversial credit categories, e.g., REDD+, are almost always ICROA certified but bear a significant risk of causing reputational damage as the methodologies are more error-prone. An alternative can be found in newer carbon funds that do not allow carbon neutrality claims but offer an easy way to contribute to a portfolio of pre-vetted credits. The Climate Transformation Fund from Milkywire is an example that is already easily accessible while providing holistic climate action.
- Customers’ awareness of carbon credits. Enterprises show an awareness gap in their knowledge about the fundamental difference between carbon credits. Consequently, customers with a less detailed understanding of the resulting short and long-term impact on the environment are more likely to have a lower willingness to pay than clients with more pre-existing knowledge. This comes with the challenge of educating customers on the value a higher-quality portfolio can deliver. Generally, using science-backed metrics can serve a good purpose for including these credits.
- Margin structure. Besides the sustainability commitments, reputational consideration, and carbon credit knowledge, the margin level represents a constraint for the customers’ compensation strategy. Customers in lower-margin industries will have less flexibility to invest in higher-quality portfolios and have to educate their customers upfront to legitimize the investment or markup. Customers within higher-margin industries can, conversely, use high-quality credits as a real differentiator without risking their ability to generate sufficient margins.
In sum, leading credit buyers classify their clients based on different dimensions, including the willingness to pay. Hardly the resulting overview leads to a one-size-fits-all approach. While some customers might ask for removal-only portfolios to make their SBTi-aligned targets, other companies might push on pricing to keep costs low.
As a result, it can be beneficial to set up sub-portfolios for common types. This also allows companies to leverage their customer base to enhance their carbon reduction by enabling a more significant contribution. Practically, sub-portfolios can be tailored to customers' specific needs and are often required to be signed off as part of the general procurement negotiations.
Turning measurable climate action into competitive advantage
Keeping an overview of one's credit portfolio and sub-portfolios for customers can be tricky. Especially ensuring that credits are not accounted for both is essential. Many buyers of compensated products require access to the registry retirement certificates as well as detailed data about what credits and retirements were used for each delivery. That said, there are a few best practices for generating competitive advantage by managing downstream climate action:
- Using a central tool to hold credits and track their retirement. Platforms like CEEZER allow users to consciously procure and manage credit portfolios with objective data points that ensure compliance with any requirement. Also, CEEZER enables the creation of sub-portfolios and tracks retirements against those.
- Generating purchase advantages. By centrally sourcing credits for both Scope 1+2 and customers (or multiple customers), companies can increase their purchase volume and profit from significantly better pricing. Also, maintaining a more extensive portfolio gives more flexibility to act if the customer demands change or volume adjustments quickly are required short-term.
- Complementing credits with customer service. Providing compensated products can be an advantage in itself. However, offering additional services around the pure provision of certificates for product-related GHG emissions can really set the offering apart. Monitoring the VCM and portfolios to ensure optimal impact for the possible price can provide additional benefits and help with supplier- and buyer trust.
- Giving customers the tools to communicate climate action. Ensuring end-to-end visibility for customers is beneficial to keep a clear view of the provided service and to enable customers to integrate any compensation into their climate ambition and story. CEEZER allows centrally tracking retirements and credits usage across different customer products and sub-portfolios, ensuring a consistent ledger across all companies. This way, metrics on credit quality and
In conclusion, compensating for one's customer can be challenging and, if done wrong, can lead to more damage than value. It is crucial to understand what the customer wants to achieve in terms of climate ambition and to tailor the credit portfolio accordingly. Companies can achieve maximum impact from their VCM investments by using central steering tools, in-depth data on credit methodology and quality, and offering clear end-to-end traceability of credits for every good or service sold. Done correctly, this can both be used to differentiate from competitors and to enable customers to communicate on climate action with maximum impact. Along the way, companies can get tactical price and procurement advantages by pooling their and customers' demands.
Contact us to learn more about how CEEZER can help your company take your climate action to the next level.