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Policymakers and registries propose insurance for carbon credit permanence

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Mathilda Ström

29th Apr 2024

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There are many changes underway these days to bring greater transparency, integrity and certainty to the voluntary carbon market (VCM). One key development is that regulators and registries are increasingly proposing in-kind insurance as a risk mitigation mechanism to secure the permanence of carbon sequestration efforts – as a replacement for, or in addition to, buffer pools.

The European Union (EU), United Nations (UN), American Carbon Registry (ACR), and Climate Action Reserve (CAR) have all highlighted insurance as an ideal solution for protecting the long-term permanence of sequestered carbon. For example:

  • In its 2023 draft recommendations on activities involving carbon removals, the UN Supervisory Body of Article 6.4 of the Paris Agreement stated that in-kind insurance can ensure that any reversals are compensated for with replacement carbon removals”.
  • The EU Commission’s 2022 proposed Carbon Removal Certification Framework (CRCF) provides that “appropriate liability mechanisms should be introduced to address cases of reversal. Such mechanisms could include […] up-front insurance mechanisms”.
  • ACR allows insurance in place of buffer pool contributions, stating, “In lieu of making a Buffer Pool Contribution or Reserve Account Contribution, Project Proponents may propose an established insurance product for ACR approval as a risk mitigation mechanism.
  • While not yet allowing insurance to replace its buffer pool, CAR has stated that it “anticipates that other insurance instruments may be available to insure against reversals.

CarbonPool is actively engaged in discussions with these and other policymakers, regulators and registry and verification bodies regarding risk transfer for permanence. These stakeholders agree that insurance, and especially in-kind insurance, is an appropriate mechanism to ensure permanence.

Insurance is an important and necessary mechanism underpinning all mature markets, from infrastructure to commodities to health services. The fact that regulators and registry bodies alike are proposing in-kind insurance mechanisms for carbon is an indication that there is a move to professionalize carbon markets to bring stability to investments in this space. This will ultimately serve to create confidence in the market and unlock the large flows of capital needed to prevent the worst effects of climate change.

What is permanence and why does it matter?

“Permanence” refers to the amount of time that carbon will remain sequestered rather than being released back into the atmosphere through natural processes or human activities. If sequestered carbon is released back into the atmosphere, it is called a reversal.

All carbon credits – including those from technological solutions like direct air capture – are subject to reversal risks. This can come from weather-related perils like fire, wind, extreme temperatures or drought, but it can also come from machine breakdowns or leakages from storage facilities.

If a reversal happens, the environmental benefits of that particular tonne of sequestered carbon is lost and, in the simplest terms, the global calculation to remove 6-11 gigatonnes of carbon dioxide annually from the atmosphere by 2050 needs to be adjusted to add another tonne back to the target. Or, for a carbon credit buyer who retired that credit to compensate for their emissions, that credit has no longer achieved its purpose and therefore needs to be replaced with another credit.

For companies selling carbon credits that promise a certain degree of permanence, or companies that are using carbon credits to offset emissions, permanence can thus become a significant issue. If the credits they purchase experience a reversal at any point post-sequestration, their ability to deliver to customers or to make good on their climate commitments claims may be at risk if they cannot find a replacement.

Solutions for permanence – in-kind insurance trumps buffer pools

Permanence is the sixth criterion in the Integrity Council for the Voluntary Carbon Market’s (ICVCM) ten “Core Carbon Principles“, which are quickly becoming the market standard for high-quality, high-integrity carbon credits. This criterion requires that there must be measures in place to compensate for reversal risk where it exists.

It’s important for project developers and carbon credit buyers alike to understand how reversal risk can actually be mitigated.

The most common way the industry has dealt with this to date is through “buffers” or “buffer pools” – established by registries, intermediaries, buyers or project developers themselves. Buffers essentially set aside a proportion of the credits being issued by a project (anywhere from 10 to 40%) that cannot be sold or retired, and if there is a reversal event then credits are taken from this buffer to compensate for that loss. Many registries then “pool” buffers from all the projects they certify, and some promise as much as 100 years of permanence thanks to this buffer pool.

Yet buffer pools today lack many of the fundamental principles required for them to effectively act as a permanence mechanism – in fact, there is a real risk that these pools will fail to provide the permanence they promise in the long term.

Required contributions to registry buffer pools are not calculated using thorough quantitative risk assessments and therefore are, in all likelihood, wrong – meaning the backstop that many buyers rely on is fundamentally at risk. These buffer pools, which act as an insurance mechanism, are also unregulated – no regulatory authority or experienced risk expert has rigorously assessed their solvency. In addition, it is not at all clear how these buffer pools actually work, since little data is available about them. Has there been continuous monitoring of projects to remove or invalidate credits that may have suffered a reversal event? Have credits in the buffer pool actually been used to compensate for reversed credits? What kind of credits are in the buffer pool? Considering the recent exposure of multiple projects that failed to deliver the benefits they promised, there is a real risk that these buffer pools are filled with credits of questionable quality.

By contrast, in-kind carbon credit insurance offers several critical advantages – and is the only mathematically sound contingency plan for the planet. In-kind carbon credit insurers like CarbonPool allow registries, intermediaries, buyers, and developers to pay an insurance premium based on an accurate, customized risk assessment instead of contributing a uniform amount to buffer pools. The transaction is transparent and regulated by contract. And if there is a reversal event, the number of credits lost is immediately made good by providing the insured party with high-quality carbon removal credits from the insurer’s own balance sheet – the quality of which is also covered by contract. In contrast to buffer pools, CarbonPool’s pool of credits can guarantee quality, solvency, and permanence – and, our clients know what’s in it.

It’s no wonder that policymakers and experts, including the EU, UN, ACR and CAR, are endorsing in-kind carbon credit insurance as a mechanism to address permanence issues – and we expect to see more of this in the next months, as efforts to ensure the integrity of carbon credits under the VCM continue.

More to come on buffer pools from CarbonPool in the future — for now, check out our other publications in our knowledge center!

Photo by Guillaume Périgois on Unsplash