Build a voluntary carbon credit portfolio

This action builds on previous information provided in the action Procuring Natural Climate Solution Carbon Credits. Please first read this action for more information on the role of carbon credits in a Net Zero journey.

While a business’s primary focus should be on decarbonizing as quickly as possible, by purchasing carbon credits, a company can go above and beyond net-zero by addressing annual remaining and residual emissions, and help to close the significant finance gap for reaching our global climate and nature targets (1). Through the purchase of credits, businesses can also make sustainability claims, improve stakeholder relations, drive differentiation & competitive edge, attract and retain talent and secure high-quality credit supply before demand outstrips supply.

All carbon credits represent the same intended outcome of 1 metric ton of CO2e reduced or removed from the atmosphere. However, carbon credits can be differentiated based on their function and their origin.

Figure 1: Types of carbon credits and market size

As the global economy transitions to net zero, the VCM will undergo a significant shift inverting from a focus today of carbon reduction credits to one that is largely based on removal credits. According to the Oxford Principles, the VCM will be increasingly dominated by NCS removal credits by 2030 (from ~10% of the entire VCM market today) and by 2050 the predominant credit type will be TbS removals. For this market trend forecast to materialize, there will need to be greater investment far more urgently deployed into TbS removals; as of today, only 0.5% of companies with a SBTi target have made any purchases of TbS carbon removal credits.

Figure 2: Oxford Principles percent breakdown of carbon credit portfolio over time

As businesses define their decarbonization pathways, a key task is to identify the role of carbon credits and to ensure that carbon credit investments achieve the intended climate outcomes of avoiding and/or removing carbon from the atmosphere. To meet such outcomes, it is recommended to take a portfolio approach to the VCM.

A portfolio approach seeks to balance typical company objectives --- managing costs, maximizing business opportunities and co-benefits, increasing market knowledge, mitigating project specific risk, use case optionality (e.g., use credits for voluntary claim or for compliance market)—through the procurement of high-integrity credits from different solution types, geographies, developers/partners, etc.

This Action presents a two-stage approach to inform decision-making at the management level and enable portfolio construction and implementation at the executional level.

• First, the initial design of the portfolio by identifying the distinctive uses cases, which later serves as important input for demand quantification, and high-level solution mix. Once these two key outputs are set, businesses can plan the required budget for the portfolio.

• Second, portfolio managers can detail the solution mix to project type level before proceeding to implementation and reporting/ claiming of the portfolio efforts. Importantly, prior to engaging the two-stage portfolio approach it is recommended that businesses develop a macro-view on how the market for voluntary carbon credits will evolve and implications for each businesses carbon credit portfolio.

Selecting carbon credits of high integrity, backed by a rigorous due diligence process, is of utmost importance for businesses, especially those aligning with the criteria established by the Integrity Council for the Voluntary Carbon Market (IC-VCM), known as the Core Carbon Principles (CCPs).

Figure 3: Portfolio construction approach

Below you will find key information for every step in the portfolio construction approach. For more detailed information on the different steps please see the read more section at the end of this page.

Stage 1: Primary Design Variables Assessment

Step 1 - Define your use case(s) for voluntary carbon credits

The first step to take towards the design of an effective portfolio is to identify the use cases for purchasing and retiring voluntary carbon credits. The expected use of the voluntary carbon credits may define the solution types that will be selected.

Step 2 – Define the volume of carbon credits needed

The selection of the use cases for voluntary carbon credits will influence the total volume of credits necessary on a yearly basis to fulfil the objectives of the selected use cases. After identifying the potential combination of use cases for businesses in transition or at net-zero, businesses can consider certain factors to decide the quantity of voluntary carbon credits for their identified use cases.

Step 3 - Identify what solution type(s) should be included in the portfolio

Each use case has implications on portfolio mix. The first decision to make is what type of solution(s) is the best for the selected use case(s).

1. TbS reductions or removals

2. NCS reductions or removals

At the end of Stage 1, the business will have a portfolio “framework” that can be used for annual decisions on what project types and project to purchase and retire (see Stage 2). The share of each solution type could be indicatively defined already at this stage, as each type (TbS/Reduction; TbS/Removal; NCS/Reduction; NCS/Removal) have different process ranges.”

At this stage the business can have a preliminary cost estimation of its carbon credit portfolio to facilitate internal decision-making on investment and resource requirement.

By the end of the above-mentioned process, businesses will have key outputs regarding quantity of carbon credits needed, solution-type portfolio mix, and cost to seek for managemental level alignment. Businesses will then proceed to breaking down the portfolio to project types considering the key variables.

Stage 2: Secondary Variables Assessment

Step 1 - choose project types within each solution type by making informed trade-offs

First, as the business considers both the outcome and feasibility, the business should evaluate different project types at a minimum on four variables. The comparative assessment between different project types must be conducted for each of the solution-type selected, as reduction/ removal and NCS/ TbS projects exhibit distinct characteristics that are not directly comparable to one another.

Step 2 - adjust the portfolio by evaluating executional considerations on project level

The final step in designing the portfolio is to identify specific features, such as geographic coverage, ownership, and size that should be considered before moving to the procurement of the credits, which will entail the selection of specific projects. These elements are not necessarily linked to specific project-types.

At this stage, buyers can now move to the procurement of the credits. The procurement process generally follows 8 steps. These have been described and illustrated in A Buyer's Guide to Natural Climate Solutions Carbon Credits and Procuring NCS Carbon Credits in the Action Library More support on this process can also be found in the NCS Procurement Hub.

The 8 steps will help businesses procure high-quality carbon credits. These steps are critical to ensuring high quality and avoiding the reputational risks associated with purchasing low-quality carbon credits. Projects or programs generate high-integrity carbon credits when they address the permanence, additionality, leakage, double-counting, robust quantification and verification of the climate mitigation activities implemented.”

To familiarize businesses with the two-stage approach and provide them with industry examples, three examples are provided to highlight how different companies in different sectors can utilize the same portfolio approach process yet will yield a different portfolio allocation of credits.

1. To quantity the demand for carbon credits, each company assesses the voluntary carbon credits use cases together with other key consideration factors including climate ambition, decarbonization progress anticipation, new business/investment opportunities and budget considerations.

2. Then the company indicatively allocates credits in the projected portfolio by solution-type ensuring such carbon credit allocation aligns with defined use case(s) while balancing for other factors including budget constraints, emission intensity/source, natural capital dependency, and SDG commitments.

Corporate example A – Tech Co. driving technological breakthrough

In 2030, Tech Co. defines the macro scenario as “Rapid Adoption” because of the belief that SBTi will further endorse carbon credit usage for counterbalance purpose in transition, or they anticipate that VCMI’s Claims Code of Practice will be widely adopted and recognized, and that VCM value chain barriers will be gradually removed. Therefore, it adopts an ambitious approach to claim VCMI Platinum by adopting carbon credits as 130% of its annually unabated emission. With advantages in high profitability, low emission intensity, and tech endowments, it aims at being at the forefront of significantly investing in tech-based solutions.

Figure 4: Portfolio construction process and simulated results for 2030 – Tech Co.

Corporate example B – Consumer Product Co. building a balanced portfolio:

In 2030, CP Co. defines the macro scenario as “Rapid Adoption” because of the belief that SBTi will further endorse carbon credit usage for counterbalancing purpose in transition, or they anticipate that VCMI’s Claims Code of Practice will be widely adopted and recognized, and that VCM value chain barriers will be gradually removed. Therefore, it adopts an ambitious approach to claim VCMI Gold by adopting carbon credits as 100% of its annually unabated emission. With high dependency on water and relevancy with farmers in its value chain, CP Co. focuses on NCS credits with additional sustainability development contribution. It also starts modest investment in TbS removals.

Figure 5: Portfolio construction process and simulated results for 2030 – Consumer Product Co.

Corporate example C – Industrial Co. focusing on economic feasibility

In 2030, Industrial Goods Co. defines the macro scenario as “Incremental Adoption” because of the belief that SBTi will consider endorsing carbon credit usage for counterbalancing purpose in transition, or they anticipate that VCMI’s Claims Code of Practice will be gradually adopted and recognized, and while VCM value chain barriers remain, they will be largely removed. Therefore, it adopts a pragmatic approach to claim VCMI Silver by adopting carbon credits as 50% of its annually unabated emission. With low profitability, but high emission intensity and dependency on natural capital, it focuses on NCS credits that are cost-efficient, have volume potential, and can deliver immediate impact.

Figure 6: Portfolio construction process and simulated results for 2030 – Industrial Co.

Nature Impact

High-quality NCS projects generate numerous positive core benefits such as:

• Protecting forests, wetlands and grasslands

• Enhancing soil health and fertility through regenerative agricultural practices

• Rehabilitating degraded ecosystems, such as degraded mangrove forests and degraded coastal habitats

• Better management of timberlands, croplands and grazing lands

• Restoration of forests and peatlands

• Protection of endangered species and return of previously eradicated species

• Protect/conserve wildlife corridors

• Promoting sustainable land use planning to minimize habitat fragmentation and encroachment

• Supporting indigenous and local communities in traditional land management practices that promote biodiversity conservation

Climate Impact

NCS credits can have a supplementary role in a corporate’s high-ambition net zero pathway. They can contribute to net zero goals by counterbalancing unabated emissions, addressing historical emissions and reducing and neutralizing value chain emissions.

Figure 7: Achieving Net Zero with natural climate solutions (3)

Business Impact

Benefits

A portfolio approach can benefit a company as it seeks to balance typical company objectives:

• Managing costs: TbS reduction credits are typically the lowest cost option (below $5/ton), whereas TbS removal credits can cost upwards of $500/ton. A portfolio approach provides a blended price per credit for the buyer and provides acceptable guardrails for the average price per credit type.

• Identifying business opportunities: Companies may find business opportunities emerge from investments and partnerships to develop new technologies that generate carbon credits. A portfolio approach expands the playing field for such opportunities.

• Mitigating project specific risk: Sourcing from only one project or only one project type can incur unnecessary risk for the buyer, as there are several project specific risks that can emerge—overissued credits, local community opposition emerges, ineffective technology, etc. A portfolio approach mitigates this risk through buying from various projects, project types, developers, and/or geographies.

• Maximizing core benefits: NCS projects generate numerous positive core benefits from biodiversity protection, livelihood improvements, and soil, air and water quality enhancements. Likewise, in addition to the generally greater levels of measurability and permanence, TbS projects may have positive impacts regarding industrial development and livelihood improvements. Such core benefits are often quantified as SDG impacts or SDG outcomes and may increase price per credit.

Lastly, a portfolio approach towards carbon credits can help advance a company’s reputation through communicating its dedication to achieving the primary climate outcomes of reduced or removed carbon from the atmosphere, while highlighting how its carbon credit procurement aligns with company brand values and larger sustainable objectives. For example, an agricultural company may prioritize NCS credits, both reduction and removal, especially if such credits can quantify positive biodiversity benefits and livelihood improvements for smallholders and local communities. Likewise, an innovative technology company may prioritize investments into nascent TbS removal credits, illustrating a willingness to be at the vanguard of decarbonization.

Constructing a portfolio to balance competing timeframe needs, manage associated risks, and maximize sustainability development impacts requires a strategic and systematic approach. Furthermore, investing now boosts carbon market liquidity and can advance needed removal technologies by bringing down the project cost and increase the accessibility of carbon credits in the future.

Figure 8: Businesses’ challenge in participating in VCM, and benefits of a portfolio approach

Costs

Budget is one consideration that will influence the decision of what type of solutions should be included in the portfolio. Reduction credits, especially NCS type, typically come at a lower cost. Businesses facing budget limitations can opt for integrating a higher amount of reduction credits.

There is large price variance among different solution types of carbon credits, for example, TbS/Removal compared to NCS /Reductions; NCS/Reduction credits can deliver immediate carbon impact at scale with relatively cheaper prices; however, with natural and land resources becoming increasingly scarce, NCS solutions are likely to see price rise. TbS removal credits are important to support permanent removal of unavoidable emissions and require investment today to drive down the cost curve. Meanwhile, it is crucial to note that high quality is a pre-requisite for carbon credit procurement, and businesses should not sacrifice the quality of carbon credits for lower cost.

Figure 9: Basic cost structure of voluntary carbon credit portfolio

Impact beyond nature, climate and business

Co-benefits

Well-designed and properly implemented NCS projects and programs deliver climate mitigation benefits and biodiversity gains, and generate socio-economic benefits in particular for Indigenous Peoples and local communities (IPs and LCs), who often in turn improve the effectiveness of NCS projects and programs.

Potential side-effects

Performing due diligence on projects and programs to ensure they are high quality can help mitigate the various risks associated with carbon credits.

Typical business profile

Businesses in all sectors, regardless of size, can invest in high-quality carbon credits through the voluntary carbon market to counterbalance their unabated value chain emissions, thus contributing to global climate mitigation and biodiversity recovery targets.

Approach

Businesses who already have in place a robust, science-based net-zero emissions targets should consider purchasing and retiring high-quality NCS voluntary reduction and removal credits during the transition to net zero to counterbalance unabated value chain emissions. These credits should not be used in lieu of or delay the emissions reductions necessary to meet long-term science-based targets for Scopes 1, 2 and 3. They can also go beyond net zero by purchasing and retiring high-quality NCS voluntary carbon credits to counterbalance historical emissions and contributing towards climate recovery.

Stakeholders involved

The VCM is complex and evolving quickly and some stakeholders hold multiple roles in the procurement process. Across the VCM, six main groups of stakeholders play important roles

• Land stewards and carbon rights holders: Primarily Indigenous Peoples and local communities, they are crucial for delivering high-quality NCS projects, requiring their full participation and consent.

• Project developers: Design and implement projects, collaborating with land stewards, carbon rights holders, and local communities. They ensure agreements with carbon rights holders and provide support services.

• Non-governmental organizations (NGOs): Provide technical support, partner with project developers, and advocate for high-integrity standards, especially regarding conservation and human rights.

• Governments: Can act as program developers, setting regulations, issuing permits, and supporting projects through tax initiatives. They are pivotal for establishing registries under Article 6 of the Paris Agreement.

• Intermediaries: Facilitate transactions between developers and end-buyers, offering services like portfolio management, brokerage, and marketplaces.

• End-buyers: Purchase NCS credits to offset emissions. They counterbalance unabated emissions, neutralize residual emissions, and compensate for historical emissions.

Other key entities include carbon crediting programs, validation/verification bodies, registries, governing bodies, and carbon credit rating agencies, each contributing to the credibility and transparency of the VCM.

Implementation and operations tips

For insights and guidance on the procurement of NCS carbon credits, consider exploring the NCS Procurement Hub. The online platform is a practical resource for companies interested in learning more about integrating carbon credits into their decarbonization strategies. It is tailored specifically to help current and potential carbon credit buyers and investors through the procurement journey.

Stage 1: Primary design variables assessment

Step 1 - Define your use case(s) for voluntary carbon credits

“Voluntary carbon credits can support several use cases for businesses:

1. Counterbalancing remaining emissions. While prioritizing emission reduction within the value chain, businesses may purchase voluntary carbon credits to counterbalance their annually remaining emissions during the transition phase.

2. Neutralization at net-zero. Once businesses reach net-zero status, in which their carbon emissions cannot be further reduced, they are required by SBTi to remove an equivalent amount of carbon to residual emissions. In addition to in-value chain removal activities, businesses can use removal carbon credits to neutralize residual emissions.

3. Compensation for historical emissions. With strong climate ambition (e.g., achieving carbon negative), businesses can take further action beyond counterbalancing remaining emissions and neutralising residual emissions by compensating their historical emissions during the transition phase and at net-zero state.

4. Temporarily close Scope 3 reduction target gap. A company could make limited use of high-quality carbon credits to close the gap between its estimated scope 3 greenhouse gas (GHG) emission reduction target level, and its current scope 3 emissions in a given year, as long as it has already taken other steps to reduce current emissions (i)

5. Compliance market. In some situations, VCM credits may be accepted by certain compliance markets. For example, certain emission trading schemes (e.g., US California Cap-and-Trade Program) allow businesses to purchase voluntary carbon credits to fulfil part of their compliance obligations. The allowance cap is often set low (e.g., 5-10%) to limit voluntary carbon credit use.”

Step 2 – Define the volume of carbon credits needed

1) Counterbalancing remaining emissions. The majority of companies are currently in transition to net zero; such companies should quantify their annual carbon emissions across scopes 1, 2 and 3 and then multiply by the percentage to be counter-balanced (‘counterbalancing of unabated emissions’). For example, a company with projected annual 2M tons of scope 1, 2 and 3 emissions that wishes to counter-balance 20% of its total emissions, would allocate a budget sufficient to procure 400,000 tons of credits. Some companies may wish to counter-balance 100% or more of their emissions, and even begin to address their historical emissions.

When deciding on how much to counterbalance through credits there are various factors to consider:

• Climate ambition: what is the company’s market positioning, branding, and values as a climate leader? Is there a decision to align with a certain carbon claim such as carbon neutral or to align with a VCMI claim tier? Is the company preparing for neutralization?

• Decarbonization progress: is the company operating in a hard-to-abate sector where economically feasible alternatives are slow to materialize (e.g., Sustainable Aviation Fuel) and therefore a higher percentage of counterbalancing is required?

• New business and investment opportunities: Does the company foresee business opportunities in emerging low-carbon technology / solutions that may emerge from investments into carbon credits?

• Budget consideration: Given the company’s profit margins and intangible brand value, what is an appropriate budget for counter-balancing the company’s unabated emissions through carbon credits?

To find out more about making claims associated with the use of voluntary carbon credits, please visit www.vcmintegrity.org.

2) Neutralization at net-zero. A minority of companies have thoroughly decarbonized and now reside at net zero. These companies should forecast their demand by assuming carbon credit purchases for 100% of the total residual emissions (‘neutralization at net zero’). According to SBTi requirement, corporates must fully neutralize any residual emissions with permanent removal and storage of carbon. This means the quantity of voluntary carbon credits can be as high as the amount of all unavoidable in-scope emissions when businesses are at net-zero.

3) Compliance market. Companies may be exposed to compliance markets for carbon emissions where a limited number of VCM credits are allowed.

The quantity is dependent on the following three factors. If the answers are positive, businesses may procure carbon credits to fulfil certain part of their compliance obligation, which is up to offset cap regulated by each scheme.

1. Whether there is any ETS/Carbon Tax policy to regulate businesses’ legal entities, and their geographical and sectoral information

2. Whether scope 1 (& 2) emissions exceed the allowance

3. Whether leveraging carbon credit is more economically efficient than purchasing allowance or paying tax”

Step 3 - Identify what solution type(s) should be included in the portfolio

“Example of how the different solution types match the different use cases are:

• Counterbalancing remaining emissions. Both reduction and removal credits can be applied for this use case. Reduction credits are generally more available and can slow down the pace of climate change, addressing the emissions generated by actors that would not have the finance or the incentives to reduce their emissions.

• Neutralization at net-zero. As SBTi currently only recognizes removal credits for neutralization, businesses are recommended to purchase and retire an equivalent amount of removal credits. While TbS removal credits are generally preferred given greater assurance of permanence, this case for NCS removal credits remains especially for FLAG sectors.

• Temporarily close Scope 3 reduction target gap. Both reduction and removal credits can be applied for this use case. However, as the credits are used against an emissions that should have been reduced, businesses are recommended to purchase and retire an equivalent amount of removal credits.

• Offset for compliance obligation. If a company is operating under a compliance mechanism that allows a set percentage of VCM credits, then the company must review the requirements of each compliance mechanism as the solution types and specific carbon credit methodologies accepted will vary.

Stage 2: Secondary variables assessment

Step 1: choose project types within each solution type by making informed trade-offs

The variables to consider are:

1. Assurance of carbon impact. Permanence of the carbon mitigation outcome refers to longevity of the mitigation outcome associated to the carbon credit. Permanence applies both to reduction and removal activities; but it is considered more central to the selection of removals, especially when the use case is neutralisation. If companies are using removal credits to counterbalance their remaining emissions, then the permanence of the mitigation outcome could be 40-year, as required by IC-VCM’s CCP. However, if companies are using removal credits to neutralize their residual emissions at net zero, then longer permanence should be the standard, as the essence of neutralization is about balancing carbon flows within the geosphere. Certain policies and standards may also have specific requirements on permanence of credits for neutralization purposes.

2. Additional sustainability development (SD) contribution refers to additional positive impact that different project types are more likely to generate beyond their climate mitigation outcomes (emission reductions and carbon removal). If businesses are committed to the delivery of other Sustainable Development Goals, their choice of project type may vary depending on the specific sustainable development goal(s) they prioritize. For example, they may opt for forestry projects because they come with biodiversity conservation and employment/ livelihood improvement. They may also choose Direct Air Capture for Carbon Storage (DAACS) as part of their TbS removals share because they stimulate the development of industry, innovation, and infrastructure.

3. Cost refers to the cost of reducing or removing carbon, including capital and operating cost of the carbon credit project type.

4. Feasibility refers to the process/technology maturity, MRV feasibility and the complexity of stakeholder management of the carbon credit project type. Future-looking refers to the novelty of the project-type both in terms of process/technology or ecosystem.

In order to facilitate the comparison of various project types, businesses must first determine which variables to prioritize before conducting the assessment. To achieve this, it is advisable for businesses to consider three key dimensions for prioritizing variables and managing the associated trade-offs:

1. Relevancy to business (additional SD contribution)

2. Climate ambition (assurance of carbon impact, additional SD contribution, feasibility)

3. Budget (cost)”

Step 2: adjust the portfolio by evaluating executional considerations on project level

1. Project location refers to the physical sites or geographical areas where emission reduction/removal projects are implemented: The business may consider geographical proximity to business operation, while avoid over-concentration in a single area

2. Ownership refers to the type of legal ownership of the credits (local communities; Indigenous People; corporate).

3. Size of the project refers to the scale of the project delivering the credits. This variable is often linked to Ownership.

Footnotes

(i) Note: This use case is supported by VCMI's new Scope 3 Flexibility Claim – launched as a beta version on November 28th 2023 as a standalone document made publicly available through VCMI's website. The new claim permits a company to make limited use of high-quality carbon credits to close the gap between its estimated scope 3 greenhouse gas (GHG) emission reduction target level, and its current scope 3 emissions in a given year, as long as it has already taken other steps to reduce current emissions.