Rethinking Carbon Credits: A Dive into Emissions Liability Management

Can an accounting method fix the carbon markets?

In the quest to combat climate change, carbon crediting has emerged as a pivotal tool, offering a pathway for companies and individuals to offset their carbon footprint. However, the carbon markets possess a number of hefty flaws around the quality of carbon credits and the duration that carbon is being stored for. To overcome some of these problems, a new accounting scheme called Emissions Liability Management (ELM) has been thought up by policy researchers at Stanford University [1].

Emissions Liability Management redefines how businesses account for their carbon emissions, treating them as ongoing liabilities rather than one-time offsets. This blog post aims to provide a clear and detailed exploration of ELM, highlighting its structure and potential benefits over the existing carbon crediting framework. It discusses how the implementation of ELM can overcome some of the current system’s shortcomings and provide greater quality and permanence to the carbon markets.

How ELM works

Emissions Liability Management (ELM) redefines the approach towards carbon crediting, focusing on continuous responsibility and realism in carbon offsetting. The concept is incredibly simple: Rather than treating carbon credits as one-off purchases never to be thought of again, treat them as temporary assets covering your long-term liabilities. This means that a company’s carbon output is continually assessed and managed, mirroring how financial liabilities are handled in standard accounting practices.

Under ELM, companies are required to keep an accounting book of all their carbon emissions for each year. These liabilities last for as long as the carbon is in the atmosphere (likely forever), and they must be matched with carbon credits that have an expiration date. Unlike the traditional method where credits are seen as permanent, ELM recognizes that these assets have a finite lifespan.

Under ELM, companies must regularly reassess their carbon credits. As credits expire or become ineffective, they are replaced with new ones. ELM places a long-term accountability on companies for their emissions. By constantly updating their carbon credits, companies stay actively engaged in their environmental impact, rather than relying on past actions to justify current emissions. Companies can handle this responsibility by forming multi-decadal trusts or using third-party providers of ELM accounting.

ELM also acknowledges the varying permanence of different carbon credits. Credits from direct air capture or certain geological methods may have a permanence long enough to entirely wipe out liabilities. Credits from nature-based projects come with an end-date after which they need to be renewed.

ELM compels companies to actively manage their carbon footprints, leading to enhanced credibility in sustainability efforts. Right now, companies face reputational risks when they buy credits that are later shown to be invalid. Reporters then delight in highlighting that Company X bought phony credits. An ELM accounting framework could shift the conversation from:

“Company X bought bad credits and was greenwashing”

to

“Company X was duped into buying bad credits, and will have to re-balance its accounting books with new ones”

There is an implication here that ELM may encourage companies and insurers to more aggressively combat fraud in the carbon markets. After all, why is Delta Airlines being sued right now by customers for buying fraudulent carbon credits, rather than Delta suing their carbon provider for selling them fraudulent credits? A lot of it comes down to the way Delta framed its offsetting program, not as a stopgap solution to cover its emissions — but as a permanent one-off solution that they’d never think about again.

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Advantages of ELM for carbon credit quality

Emissions Liability Management (ELM) has the potential to significantly enhance the quality of carbon credits in the market. There are several mechanisms for that to happen:

• ELM encourages companies to insure their carbon credits (lest they need to buy more). Right now, insurance in the carbon markets isn’t handled by disinterested third-parties, it's handled by the registries who create the credits. Carbon registries like Verra have an insurance buffer pool where they set aside carbon credits in case anything goes wrong. Perhaps unsurprisingly, these buffer pools have been shown to be insufficiently large [2], and registries are hesitant to actually make use of them. Of the many scandalous REDD+ projects ‘on hold’ (such as Kariba, South Cardamoms, and Maisa), Renoster only knows of two projects that have accessed the buffer – despite there being numerous projects with reversals.

By placing the responsibility of purchasing more offsets on companies rather than registries, those companies will naturally seek to insure their assets. Third party insurers in the carbon market will only opt to insure the highest quality carbon projects, and therefore a market mechanism will exist to improve project quality.

• Quality in forest carbon permanence and additionality is also improved under ELM. Forest carbon projects that are 100 years long are typically thought of as the gold standard. However, realistically most people signing 100 year easements on their land didn’t intend to harvest their trees in the first place. It has led to a lot of carbon projects taking place on essentially park land (owned by private land trusts for example). Forest carbon projects that are super short duration are also not so great. It is difficult to ascertain whether or not someone was likely to harvest their trees in a 5-20 year window. This poses challenges for determining additionality.

Under an ELM scheme though, projects that are medium length can be incentivized to protect trees for a few decades, and then when the contract length is up companies simply buy another set of credits or extend the project. Companies that want 100 year permanence initially can simply opt to buy something like 5 sets of 20 year credits, reserving them for periods in the future. This solution solves both the problem of permanence with one-off credits that have short contracts (like 30 years), and the problem of additionality and risk with long contracts.

In the realm of carbon accounting, several methodologies exist alongside ELM. Obviously, there’s the system that we have right now where companies treat their carbon purchases as one-time transactions to offset emissions.

Another approach is called Tonne-Year accounting. This method involves calculating the long-term impact of shorter-term carbon offset projects, adjusting the number of credits issued based on their projected environmental benefit over a longer period, like 100 years. While this approach encourages a more realistic assessment of carbon offsets, it often places a greater burden on project initiators, like landowners or farmers, who might receive fewer credits for their efforts. This could potentially make carbon offset projects less financially viable for them, impacting the market's overall supply and diversity. ELM offers a solution to this by putting the burden of 100+ year permanence on the purchaser of the credits – and isn’t that where it should be in the first place?

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Emissions Liability Management in Practice

In practice, ELM is difficult to implement. It requires companies to continuously monitor their carbon purchases for expirations dates and reversals. Ideally, a third party could play this role, and one proposed solution is a long-term trust established to balance emissions and carbon assets.

However, another solution may exist in the private sector. Companies could begin to offer ELM as a service, balancing portfolios for companies over the course of time. A notable example is the initiative by the company Rubicon, which has developed a system akin to ELM for managing their carbon credits. They maintain a portfolio of credits, regularly rebalancing it to account for expiration and effectiveness, thereby ensuring their carbon offsets remain valid over time. They then offer a balanced long term share in their portfolio with Rubicon Carbon Tonnes rather than a credit from this project or that project [3]. Of course, oversight is still needed to ensure that they balance their portfolio properly over the years.

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Conclusion

Emissions Liability Management (ELM) represents a significant shift in the approach to carbon accounting and sustainability. By treating carbon credits like assets used to cover liabilities – with expiration dates and risks associated with them, companies can improve their carbon crediting programs and reduce the risk associated with them.

The approach shifts incentives and responsibilities for carbon credits away from carbon registries and towards consumers. In doing so, it encourages higher quality credits, third party insurance mechanisms, and project types and durations that make more sense ecologically and financially to landowners. Thus, ELM offers a forward-looking perspective on carbon accounting, one that could drive meaningful change in corporate environmental strategies and contribute significantly to global climate change mitigation efforts.

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Citations

[1] Marc Roston, Alicia Seiger, & Thomas C. Heller, What’s Next After Carbon Accounting? Emissions Liability Management, Working paper, April 25, 2023 (available at SSRN.com: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4430164).

[2] https://carbonplan.org/blog/buffer-update-three

[3] https://landing.rubiconcarbon.com/intro-to-rubicon-carbon-white-paper

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