What are compensation credits and why are they so controversial?

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The Scholven hard coal power station in Gelsenkirchen, Germany

Corporations whose business models require the exploitation and destruction of nature are increasingly marketing products as carbon-neutral and deforestation-free. This is made possible by the concept of “compensation instead of reduction”. How does it work?

“Compensation instead of reduction” is becoming increasingly popular in international environmental protection: A company may legally exceed a limit – for example for the emission of greenhouse gases – if it documents that it ensured an additional reduction of emissions elsewhere. Tradable compensation credits provide such evidence. Trade in compensation credits cannot prevent the destruction of primary forest or the increase of greenhouse gases in the atmosphere, however. The alleged mitigation of emissions or prevention of deforestation in one location permits the exploitation of resources or emissions exceeding limits established by law or social norms in another. At best, this is a zero-sum game. In addition, it is not possible to verify whether the allegedly mitigated greenhouse gases would have in fact been emitted, or whether the destruction of nature would indeed have occurred without the compensation project. Since compensation credits allow additional emissions or destruction, the result of the trading of compensation credits is frequently more, but never less destruction or pollution than would have occurred without the trading.

The Kyoto Protocol, the United Nations convention to reduce greenhouse gases that was signed in 1997 and came into effect in 2005, provided the idea for trade with compensation credits. It sets targets for reducing greenhouse gas emissions in industrialized countries, while at the same time allowing them to buy their way out of their mitigation obligations at home. Emissions trading, including but not limited to trading in carbon offsets or carbon credits, is the instrument of choice here. The purchase of such carbon credits permits corporations to legally exceed the limit for the emission of greenhouse gases established in the Kyoto Protocol for factories, refineries and other industrial plants in industrialized countries, if they document the additional mitigation of such emissions elsewhere.

Compensation credits for biodiversity let buyers assert that the damage they caused has been offset elsewhere. The damage – the destruction of biological diversity – exceeds applicable limits here as well. In the case of compensation credits for the loss of biodiversity, such limits can be the prohibition of mining in protected areas or particularly biodiverse forests; they can also arise from social norms, for example in the case of food companies promising to manufacture their products without deforestation. Compensation credits for loss of biodiversity facilitate the expansion of mining in protected areas, or the clearing of biodiverse forests for oil palm and soy plantations and industrial cattle farming. Corporations market the products of this exploitation as “deforestation-free”, “carbon-neutral” or as mining with a “net positive impact” on biodiversity.

How does the trade with compensation credits work? 

A compensation credit permits pollution or the destruction of nature in excess of a set limit. This additional pollution or destruction must be offset through a compensation project. The project must demonstrate that it is preserving a habitat that otherwise would not have been protected, or that emissions that would otherwise have been released were prevented. If, however, the protection or restoration measures had already been planned, then no additional habitat will have been preserved or restored.

The additional damage thus has not been offset. If an emissions reduction would had been realized even without a compensation project, then the savings are not additional, even though the credit offered by the compensation project permits additional emissions of fossil carbon (coal, oil, natural gas). The result is then not a net-zero, but an increase in greenhouse gas emissions or destruction of nature exceeding the agreed limits.

Cheat Neutral. A 5-minute video that illustrates the conceptual contradictions of compensation credit.

To avoid such a result, compensation projects are supposed to provide extensive external audits and documentation showing that without the project, emissions would have been released or destruction would have taken place unmitigated, and that the credits thus truly represent reduced emissions or forest protection. The problem here is that the assertion that emissions would not have been mitigated or forest would not have been preserved without the existence of a compensation project ultimately cannot be verified. Yet behind every compensation credit, there lies the assumption that precisely that additionality is evident and has been verified by independent auditors.

How does a compensation project calculate the volume of marketable credits?

When grain, oil, cotton or real estate is traded, buyers or speculators know that somewhere, a certain quantity of that product physically exists (or will exist) in a precisely defined quality, either in a warehouse, on a field, in an oil tanker or as land. The object being traded is not necessarily the product itself, but a placeholder that represents a well-defined quantity and quality of the traded items. Placeholders are also bought and sold in compensation credit trading.

In at least one aspect, however, trading in compensation credits differs fundamentally from trading in commodities. Compensation credits represent the promise to preserve a specific habitat or a particular ecosystem function (carbon storage, water filtration). This habitat or function is assumed to be in danger and the vendors of the credit promise to refrain from supposedly planned habitat destruction or the release of emissions. The compensation credit thus stands for this absence of (destructive) activity.

However, the absence of the activity always remains hypothetical, because the compensation project prevents that activity that would have destroyed the forest or released greenhouse gas emissions. Compensation projects, be they intended to mitigate greenhouse gas emissions or offset biodiversity loss, thus always calculate the volume of marketable credits in relation to a hypothetical threat: X hectares of forest would have been destroyed (by local use), had it not been for the compensation project. The number of credits that can be marketed by a compensation project for forest biodiversity reflects the difference between the forest area that (hypothetically) would have been destroyed and the area currently protected by the compensation project.

Depending on the quality and comparability of the assumed additionally protected area to the actually destroyed area, buyers then calculate the number of credits needed to offset an act of destruction that exceeds a regulatory limit. Viewed objectively, buyers of compensation credits are paying for a good story rather than a verifiable additional restoration, the protection of habitat, or for emission reductions.

This calculation method also has the effect of generating more credits, the greater the described hypothetical future destruction or pollution would have been without the project.

Compensation credits are controversial

Numerous civil society groups and social movements, especially in the global South, reject compensation credit trading. The arguments for their position are wide-ranging and reflect the negative social, environmental and economic impacts of compensation projects that frequently affect the disadvantaged particularly severely. They also criticize the unfounded assumption underlying the principle of compensation credit trading – that an additional mitigation or protective measure can be verified.

For the most widespread application of compensation credits to date, the trade in carbon credits, their rejection is based on the following arguments:

  • Trade with carbon credits does not reduce emissions, it merely moves them. The additional emissions mitigation offered by the compensation project financed through the sale of such credits permits the release of fossil carbon exceeding legal or moral limits elsewhere. Ultimately, net-zero is the best possible result that can be attained with carbon credits.
  • The additionality of emissions reduction that the carbon credit represents is unverifiable, because in the case of compensation projects, the calculation is based on the comparison of the project’s current emissions with a hypothetical reference scenario. All projects that market carbon credits are faced with the dilemma of not only reviewing and confirming the accuracy of a forecast, but also quantifying it down to the precise ton of carbon dioxide. To be determined is the volume of potential emissions that would have been released, had it not been for the compensation project. In a second calculation, the level of emissions taking the compensation project into account is established. The difference between the two figures is the number of tons of greenhouse gas emissions that are supposedly prevented by the compensation project, which in turn determines the volume of carbon credits that the compensation project can issue.  Hypothetical scenarios by definition cannot be verified, however, and the projected volume of greenhouse gas emissions without the project cannot be verified due to the very existence of the project.  A consequence of this underlying assumption that non-existing values can in fact be verified is that the emissions scenarios of many compensation projects state very high hypothetical emissions so as to maximize the volume of credits that the project can issue. Scientific studies on the credibility of REDD+ projects therefore increasingly describe compensation credits from REDD+ projects as “virtual reductions”, i.e. as carbon credits that are not founded on an actual (additional) mitigation of emissions.
  • Since the additionality of an emissions reduction cannot be verified, yet carbon credits are used to justify emissions exceeding a set limit, carbon trading schemes probably contribute to a further increase in the concentration of greenhouse gases in the atmosphere.
  • The dilemma that carbon credits are based on a calculation that assumes that hypothetical emissions are verifiable weighs especially heavily on projects that market carbon credits related to land use. Factors that influence future land use are wider-ranging and more variable – making forecasts even more speculative – than in other areas.
  • Trading emission credits is fundamentally unfair because those who are least to blame for the problem of global warming are required to reduce emissions further so that the biggest polluters can continue using more than their fair share of natural resources – in the case of carbon credits, fossil fuels.
  • Injustices and inherent shortcomings are exacerbated in the implementation: Up to 75% of traded carbon credits from CDM projects demonstrably do not represent an additional reduction of emissions. A variety of projects, especially those that offer carbon credits from REDD+ and land use projects, are responsible for human rights abuses and the displacement of families that have usage rights but no formal titles to their land. Many of these controversial projects were awarded labels by various certification standards despite the documented conflicts.

This article is part of our dossier "New Economy of Nature".

Further reading:

  1. Kill, J. (2015): Economic Valuation and Payment for Environmental Services. Recognizing Nature’s Value or Pricing Nature's Destruction? Heinrich Böll Foundation e-paper.
  2. FERN (2010): Trading carbon: how it works and why it is controversial.
  3. Altvater, E. und A.Brunnengräber (Ed.) (2006): Ablasshandel gegen Klimawandel? Marktbasierte Instrumente in der globalen Klimapolitik und ihre Alternativen. VSA-Verlag.
  4. Louise Carver (2015): Measuring the value of what? An ethnographic account of the transformation of ‛Nature’ under the DEFRA biodiversity offsetting metric. LCSV Working Paper Series No. 11. Leverhulme Centre for the Study of Value.
  5. Climate Neutral offsetting spoof website. The site features a promotional video, a fake CO2 calculator and a presentation of real compensation projects that offer carbon credits.
  6. Cheat Neutral. A 5-minute video that illustrates the conceptual contradictions of compensation credit.