Carbon Offset Credits: Caveat Emptor

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With the public's growing interest in climate change, even companies not covered by Kyoto are jumping on the green bandwagon. British banks such as Barclays (BCS) and HSBC (HBC) already have become "carbon neutral" by reducing their own emissions and buying credits to cover whatever they can't cut. And airlines such as British Airways (BAY.L) and Virgin Atlantic now offer fliers the chance to offset carbon emissions by buying credits via the airlines' Web sites.

Britain has seen the emergence of a new class of carbon intermediaries, such as Oxford-based Climate Care and London-based CarbonNeutral. These firms invest in carbon-reducing projects, mainly in emerging economies, that range from tree-planting to wind farms to outfitting African farmers with energy-efficient stoves. The ensuing carbon credits are then sold to companies and individuals seeking to reduce their carbon footprints. All told, the number of such firms in Britain has grown from about 15 in 2003 to almost 120 this year.

Possible Backfire

There's a similar move across the Atlantic, where companies such as PricewaterhouseCoopers and Dell (DELL) have moved to offset their global emissions. In June, Delta Air Lines (DAL) started offering voluntary carbon offsets to passengers. A crop of carbon middlemen, such as TerraPass in Menlo Park, Calif., also is springing up in the U.S. to channel funds from companies and consumers into green projects. TerraPass says it has already processed 80,000 carbon offset requests this year, compared with a quarter that number at the same time in 2006.

But the rapid expansion in the unregulated voluntary market has caused some companies to worry about investing projects that don't pan out—and the potential for ensuing negative publicity. "People need to step very carefully when they enter this sector," says James Wilde, director of Insights at the Carbon Trust in Britain, a government-funded program that raises awareness of green issues in the business community. "If they don't take precautions, offsetting could be more of a risk than a gain."

The type of offsetting program also matters for consumers looking to do their part for the environment. According to a report by French savings and loan association Caisse des Depots, more than one-third of offsets in the voluntary sector during 2006 came from forestry projects. Each tree planted, however, must survive 100 years to offset an individual's emissions, which makes monitoring the impact of reforestation extremely difficult, according to the Edinburgh Center for Carbon Management.

That's one reason CarbonNeutral has cut the percentage of forestry projects in its portfolio to less than 10%. Instead, the firm has turned its sights to renewable energy and energy-efficiency programs, and employs auditor KPMG to ensure its projects truly reduce emissions.

Cost and Price Disparities

Another troubling issue for consumers is the widely varying price of offset credits—and their often high markup. The Katoomba Group reckons the average price of carbon in the voluntary market for 2006 was $4.10 per metric ton of CO2 equivalent. By comparison, Climate Care charges individuals $24 to offset the emissions for a flight between New York and London—the equivalent of $15.51 per metric ton, or nearly four times as much.

Climate Care concedes the difference, but says that built into its business model is a significant "risk premium" to cover the cost of offset projects that may never get off the ground. "A lot of money has to go back into project development," says spokesman Michael Buick, who notes that Climate Care also uses a third party to inspect its carbon portfolio, which must meet the standards set by the International Emissions Trading Assn., the Climate Group, and the World Economic Forum. According to Buick, 90% of the money channeled through Climate Care goes into the projects it funds and to running the organization, while only 10% is retained as profits.

That's a far better ratio than normal. Industry analysts believe on average only 55% to 65% of the money spent on offsetting goes to carbon projects. The remaining 35% to 45%, sources say, goes into everything from administrative costs to corruption.

The new industry guidelines should help improve the credibility of carbon offsetting intermediaries and the programs they offer consumers. Clearer rules also should improve the effectiveness of carbon-reduction and compensation programs around the world.

"The industry has exploded in just a few years," says Buick. "It's an issue of the industry being clear on what the regulation should be."

Scott is a reporter in BusinessWeek's London bureau .