8 minute read
Derisking offsetting
offsetting Derisking
Since the Paris Agreement in 2015, 192 countries and the European Union have signed up to the fight against climate change – aiming to reduce carbon emissions and limit the global temperature increase to below two degrees Celsius this century. In effect, that means the world must reach net zero emissions by 2050.
And yet, 2021 saw the amount of CO2 emissions rise to an historic high of 36.3 billion tonnes – a year-on-year increase of six per cent, according to the International Energy Agency. The main culprit was coal, and that was despite renewable energy generation recording its largest ever output.
Do we despair? No. We offset… in the short-term at least.
Offsetting is seen by some as a get-out-of-jail card for big polluters and by others as a pragmatic solution to avoid choking the planet before Millennials are old enough to claim their pensions. But, whatever the merits, the result has been to turn carbon into a commodity to be traded.
So-called ‘cap-and-trade’ compliance carbon markets, such as the EU Emissions Trading System, are based on government-issued and regulated pollution permits or certified emissions reductions (CER) certificates. Regressive by design, the theory is that companies are incentivised to reduce their emissions in line with a declining carbon cap or be forced to buy expensive additional credits; if they reduce their emissions faster than the permits allow, they can sell that extra capacity to others who need it.
But many companies who don’t fall under mandatory schemes are being driven by stakeholders to make voluntary progress towards net zero. And a shortcut to that is by using the parallel voluntary carbon credits (VCC) market, which allows them to net off their CO2 emissions by investing in projects that contribute to climate goals.
An entirely new cohort of providers has grown up to service that need, such as Native Energies’ Help Build™ Carbon Offsets, which is the offsetting scheme of choice for many big players, including eBay and Ben & Jerry’s.
In the VCC marketplace, businesses of all sizes can buy credits that each represent a certified metric tonne of removed,
With still so much uncertainty surrounding the trade in voluntary reduced or avoided CO2 or greenhouse carbon credits, Natalia Dorfman, Co-founder and CEO of startup gas (GHG) equivalent, Kita, believes insurance could be key to reaching net zero thereby, in theory, generating huge amounts of investment for the carbon-reducing technology and projects that are selling the credits to them. A COMPLEX CARBON MARKET Carbon offsetting has increased exponentially in the last five years. More than $1billion worth of carbon offsets were sold in 2021. The volume of credits required globally is expected to multiply 20-fold by 2035, or even higher if practices align with the goals set out by the Paris Agreement. But the challenges for the VCC market are extensive, not just in balancing supply and demand but also in determining the quality of the credits traded. “The carbon markets are a complicated space,” says Natalia Dorfman, co-founder and CEO of Kita, a carbon insurance company. “The voluntary carbon markets are still new and evolving. There are challenges around lack of transparency and consistent risk management, and there are a lot of different types of carbon credits one can purchase. “Given this lack of consistent metrics, it is difficult for a buyer of carbon credits to assess quality.”
For the world to meet its climate change goal, the Taskforce for Scaling Voluntary Carbon Markets (TSVCM) estimates that the availability of voluntary carbon credits will have to increase 15-fold by 2030. And due to the shortage of carbon credits being issued, purchasers may resort to pre-buying credits where carbon offsets are promised, but not guaranteed.
“There is a real supply shortage of carbon removal credits, and buyers are increasingly needing to pre-finance projects. So you’re paying for carbon credits before a tonne of carbon is removed from the atmosphere and stored away. And it is only at that point where it is removed and stored away, and verified as such, that you can use the credit,” explains Dorfman.
Such an approach carries a high level of risk for the investor, which could act as a disincentive for companies to engage with the market. And it’s that deficit of confidence that startup Kita seeks to address because insurance products built around these risks make it safer for investors to trade. “Kita’s vision is to develop a portfolio of insurance products for the carbon removal space, because we see the need for insurance to de-risk and enable all the different parties in the chain, from the people developing the projects to the intermediaries trading, to the buyers. This will help the market scale to the levels the world needs,” says Dorfman.
THE CHALLENGE FOR STARTUPS
Before founding Kita, Dorfman spent eight years at the insurance-focussed law firm Clyde & Co, where she helped to start and then led business development and strategy for the firm’s climate risk practice.
But it was when she became involved in Carbon 13, a venture-building ecosystem of academics, entrepreneurs and researchers operating out of Cambridge, UK, that she clearly identified the challenges that carbon removal startups were inevitably going to face without the agency of insurance.
“I saw that these climate tech solutions were going to struggle to access insurance because they were dealing in new technology, new risk, and a new market. If you can’t access insurance, at some point you’re going to be blocked from scaling because you aren't going to be able to access the forms of capital you need.”
It was at Carbon 13 that Dorfman also met her future Kita co-founders, CTO Paul Young and CPO Thomas Merriman. Young has spent more than 24 years in hedge funds, and previously co-founded an AI company, Sybenetix, which was acquired by Nasdaq. Merriman has a fintech product development background and was head of product at Nasdaq for its buy-side compliance platform. With their respective views and expertise in the voluntary carbon market, the three decided to build an insurance company that would help climate removal solutions scale faster.
While still a developing market, there are some clear areas where insurability is an obvious need. SwissRe’s 2021 report, The Insurance Rationale For Carbon Removal Solutions explained how insurance can be useful for risk management, long-term
investment, and buyers of green products and services to stimulate the market. Insurance could act as a partner to businesses in the VCC market to build further regulation and standards of integrity.
The real ambiguity of the market, and where insurance has yet to have an impact, is in its pricing. The report points out how there is not enough loss history or performance data for insurers to calculate credible loss expectations.
Kita will be working on a whole suite of insurance solutions to tackle the many issues in the market, but its first offering will focus primarily on the needs of the credit buyer.
“What we insure is under-delivery,” says Dorfman. “Our assessment of under-delivery risk spans past performance, technical risk, location, and the carbon standard invalidation risk.
“Given that there is not a huge amount of historical data on under-delivery risk in this market, we have certain proxies that we use, and we’re also looking at it from a relative risk basis. It's an assessment of what would make a project a higher delivery risk than another project, helping with the directing of that pre-finance.
“Kita is taking an educated guess that via providing insurance to this market, insurance will be an enabler to help the market grow faster. And through being an early-mover in that market, Kita will gain the market share and the knowledge to be able to build out our portfolio of products to become the significant insurance company we plan to be by the end of the decade,” says Dorfman.
In July, Kita completed its work in Lloyd’s Lab during the Cohort 8 programme, which focussed on decarbonisation and climate change.
“Lloyd’s Lab was fantastic. We were fortunate to go through the lab at a formative stage in our process,” says Dorfman. “We had amazing mentors, and we learned a lot about the insurance industry, particularly how the structure of Lloyd's works. We went in with two insurance products, and our mentors helped direct our thinking as to which of those products would be best to get to market faster. Given that we want to become a managing general agent (MGA), we want to work with the larger insurance companies and we need to understand their risk appetite.
“Right now, we’re working with one of those mentors as our lead capacity provider. And so the lab gave us everything we needed in terms of knowledge, connections, and an accelerated route to getting our first product to market.”
Its launch in January 2023 is the company's main goal for the present. For the rest of next year, Kita will be focussed on scaling that initial product and growing its operational structure to facilitate the offering. Over the next 24 months, the company hopes to expand its distribution strategy, moving beyond direct-to-clients, to an embedded channel in the carbon removal marketplace.
In the weeks leading up to COP 27 in November 2022, climate tech startups accumulated around $19billion in funding, 21 per cent less than last year's mid-year funding of $23million.
Standardisation is needed to secure confidence in these solutions and Dorfman passionately believes that insurance of carbon credits is one way to convince businesses to engage by giving them that confidence in their offsetting goals.
