Shell's Fake Carbon Credit Scandal Explained!

Europe’s largest oil and gas company Shell was accused in an investigative report from Greenpeace Canada of selling millions of carbon credits tied to CO2 removal that never took place.

Let’s look at what Shell did, how carbon offsets work, and how environmentally beneficial they actually are.

Patrick's Books:
Statistics For The Trading Floor:  https://amzn.to/3eerLA0
Derivatives For The Trading Floor:  https://amzn.to/3cjsyPF
Corporate Finance:  https://amzn.to/3fn3rvC

Patreon Page: https://www.patreon.com/PatrickBoyleOnFinance
Buy Me a Coffee: https://buymeacoffee.com/patrickboyle

Visit our website: www.onfinance.org
Follow Patrick on Twitter Here: https://twitter.com/PatrickEBoyle
Patrick Boyle on YouTube

Out-of-the-box insights from digital leaders
Delivered is your window in the minds of people behind successful digital products.

Listen on: Apple Podcasts   Spotify

Transcript

Europe’s largest oil and gas company Shell was accused in an investigative report from Greenpeace Canada of selling millions of carbon credits tied to CO₂ removal that never took place.

Carbon offsets are tradable certificates linked to projects or activities that lower the amount of CO2 in the atmosphere. Each credit is supposed to represent one ton of Carbon that has been removed. The idea is that by buying these certificates, an individual or a business can fund projects that reduce atmospheric CO2, and they do this to offset their own carbon emissions rather than cutting back themselves. The certificates “offset” the buyer’s CO2 emissions by paying someone else to reduce the amount of CO2 being released. The idea is that the polluter pays, and the cleaner earns.

The idea of offsets emerged in 1989 when Applied Energy Services was building a series of coal-fired power plants around the United States. The CEO was concerned about the environmental damage associated with burning coal and at first came up with the idea of surrounding their largest powerplant with a newly planted forest large enough to absorb the CO2 output that came from generating electricity. 

When the calculations were done, they worked out that they would have to plant over fifty million trees near the powerplant in Connecticut taking up a huge swathe of valuable land, it was decided that a cheaper way of achieving the same goal would be to pay Guatemalan farmers to plant trees instead. There was no real business case for this in 1989. It cost the company two million dollars and was essentially environmental philanthropy.

The idea did make the news though and it really caught on, Time magazine described the forestry project as the “Antidote for a Smokestack”. 

The concept of carbon offsetting meant that polluting businesses based in wealthy countries could either through choice initially and later due to regulation make up for their pollution by paying for green projects in impoverished nations. Tied into this was the idea that it might help impoverished indigenous populations around the world.

Early on, both skeptics and environmentalists questioned whether these projects were environmentally beneficial, or just ways for polluters to make a payment so that people would look the other way.

Forest protection projects like this one are amongst the most difficult projects to assess for quality but they are also amongst the cheapest ways to earn carbon credits.  Carbon Capture And Storage like the project Shell is in trouble for is the most provable in terms of CO2 reduction, but it’s also amongst the most expensive type of project to run, and that is where Shell ran into problems. 

So, let’s look at what Shell did, how carbon offsets work, and how environmentally beneficial they actually are.

I’d like to clarify early on, that I have no qualification, nor do I claim any expertise in environmental science and my opinions on the need for these projects or their effectiveness wouldn’t add much value. Other than relying very heavily on the research of others I’ll mostly be sticking to the topics that I know something about which is the financial side of how the market in carbon offsets works, and the conflicts of interest that exist in those markets.

The Quest Carbon Capture and Storage project is located at the Scotford upgrader near Edmonton, Alberta. It’s operated by Shell Canada and owned by Canadian Natural Resources, Chevron and Shell Canada.

More than half of the world’s oil majors are working on carbon capture and storage projects similar to this or have financially supported them as they argue that this technology offers a way to reduce emissions from sectors like the oil and gas sector that are otherwise pretty much impossible to decarbonize. One of the reasons the oil industry likes this technology is that cleaning up as they go allows for continued expansion of their industry.

Some environmentalists dislike this approach as they argue that direct air capture should only be used to balance out past emissions — not to cancel current or future emissions. As much as you might like that argument, hydrocarbons today make up around 82% of the global energy mix, so a sudden halt in their extraction or use would dramatically affect lifestyles in a way that people appear to be unwilling to accept.

It coats about as much to capture and store CO2 as it costs to extract and process the hydrocarbons that we use for energy and if Oil and Gas companies were to be shut down tomorrow, not only would we lose 82% of our energy but there would be no one willing to pay for this expensive process. It is unlikely that these expensive facilities would be built, if the builders did not benefit from building them.

Now, while each carbon credit is supposed to represent one ton of Carbon dioxide being removed from the atmosphere, The Alberta provincial government in Canada made a deal with Shell allowing them to register and sell carbon credits equivalent to twice the volume of the CO2 extracted at the Quest carbon capture facility between 2015 and 2021. This subsidy was then reduced and finally ended in 2022.  According to Greenpeace, the Quest project sold over $200 million Canadian dollars’ worth of phantom carbon credits over that period.

Greenpeace say that “these phantom credits provide no environmental benefit while enabling Shell and its partners to extract more oil from their oil sands operations because they don’t have to pay the full carbon compliance costs.”

Greenpeace used Freedom of Information legislation to get access to documents that show that Shell requested these multiple credits in 2009 as part of negotiations with the provincial government to increase subsidies for the project.

The International Energy Agency argues that achieving net zero goals would be impossible without Carbon Capture and Storage and that while a number of factors can explain the slow uptake of these projects, high cost is one of the most frequently heard.

The cost of this process ranges from $15- 25 dollars per ton when the CO2 is captured during industrial processes where there are highly concentrated CO2 streams (such as ethanol production or natural gas processing). It is more expensive ranging from $40 - $120 dollars per ton for processes with “dilute” gas streams, such as cement production and power generation. The most expensive method is direct air capture where it costs between 134 dollars and 342 dollars to capture and store a ton of CO2.

There are around 40 commercial facilities in operation today applying carbon capture, utilization and storage to industrial processes according to the IEA. 

Alberta is home to the Canadian oil sands, which is one of the biggest and most carbon-intensive oil deposits in the world. Production there has boomed in recent years. 

At the Quest facility it costs $168 dollars to capture and store each ton of CO2. The facility captures CO2 during the process of making hydrogen gas, which is then used to turn deposits from oil sands into crude oil.  The captured CO2 is compressed to a liquid and piped 65 miles north where it is it is then pumped two kilometers underground into a layer of hard rock in an old well site. The average carbon credit price over the same period for Canadas big industrial emitters was around $50 dollars per ton, meaning that this process was uneconomical without being subsidized. It cost $168 dollars to generate a credit which could be sold for $50 dollars.

Canada has one of the most generous incentive schemes for carbon capture and storage, but even with the subsidies the industry is not really commercially viable.

If the Canadian government wanted this uneconomical facility built, they could have written a big check which costs money. The approach they chose was to register extra carbon credits which Shell could sell, bringing in money to help pay for the facility.  This approach cost the government nothing, but it did mean that the credits being sold did not represent any reduction in atmospheric CO2.

Now, this is by no means the first scandal in the market for carbon credits. A New Yorker article from last year exposed an avoided deforestation project in Zimbabwe calling it “The Great Cash for Carbon Hustle.” 

The New Yorker article profiled a Carbon Credit company called South Pole which reached a private valuation of a billion dollars in 2021 and was described as the first Carbon Unicorn.   

South Pole’s origin story is that its three founders were university students who were invited to a sustainability conference in 2002 to make a presentation on the topic of carbon trading. On a whim, the team decided to ask the conference delegates at the end of their presentation to pay them a fee to offset the emissions from their flights to Costa Rica where the conference was being hosted. The group were shocked when they raised more than ten thousand dollars at the conference and then had to quickly come up with something to do with the money that might reduce co2 emissions. They used the money to pay for the installation of solar heaters at the university where the event had been hosted, replacing a diesel boiler and they estimated that this upgrade would save around seventy tons of CO2 per year going forward.

After that there was no looking back, they set up a website allowing people to calculate their emissions, pay the appropriate penance and receive a laser printed certificate in the post.  They used the money they raised to fund solar projects, hydroelectric projects and to pay subsistence farmers in places like Zimbabwe to protect forests instead of clearing them to graze animals and plant crops.

The problem they found is that while it might be easy enough to pay someone to do something, it’s more complicated to pay someone not to do something as its easier to measure what has been done than to measure what has not been done.  For example, at no point during the making of this this video did I cut down a tree, but no one has paid me for that service.

To quantify how much CO2 one of these forest preservation projects has saved, you need to show that without the project the forest would have been destroyed, and that can be difficult to prove.  A possibly bigger problem is that if you pay for one forest to be protected, but the demand for lumber remains the same, a different forest may be logged, and no CO2 has been saved overall.

An accreditation agency called Verra came up with a process where the project managers had to predict how much of a protected forest would be lost without protection, and thus determine how much carbon the scheme would conserve over a thirty-year life span. Credits would be issued every year against that total, and the prediction would be checked once a decade, by comparing the protected area with an unguarded reference area nearby.

As the carbon credit industry grew, businesses were able to advertise their green credentials. LNG companies were now selling carbon neutral natural gas, Luxury goods companies were announcing that they had offset the CO2 of their supply chains and Porsche advertised that the emissions from ten thousand miles in a Cayenne (the ugliest SUV available at the time) could be erased for as little as sixty-seven dollars. The Qatar World Cup in 2022 claimed to be carbon neutral after excluding the emissions associated with constructing seven air-conditioned stadiums.

According to The New Yorker article, South Pole’s Zimbabwean forest protection project went wrong in a number of ways. 

The first sign of trouble came when Elias Ayrey, a forest-carbon specialist posted a satellite image of the Zimbabwe project on LinkedIn. “I find myself quite upset, today” he wrote. “I just reviewed a carbon project that’s likely receiving more than 30x as many credits as it should.” His image showed that deforestation in the unprotected reference area was significantly lower than the company had stated. He signed off with a disclaimer: “All opinions are my own. And my own opinion is that everyone involved with this project should be arrested.”

On top of the fact that the carbon credits were being overstated, there were also allegations that the money that was supposedly being sent to farmers in Zimbabwe to protect the forests didn’t all make it, as the man in charge of distributing the funds to stakeholders kept no accounts and claims that he handed it out in wads of cash (in the style of a Zimbabwean Mr. Beast).

There is a lot of complexity associated with generating carbon credits which means that even the best intentioned plans can go wrong.  A good example being the Surui Forest Carbon Project which was launched in 2009 by the Paiter-Surui indigenous people of the Brazilian Amazon. It was heralded as the first indigenous-led conservation project financed through the sale of carbon offsets. The project dramatically reduced deforestation within the territory during its first five years of operation and generated almost three hundred thousand carbon offsets, but even early on there were disagreements amongst the tribe over how to distribute the money. In 2015 gold deposits were found on the territory and Paiter members colluded with illegal miners who extracted the gold by digging up massive amounts of soil, used mercury to draw out any gold, then burned the residue to release the gold from the mercury. This is not a clean process… The tribespeople then used the resulting income to purchase cattle and cleared even more forest for pasturelands. In 2016 diamonds were discovered on the territory and needless to say, the project was finally suspended in 2018.

Another promising carbon reduction project that didn’t work out as expected was the Koppal cookstove project in India. Approximately three billion people around the world cook their meals over open fires today. These small fires are extremely inefficient and are responsible for twenty five percent of global black carbon emissions. This is a less studied component of smoke that has negative health effects and is said to contribute to climate change. 

Laboratory studies suggested that providing more efficient, cleaner-burning cook stoves could reduce a family’s fuelwood consumption by up to 67 percent, thereby reducing CO2 emissions, black carbon emissions, household air pollution and deforestation. Additionally, the more fuel efficient stoves would free up the time women and children spent collecting firewood, which might allow more time for education.

The problem is that people who cook over open fires can’t typically afford to buy these more efficient cookstoves, but if this was good for the environment carbon credits could be sold to raise funds to pay for the more efficient cookstoves which could be handed out for free and all of these benefits would be realized.  

As you can imagine, this project which sounds like a great idea got a lot of attention and looked like an easy win.  Unfortunately, when researchers came back and studied household wood consumption after the stoves had been handed out, they found that the households with efficient cookstoves barely reduced their wood consumption at all, and almost no environmental benefit was realized.  This was because households with the new cookstoves continued to light open fires and the cookstove just gave them an additional cooking surface. 

Once again with this project, hundreds of thousands of carbon credits were issued for a project that had no real environmental benefit.

Do you think that the companies who bought those credits are going back and restating their claims about carbon neutrality? Probably not, but who knows.

“The Problem of Social Cost” is a highly influential law review article written in 1960 by Ronald Coase, analyzing the economic problem of externalities.

Externalities are when consumption, production, and investment decisions of individuals, households or firms affect other people who were not directly involved in the transactions. Externalities can be positive or negative, but pollution is the most commonly cited example of a negative externality—a polluter might make decisions based only on the direct cost of and profit opportunity from production without considering the indirect costs to those harmed by the pollution.

The Coase Theorem states that where there are complete, competitive markets with no transaction costs and an efficient set of inputs and outputs, an optimal decision will be selected.

The Coase theorem is considered an important basis for most modern economic analyses of government regulation, especially in the case of externalities, and it has been used to analyze and resolve legal disputes.

Coase came up with this idea when analyzing optimal regulation of radio frequencies. The problem he was trying to solve was how to regulate bandwidth so that competing radio stations would not overlap and interfere with each other’s broadcasts. Regulators were trying to prevent this interference and allocate frequencies efficiently to radio stations. What Coase proposed was that as long as property rights in these frequencies were well defined, it didn’t matter if adjacent radio stations interfered with each other by broadcasting in overlapping frequency bands. Furthermore, it didn’t matter to whom the property rights were granted either. His reasoning was that the station able to reap the higher economic gain from broadcasting would have an incentive to pay the other station not to interfere.

In the absence of transaction costs, both stations would strike a mutually advantageous deal. It wouldn’t matter which station had the initial right to broadcast; eventually, the right to broadcast would end up with the party that was able to put it to the most highly valued use. Of course, the parties themselves would care who was granted the rights initially because this allocation would impact their wealth, but the result of who ended up broadcasting on that frequency would not change because the parties would trade to the outcome that was overall most economically efficient. This counterintuitive insight—that the initial imposition of legal entitlement is irrelevant because the parties will eventually reach the same result—is Coase's invariance thesis.

Coase argued that if we lived in a world without transaction costs, people would bargain with one another to produce the most efficient distribution of resources, regardless of the initial allocation.

Coase's main point, cited when he was awarded the Nobel Prize in 1991, was that transaction costs, can’t be neglected, and therefore, the initial allocation of property rights often matters.

When faced with an externality, the same efficient outcome can be reached without any government intervention as long as: property rights are clearly defined, there are little to no transaction costs; There are a small number of affected parties (as otherwise the transactions costs of organizing them gets to be too great).

Because the assumption of costless negotiation often falls short in the real world and because there are numerous affected parties, the theorem is often not applicable as a real-world solution. Nevertheless, the Coase theorem is an important reminder that, even in the case of complex environmental problems, there may still be room for mutually beneficial compromises.

There are all sorts of projects that can generate carbon credits like planting trees, paying people not to cut trees down, flaring methane that leaks from landfill, plugging orphan oil wells, building electric vehicles, preventing a cow from burping in Canada. People want to encourage these things, but it is tricky accounting for how much environmental benefit each project achieves.

A study covering almost 300 carbon offset projects found that the industry’s top registries have consistently allowed developers to claim far more climate-saving benefits than are justified. If you think of carbon credits as precisely representing one ton of CO2 that has definitely been removed from the atmosphere this is a huge problem. The projects where the benefit is hardest to account for like avoided deforestation are the projects that produce the cheapest carbon credits, and the cheapest carbon credits are the ones that people want to buy.  After all, you are just trying to drive your Porsche Cayenne guilt free, you don’t really want to dig into the details of where the $67 dollars went. 

The European Commission announced earlier this week that they have initiated a probe into 20 airlines for greenwashing. The inquiry scrutinizes the airlines’ environmental claims, particularly those related to carbon emissions offsetting.

The Shell carbon Capture project did generate phantom CO2 reductions if they were permitted to sell twice as many credits as they generated, but the CO2 being captured and stored in that project is at least measurable and provable.  Many of the other types of project possibly earned carbon credits without generating any CO2 reduction.

The problems with the carbon market may just be too difficult to fix, and many critics have stated this from the start.  Some people dislike the idea that these credits can be seen as a license to pollute. Others dislike that the projects are impossible to police. The border problem can be a big issue too.  If one country forces its factories to buy carbon credits to offset their pollution, competitors in a country without that requirement are now suddenly advantaged. Instead of reducing pollution, the regulation just moves jobs and manufacturing offshore.

The New York Times reported in 2012 that when factories in China and India worked out that they could earn more than 11,000 carbon credits per ton for destroying a waste gas normally released in the manufacturing of a refrigerant that has a huge global warming effect, they ramped up the production of that refrigerant just so that they could be paid to destroy its waste product. This was not the intention of the people who came up with these rules.

There are plenty of villains in this story, but there are many more, good, well-meaning people who are trying to solve a problem that they believe is important.  Unfortunately, there are no easy solutions as trying to solve the problem of economic externalities is a thorny prickly problem, where solutions that look good on paper often fail in the real world.

If you are wondering how the Guatemalan tree planting project funded by Applied Energy Services back in 1989 worked out, unfortunately researchers found that it too, mostly failed. There were problems with the types of trees planted, conflicts over the land devoted to forestry which led to food shortages. Some farmers who were denied access to the forest are said to have sabotaged the project too. In the end, the researchers calculated that the program had offset only about ten per cent of the emissions from the coal plant in Connecticut.

Thanks for tuning in to this week’s podcast, if you found it interesting, I’d appreciate if you could send a link to a friend to help the podcast grow.  Have a great week and talk to you again soon, bye.