1 September 2022
This article, the third in our carbon risk factor series, explores leakage. The BeZero Carbon Ratings team unpack the critical components of leakage assessments and the different parameters to consider for different sector groups. They draw on BeZero’s database of over 250 carbon credit projects to explain how leakage risks affect carbon credit performance.
Leakage is the risk that the carbon avoided or removed by a project is pushed beyond its boundaries, thereby undermining the degree of carbon efficacy. The two sources of leakage are market leakage and activity displacement.
BeZero assesses leakage by interrogating the extent of possible risks, including those associated with activity within and around a project area, as well as any safeguards put in place to mitigate such risks.
We find that Nature-Based Solutions (NBS) projects generally hold higher risks of leakage than those under non-NBS.
What is leakage?
Leakage is “the risk that emissions avoided or removed by a project are pushed outside the project boundary”. The sources of such emissions vary from sector to sector, however, they can be broadly categorised into two: market leakage and activity displacement.
Market leakage occurs when a project’s activities alter the supply and demand equilibrium, shifting market dynamics such that emissions avoided or removed by a project are offset by market activities elsewhere. Meanwhile, activity displacement refers to a specific emitting activity being displaced more locally.
Taking Improved Forest Management (IFM) as an example, these projects increase carbon stocks by enforcing a more conservative harvest than the modelled baseline scenario. This results in a reduced supply of timber, demand for which needs to be met from elsewhere. When that demand is met from other sources in proximity to the project, this is called activity displacement. Where reduced supply is met from the wider market, this is defined as market leakage.
Both market leakage and activity displacement are unintended consequences which can undermine the carbon benefits of a project. It is vital that project developers anticipate, monitor and mitigate risks to ensure that each credit delivers a full tonne of CO₂e avoided or removed.
The importance of leakage in determining carbon credit quality is reflected by it receiving the third-highest weighting within the BeZero Carbon Ratings (BCR) framework, alongside non-permanence.
This piece discusses the key factors which determine leakage risks across the Voluntary Carbon Market (VCM), including its components and possible safeguards, and how they vary across sectors. It then explores how these considerations relate to the BCR, through examples drawn from more than 250 projects currently rated.
Key factors when assessing Leakage risks
To break down our assessment of leakage risks and safeguards, we lay out the primary considerations and how these differ between sectors.
1. Components and safeguards: NBS
NBS projects are exposed to both market leakage and activity displacement. Market leakage can emanate, for example, from national or global demand for timber supplies. If a project’s activities raise the supply of a certain type of timber in an area where demand is relatively low, such as through the establishment of sustainable plantations, leakage may arise in the form of export emissions.
Meanwhile, an example of activity displacement can occur when an Afforestation, Reforestation & Restoration (ARR) project is in an area historically used for cattle grazing, an agricultural practice associated with methane emissions. This can lead to such activities being displaced beyond the project’s boundary, thus introducing leakage risks.
It is also important to note that positive leakage can occur, such as when a project’s activities lead to a growth in carbon stocks beyond its boundaries. An example of this is when the management of sustainable woodlots leads to continued growth of carbon stocks outside of a project, acting to mitigate negative leakage.
There is variation in how projects account for leakage, if at all. If risks are deemed to be negligible, leakage is assumed to be zero. Chart 1 highlights such disparities within NBS sub-sectors.
In line with the BCR framework, we consider risks arising from both a top-down and bottom-up perspective. For the former, this involves consideration of global and national data on parameters such as timber supply and demand. The latter pertains to the interrogation of project-specific information on factors, such as historic land-use in the area.
This hybrid approach ensures as broad a range of sources as possible of potential leakage risks are considered and accounted for in the rating.
Once potential leakage sources are identified, we interrogate any safeguards employed by the project. Possible safeguards include leakage belts, dedication of leakage allocations and the development of alternative livelihoods, among others.
Within Avoided Deforestation projects, a key consideration is the appropriateness of the employed leakage belt. A leakage belt is a parcel of land surrounding or adjacent to a project area which is supposed to represent an area at risk of activity displacement and resulting emissions in the region, and makes up one component of issuance calculations for relevant projects. The suitability of a leakage belt is contingent on whether it accounts for accurate drivers and rates of deforestation.
Another key safeguard within NBS projects is the use of a discount factor to mitigate risks of market leakage. A discount factor is applied to the net emission reductions achieved by the project annually, or to a portion of such reductions in the case of IFM projects. Its degree of suitability can be inferred by comparing the employed value to other estimates of leakage rates in a project’s region, whether our own in-house estimates or those from peer-reviewed literature. One example of our internal databases is for Chinese IFM projects under VCS, for which we go beyond single project requirements to assess national-level leakage risks for projects attached to this single registry.
2. Components and safeguards: Non-NBS
In general, non-NBS projects typically face negligible risks of activity displacement. This is because upstream emissions associated with infrastructure acquisition and construction for such projects tend to be small relative to the carbon savings over the project lifetime.
Cookstove projects are the exception, with risks of displacement from the high-emission stoves being replaced. The introduction of more efficient cookstoves can result in increases in the consumption of non-renewable biomass beyond a project’s boundary, if the traditional stoves which were displaced are then re-used.
Assessments of leakage for non-NBS projects are based primarily on the incidence of market leakage. For example, renewable energy projects often assume leakage to be zero. However in regions with high renewables penetration, growing use of renewable energy can result in lower fossil fuel prices as demand drops for traditional energy inputs. This may lead to project leakage at a country level if lower prices for fossil fuels stimulate demand in other energy-intensive sectors, e.g. transport. This is known as the rebound effect.
As for safeguards, non-NBS projects can also apply discount factors. Similarly to NBS projects, assessing the appropriateness of such measures requires the applied value to be corroborated with top-down values which are indicative of the degree of risk. For example, monitoring of cookstove usage rates can also be conducted to gauge the extent of high-emitting stoves being displaced as previously described, with the adopted approach also interrogated as part of our analysis.
Leakage requirements across the VCM
The VCM’s major registries typically determine accounting requirements for leakage at a methodological level, with similarities and variation across different accreditors.
For example, for many cookstove projects, both Verified Carbon Standard (VCS) and Gold Standard (GS) require the use of a 0.95 discount factor to emissions reduction calculations. This means that for every 100 tonnes avoided by the introduction of improved cookstoves, the discounting applied in the project’s carbon accounting leads to 95 credits issued.
Disclosures around leakage requirements for American Carbon Registry (ACR) and Climate Action Reserve (CAR) are less transparent. The former notes how project developers must account for certain types of leakage according to methodological requirements, while the latter does not require explicit accounting for leakage emissions.
Mapping Leakage in the BCR universe
Across the VCM, the degree of leakage risk depends on the likelihood of market leakage and activity displacement occurring, as well as the suitability of employed safeguards. We reflect the varying degrees of risk using the following language, from highest risk to lowest risk: significant risk, notable risk, some risk and little risk.
A key insight from our universe of rated projects is that NBS projects typically hold higher leakage risks than non-NBS initiatives, with the exception of Household Devices.
We find NBS projects’ leakage risks arise from a variety of sources across both market dynamics and activity displacement. Comparatively, many non-NBS projects largely face minimal leakage risks from activity displacement.
We also find:
The sector groups with the lowest leakage risks are Industrial Processes, Tech Solutions and Waste. This is because 75% of projects within these sector groups are deemed to have some or little risk.
Projects within Household Devices and NBS hold the highest risks, a large proportion of projects in these sector groups hold either significant or notable risks, at 36% and 25% respectively.
For Household Devices, this is likely due to the likelihood of traditional cookstoves being re-used beyond a project’s boundary. Meanwhile, NBS projects are exposed to both types of leakage and variations in the application of leakage belts, as well as in how deforestation is tracked and accounted for.
In general, non-NBS projects face the lowest risks. This is likely due to the largely negligible risks of activity displacement associated with such projects, while market leakage is only likely to occur in areas with high penetration of a project’s employed technology. This is consistent with many non-NBS projects assuming leakage to be zero.