The Time Value of Carbon

I've had this idea bouncing around in my head for a while, that we need to implement something like a Time Value of Carbon (TVC).

In economics and finance, we're accustomed to considering the Time Value of Money (TVM). This is the idea that a sum of money today is worth more than a sum of money in the future, based on the earning potential of a sum of money today that can deliver compounded returns into the future. It is why developers and financiers calculate the Net Present Value (NPV) of an investment that has a high up-front cost but is expected to deliver returns far into the future. A longer time horizon to reach profitability results in a lower NPV. Renewables are challenged in this regard because there may be other investments that could deliver positive cash flow much sooner, and the longer the development timeline, the higher the expected returns must be to overcome this hurdle.

Time Value of Carbon (TVC) reflects the same concept in terms of emissions reduction. A ton of CO2 avoided today is worth more to the prevention of catastrophic global warming than a ton of CO2 avoided ten years from now. There are several reasons for that, the most important being the precarity of positive feedback loops and tipping points that abound in the global climate system. Loss of polar ice speeds up warming as the darker water and land absorbs more of the sun's energy, for example. Every square meter of polar ice lost contributes to a reduction in our planetary albedo, the reflective capability to bounce the sun's energy back toward space.

Time Value of Carbon for Carbon Offsets and Emissions Disclosure

Carbon offset markets have been rocked by controversy in the past several years, thanks in large part to the fraudulent scheme perpetrated by the world's largest carbon offset provider, as revealed by this New Yorker piece. A growing U.S. backlash against environmental, social, and governance (ESG) metrics for investing, and carbon reduction pledge reversals from major corporations like Shell have further contributed to a growing sense that today's capitalism is not fit for purpose to meet the climate challenge. We highlight this trend as part of the Trust and Verification macro-theme in our 2024 report, Macro Meets Micro: Deciphering Renewable Energy Trends in 2024.

The ongoing roll-out of new standardized sustainability reporting for investors might help. According to the IFRS Foundation, their International Sustainability Standards Board's disclosure standards are poised to be implemented in markets representing over half of global GDP and carbon emissions.  In the absence of binding legal requirements, it will be up to investors to hold companies accountable for taking meaningful and timely action. Even climate-forward companies like Microsoft are struggling to meet their near-term goals because of growing computing demand from AI development, and they're full of excuses for the shortfall. Bloomberg's Zero podcast weighs the pros and cons of delayed carbon reduction with the potential innovative value of AI technology in this recent episode. Another Bloomberg podcast, Switched On, has a great episode that breaks down the nuances between all the different reporting standards and how their implementation will impact carbon emissions disclosure.

What we really need to do is incorporate a Time Value of Carbon into carbon offset markets and climate disclosure reporting. We should evaluate the timing and duration of an offset or emissions reduction action - is it durable or temporary? How long does it take to remove a certain amount of carbon, and how long is it kept out of the carbon cycle? Are we assigning an appropriate value to the reduction or offset of carbon equivalents, like methane, which have a different warming effect and natural cycle than carbon?

Turns out, this is not an original idea. The more I thought about it, the more I was certain that some smart academics and subject matter experts had already put in the work to outline how this should work. The Carbon Leadership Forum has a page of their website dedicated to their white paper on the Time Value of Carbon, while Generation Investment Management makes the case for how investors should weight the importance of TVC in their investment decisions. Academics continue to dive into the nuances of carbon storage in papers like this one, published in 2022 and cited by 22 others.

This piece from the Financial Times seeks to find comfort in all the corporate backsliding we've been seeing, by pointing out that some of the 239 companies who failed to submit their net zero plans to the Science Based Targets Initiative (SBTi) are focusing on 2030 goals instead of 2050. Success on these near-term goals would be reassuring, if only there was any mechanism for punishing failure beyond the continued, slow simmer of a warming planet approaching a rapid boil.