Should I offset or should I plough? Voluntary carbon offsets and ETS in an evolutionary model

Companies with high emissions can offset their climate impact by participating in emission reduction projects through voluntary carbon markets (VCMs) in several countries. Firms that generate these offsets and provide them to polluting companies dedicate a portion of their activities to carbon sequestration in exchange for compensation. This emitter–absorber interaction has unclear environmental and economic implications, especially within the same jurisdiction of a compliance carbon market (CCM), such as the Emissions Trading System. The impact of stringent climate policies on competitiveness is debated, and their effects on VCMs remain unknown. This study presents an evolutionary model that explains how carbon leakage (CL), the preference to relocate industrial activities to jurisdictions without mandatory permit requirements, can influence VCMs diffusion in a jurisdiction already implementing CCM. We compared the structural changes in offset suppliers resulting from the substitutability of emission absorption and mainstream business models in two cases: (i) non-negative switching costs and (ii) zero switching costs. The results indicate that, while firms might be willing to participate in VCM, CL reduces the incentive to do so and, therefore, the demand for offsets. However, the welfare performance and competitive outcome of both sides of the VCM improve when offset practices are combined with agricultural activities, particularly when the government introduces barriers to firms’ exit or limits the availability of offsets.