Carbon Credits Basics

Carbon Credits Basics

Global climate change has made one thing clear: we must drastically cut greenhouse gas emissions to prevent catastrophic warming. The 2015 Paris Agreement set a critical target to limit global warming to well below 2°C, with an aspirational goal of keeping it within 1.5°C above pre-industrial levels. Achieving this requires nations, industries, and individuals to reach net zero emissions—where the amount of greenhouse gases emitted is balanced by the amount removed from the atmosphere. To date, 130 countries have committed to achieving net-zero emissions by 2050.

Reaching net zero demands significant emission reductions through technological innovation, shifts in consumer behavior, and the adoption of sustainable business practices. However, some sectors will face persistent challenges in fully eliminating their emissions. Industries such as aviation, heavy manufacturing, and construction may not yet have viable alternatives to completely eliminate their carbon footprints.

This is where carbon credits play a crucial role. The IPCC estimates that to avoid surpassing 1.5°C of warming, 6 to 10 gigatonnes (Gt) of carbon dioxide removal will be needed annually by 2050, with over 1 Gt required per year by 2030. The voluntary carbon market is instrumental in scaling these carbon dioxide solutions.

Carbon credits allow companies and individuals to offset their unavoidable emissions by investing in projects that reduce, remove, or prevent emissions elsewhere. By purchasing these credits, they can balance their remaining emissions and progress toward carbon neutrality.

But how exactly do carbon credits work? What distinguishes carbon credits from carbon allowances? And how are they generated? This blog will dive into the fundamentals of carbon credits, their role in achieving carbon neutrality, and why they are essential for the future of climate action.

Contents:

1. The Role of Carbon Credits to Achieve Carbon Neutrality
2. Carbon Allowances vs Carbon Offsets
   2.1 Carbon Allowances
   2.2 Carbon Offsets (Carbon Credits)
3. Compliance vs Voluntary Carbon Market
   3.1 Compliance Carbon Market
   3.2 Voluntary Carbon Market
4. How Do Climate Projects Generate Carbon Credits?
   4.1 Carbon Avoidance
   4.2 Carbon Removal
5. The Carbon Credit Lifecycle in the VCM
6. High-Quality Carbon Credits
   6.1 Additionality
   6.2 Verifiability
   6.3 Immediacy
   6.4 Durability/Permanence
   6.5 Leakage
   6.6 Co-benefits
7. Why Companies Buy Carbon Credits
8. Conclusion and The Future of Carbon Credits

1. The Role of Carbon Credits to Achieve Carbon Neutrality

Carbon credits are integral to achieving carbon neutrality. Each credit represents a reduction of one ton of carbon dioxide or its equivalent in other greenhouse gases (CO₂e) from the atmosphere.

For companies aiming for carbon neutrality, carbon credits offer a solution for emissions that cannot be eliminated through direct action. For example, a company might reduce its emissions by adopting renewable energy but still generate unavoidable emissions from manufacturing processes. By purchasing carbon credits from projects that offset emissions elsewhere, the company can balance its carbon footprint.

While carbon credits help companies achieve carbon neutrality, they are not a license to continue polluting. Companies must prioritize direct emissions reductions within their operations and supply chains. Carbon credits should be used as a complementary strategy to offset emissions that cannot be eliminated in the near term.

Carbon credits are issued, monitored, and verified according to stringent, internationally recognized standards, allowing businesses to compensate for their unavoidable emissions reliably and transparently.

2. Carbon Allowances vs Carbon Offsets

The terms carbon allowances and carbon offsets are often used interchangeably, but they represent distinct mechanisms within the carbon market.

2.1 Carbon Allowances:

A carbon allowance, also known as an emission allowance, is a permit that allows a company to emit a specific amount of greenhouse gases. These are typically issued under a cap-and-trade system, where a governing body sets a limit (or cap) on total emissions allowed within a region or sector. Companies are allocated a certain number of allowances, and they must hold enough allowances to cover their emissions. If they exceed their allowances, they can purchase additional ones from other companies.

This system incentivizes companies to reduce emissions, as any unused allowances can be sold for profit. The fewer emissions a company produces, the more allowances they can sell. Over time, the governing body may lower the cap, forcing companies to reduce their emissions further.

2.2 Carbon Offsets (Carbon Credits):

A carbon offset, or carbon credit, represents a reduction in greenhouse gases achieved through external projects, such as reforestation, renewable energy, biochar, or soil sequestration. Unlike allowances, which permit companies to emit a specific amount of carbon, offsets allow companies to invest in emission reduction projects elsewhere to compensate for their own emissions.

Before turning to carbon credits, companies should first focus on reducing their direct emissions through operational changes, such as improving energy efficiency or transitioning to renewable energy. After these efforts, carbon credits can be used to compensate for the remaining emissions that cannot be immediately eliminated.

For example, if a company emits 10,000 tons of CO₂ after implementing reduction strategies, it can purchase offsets from a renewable energy project that prevents 10,000 tons of CO₂ from being emitted elsewhere. By doing so, the company balances its carbon footprint, achieving net-zero emissions. This approach ensures that carbon credits are used as a complementary measure, not as a substitute for genuine emissions reductions.

The key difference is that allowances are part of a regulated system with a set cap on emissions, while offsets are a voluntary or supplementary measure used by companies to achieve carbon neutrality.

3. Compliance vs Voluntary Carbon Market

There are two main types of carbon markets where carbon credits are bought and sold: the compliance market and the voluntary market.

3.1 Compliance Carbon Market:

The compliance carbon market is regulated by governments or international agreements. It operates under systems like the European Union Emissions Trading System (EU ETS) or California’s Cap-and-Trade Program. In these markets, companies are legally required to reduce emissions and are given a certain number of carbon allowances. If they exceed their allowance, they must purchase additional credits or face penalties.

Compliance markets are designed to meet government-imposed emission reduction targets. The cap on emissions creates a market where the price of carbon is driven by supply and demand. Over time, the cap is typically reduced, forcing companies to innovate and find new ways to lower their emissions.

3.2 Voluntary Carbon Market:

The voluntary carbon market operates outside of legal requirements. It allows businesses, governments, NGOs, and individuals to purchase carbon credits on a voluntary basis. This market appeals to companies that want to take additional steps towards carbon neutrality or demonstrate leadership in sustainability.

In the voluntary market, businesses purchase credits to offset their carbon emissions as part of their sustainability strategies or corporate social responsibility (CSR) goals. These markets offer greater flexibility, allowing companies to invest in a broader range of carbon-reducing or avoidance projects.

Both markets play an essential role in driving investment in emission reduction projects globally.

4. How Do Climate Projects Generate Carbon Credits?

Carbon credits are generated by projects that deliver climate benefits by avoiding or removing greenhouse gas emissions. These projects can range from nature-based solutions like soil sequestration to technology-based solutions like biochar. However, not all carbon credits are the same—credits vary based on the type of project and its environmental impact.

4.1 Carbon Avoidance:

Carbon avoidance credits are generated by projects that prevent the emission of greenhouse gases into the atmosphere. These projects avoid emissions that would have otherwise occurred. Examples include Deforestation Prevention Projects and Renewable Energy Projects.

4.2 Carbon Removal:

Carbon removal credits are generated by projects that physically remove CO2 from the atmosphere. These projects reduce the concentration of greenhouse gases in the air. Examples include: Soil Sequestration, Direct Air Capture (DAC), and Bioenergy with Carbon Capture and Storage (BECCS).

Currently, carbon avoidance credits dominate the market, representing about 80%  of supply. However, by 2030, removal credits are projected to make up 35% of the market, signaling a significant shift in climate mitigation strategies. Both carbon avoidance and removal play equally vital roles in achieving net zero emissions. A comprehensive net zero strategy must balance both approaches:

• Avoidance tackles the root cause by reducing new emissions
• Removal addresses the existing carbon burden in our atmosphere

Companies and policymakers should consider a diversified approach, investing in both types of credits to maximize their impact on climate change mitigation. This balanced perspective acknowledges current market dynamics while emphasizing the growing importance of removal credits in achieving net zero emissions.

5. The Carbon Credit Lifecycle in the VCM

The carbon credit value chain is a collaborative process that involves multiple stakeholders and consists of six primary stages. It begins with project planning, where developers design and implement initiatives, often securing investors to cover initial funding, and ends with the retirement of the carbon credit.

Throughout these stages, organizations can claim offsets as part of their decarbonization strategy, ensuring the credit is not re-used and thus preventing double-counting in the market. Here’s an overview of the carbon credit lifecycle.

1. Project Development: Project developers design and implement initiatives aimed at reducing greenhouse gas (GHG) emissions. Examples include reforestation, renewable energy installations, methane capture, and sustainable agricultural practices. Each project must follow a specific methodology or protocol, such as those established by Gold Standard or Verra, which is relevant to the type of project and outlines how to quantify the emission reductions.
2. Validation and Verification: Before a project can be registered, it undergoes a validation of its design and a verification of its carbon reduction claims. A Verification/Validation Body (VVB) assesses the project's emission reduction claims by comparing them against a baseline. Through desktop reviews and site visits, the VVB verifies the project’s baseline scenarios, monitoring processes, and calculation methodologies to ensure compliance with the carbon certification program requirements.
3. Registration: Once the project has successfully passed the validation and verification process, it is officially registered with a carbon credit registry. This registration creates a public record of the project’s methodology and its potential to generate carbon credits, formally introducing the project into the carbon credit system.
4. Issuance: After the project has been implemented and the emission reduction activities are underway, the reductions are continuously monitored. At the end of each monitoring period, an independent verification audit is conducted. If the audit confirms that the project has achieved its reduction targets and adhered to all requirements, carbon credits are issued based on the verified reductions.
5. Trading: Once issued, carbon credits can be traded in the carbon market. They are purchased by individuals, investors, and businesses seeking to offset their emissions. Buyers can acquire these credits directly from the project developer or through intermediaries like brokers, traders, and exchanges. The registry records each transaction to prevent double-counting of the credits.
6. Retirement: When a carbon credit is used to offset emissions, it is retired from circulation. This means the carbon credit is permanently removed from the market and can no longer be traded or claimed by another party. Retirement ensures that the emission reduction represented by the credit is not double-counted, maintaining the integrity of the carbon market.

This lifecycle ensures that each carbon credit represents a genuine and verifiable reduction in emissions, supporting the overall goal of global decarbonization.

6. High-Quality Carbon Credits

Not all carbon credits are created equal. To ensure genuine emissions reductions and climate benefits, carbon credits must meet specific quality criteria. Two main frameworks guide the evaluation of high-quality carbon credits: the AVID+ framework (Additional, Verifiable, Immediate, and Durable) and the Core Carbon Principles (CCP) introduced by The Integrity Council for the Voluntary Carbon Market (ICVCM). While these frameworks use different terminology, they share similar principles. Understanding both can help companies and consumers choose high-quality offsets that effectively cut emissions. Here's a breakdown of these key principles:

6.1 Additionality:

Emission reductions must be additional to what would occur without the offset. For example, protecting part of a forest isn’t additional if deforestation simply shifts to another area, and funding a solar farm that would have been built anyway due to low costs doesn't qualify. Offsets must represent genuine, additional cuts in emissions.

6.2 Verifiability:

Carbon projects must undergo rigorous Monitoring, Reporting, and Verification (MRV) by accredited third parties. This ensures that emissions reductions are accurately measured and transparently reported. For instance, if trees are planted, the project must verify not only that they are planted but that they will survive and store carbon for decades. Similarly, if low-emission cook stoves are provided, their delivery, maintenance, and use must be verified.

6.3 Immediacy:

The time value of carbon is crucial. Emissions reductions need to occur now to counteract current emissions. Projects with long-term benefits, like tree planting or future technologies, won’t offset today’s emissions. Immediate impact is essential for high-quality credits.

6.4 Durability/Permanence:

Offsets must represent permanent reductions or removals. For example, carbon stored in a forest could be released if a wildfire occurs. Many programs use "buffer pools" of extra credits to manage such risks. Since CO₂ remains in the atmosphere for a century or more, offsets must ensure equivalent long-term reductions.

6.5 Leakage:

High-quality projects must consider and mitigate potential leakage, where actions to reduce emissions in one area cause emissions to increase elsewhere. For instance, protecting a forest in one region shouldn’t lead to increased logging in another.

6.6 Co-benefits:

Beyond reducing emissions, high-quality credits should provide additional benefits, such as job creation, poverty reduction, improved health, and social justice. Projects should positively impact local communities and ecosystems, contributing to broader social and environmental goals.

By focusing on these criteria, companies can select carbon credits that genuinely support their climate goals and provide tangible benefits to society and the environment.

7. Why Companies Buy Carbon Credits

As companies work toward net-zero emissions, they often encounter the challenge that not all greenhouse gas emissions can be fully eliminated. To address these unavoidable emissions, many businesses are turning to carbon credits.

Purchasing voluntary carbon credits not only funds immediate climate action but is also linked to companies that are already proactive in reducing their emissions. According to a study by Forest Trends’ Ecosystem Marketplace, businesses that purchase carbon credits are more likely to report lower gross emissions year after year and invest significantly more in emissions reduction efforts. Addittionally they are 1.3X more likely to have supplier engagement strategies, indicating proactive climate efforts across their supply chain.

By purchasing carbon credits, companies can:

• Offset their unavoidable emissions.
• Contribute to climate change mitigation by investing in projects beyond their operations or geographical areas.
• Meet sustainability goals by addressing emissions that cannot be eliminated immediately.

However, companies must ensure that their investments in carbon credits complement—not replace—efforts to reduce their own emissions. Carbon credits should be part of a comprehensive strategy to achieve science-based decarbonization goals.

8. Conclusion and The Future of Carbon Credits

Carbon credits have emerged as a critical tool in the global fight against climate change, offering a flexible and scalable solution to help businesses and governments achieve carbon neutrality. They provide essential funding for climate projects that remove or reduce greenhouse gas emissions, while also promoting biodiversity, social equity, and sustainable development.

The voluntary carbon market has experienced significant growth in recent years, with the market value reaching $2 billion in 2021. Projections suggest this could expand between $10 billion and $40 billion by 2030 highlighting the increasing importance of carbon credits in climate strategies.

However, the carbon credit market faces several challenges:

• Financial Barriers for Project Developers: Smallholder landowners and mid-sized developers struggle to secure funding due to high costs of registering carbon projects. This financial burden delays or halts many initiatives, preventing potential climate and social benefits.
• Quality concerns: Ensuring the integrity and quality of carbon credits is crucial to maintaining their effectiveness.
• Market volatility: The early months of 2023 saw the value of voluntary carbon credits decline by nearly 50% to approximately $1.7 per metric ton.
• Transparency issues: Nearly 90% of intermediaries do not provide transparent information about their fees or profit margins.

Despite these challenges, the market is evolving:

• Shift to removal credits: Avoidance credits currently represent about 80% of supply, but removal credits are expected to reach 35% by 2030.
• Technology-based solutions: Technology-based carbon removal is projected to outpace nature-based measures after 2030.

For companies, investing in carbon credits can help bridge the gap between their current emissions and their net-zero goals. Looking ahead, carbon credits will play an increasingly important role in global climate action. BloombergNEF projects that in a high-quality scenario, carbon credit prices could reach $238/ton by 2050, with the market valued at $1.1 trillion annually.

Interested in carbon credits? Take action today by investing in high-quality carbon credits that deliver real social and environmental benefits. Explore how our credits can help you achieve your sustainability goals with confidence. Contact us now to learn more and begin your journey toward a net-zero future. The time to act—with integrity—is now.