Carbon Credits

Last Updated:
February 14, 2024
Carbon Credits explained
The transition to a low carbon economy is on every CEO's agenda nowadays. The impacts of climate change and responses to it will transform every business sector in the coming decades. Although Climate change will affect a majority of companies, all will be expected to contribute to its solution.
Nevertheless, it is challenging for most companies to devise and implement a credible decarbonisation strategy. The transition requires new ways of doing business, including new ways of displaying capabilities and resources and new ways of thinking. But despite the challenges, companies around the world are scaling up their decarbonisation commitments.
We can see this trend with the number of companies committing to reducing emissions. More than 2000 companies have confirmed emissions reduction targets under the Science Based Target initiative (SBTi). Additionally, more than 370 have committed to The Climate Pledge, pledging to achieve net zero emissions by mid-century or sooner.
For most companies and investors, carbon credits play a crucial role in their Net-Zero strategy. They allow companies to make earlier and more ambitious commitments. Credits allow companies to reduce their current emissions through offsets, while taking cost-effective steps to reduce future emissions through asset rotation and business model development. In the long term, credits can play an essential role in offsetting difficult-to-avoid emissions from products for which no low- or zero-emission options exist.
The growing interest in recent years is also reflected in the Voluntary Carbon Market (VCM), which organises the pledging and trading of carbon credits. In 2022, the demand for carbon credits is at its peak. Prices have increased by more than 140% since 2021 and forecasts assume that demand for credits will increase 15-fold by 2030, to $50 billion per year.
But the voluntary carbon market has a problem. It cannot cope with demand. Access, which plays a crucial role in the global effort to combat climate change, is often limited to large organisations and is characterised by opaque pricing and market inefficiencies. Furthermore, due to a lack of transparency and credibility, it has faced a number of problems in recent years.
This report examines the key role for on-chain carbon credits as part of net zero strategies and the VCM. It was prepared by senken to help business decision makers identify and understand the best use of credits for their business.

What are Carbon Credits?

In the context of the Voluntary Carbon Market (VCM), carbon credits are tradable certificates that represent the reduction, avoidance, or removal of one metric tonne of Carbon Dioxide (CO2) or other Greenhouse Gases (GHGs) from the atmosphere. They are generated by projects that either avoid/reduce emissions, or projects that remove CO2, all of which contribute to climate change mitigation.

How Carbon Credits Work in Climate Change Mitigation

Carbon credits are created by projects that either reduce emissions or remove CO2 from the atmosphere. These projects issue credits for their impact, which can then be bought, sold, and retired in the VCM.

When an entity buys a carbon credit, they pay for the reduction or removal of a ton of CO2 that they themselves have not achieved, which can be used for their own internal sustainability strategies. This system incentivises project developers by channeling increased revenue towards these projects, and is one of the most effective mechanisms we have in place to combat climate change.

Mitigation Hierarchy
A good decarbonisation strategy should follow the mitigation hierarchy, prioritising avoidance and reductions before offsetting.

Verification of Carbon Credits

  • Registries: Carbon credits are registered to ensure transparency and credibility. This is done by tracking issuance, ownership, and retirement activity. Examples of registries include Verra, Gold Standard, Puro, and EcoRegistry.
  • Digital Measurement, Reporting, and Verification (dMRV): This process upholds the accuracy and integrity of carbon credit projects by ensuring that the reductions/removals of a project are real, measurable, and permanent. Examples of MRV include satellite monitoring and iOT devices.
  • Rating Agencies: Organisations like BeZero and Sylvera rate carbon credit projects by assessing their impact and reliability. This helps buyers make better informed decisions when purchasing carbon credits.
  • Additional Methods: Ongoing monitoring and third-party audits are also often used in order to maintain the integrity of carbon credits.

Understanding the Different Types of Carbon Credits

  • Removal vs. Avoidance: Removal credits involve directly removing CO2 or GHGs from the atmosphere, whereas avoidance credits prevent/reduce further emissions.
  • Spots, Futures, Offtakes: Spot transactions involve an immediate sale and delivery of credits. Futures are contracts for the delivery of credits at a future date. Offtakes are agreements to purchase credits from a project once they are generated.

Why should Companies Buy Carbon Credits?

There are two primary reasons why a company would purchase carbon credits:

  1. It helps companies to address Net Zero commitments and comply with upcoming regulations.
  2. Once a company is done avoiding and reducing emissions within its operations, purchasing removal credits is the most effective way to compensate for unavoidable emissions. This is allows companies to meet their carbon neutrality or Net Zero targets. In fact, according to scientific bodies such as the SBTi and IPCC, removal credits are essential in order to be able to make Net Zero claims.
  3. Certain carbon credit projects extend their impacts beyond CO2, such as by increasing livelihoods, biodiversity preservation and ecosystem services.
  4. This provides companies with internal and external communication material for marketing purposes, which is a great way to improve brand image and increase revenues. Avoidance and removal credits with good co-benefits can also help companies address some of their other ESG goals through the social impact attached to these credits.