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How Do Carbon Credits Work?
When an organisation buys a carbon credit in the Voluntary Carbon Market (VCM), they fund the reduction or removal of one ton of CO2 that was achieved elsewhere. The removals or reductions achieved by these climate projects can then be used to support the company’s own sustainability goals and strategies.
This system rewards project developers by directing more money towards projects such as afforestation and reforestation, biochar, and enhanced weathering. Thanks to income from carbon credits, these climate projects are becoming increasingly more profitable. This incentivises more climate-positive activities, which is why carbon credits are one of the best mechanisms we currently have to combat climate change.
Why do companies buy carbon credits?
Companies generally buy carbon credits for the following reasons:
- Adhere to the IPCC’s 1.5°C Pathway to limit global warming to 1.5°C above pre-industrial levels through emission reductions.
- Compensate for unavoidable emissions as part of a decarbonisation strategy to reach net zero.
- Contribute to global climate mitigation efforts.
- Contribute to projects with additional co-benefits as part of a broader ESG strategy.
To use carbon credits properly, companies should follow the mitigation hierarchy. This involves prioritising avoiding and reducing emissions within one’s value chain before going forward with neutralising unavoidable emissions.
How carbon credits are generated
Carbon credits are generated by verified climate projects that successfully prove reduction, avoidance, or removal of GHG emissions. Examples of different types of projects include:
- Biochar: A type of charcoal made from plant matter that can be stored in soil. Biochar projects can store carbon for hundreds, or even thousands of years.
- Afforestation & Reforestation: Projects aimed at preserving and/or increasing the Earth's tree cover to combat climate change by natural means.
- Blue Carbon Projects: These projects focus on preserving and increasing the Earth's ocean and coastal ecosystems. These ecosystems are highly effective at absorbing and storing CO2.
- Enhanced Weathering: A cutting-edge method of carbon capture and storage that involves natural geological processes to remove CO2 from the atmosphere, storing it permanently in the soil.
Who issues carbon credits?
Carbon credits are issued by recognised standards organisations that create the methodologies to validate and verify climate projects. These standard help to ensure that carbon credits are credible and that the projects deliver real, measurable climate benefits.
Some key standards in the Voluntary Carbon Market include:
- Verified Carbon Standard (VCS): The VCS is managed by Verra and is one of the most widely used standards for voluntary credits.
- Gold Standard: Focuses on projects that not only reduce emissions but also contribute to sustainable development.
- Puro.earth: Specialises in carbon removal credits. They have developed unique methodologies for biochar, direct air capture, and carbon sequestration in building materials.
How to ensure the quality and integrity of carbon credits
- Registries: These databases track the issuance, ownership, and retirement activity of carbon credits to promote transparency and credibility in carbon markets. Examples of registries include Verra, Gold Standard, Puro, and EcoRegistry.
- Integrity and Standards: Several initiatives focus on maintaining the credibility and effectiveness of voluntary carbon markets. The Integrity Council for the Voluntary Carbon Market (ICVCM) sets high standards for carbon credits, ensuring they are credible and impactful. The Voluntary Carbon Markets Integrity Initiative (VCMI) provides governance frameworks for companies to make credible claims about their carbon credit usage.
- Measurement, Reporting, and Verification (MRV): 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 independently rate carbon credit projects by assessing their impact and reliability in an impartial manner. This helps buyers make better informed decisions when choosing which projects they should invest in.
- Additional Methods: Ongoing monitoring, independent due diligence, and third-party audits can also be used to maintain the integrity of carbon credits.
What are carbon credits worth?
The value of carbon credits in the Voluntary Carbon Market varies considerably. It is dependant on factors such as the type of project, its vintage, location, and the co-benefits it provides (e.g., biodiversity conservation, social impact). Prices can range from a few dollars to over $50 per metric ton of CO2. High-quality projects that deliver additional social or environmental benefits, or projects that use more innovative technology, generally go for higher prices. The price of carbon credits is forecasted to increase considerably as we approach 2050.
How buying carbon credits can reduce global emissions
By purchasing carbon credits, companies can directly finance projects that reduce or remove carbon from the atmosphere. This not only helps to offset their emissions but also contributes to the broader goal of reducing global carbon levels. Climate projects rely on funding from credit sales to operate. This means that the purchase of credits can have a direct impact on reducing emissions. Companies can determine how to invest in carbon credits using three main approaches:
- Tonne-for-tonne
- Money-for-tonne
- Money-for-money
Different approaches for companies to reduce global emissions
- The tonne-for-tonne approach is the traditional approach that the VCM operates in. It ensures that every tonne of CO2e emitted by a company or entity is matched by an equivalent tonne of CO2e that has been removed or avoided by a carbon credit project. Generally speaking, most companies will opt for this approach since they can use credits purchased in this fashion for net zero and neutralisation claims.
- The money-for-tonne approach encourages more responsible and impactful investment. It works by directly linking financial decisions to climate impact by setting an internal carbon price. This price is an estimate of potential climate risks related to increased emissions. For every tonne a company emits, they will invest whatever their internal carbon price is in climate projects. In this approach, the climate impact is prioritised, and it is generally adopted by companies looking to go beyond net zero with their sustainability strategy.
- The money-for-money approach involves companies allocating a portion of their revenue to promote broader mitigation efforts. In this method, companies do not expect quantifiable returns in CO2. This means that climate investments using the money-for-money approach are typically intended to:
- Channel funding towards emerging carbon dioxide removal (CDR) technologies.
- Promote projects that focus more on co-benefits compared to emission reductions/removals.
Are carbon credits effective?
Carbon credits can be highly effective in reducing global emissions, but this is not always the case.
To maximise the effectiveness of carbon credits, it is important for companies to create a diversified carbon credit portfolio with a combination of different types of credits to align their investment with their strategy and needs.
Every company has different requirements, but generally speaking, every company has:
- Budget considerations
- Stakeholder demands
- The need for high quality credits.
For carbon credits to be effective on all fronts, it is essential to balance these needs when choosing projects to invest in.
Why carbon credits don’t work in certain cases
There is ongoing debate about the effectiveness of carbon credits. Critics have raised concerns that they could be used as a form of greenwashing. This can happen both intentionally or unintentionally, but the two primary instances where they don’t work are:
- Some companies purchase credits to appear environmentally responsible without making significant reductions in their own emissions. Companies can be guilty of this when they rely on purchasing carbon credits as a ‘get out of jail free card’ instead of making meaningful reductions within their own operations.
- Not all carbon credits are created equal. Some credits may not deliver the promised environmental benefits due to management issues, or even the project methodology itself. This is why Senken has implemented a robust due diligence process to ensure the highest quality of carbon credit projects.
This means that companies need to prioritise emission avoidance and reduction activities within their own operations in addition to buying carbon credits, as mentioned above.
How do carbon credits compare to other mechanisms?
Carbon Credits and Carbon Offsets
Carbon credits are often referred to as carbon offsets. In practice, buying credits allows companies to offset their own emissions by supporting projects that contribute the reduction or removal of emissions elsewhere, so the two terms are often used interchangeably. It is also possible to purchase carbon credits as a form of commodity trading or as an investment. In those instances, a carbon credit would not be considered as a carbon offset.
Carbon Credits and Carbon Footprint
Purchasing carbon credits is a mechanism for companies to reduce their corporate carbon footprint. This helps reduce the impact of a company’s footprint by offsetting emissions that cannot be feasibly reduced or avoided. This can help companies to reach a state of climate neutrality or net zero, where their carbon footprint is effectively zero.
Carbon Credits and Carbon Accounting
Carbon accounting refers to the process of measuring and tracking the amount of carbon dioxide (CO2) and other greenhouse gases that a company or organisation emits. It typically involves detailed calculations of emissions across all activities, often categorised into Scopes 1, 2, and 3. The number of carbon credits a company needs to purchase is determined by carbon accounting.
Carbon accounting is a vital part of the Voluntary Carbon Market ecosystem, and there are several companies and tools that can help companies with these complex processes.
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Carbon Credits vs. RECs
Renewable Energy Certificates (RECs) are similar to carbon credits but differ in their focus. RECs represent the environmental benefits of generating one megawatt-hour (MWh) of electricity from renewable sources. While RECs support the transition to renewable energy, they do not directly reduce carbon emissions unless they displace fossil fuel-based energy. In contrast, carbon credits specifically represent the reduction or removal of GHGs.
Carbon Credits vs. ETS
Emission Trading Systems (ETS), such as the EU Emissions Trading System, are regulatory frameworks where companies buy and sell emission allowances under a cap-and-trade system.
ETS is mandatory for companies that are responsible for significant greenhouse gas emissions in specific industries such as:
- Power generation
- Manufacturing
- Aviation
- Certain sectors of the chemical industry
Companies mandated to participate in emission trading schemes are required to ensure that their emissions stay within the capped limits.
In contrast, carbon credits in the VCM can be bought by any company that wishes to compensate for their unavoidable emissions or contribute towards global climate mitigation efforts.
Carbon Credits vs. Carbon Tax
A carbon tax is a fee imposed by governments on companies for emitting GHGs. The tax incentivises emissions reductions by making it more expensive to pollute. In contrast, carbon credits are part of a market-based approach where companies voluntarily purchase credits to offset their emissions. Both tools aim to reduce emissions, but they operate through different mechanisms—carbon tax is a regulatory measure, while carbon credits provide flexibility in voluntary markets.
Key Takeaways
- Carbon Credits: Tradable certificates representing the reduction, avoidance, or removal of one metric tonne of CO2 or equivalent GHGs. They are primarily bought to compensate for emissions and contribute towards sustainability goals.
- Functionality: Companies use carbon credits to finance projects like afforestation, biochar, and enhanced weathering. This helps neutralise their carbon footprint by reducing or removing GHGs from the atmosphere.
- Quality and Integrity: Carbon credits are issued by recognised standards organisations like Verra, Gold Standard, and Puro.earth. Their integrity is maintained through registries, digital MRV, and independent rating agencies.
- Value and Pricing: The value of credits varies widely depending on project type, location, and co-benefits. Prices are expected to rise significantly as we approach 2050.
- Effective Use: Carbon credits are most effective when they are part of a comprehensive decarbonisation strategy that prioritises emission reductions and aligns with the mitigation hierarchy.
- Greenwashing Concerns: Credits not used correctly can result in accusations of greenwashing. It is critical to look for high-quality credits while also implementing proper reduction strategies to avoid greenwashing.