What is a Carbon Credit?

A carbon credit is a market-based mechanism designed to encourage the reduction or absorption of greenhouse gas (GHG) emissions. Companies, organizations, or countries that reduce GHG emissions through specific projects can be awarded carbon credits, which can then be traded. These credits are purchased by individuals or businesses seeking to offset their emissions, thus advancing efforts to combat global warming.

How Carbon Credits Work

Carbon credits function primarily through emissions trading, following these steps:

Implementation of Emission Reduction Projects: Projects like the development of renewable energy, forest conservation, methane reduction, and energy efficiency improvements must be carried out to generate carbon credits. These projects need to produce measurable and verifiable GHG reductions, certified by international standards.
Certification of Reductions: The reduction from the project is verified by a certification body. Once the amount of GHG reduced is confirmed, the reduction is converted into credits that can be traded.
Trading Credits: The issued carbon credits are sold in markets. Companies or countries with high emissions can buy these credits to offset their excess emissions and help achieve carbon neutrality or emission reduction targets.

Two Types of Carbon Credit Markets

Carbon credits are classified into two main categories: regulated markets (compliance markets) and voluntary markets.

1. Regulated Markets (Compliance Markets)

These markets are governed by legal frameworks established by governments or international institutions. Companies and industries are often given emission caps, and those exceeding their caps must purchase credits to offset the excess. Key examples include:

EU ETS (European Union Emissions Trading System): The world’s largest compliance market, where companies must adhere to emission caps by buying credits when needed.
CDM (Clean Development Mechanism): Part of the pre-Paris Agreement framework where developed nations implemented emission reduction projects in developing countries, earning credits known as CERs (Certified Emission Reductions).

2. Voluntary Markets

These markets are for organizations and individuals voluntarily reducing GHG emissions. Companies may purchase credits to meet carbon-neutral goals or to enhance their environmental, social, and governance (ESG) standards. Examples of voluntary market certification include:

Verra (VCS: Verified Carbon Standard): The most widely used voluntary credit certification program, recognizing a variety of emission reduction projects.
Gold Standard: Established by WWF, this certification focuses not only on climate change mitigation but also on sustainable development goals (SDGs).

Use Cases of Carbon Credits

Carbon Neutrality: Organizations can offset the GHG emissions they cannot reduce by purchasing carbon credits, achieving net-zero emissions.
Carbon Offsetting: Individuals or businesses offset emissions from events, product production, or travel by purchasing carbon credits, thus minimizing their environmental impact.
ESG Investments: Investors evaluate companies based on their environmental, social, and governance (ESG) practices. Companies that reduce emissions or use carbon credits may attract more ESG-conscious investors.

Benefits of Carbon Credits

Climate Change Mitigation: Carbon credits are a powerful tool for reducing GHG emissions, providing funding for emission reduction projects that contribute to combating global warming.
Corporate Social Responsibility (CSR): Companies can use carbon credits to achieve sustainable growth and demonstrate social responsibility, enhancing their brand value and investor appeal.
New Business Opportunities: Carbon credits create new business models around renewable energy, forest conservation, and sustainable industries, fostering growth in these sectors.

Challenges of Carbon Credits

Ensuring Reliability: Strict verification and certification are necessary to ensure that carbon credits genuinely contribute to reducing GHG emissions. Inaccurate credits can undermine climate action.
Double Counting Risk: If the same reduction is counted for multiple credits, it inflates the reported emission cuts. Robust tracking systems are essential to prevent this issue.
Dependency on Actual Reduction: Purchasing credits should complement efforts by companies or countries to reduce emissions directly. The focus should remain on cutting emissions, with credits serving as a supplementary tool.

Conclusion

Carbon credits are an important tool for promoting GHG reduction through market mechanisms. Traded in both regulated and voluntary markets, they finance emission reduction projects and help companies achieve carbon neutrality. However, ensuring the reliability of credits and prioritizing actual emission reductions are essential for effective and sustainable climate action.