How do carbon credits work?
A carbon credit gives the holder permission to emit one metric ton of CO2 or equivalent greenhouse gases, representing that quantity removed from the atmosphere elsewhere. They are typically purchased by companies to offset emissions from manufacturing, transport and other activities. Once used, the credit is 'retired'. Carbon credits put a price on CO2 emissions, with the goal of discouraging high-emissions activities and helping finance carbon reduction projects.
In general, carbon credits can be divided into two categories: avoidance and removal. Avoidance credits are associated with projects that reduce CO2 emissions, such as carbon capture. Removal credits, meanwhile, are associated with the removal of CO2 which is already in the atmosphere, such as tree planting and direct air capture.
These credits are separate from renewable energy certificates (RECs), which allow for green credentials to be traded, and are at the core of many businesses' clean energy targets.
Carbon credits can be purchased voluntarily, but in some jurisdictions they are legally required to offset excess emissions. These compliance markets, which include the EU, UK and the state of California, cover more than 20 percent of global emissions.
A fast-growing global market
The carbon offset market is growing as organizations face pressure from both authorities and consumers to take responsibility for their emissions.
Estimates for the size of the carbon market vary, but experts all agree it's expanding. The Institute of International Finance predicts that the carbon credit market could increase by a factor of 15 by 2030. And according to the World Bank, global carbon credit revenue grew 60 per cent to $84bn in 2021. But despite this increase, the current trajectory is “far from adequate” for meeting climate goals. Just four new carbon pricing mechanisms were implemented in the previous year, and the price in most jurisdictions remains well below that required to deliver on Paris Agreement goals.
The challenge of transparency
Carbon credits are seen by critics as a means of allowing organizations to continue 'business as normal'. It is important, then, to ensure that purchasing carbon credits can be trusted to bring tangible CO2 reductions – this remains a challenge.
The market has been criticized for lacking transparency, making it difficult to be certain that money paid for carbon credits is going to good causes. Concerns have also been raised about the large number of brokers in the market and "shockingly little data" about how money is spent.
This opacity makes it hard to guarantee "additionality”, meaning that the associated emissions reductions would not have happened without that support. Evidence of fraud and over-crediting has shaken trust in the fundamental idea that purchasing a carbon credit offsets one metric ton of CO2. In 2016, the European Commission found that 85 percent of projects it examined were unlikely to achieve their stated reduction claims – similarly concerning conclusions were found in a 2019 ProPublica investigation and a 2021 study on forest preservation projects.
There is also the question of the long-term benefit of carbon credits when it is almost impossible to guarantee that emissions are permanently avoided. The risk remains that, for instance, land allocated to afforestation could be deforested by future generations, while increasing extreme weather threatens the destruction of preserved forests.
How to build trust
A McKinsey report on how carbon markets could be scaled up recommends:
- strengthening verification methodologies;
- matching buyers and suppliers with a set of standardized descriptors for projects;
- establishing market infrastructure;
- and installing mechanisms to safeguard the integrity of the market, such as a digital verification process and a governance body.
Carbon credits are a powerful instrument for financing sustainable energy projects, so building trust in the market is vital to achieving climate goals – this means strengthening regulations to establish transparency, standardization and stability.