What are carbon credits?

Whether you're in an industry that's leading the net-zero push or not, you will have likely heard the terms 'Carbon Credits' or 'Carbon Offsets' before. This carbon offset guide will update you on everything including what they are, how they're traded, the issues and risks associated with carbon projects and the role they may play in the future as demand for energy increases, and our goal of net-zero emissions remains.

What are carbon credits?

Carbon credits are permits that allow the owner to emit greenhouse gasses. One credit equates to 1 tonne of Carbon Dioxide emissions permitted (or the equivalent in other greenhouse gas emissions). Credits are then traded worldwide in ‘Cap and Trade’ programs aimed at lowering the world's carbon intensity.

N.B - both the terms 'carbon offset' and 'carbon credit' are used but can mean slightly different things. Carbon offset refers broadly to the reduction in Green House Gas (GHG) emissions to become carbon neutral, whereas a ‘credit’ or a ‘carbon offset credit’ refers to a transferable instrument certified by governments.

One of the core carbon principles regarding carbon allowances is to provide an incentive for companies and personal buyers of carbon credits to reduce their carbon footprint and combat fossil fuel use by either avoiding 'carbon taxes' by having to buy more carbon offset credits or through selling any surplus of carbon credits a company may have. The goal is to decrease the permitted output level of all businesses periodically and reduce everyone’s CO2 emissions.

Advocates of carbon trading credit programs claim the cap and trade set-up combined with periodically reducing the number of permits leads to measurable emissions reductions.

The market for Carbon Credits

The Kyoto Protocol (1997) was the first time the United Nations set emission reduction targets. This was followed by the foundation of the International Carbon Action Partnership (2007) appointed by 15 governments to bring together states to combat the carbon intensity of energy production. Since then countries have been allowed to sell their surplus credits to other countries if they emit less than their permitted number of hydrocarbons. Further meetings like the Doha Amendment (2012), the Paris Agreement (2015), and The Glasgow Climate Change Summit (2021) all set out new targets and ratified counties’ acceptance of the agreements. The United Nations has agreed through these agreements to limit global warming to no more than 2 degrees above preindustrial levels. Currently, more than 70 countries are committed to the 'Net-Zero Coalition' covering 76% of global emissions.

The emission reduction targets and the subsequent agreement that countries can trade surplus CO2 emissions on new credit projects have led to a program for trading GHGs with two main components: the compliance market (started with the Kyoto Protocol [1997]) and the voluntary market for carbon credits (launched in the early 2000s). The Compliance Market applies to large companies that have an emission limit set on them by their government has dramatically increased the demand for carbon credits. It requires buyers of offsets to purchase carbon offset credits should they emit more than they are permitted. They can purchase them from companies that have exceeded their carbon savings targets, or by investing in renewable energy projects that result in a net removal of emissions.

The voluntary carbon credits market (scaled by Mark Carney in 2018) is for companies, governments and other organisations to offset their carbon emissions voluntarily to reduce the cost of carbon and increase the social benefits of carbon credits like job creation and public health improvements. Although the demand for carbon credits is not driven by the voluntary market and it's ultimately unregulated, companies still use accreditation verifiers like 'Gold Standard' to verify high-quality, sustainable development projects. Not-for-profit companies like 'Carbon Market Watch' (Carbon Watch) also oversee pricing and ensure projects have a meaningful impact towards cutting pollution, driving a transition towards net zero.

Overall, the carbon credit market's revenue is estimated at $414.8 Billion in 2023 and is suspected to reach $1,602.7 Billion by 2028.

How are they traded

GHGs mix globally into the atmosphere so it doesn't matter where carbon savings come from. Therefore, crucially, they can be traded internationally, as the majority of natural carbon sinks (blue carbon/forest resources) lie in the southern hemisphere whereas most of the demand for carbon credits is located in the northern hemisphere. The offsets for emissions themselves can be actually bought through a program for trading GHGs (where the market prices are calculated). Buyers of offsets can purchase them directly from a developer, through a broker or on an international marketplace such as the 'Climate Trade Marketplace' that operates in a country or state such as 'California's Cap and Trade Program'. To monitor carbon trading the use of blockchain technology has become increasingly common as a means of creating a transparent and efficient carbon credits market. Credits can also be traded in a futures market on a set date and price, helping to mitigate risks for traders. Crucially, whatever way they are traded, in order to claim carbon savings a company must ‘retire’ its credit after it has been sold to ensure it isn't used more than once.

Sequestration types

Farms and businesses can sequester carbon in order to sell credits. Sequestered types can be split into three main categories:

• Biological
• Geological
• Technical

1. Biological Sequestration

• • Ocean (Blue carbon)
    • Oceans absorb roughly 25% of CO2 emitted from human activities annually
  • Soil
    • Sequestration takes place in the soil through photosynthesis and can be stored as soil organic carbon (SOC)
  • Forests (Native Forests/Tropical Forests)
    • Find land for sale in England or Wales for your UK-based forest
  • Grasslands
    • While native forests and tropical forests are known as the best for sequestration, forest degradation means there's now more pressure on grasslands

2. Geological Sequestration

• • Injecting emissions from industrial processes into geological formations

3. Technical Sequestration

• • Graphine production
    • Graphine is used as a raw material to create screens for smartphones and other tech devices
  • Direct air capture (DAC)
    • Directly from the air using advanced technological plants
    • Energy intensive and expensive ($500 - $800 per ton removed)

The UK's promise to plant 1 million acres of trees by 2050 means carbon sequestration projects in the UK can come with sizable grants. See the government guidance to see the full requirements for a project, and Addland to find the perfect plot for a sequestration site.

Issues with carbon offset credits

The core carbon principles necessary for the market to provide tangible environmental benefits are the concepts of 'additionality' and 'permanence'. If the offset project would have been pursued anyway and/or is not permanently sequestering, carbon offset credits should not be issued and the environmental/social benefit is severely reduced. A Carbon reduction claim by investing in an underlying project that may have been pursued anyway is known as 'greenwashing'. Certification programs like Gold Standard monitor this as closely as possible but like all voluntary markets, the voluntary carbon offset market has no central authority and there are no laws governing whether a company has managed to offset their emissions or not, and is therefore harder to regulate, but still provides an incentive for companies.

There are initiatives to ensure the voluntary carbon market is used effectively. One of which includes the ‘The Oxford Principles for Net Zero Aligned Carbon Offsetting 2020', a science-based targets initiative (SBTi), encouraging businesses to set near-term and future emissions targets that align with the Paris Agreement.

Every sequestration project comes with its own risks to the outlook for carbon credits:

Sequestration type	Permanence requirements	Associated risks
Blue carbon coastal wetland restoration	1,000+ years	Sea level rise, coastal erosion, storm surges, pollution, habitat loss
Afforestation and reforestation (Native / Tropical / Rainforest carbon offsets)	100+ years	Forest fires, insect infestations, deforestation, logging, climate change
Soil sequestration	100+ years	Soil degradation, land-use changes, erosion, drought, floods
Biochar	100+ years	Improper storage, decomposition, wildfire, soil erosion, unsustainable production
Carbon capture and storage (CCS) (Carbon removal technologies)	1,000+ years	Leaks, geological instability, cost-effectiveness, public acceptance, lack of regulation

The potential for double counting areas of sequestration as carbon offset credits also poses a risk to the additionality of a project. To tackle double counting Gold Standard set guidelines to countries stating:

1. ''The Project Developer may seek evidence to demonstrate to Gold Standard that their issuance is not at any risk of double counting.
2. The Project Developer may cancel a valid/eligible unit as applicable within the host country/international accounting mechanism.''

Social considerations are also important. Forest planting for example can lead to the displacement of indigenous people, harming the potential image and overall outlook for carbon credits.

How to ensure Additionality and Permanence

Additionality

Proving 'Additionality' is a core carbon principle necessary to hit our climate targets, but proving carbon savings is no easy feat. Additionality means the reductions in the emission of greenhouse gases achieved by the underlying project must be ‘above business as usual’. For example, landfill operators in California are required by law to acquire and install equipment that makes carbon savings by capturing and destroying methane; they would have needed to install this in line with legislation so it's not considered to be 'above business as usual'. The same can be said when an underlying project uses a ‘green’ product because it's the most cost-effective compared to a conventional power plant. This is true of many renewable energy projects in the UK. The high demand for energy and overall costs of conventual power plants has meant many operations are turning to renewables and nuclear energy projects as the primary source of energy supply. As it's actually just the cheapest option it provides no additionality and can't be used to supply credits.

Permanence

Making the removal of emissions permanent is an equally important core carbon principle and driver of the demand for carbon credits. The permanent removal in a carbon offset project ensures the GHGs sequestered will have a long-lasting impact. The description of ‘permanence’ specifically relates to the period of time the GHGs will remain out of the atmosphere.

For example, planting and replanting trees is viewed as a permanent means of sequestration as trees sequester for hundreds of years to outlast the current intensity of GHGs and the intensity of energy supply, so long as there is no unexpected forest degradation. Carbon Capture and Storage (CCS) projects on the other hand are commendable for measurably removing CO2 from the atmosphere (therefore providing certain additionality) but are worse at ensuring permanence with ongoing maintenance requirements to ensure 'permanent' sequestration.

Generally, the benchmark for permanence is 100 years to make a genuine carbon reduction claim, but some protocols and registries could require a longer timeframe; 1000 years is not uncommon. The Climate Action Reserve's (CAR) management team deems permanence for forestry projects to be 100 years but demands a 500-year performance standard for geologic sequestration projects.

Subsequently, there's a big incentive for companies to purchase high-quality carbon credits often in coastal ecosystems such as mangroves, tidal marshes and seagrass meadows.

The outlook for carbon credits

By 2020 over 110 countries committed to a net zero emissions target by the year 2050. With the increasing demand for energy and slow progress in improving energy efficiency, the market price and demand for carbon credits look set to increase. But, cases of forest degradation and false carbon reduction claims, make it hard to argue a faultless outlook for carbon credits. Improvements in monitoring and perhaps tighter regulation seem necessary for it to be proven as a feasible greenhouse gas reduction project.