How Do Carbon Credits Work?
In the current carbon market, a credit represents one metric ton of CO2 or equivalent greenhouse gas emissions reduced through certified climate action projects. Individuals and companies seeking to offset their own emissions can purchase credits from projects that reduce, avoid or remove carbon through a middleman or directly from those responsible for the project. This type of carbon credit is most commonly created through agriculture or forestry practices, although a credit can also be produced through other means that reduce, avoid or remove GHGs, such as energy efficiency, renewable energy, landfill diversion, and methane capture.

Proponents of the system argue that it provides a strong monetary incentive for companies to reduce their own emissions and creates an alternative for those who do not have the ability to eliminate their carbon.credit footprint completely. As a result, the voluntary carbon market has seen tremendous growth in recent years.

Many of these companies are aiming to achieve net-zero emissions, which requires deep and broad-ranging reductions across their entire operations. This is an important step for the world to limit global warming to 1.5 degrees Celsius above preindustrial temperatures and mitigate climate change.

Companies that have pledged to reach net-zero are required to disclose their full GHG emissions to a third party and develop a plan for eliminating those emissions over time. In the process, they may choose to purchase and “retire” carbon credits from the voluntary market to neutralize the remaining unavoidable emissions that they will not be able to eliminate through their own efforts.

The voluntary market’s rapid expansion has been driven by more companies aligning with the Paris goals and pledging to reach net-zero emissions. To ensure this market can support the ambitious climate goals, it needs to be strengthened by improving its integrity through increased transparency, standardization and stability. Creating an independent verification mechanism, hosting and curating core carbon principles and defining an attribute taxonomy to categorize projects would help build the market’s trust. This will enable a more liquid reference market that supports risk management, supplier financing and the growth of a wider supply chain.

In addition, establishing a standard methodology for carbon credit quality thresholds could lower issuance costs and shorten payment terms, accelerate issuance of credits, boost cash flow to projects, and improve the credibility of corporate claims related to the use of their credits. Finally, a digital process to verify projects and their impact at regular intervals would streamline credit issuance, speed payments, allow for greater project flexibility, and reduce the potential for fraud and money laundering. The creation of these mechanisms will provide a critical market signal for companies to make long-term commitments to carbon reductions and reduce uncertainty about the reliability of the voluntary carbon market as a tool for climate protection. These changes will be vital to achieving the global ambitions of the Paris Agreement. To do so, we need the support of governments, regulators and other key players across all sectors of the economy.