The Ultimate Guide to Understanding Carbon Credits


## **Introduction**

In 1997, the Kyoto Protocol and in 2015, the Paris Agreement were global agreements that set targets for reducing CO2 emissions. The Paris Agreement has been accepted by nearly all countries, except six, leading to the establishment of national emission targets and corresponding regulations.

As these new rules take effect, businesses are under increasing pressure to lower their carbon emissions. Many of the temporary solutions available today involve using carbon markets.

Carbon markets work by assigning a value to CO2 emissions and treating them as a tradeable item. There are two main types: carbon credits and carbon offsets. Both can be bought and sold on these markets. This concept offers a market-driven solution to a complex problem.

## **What are carbon credits and carbon offsets?**

People often use the terms "carbon credits" and "carbon offsets" interchangeably, but they work differently.

**Carbon Credits:** These are like permission slips for emitting carbon. When a company buys a carbon credit, usually from the government, they're allowed to release one ton of CO2. Carbon credits involve a vertical flow of money from companies to regulators. If a company has extra credits, they can sell them to others.

**Carbon Offsets:** Offsets involve a horizontal flow of money between companies. If one company removes a unit of carbon from the air as part of their usual activities, they earn a carbon offset. Other companies can buy these offsets to lower their own carbon emissions.

Although people sometimes use "carbon offsets" as "offset credits," it's important to remember that these terms have distinct meanings. The key difference lies in regulatory compliance credits (carbon credits) versus voluntary offsets.

## **How are carbon credits and offsets created?**

Credits and offsets are part of two related but slightly different markets, both based on the equivalent of one ton of carbon emissions (CO2e).

It's important to note that a ton of CO2 refers to a specific weight. On average, an American generates 16 tons of CO2e each year from everyday activities like driving, shopping, and using energy at home. For perspective, a drive from New York to Las Vegas in a typical 22 mpg car would emit about one ton of CO2e.

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Carbon credits are given out by national or international governments. For example, the Kyoto and Paris agreements established the first global carbon markets. In the US, California has its own carbon market that issues credits to residents based on their gas and electricity use.

Credits are often issued as part of a "cap-and-trade" program, where regulators set a limit (cap) on carbon emissions. This cap gradually reduces over time, pushing companies to cut their emissions.

Imagine carbon credits as permission slips for companies to emit a specific amount of CO2e each year. Cap-and-trade programs exist in various countries, including Canada, the EU, the UK, China, New Zealand, Japan, and South Korea.

Carbon offsets operate differently. Organizations that do things to reduce existing carbon, like planting trees or using renewable energy, can issue offsets. These offsets are voluntary and form the "Voluntary Carbon Market". Companies can buy these offsets to further decrease their CO2e emissions.

In summary, credits and offsets offer ways for companies and individuals to manage their carbon emissions, contributing to a greener future.

## **What is the carbon marketplace?**

In the carbon marketplace, there are two significant markets for selling carbon credits:

- **Regulated Market:** This market is determined by "cap-and-trade" rules set at the state and regional levels. Each company in a cap-and-trade program is given a specific number of carbon credits annually. Some companies emit fewer emissions than their allotted credits, creating a surplus. Others, especially those with older and less efficient operations, produce more emissions than their credits cover. These companies need to buy credits to offset their excess emissions to meet their requirements.
- **Voluntary Market:** This market is optional and involves businesses and individuals choosing to buy credits to offset their emissions voluntarily.

In the regulated market, companies under cap-and-trade programs receive carbon credits each year. Some companies produce fewer emissions than their credits, leading to a surplus. On the other hand, less efficient companies emit more than their credits cover and need to buy additional credits to comply.

Many big companies are making efforts to reduce their carbon footprint, but the credits allocated to them might not be sufficient. Some companies are years away from significant emission reductions, yet they need to operate and generate funds to improve their carbon footprint. So, they look for ways to offset their current emissions.

For example, if Company 1 is allowed to emit 300 tons of carbon but is on track for 400 tons, they can purchase credits from Company 2, which emits only 200 tons. This helps Company 1 stay within its emission limit and avoid penalties.

In summary, the regulated market is mandatory, while the voluntary market is optional, and both provide mechanisms for companies to manage their carbon emissions.

## **Overall size of carbon offset markets**

Measuring the voluntary carbon market is challenging. The cost of carbon credits, especially offsets, can vary significantly due to the perceived quality of the issuing company. Third-party validators ensure that offsets are based on real emissions reductions, but differences in types of offsets can still exist.

Although the voluntary carbon market was valued at around $400 million last year, projections estimate its value to be between $10-25 billion by 2030. This wide range depends on how determined countries are in pursuing their climate goals.

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Despite the challenges, experts agree that the voluntary carbon market is rapidly expanding. Even with this growth, the market falls short of the investment needed to fully achieve the goals set by the Paris Agreement.

## **How to produce carbon credits**

A wide range of businesses can generate and sell carbon credits by taking actions that reduce, capture, and store emissions through various processes. Different types of carbon offsetting projects include:

- **Renewable Energy Projects:** Countries with natural resources like wind, water, or sun, like Brazil, Canada, Denmark, and Germany, can harness renewable energy for power generation, creating carbon offsets along with clean energy.
- **Energy Efficiency Improvements:** Making buildings, infrastructure, and industrial processes more energy-efficient reduces power demand. Even small changes like using LED bulbs can contribute to emission reduction.
- **Carbon and Methane Capture:** Practices that capture carbon dioxide (CO2) and methane (over 20 times worse for the environment than CO2) from the air. Burning off methane converts it to less harmful CO2, while direct carbon capture from sources like chemical plants is also used.
- **Land Use and Reforestation:** Projects involving trees and soil act as natural carbon absorbers. Protecting old forests, creating new ones, and managing soil help store carbon, benefiting both ecosystems and emission reduction.

Capturing CO2 involves storing it, and while carbon capture for enhanced oil recovery has been around, long-term storage is a newer idea.

By using these methods, businesses can generate carbon credits that can be sold in the market, allowing companies to offset their emissions.

## **How companies can offset carbon emissions**

Companies have numerous options to offset carbon emissions. While not an exhaustive list, here are some popular practices that are often considered as offset projects:

- **Investing in Renewable Energy:** Funding projects that generate wind, hydro, geothermal, and solar power, or transitioning to these cleaner energy sources.
- **Enhancing Energy Efficiency:** Improving energy efficiency globally, such as providing more efficient cookstoves in rural or economically disadvantaged areas.
- **Carbon Capture and Biofuel Creation:** Capturing carbon from the air and converting it into biofuel, making the fuel source carbon-neutral.
- **Biomass Return to Soil:** After harvesting, returning biomass to the soil as mulch instead of burning it. This conserves water by reducing soil evaporation and nourishes soil microbes and earthworms, improving soil quality.
- **Forest Regrowth:** Initiating tree-planting and reforestation projects to encourage forest regrowth.
- **Transitioning to Lower-Carbon Fuels:** Adopting alternative fuel types like lower-carbon biofuels such as corn-based ethanol and biodiesel.

## **What are the benefits of carbon credits?**

Carbon credits offer several advantages for the environment, countries, and businesses.

- **Environmental Benefits:** Selling carbon credits contributes to a healthier environment by reducing carbon in the air. This is achieved through actions like tree planting or transitioning to clean energy, which prevents emissions from happening in the first place.
- **Economic Boost:** Businesses, organizations, and even nations that lower their carbon emissions can use the money saved to invest in sustainable projects. This not only helps the environment but also stimulates economic growth.
- **Positive Image:** Businesses that buy carbon credits can enhance their reputation and brand image. It shows their commitment to addressing climate change and being environmentally responsible.

## **What are the types of carbon markets?**

### **The voluntary carbon market (VCM)**

The voluntary carbon market is a place where individuals and businesses can trade carbon credits they earn for reducing, avoiding, or limiting greenhouse gas emissions. The worldwide voluntary carbon market is projected to grow steadily, with an expected yearly increase of 42.91% between 2022 and 2027. Additionally, the amount of trading in this market is anticipated to go up by 14.69% each year.

### **The regulated carbon credits market**

The regulated carbon credits market is guided by rules set by governments or international bodies. These regulations make sure that nations or regions meet their carbon reduction targets. The global market for trading regulated carbon credits is predicted to expand at a rate of 24.4% annually from 2022 to 2027. This growth is expected to transform a market valued at around $67.3 billion in 2022.

### **Where can you buy carbon credits?**

Buying carbon credits is a straightforward process that both individuals and businesses can engage in. You can purchase carbon credits from various sources worldwide, including:

- **United States:** The Western Climate Initiative, which collaborates with Quebec, offers cap-and-trade programs.
- **Europe:** The EU Emissions Trading System (EU ETS) is a big carbon market that supports cap-and-trade systems. It's the largest carbon market globally.

### **Where and how can you sell carbon credits?**

Carbon trading, also called carbon emissions trading, is when companies or others buy and sell credits that let them release a certain amount of CO2. These credits are traded on different markets, like global, national, state, and local ones.

Companies like Tesla make money by selling carbon credits to other businesses. This helps those businesses follow pollution laws and avoid fines. Big car companies, such as Stellantis, have paid Tesla over $2 billion for credits in the last two years.

As rules about carbon pollution get stricter (which is expected), more businesses will likely focus on making money from these credits.

### **Selling carbon credits can be done in three ways:**

- Direct Selling: You can sell credits directly to companies that want to buy them.
- Offsetting Organizations: Some companies specialize in creating carbon credits, like DGB Group. You can sell to them.
- Brokers: Brokers in the carbon trading market can help. They find buyers, match them with the right credits, and make deals happen.

### **What is the cost of carbon credits?**

The carbon credit market is like a marketplace where companies and investors trade carbon credits. These credits decide how much it costs to deal with carbon pollution. The price changes based on how many people want to buy them and how many are available. Usually, the price is between $40 and $80 for each metric tonne of carbon.

Even though the prices can go up or down, they're predicted to rise this year and in the years ahead.

### **What will carbon credits cost in the future?**

In February 2023, the cost of emitting carbon in the EU went up a lot, reaching a record €100 for every tonne of carbon. This is a big moment for the EU, as it shows they are serious about reducing pollution. Experts think this high cost will push companies to think about greener choices or to invest in advanced technologies like trapping and storing carbon. The cost of carbon could go even higher, around €130 per tonne, by 2030.


Carbon markets work by assigning a value to CO2 emissions and treating them as a tradeable item. There are two main types: carbon credits and carbon offsets. Both can be bought and sold on these markets. This concept offers a market-driven solution to a complex problem.

The Ultimate Guide to Understanding Carbon Credits

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