Carbon credits are tradable units of one ton of carbon dioxide equivalent that companies can purchase in order to offset their own emissions. These carbon credits are generated by different types of sustainable projects that either reduce, remove, or avoid greenhouse gas (GHG) emissions. They are then verified by a third party, such as Gold Standard, and can be sold to companies that wish to reduce their emissions or to individuals who want to invest in climate action projects.
Proponents of the system say that it leads to measurable, verifiable emission reductions from certified climate action projects. It also provides a monetary incentive for businesses to reduce their emissions, as doing so makes the company more competitive by lowering the cost of operating within the emissions cap that is being set by regulators.
As with any marketplace, there are problems in the voluntary carbon market that impede growth and make the industry vulnerable to fraud, manipulation, and money laundering. For example, it is not uncommon for the price of a credit to rise or fall based on a variety of attributes that are added during the verification process. These attribute-driven prices are not a result of environmental benefits, but rather the market’s demand and supply for a specific type of credit.
A key problem in the carbon market is the difficulty of matching buyers and sellers of credits. This is due to the highly heterogeneous nature of a carbon credit, which can have numerous additional attributes. As a result, buyers often do not value the same attributes as suppliers, which creates a mismatched supply and demand. This can result in a large discrepancy between the price of a credit and its actual economic value.
In addition, many of the existing markets for carbon.credit exchange have flaws that undermine their credibility. For example, in tightly regulated programs such as California’s, the amount of carbon credits that can be sold is limited. If a company exceeds the limit, it must buy extra credits from the state to stay within the cap. This can result in companies overpaying for credits, which may then be used to commit environmental fraud and launder money.
Moreover, the price of carbon credits often does not accurately reflect their genuine environmental impact, as the values ascribed to them are too variable and subjective. For example, the varying valuation of community-based clean cookstoves projects with a variety of beyond-carbon benefits has led to a large discrepancy between average historical carbon credit prices and their economic value.
To address these issues, it is important that standards-setting organizations, financial institutions, market-infrastructure providers, and other constituencies work together to create a more credible carbon credit market. This should include developing a more rigorous framework for quantifying and linking the climate impact of a project to its price. It should also establish a more efficient, transparent, and secure carbon-credit-trading process that allows all parties to track and verify a project’s impacts at regular intervals.