Carbon credits are a product of the cap-and-trade system. The system was established in order to help companies offset greenhouse gas (GHG) emissions. Companies can get credits for polluting and sell them for extra money. However, there are some drawbacks of the cap-and-trade system, including lack of transparency and higher risk of fraud.
There are two main markets for carbon credits. One is the voluntary market, and the other is the regulatory market. Each has its own rules and guidelines. These markets allow companies to choose how they want to participate.
In a voluntary market, credits are sold only if they meet certain criteria. These standards are designed to verify that the project provides benefits and that it achieves its objectives. They also provide an assessment of the volume and quality of the reduction. For example, a reforestation project may be subject to specific rules governing CO2 absorption. Likewise, a land use project such as soil management could follow a specific set of regulations.
Often, the price of carbon credit exchange will be affected by the geographic location of the project. Industrial projects tend to be larger-scale, while community-based projects are often smaller. Community-based projects are more expensive to certify, and they often generate more co-benefits.
Many industry sectors have joined the offsetting market. This includes oil and gas majors, airlines, and tech companies. But even though these companies produce relatively low amounts of CO2, they might be years away from being able to fully offset their carbon emissions. Consequently, they may need to look to the regulatory market to trade their excess credits.
Alternatively, the companies can purchase credits from the voluntary market. They might do so to enhance their brand image, or to prepare for upcoming environmental regulation. Voluntary markets work under international credit accounting standards and are sometimes partnered with industry-wide schemes.
Although some carbon markets have established themselves, others are still in their infancy. Examples include the Chicago Climate Exchange, the American Carbon Registry, and the Climate Action Reserve. Various standards and methodologies are used to calculate the volume of each type of carbon project. Generally, the more standardized products are preferred by financial players.
As a result of the rising demand for carbon credits, more industry sectors are participating in these markets. More are setting net-zero emission targets, and more are joining the offsetting market. Moreover, more are looking for ways to hedge their financial risks of the energy transition.
Nevertheless, the United Nations is working towards regulating the carbon credit market. A multi-stakeholder initiative aims to ensure that the voluntary carbon markets operate for the long haul. It is focusing on drafting a list of “core carbon principles” for these markets. Additionally, a high-level taskforce has been established to address integrity issues related to net-zero claims.
Carbon projects are required to provide additional social and environmental benefits. To be eligible to trade, a carbon project must meet the requirements of the UN Sustainable Development Goals (SDGs). When a project meets these standards, it can trade at a premium to other projects.