Carbon credits Scientists are saying a perfect storm of all-time-high temperatures, ocean heat, and sea ice in the Antarctic is accelerating the pace of climate change like never before, leaving the earth more vulnerable than ever to global warming. Fighting climate change takes the cooperation of individuals, businesses, and organizations from around the globe.
Just as climate change surfaces in different ways, including four climate records that have already been smashed this summer, there’s more than one way to fight it. One effective strategy to slash carbon emissions is through carbon credits and offsets, both of which are products designed to help the world meet climate challenge goals. Carbon credits and offsets are weapons being used to bring the world closer to net-zero carbon emissions by 2050, a goal set forth by the UN’s Paris Agreement.
The carbon marketplace is one that’s growing hand over fist. For example, the demand for carbon credits is expected to grow by a factor of 15 or more by the coming decade and by as much as 100 by 2050, catapulting the market value to a potential $50 billion by then, according to consulting firm McKinsey.
Meanwhile, the voluntary carbon-offset market was valued at $2 billion as of 2020 and is expected to balloon to $250 billion in the coming decades. Nevertheless, there’s still some confusion surrounding the carbon credits and offsets markets, something we will seek to bring clarity to in this article.
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Carbon credits are markets-based assets akin to permission slips for carbon emissions. They can be purchased by governments, companies, or other organizations to receive the environmental green light to produce one ton of carbon emissions, aka CO2e. They’re made to help these entities reduce their carbon emissions and reach climate-related milestones.
For context, the average person leaves an annual carbon footprint of 16 tons of CO2e just by living their everyday lives, including driving, shopping, consuming energy, etc. They are meant to offset the carbon emissions that individuals and organizations can’t remove through changes in behavior.
Carbon credits create an economy of their own, flowing vertically. Funds go from entities to regulators, which in turn offload their carbon credits surplus to other businesses, continuing the cycle. Carbon credits have incentivized the reduction of carbon emissions. If done correctly, carbon credits have the potential to cut carbon emissions in the atmosphere in half by the year 2030.
The voluntary carbon credit trading markets are the result of what’s known as the Kyoto Protocol from the 1990s. Later, the Paris Agreement materialized, thrusting climate change mitigation and carbon credit trading further into the spotlight. The result of Kyoto and Paris was the international carbon markets for trading.
In the U.S., the state of California’s economy is so massive it oversees its own carbon trading market. Credits are distributed to residents a couple of times a year on their energy bills. By 2030, California is seeking to shrink its carbon footprint to 40% below its 1990 size.
Carbon credits and credit offsets are similar in purpose, but there are certain nuances between the two concepts. Carbon offsets are 1 metric ton of greenhouse gases, usually carbon, that’s either been prevented or removed from the environment. Wind and solar projects are perfect examples, as they lessen the need for the development of energy using dirty fossil fuels.
While carbon credits flow in a vertical fashion, carbon offsets flow horizontally. Think of carbon offsets as carbon revenue that’s traded among companies. As one business eliminates a unit of carbon from the environment throughout their daily operations, the result is a single carbon offset. This carbon offset can then be bought by other businesses that are seeking to move closer to net zero carbon emissions. Whether you are talking about carbon credits or offsets, the asset that is traded always amounts to a single ton of carbon emissions.
There’s no shortage of ways in which carbon credit and offset projects could be applied, whether it’s in renewable energy, the capture of methane, or reforestation.
Renewable Energy: Wind and solar projects are solid examples of how the renewable energy market can support carbon credits and offsets. Developers of renewable energy projects are increasingly showing an interest in generating another stream of revenue through the sale of carbon credits to other entities. Wind and solar projects are known to produce what’s called avoidance offsets, which are the result of activities that prevent the creation of carbon emissions altogether.
Methane Capture: Methane is another major contributor to climate change, alongside carbon. As a result, methane capture is a growing way to fight climate change and participate in the carbon offsets market. Methane emissions are generated in sectors like agriculture, energy, and waste/landfills. Market participants can find numerous carbon-offsetting opportunities in projects related to these industries. The goal is to reduce the release of methane gas using technologies that burn the gas or consume it so that it never makes its way into the atmosphere.
Reforestation: Through reforestation, where trees are planted to replenish forests, governments and businesses issue carbon credits to counteract the emissions that are produced as a result of these activities. Plus, the planting of trees is a proactive step that helps to lower greenhouse emissions by strengthening tree density in the forest.
Agricultural soil carbon credits have been recognized as a cornerstone of sustainable and regenerative agriculture practices. By diving deeper into the methodologies and findings presented in the Environmental Defense Fund’s synthesis on agricultural soil carbon credits protocols, the importance and efficacy of regenerative agriculture in carbon sequestration become clear.
Regenerative agriculture isn’t just about rejuvenating the soil; it’s an advanced methodology emphasizing holistic practices to enhance soil health, increase biodiversity, and boost ecosystem resiliency. Unlike conventional farming practices, regenerative agriculture prioritizes techniques that actively renew soil health. These techniques include no-till farming, cover cropping, agroforestry, and integrated livestock management. Such practices ensure fertile and resilient soil and enhance its organic content, which subsequently acts as an active carbon storage mechanism.
The EDF’s synthesis underscores that soils when managed sustainably, possess the immense capacity to act as carbon sinks. Regenerative agriculture plays into this by enriching the soil’s organic matter, increasing its potential to store substantial volumes of carbon dioxide. This potential makes agricultural soil a formidable ally against rising global carbon levels.
However, for this potential to be realized and for farmers to adopt regenerative practices at scale, they need tangible incentives. Enter agricultural soil carbon credits. As detailed in the EDF’s synthesis, landowners and agriculturists who integrate regenerative practices can earn carbon credits. These credits, in turn, represent the tangible amount of carbon they help sequester, establishing a clear financial motive for choosing sustainable farming methods. This alignment of economic and environmental incentives can foster rapid adoption and generate broader benefits, such as improved food production and enhanced ecosystem health.
Incorporating agricultural soil carbon credits into the broader carbon credits and offsets discourse promotes a multidimensional approach to climate change mitigation. It recognizes the immense value that regenerative agricultural practices bring, both in terms of carbon sequestration and broader environmental and societal benefits. As the global community strives for effective and sustainable solutions, integrating regenerative agriculture backed by a robust carbon credit system offers a promising pathway forward.
Carbon credits and offsets offer a host of benefits both to the environment and to stakeholders, including investors. The top three benefits are environmental, societal, and economic.
The greatest environmental impact is the reduction of greenhouse gases in the environment. Carbon offsets are associated with projects that prevent or capture greenhouse gases, stopping them from entering the atmosphere. They help organizations prioritize sustainability and implement responsible behaviors aimed at fighting climate change.
In addition, as businesses and other organizations identify their mission statements, sustainability goals are increasingly being reflected there. This practice tends to lead to the creation of other opportunities, including more jobs, sustainable-focused projects, the protection of biodiversity, better health, and more.
Another benefit of carbon credits and offsets is the economic opportunity and market incentives that lead to more projects and other activities targeting the removal of carbon emissions. The sale of carbon offsets can also help businesses or entire governments to finance the addition of technology and other systems used to implement more sustainable practices in the first place, creating a win/win.
For the carbon credits and offsets trading markets to reach their full potential, there needs to be a jump in the number of climate-related projects as well as greater participation among stakeholders. Much of the activity is currently unfolding in a few select regions because of the risks involved, chief among which is financing.
For example, there’s a prolonged delay from an original investment to when the sale of carbon credits actually generates revenue, dampening the reward time for backers. As these risks are addressed and diminish, the market should benefit from a drop in carbon credit supply coupled with strengthening demand.
Strong-quality carbon credits are also hard to come by as a function of a patchwork approach to the verification process and a lack of a formal classification system. Verifying carbon credits is essential, and it can be a long, drawn-out process for suppliers. Then, when it comes time to sell them, demand tends to fluctuate, making it difficult for sellers to achieve pricing power.
Another issue is the potential for “over-crediting,” a phenomenon in which carbon credits over-project the offset potential of the credit instrument. Or businesses might use carbon credits and offsets as a smokescreen to sidestep having to take proactive steps toward shrinking their carbon footprints on their own.
The carbon credits market needs greater liquidity, better access to financing, and stronger risk mitigation practices. While it might seem like an uphill battle, these challenges can be overcome with more precise demand predictors — paving the way for greater investment — and the ongoing development of the voluntary carbon market.
There are two different types of markets around carbon credits — voluntary and compliance. Trading in both markets, voluntary and compliant, has been gaining momentum.
As the name suggests, voluntary markets are those in which participants choose to offset their carbon footprints with carbon offsets because of their commitment to the environment. These entities are not forced to do so by any rules or regulations. Carbon credits can be traded in the voluntary carbon market.
Meanwhile, there’s also a regulated carbon marketplace involving a cap-and-trade system. In this market, businesses participating in the program receive a certain number of credits annually tied to their carbon output. If they produce fewer emissions than allotted through the credits, they end the year with a surplus of credits that they can sell. But if their carbon output surpasses that of the credit allotment, they will be looking to buy more carbon credits.
If an investor wants to gain exposure to carbon credits and offsets, there’s no shortage of ways to do it. One way is to participate in the cap-and-trade program, which varies from industry to industry. By reducing one’s own carbon footprint, companies can then offload their carbon credit surplus to other companies for a profit.
Investors can also gain exposure to the carbon marketplace through carbon-focused exchange-traded funds (ETFs). These ETFs are comprised of carbon credit futures, the underlying asset for which carbon credit certificates. Carbon credit futures are known to be issued by the European Union and the state of California.
Carbon credits and offsets are unique to one another, but each instrument represents one metric ton of greenhouse gases that may be released into the atmosphere. They are generally used for trading, while carbon offsets are minted when projects involving activities such as renewable energy and deforestation avoid carbon emissions that would otherwise be created.
The carbon credit and offset market has been around for decades. However, it’s become a more mature marketplace in recent years, through the rise of activities like trading. Companies looking to participate in the carbon trading marketplace either through sustainable projects or the purchase of carbon offsets have multiple ways in which they can get involved. Investors are also coming off the sidelines as the risks around carbon trading, such as a lack of liquidity, are addressed.
Demand for carbon credits and offsetting is expected to increase substantially in the coming years, helping to bring the world closer to carbon neutrality by 2050, a goal outlined by the Paris Agreement.