Carbon Credits

A carbon credit is a financial instrument representing a reduction or removal of carbon dioxide and other greenhouse gas emissions. Credits are traded in the voluntary market and in some regulatory environments that include cap-and-trade programs. One credit is equal to one metric ton of avoided or removed emissions, and it can be used to offset another entity’s emissions.

The primary market participants in the carbon.credit arena are businesses that have a large enough footprint to be required to offset some or all of their emissions through purchasing credit. The second tier of participants are the project developers that produce the credits, and they do so through a variety of methodologies. The third tier includes the brokers and traders that connect the project developers to end buyers, charging a commission. The fourth tier is the standards organizations that define and audit the projects and their methodologies to ensure that each project meets certain specifications. Some of the most well-known standards organizations include Verra, Gold Standard and the American Carbon Registry.

As the climate changes, governments and private companies have moved to reduce their carbon footprint. Some have been forced to do so by regulators through mandatory emissions trading programs. Other companies have voluntarily agreed to do so as part of a broader corporate social responsibility initiative. In either case, the companies have to compensate for the emissions they cannot avoid — known as’residual’ emissions — and most choose to do so by buying carbon credits.

Carbon Credits Commodities

While the concept behind carbon credits is simple, the market that supports them is complex. A key player is the exchange, which is a platform where buyers and sellers can buy and sell carbon credits. In the regulated environment, the exchanges must follow a number of rules to protect the integrity of the market.

Traders and brokers often make up a significant portion of the trading volume in the carbon markets, with some exchanges creating standardized products for forward delivery (the year the credits are available to be purchased). Credits that trade under these branded labels such as CBL’s Nature-based Global Emission Offset or ACX’s Global Nature Token, for example, have specific vintages and a certification from a particular standards organization that limit their buyers.

Other market players include project developers, which generate the credits in the first place; they can be nature-based, such as reforestation and afforestation projects, or tech-based, such as carbon capture and storage (CCS) technology. Each type of project produces a different type of credit, and each has its own methodology for calculating its reductions or removals. Some projects generate additional ‘co-benefits’ in addition to their GHG offset potential, and these can drive an additional premium in the market.

The final pillar of the carbon credits marketplace is the end buyer, which can be a company or even an individual consumer. As a general rule, the end-buyers want to purchase credits with a fairly recent vintage and a certification from a recognized standard.