What constitutes a carbon credit and why should a business care about where they source credits from, aren’t they are all the same? No, unfortunately not.
“Voluntary carbon market investment in natural climate solutions has the potential – only if it is done right – to accelerate climate mitigation while increasing much needed finance for natural climate solutions. Doing it right means respecting the rights, land, and territories of Indigenous Peoples; supporting projects governed by Indigenous Peoples and local communities while increasing finance for community conservations; and ensuring gender, social, and environmental standards.”
– Hindou Ibrahim – Founder of the Association for Indigenous Women and Peoples of Chad (AFPAT)
In 2015, near to 200 countries around the world agreed to limit global warming to well under 2 degrees Celsius (3.6 F) compared with preindustrial times, with a goal of 1.5 C (2.7 F). Reaching the 1.5-degree target requires that by 2030, current global greenhouse-gas (GHG) emissions are cut by 50 percent and by 2050, are reduced to net-zero.
To meet net-zero, companies need to significantly reduce their emissions while also measuring and reporting progress, in order to achieve the transparency and accountability that investors and stakeholders increasingly want. Thus, ‘net-zero’ has become a popular way for businesses to demonstrate their commitment to climate action.
Over 30% of the 2,000 largest publicly traded companies in the world (by revenue) have promised to achieve net-zero by mid-century. For some however, it may be too expensive to reduce emissions using today’s technologies and for others, certain sources of emissions cannot simply be eliminated from their products and services. For many, it will be necessary to use carbon credits to offset emissions they can’t get rid of by other means.
So what constitutes a carbon credit and why should a business care about where they source credits from, aren’t they are all the same? No, unfortunately not. The source of how and where credits are generated can be markedly different. Indeed, reporting the purchase of certain credits could be detrimental to relations with stakeholders and would be investors.
What is a Carbon Credit & what is the Voluntary Carbon Market?
A carbon credit is a tradable unit that represents one ton of GHG emission reductions or removals. Carbon credits are purchased by companies, individuals and other entities to offset GHG emissions or otherwise contribute to emissions abatement.
The voluntary carbon market (VCM) is where private individuals and corporations buy and sell carbon credits outside of regulated or mandatory carbon pricing instruments. The VCM provides a platform for private sector finance to help initiate activities that remove GHG emissions from the atmosphere or reduce GHG emissions associated with industry, transportation, energy and buildings as well as Agriculture, Forestry, and Other Land Use (AFOLU).
Carbon credits in the VCM are used to voluntarily offset GHG emissions beyond any offsetting mandated by policy. Carbon credits may also be purchased and retired without offsetting, which drives reductions in overall GHG emissions and may enable buyers to claim other social and environmental contributions,. We will come on to this.
What constitutes a high-quality carbon credit?
High-quality carbon credits are generated from well designed, high-quality projects and programmes that are appropriately monitored and aligned with all carbon standard requirements. Policy alignment ensures that VCM activities are filling the gap to implement mitigation activities that are not (yet) required by regulation or financially supported by the host country1.
High quality carbon credits also stem from projects and programmes that follow safeguards to ensure VCM initiatives adequately address issues such as the rights of Indigenous Peoples and Local Communities (IPLCs), social participation and preservation of ecosystems. Safeguards are put in place by carbon standards and in some cases, by host country governments.
High-quality carbon credits are quantified based on credible and conservative calculations of the following: 1) baselines, 2) additionality, 3) leakage, and 4) permanence.
Baselines. Every project needs to determine what its emissions would have been if the project was not implemented. These are called baseline emissions. The number of credits a project receives is then calculated by subtracting the project emissions from the baseline emissions. In order to prevent project developers artificially increasing baseline emissions to get more credits, it was agreed at COP26 that Article 6.4 of the Paris Agreement would tighten baseline setting calculations below a business as usual’ scenario, to ensure contribution towards the host country’s carbon reduction goals2.
Additionality means that GHG emission reductions and removals associated with carbon credits would not have taken place without incentives provided by projects. One or more of the following would have been in play: finance (carbon finance), technology (equipment or infrastructure provided by the VCM activity), environmental/ecological interventions, changes to governance and/or local/social practices. Demonstrating and verifying additionality is vital but can be difficult to determine exactly how finance, technology, laws, or local practices would have changed in a counterfactual without-project scenario3.
Certain investments that reduce emissions are made simply because they are profitable, without consideration of carbon credits. For example, energy-saving lighting can pay for itself through avoided energy costs. Renewable energy technologies, like wind and solar, are increasingly cost-competitive with fossil fuels, without revenue from carbon offset sales. For a project to be additional, the possibility to sell carbon credits must play a “make or break” role in the project economics.
Leakage refers to ensuring that VCM activity avoids unintended GHG emissions increase or the shifting of emissions from one place to another. As an example, the Mikoko Pamoja project in Kenya is a community that has avoided leakage by planting pine trees outside of the mangrove project site. This provides the community with an alternative source of wood ensuring that protecting a mangrove forest in one place does not lead to mangrove deforestation elsewhere4.
Leakage should be prevented by managing, quantifying, accounting for and compensating displacements. It can be largely controlled through project design, however leakage triggered by policy interventions is more complex and harder to manage.
Permanence ensures that each carbon credit generated represents a long-term climate benefit, often defined as 100 years. Projects must mitigate the risk that in the future, GHG emission reductions or removals are not reversed due to certain events (i.e. natural disasters, climate changes or human activities). The risk of impermanence is often managed through mandatory buffer accounts: projects and programmes set aside a portion of their credits in a buffer pool, from which credits are subtracted to compensate when reversals of carbon storage occur. Permanence is primarily relevant for nature-based credits or carbon storage technologies.
Increasing quality through adoption of the United Nations Sustainable Development Goals
Carbon credit projects are increasingly associated with broader United Nations Sustainable Development Goals (SDGs), a collection of 17 interlinked global goals set up in 2015 by the United Nations General Assembly (UN-GA) designed to be a “blueprint to achieve a better and more sustainable future for all” (REF).
SDGs are a promising framework for reinforcing an offset project’s credentials. Adding UN SDG “co-benefits” to carbon credit projects gives market participants a way to report and bolster their sustainability credentials, in addition to adding a premium to the credits sold.
Based on recently reported trades by Ecosystem Marketplace Respondents, projects with accompanying co-benefits have fetched more than double a higher average weighted price than projects without.
Co-benefits can be defined as any positive impacts, other than direct GHG emissions mitigation, resulting from carbon offset projects (i.e. additional social and environmental benefits, improved welfare for the local population, better water quality, or the reduction of economic inequality)5.
However, given that the VCM is still an emerging market, up until recently carbon credit buyers could only estimate how much a given offset project contributed to the UN SDGs. A significant amount of overstated, so called ‘SDG-washing’ in the market has occurred. Thankfully the likes of Verra and Gold Standard, both major certification bodies in the VCM, have designed tools for the measurement of co-benefits, partnering with the UNFCCC Secretariat to help guide organizations towards meaningful, measurable and credible SDG impactful projects.
Gold Standard has what it calls “Gold Standard for the Global Goals” which focuses on the development and provision of a set of tools to quantify and report on the objectives of sustainable development of climate actions, including adaptability and resilience.
Women’s Role in Climate Change & Carbon Credits
Women play an essential role in addressing climate change and ensuring community resiliency. Empowering women is a critical strategy for improving outcomes of climate projects, but their contributions are often not accounted for and very limited climate finance reaches women at the local level, if at all.
In 2020, Verra, W+ Standard, and Wonderbag of South Africa announced the application of the joint VCS/W+ Standard certification process to measure emission reductions and women’s empowerment results. Buyers of W+-labeled carbon credits will be able to demonstrate that they contribute to both SDG 13 (Climate Action) and SDG 5 (Gender Equality) by providing women with financial resources that compensate them for their contributions to climate adaptation and mitigation, enabling them to improve their livelihoods6.
As these tools are taken up by the market, the hope is that demand for co-benefits will increase and development impact will become a central aspect to high quality credits in the market place.
Examples of high-quality carbon credit projects
There are many projects providing very high quality credits in the marketplace. The following examples highlight just two, one from each of the major certification bodies in the VCM:
- In 2019 Gold Standard introduced clean borehole technologies with the use of carbon finance to the people of Lango in Uganda. The Lango Safe Water Project reduces GHG emissions by eliminating the need to boil water, freeing up an average of two hours a day for local women who would previously trek to rivers and streams filling buckets of water and gathering wood to boil away impurities. Female empowerment is one of the many “co-benefits” associated with carbon projects. Similar to the emissions reduced or carbon removed, co-benefits and their contribution to sustainable development can be quantified in a similar way – I.e. as in the above Lango Project which significantly benefited the daily lives of local women – two hours saved per day7.
- The Rimba Raya Biodiversity Reserve Project, is a 64,500-hectare peat swamp in Central Kalimantan, a province of Indonesia. It’s the world’s largest privately funded orangutan sanctuary and the first project to register to Verra’s SD VISta program. Developed and maintained by InfiniteEARTH, a leading developer of tropical conservation land banks and REDD+ carbon credit supplier, Rimba Raya works on avoiding the destruction of forest representing more than 130 million tonnes of carbon. Its livelihood programs in surrounding villages advance all 17 UN Sustainable Development Goals (SDGs). These programs provide education, employment and hope for the future while increasing the standard of living and promoting gender equality8.
Ensuring the integrity and future of the VCM
Several factors impede the growth of the voluntary carbon market. There is a view that it allows polluters to pay their way out of excessive emission production, scepticism of the value and credibility of projects, as well as the lack of transparency and standardisation in the market. Add to that the lack of definition around the co-benefits (such as community economic development and biodiversity protection) a project or program can provide.
It is unfortunate that the verification step for establishing new credits can take months if not years to hurdle through. The very process which helps maintain the market’s integrity can sometimes deter project developers and financial institutions from getting involved in either trading or financing eligible carbon credit projects. In addition, when selling credits, suppliers face unpredictable demand and can seldom fetch economical prices. Overall, the market is characterized by low liquidity, scarce financing, inadequate risk-management services and limited data availability.
However, the future of the VCM is far from doom and gloom, indeed there’s mounting optimism and depending on which source you believe, the VCM is set to grow rapidly. The Bank of America Global Research report projected that the global carbon offset market to expand by 50 times by 2050. In order to see this type of growth, changes in regulation and governance need to occur. The formation of initiatives such as the Taskforce on Scaling Voluntary Carbon Markets (TSVCM) and the Voluntary Carbon Markets Integrity Initiative (VCMI) launched in 2020 and 2021 respectively are working to scale and improve the market’s transparency and credibility9.
In September 2021 the TSVCM announced the formation of an independent governance body whose aim is to set a global benchmark in proving the social value and carbon reduction potential of carbon credits and offsetting. The governance body’s first priority is to review and finalize the Core Carbon Principles (CCPs), a set of threshold standards that will set a global benchmark for carbon credit quality.
The VCMI, co-funded by the UK Government and Children’s Investment Fund Foundation, aims to ensure carbon offsets stem from high-integrity projects that benefit local communities and Indigenous Peoples. Projects help developing countries access climate finance and that businesses who use carbon credits do so not to displace or delay science-based action on decarbonisation but to go above and beyond their offsetting requirements.
In addition to improvements in standardisation and governance, technology can also play a part in adding transparency and integrity to the VCM. For example, the involvement of blockchain into the process of verification will allow the verification entity and investor to track a project’s impact at regular intervals, not just at the end. A process of using blockchain could lower issuance costs, shorten payment terms, accelerate credit issuance and cash flow for project developers, allow credits to be traced and improve the credibility of corporate claims related to the use of offsets.
Nearly 200 nations agreed to adopt the Glasgow Climate Pact at COP26 in November 2021, a pact that finally saw negotiators agree terms of the ‘Paris Rulebook’ which included Article 6.2 and Article 6.4 for the international trade of carbon credits.
Article 6.2 establishes rules for bilateral trade of carbon offsets between countries, introducing “corresponding adjustments” of carbon credits to prevent double-counting of climate reductions by buyers and sellers. Article 6.4, establishes a framework of transparency and reporting requirements for the international trade of carbon credits, including a supervisory body to monitor the reduction in carbon emissions of a transaction and ensure trades do not have other damaging environmental consequences.
The Glasgow Climate Pact will force an increase in the standardization and transparency of carbon credits, leading to standardization on carbon credit price (at least within project types) and further development of credit trading platforms and exchanges. Generating a standardized set of credit validation and trading rules will reduce fragmentation among the current voluntary carbon credit registries and facilitate more exchange-based and secondary market transactions.
The VCM may have had a chequered past and whilst there will always be those that try and make a quick buck through ignoring standards and protocols, the more educated the private sector becomes in the difference between sub-standard and high quality carbon credits, the quicker we’ll see the VCM making inroads into the overall global goal of mitigating climate change and contributing to a healthier environment and society.
“To be clear: companies’ primary responsibility is to reduce absolute emissions. But while on the trajectory to net zero they should use high-integrity credits to compensate for their emissions. At present, the market for carbon credits is small, fragmented, and of uneven quality. This market could grow to over $150 billion a year and facilitate major cross-border capital flows, as the vast majority of high-emission-reduction projects will be in emerging market and developing economies, with significant potential co-benefits for biodiversity and other UN Sustainable Development Goals.”
– Mark Carney – Clean and Green Finance – A new sustainable financial system can secure a net zero future for the world.
1. The Voluntary Carbon Market Explained (VCM Primer – https://vcmprimer.org/) by Charlotte Streck, Melaina Dyck and Danick Trouwloon, December 2021.
2. Carbon Brief. In-depth Q&A: How ‘Article 6’ carbon markets could ‘make or break’ the Paris Agreement – https://www.carbonbrief.org/in-depth-q-and-a-how-article-6-carbon-markets-could-make-or-break-the-paris-agreement
3. What makes a high-quality carbon credit? Phase 1 of the “Carbon Credit Guidance for Buyers”. June 2020. WWF-US, EDF and Oeko-Institute – https://c402277.ssl.cf1.rackcdn.com/publications/1342/files/original/What_Makes_a_High-quality_Carbon_Credit.pdf?1591405169
4. Keys to successful blue carbon projects: Lessons learned from global case studies. Lindsay Wylie, Ariana Sutton-Grier, Amber Moore. Marine Policy. 2016 Volume 65, P 76-84. https://www.sciencedirect.com/science/article/pii/S0308597X15003905
5. Second Nature. Co-Benefits of Carbon Offset Projects: Information for Carbon Offset Procurement. https://secondnature.org/wp-content/uploads/Co-Benefits-Document-Rev5.pdf
6. 2020 – Stepping Up for Climate Action and Women’s Empowerment: Webinar – https://verra.org/stepping-up-for-climate-action-and-womens-empowerment-webinar-10-september/
7. What’s in a carbon credit? New tools help quantify the sustainable development benefits of carbon offset projects – Kim Myers – https://www.ecosystemmarketplace.com/articles/whats-in-a-carbon-credit-new-tools-help-quantify-the-sustainable-development-benefits-of-carbon-offset-projects/
8. Rimba Raya Becomes First Registered SD VISta Project. 2020 – https://verra.org/rimba-raya-becomes-first-registered-sd-vista-project/
9. A blueprint for scaling voluntary carbon markets to meet the climate challenge – 2021. https://www.mckinsey.com/business-functions/sustainability/our-insights/a-blueprint-for-scaling-voluntary-carbon-markets-to-meet-the-climate-challenge