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You’ve likely come across the term “carbon credits” in various contexts—whether in news about climate change, corporate sustainability reports, or government policies. As companies and countries grapple with the urgent need to reduce greenhouse gas emissions, carbon credits are increasingly becoming a vital tool in the fight against global warming.
Carbon credits are a way for organizations to offset their emissions by investing in projects that reduce or remove carbon from the atmosphere. This concept has become particularly significant in the ESG (Environmental, Social, and Governance) space, where businesses are under pressure to demonstrate environmental responsibility.
The market for carbon credits is growing rapidly. According to McKinsey, the global demand for carbon credits could increase by a factor of 15 by 2030 [1], with the voluntary carbon market alone potentially reaching $50 billion in value. As the focus on reducing emissions intensifies, both voluntary and regulatory markets for carbon credits are drawing more attention worldwide.
In this article, we’ll break down what carbon credits are, explore the types of markets that drive their trade, and examine how they impact ESG reporting.
What Are Carbon Credits?
Carbon credits represent a way for companies and individuals to offset their carbon emissions by investing in environmental projects. Essentially, each carbon credit equates to the reduction, removal, or avoidance of one metric ton of carbon dioxide (CO2) or equivalent greenhouse gases from the atmosphere. This mechanism allows businesses, especially those in carbon-intensive industries, to balance out their emissions and contribute to climate change mitigation. [2]
Types of Carbon Credits
Carbon Reduction Credits
Carbon reduction credits are issued when actions are taken to decrease greenhouse gas emissions compared to prior practices. This is typically achieved through improvements in technology or processes. For example, a company might invest in more efficient energy systems or implement methane capture at landfills. These actions reduce the total volume of emissions released into the atmosphere. Approximately 22% of the carbon credits in the voluntary carbon market fall into this category.
However, tracking and measuring reductions can be challenging. While efficiency projects are easier to quantify, more complex projects, like low-emission cookstoves in developing regions, require careful monitoring. These challenges sometimes result in over-crediting, where more credits are issued than the actual emissions reduced.
Carbon Removal Credits
Carbon removal credits are issued when CO2 is physically removed from the atmosphere and stored for long periods. These projects range from nature-based solutions like reforestation to engineered solutions such as direct air capture. Although carbon removal projects make up only about 3% of the carbon credits available today, they are seen as essential to reaching net-zero emissions.
The durability of these projects is a key consideration. Engineered solutions often offer high durability, with carbon stored for hundreds of years, whereas nature-based solutions, like tree planting, are vulnerable to factors such as deforestation or wildfires, meaning the carbon could be re-released into the atmosphere.
Carbon Avoidance Credits
Carbon avoidance credits are generated by actions that prevent the release of carbon emissions. For instance, protecting a forest from deforestation can avoid the emissions that would have been generated had the forest been cleared. These credits make up the largest portion of the market, at roughly 75%. However, avoidance credits face challenges due to the uncertainty of establishing accurate baselines—estimating what would have happened without the project in place. Advanced data and modeling techniques are helping improve accuracy, but some uncertainty remains. [3]
The Two Types of Carbon Markets
Carbon credits are traded within two distinct markets: the Voluntary Carbon Market (VCM) and the Compliance or Mandatory Carbon Market. Each serves a different purpose and caters to different participants, though both play a crucial role in global emissions reduction efforts.
Voluntary Carbon Market (VCM)
Overview:
The Voluntary Carbon Market allows companies, organizations, and individuals to purchase carbon credits on a voluntary basis, typically to offset their carbon footprint. Unlike the mandatory market, participation in the VCM is not driven by government regulations but by the desire to meet corporate sustainability targets, strengthen brand image, or demonstrate commitment to environmental responsibility. Many corporations use the VCM to enhance their ESG (Environmental, Social, and Governance) credentials.
Market Participants:
Buyers in the VCM include corporations across various sectors, NGOs, and even individuals seeking to offset their personal carbon emissions. Major corporations often lead this charge, using credits as part of their broader sustainability strategies. For example, companies with ambitious net-zero targets may purchase credits to balance emissions they can’t immediately eliminate through direct reductions.
Project Types:
The VCM supports a wide range of projects aimed at reducing or removing carbon from the atmosphere. Common projects include investments in renewable energy, reforestation and afforestation, methane capture, and energy efficiency improvements. Nature-based solutions, like forest preservation or peatland restoration, are particularly popular, given their dual benefits of carbon sequestration and biodiversity conservation.
Challenges and Opportunities:
One of the major challenges facing the VCM is the credibility of credits. Ensuring that the credits represent real, additional, and verifiable emissions reductions is critical. Pricing in the VCM can also vary significantly, which can create uncertainty for buyers. Despite these challenges, the VCM is growing, with increased attention on improving verification processes and transparency, which presents significant opportunities for scaling up the market.
Compliance or Mandatory Carbon Market
Overview:
The Compliance or Mandatory Carbon Market is regulated by governments and requires companies to purchase carbon credits to comply with emissions caps set by regulations. These markets are primarily driven by cap-and-trade programs, where governments limit the total amount of emissions that industries can produce. Companies that exceed their emission limits must purchase credits from those who have emitted less, creating an economic incentive for companies to reduce their carbon footprint.
Cap-and-Trade Programs:
Cap-and-trade systems are a cornerstone of many compliance markets. Programs like the European Union Emissions Trading System (EU ETS) and California’s Cap-and-Trade Program are prime examples. In these systems, governments set a “cap” on total emissions and distribute or auction allowances to companies. If a company exceeds its allotted emissions, it must buy additional allowances from others or face penalties.
Regulatory Framework:
Governments regulate compliance markets by setting strict rules for how carbon credits are issued, traded, and retired. Businesses in sectors like energy, manufacturing, and transportation are most affected by these regulations, and failure to comply often results in hefty fines. As global pressure mounts to combat climate change, many governments are tightening these regulations, driving up the demand for compliance credits.
Market Trends and Growth:
The compliance carbon market is expanding rapidly as more governments introduce or expand carbon pricing mechanisms. For instance, the EU ETS has seen a steady rise in credit prices, reflecting the increasing regulatory pressure on companies to curb emissions. This market growth underscores the critical role of regulatory frameworks in driving corporate behavior and reducing overall emissions.
How Carbon Credits Impact ESG Reporting
Carbon credits are becoming an essential part of ESG (Environmental, Social, and Governance) reporting, particularly for industries with significant carbon footprints. As pressure mounts for businesses to demonstrate environmental responsibility, incorporating carbon credits into ESG reports helps showcase efforts to offset emissions and align with sustainability goals.
ESG Reporting Requirements
Many ESG frameworks now encourage or mandate companies to disclose their use of carbon credits, especially in carbon-intensive sectors like energy, manufacturing, and transportation. These credits allow companies to demonstrate their commitment to reducing emissions while adhering to the reporting guidelines of frameworks like the Global Reporting Initiative (GRI) and the Task Force on Climate-Related Financial Disclosures (TCFD).
Transparency & Verification
One of the critical challenges in ESG reporting is ensuring transparency. To maintain credibility, companies must ensure that their carbon credits are verified by third-party organizations. Verified credits help establish the authenticity of emissions reductions or removals, ensuring that businesses are not inflating their environmental achievements. Accurate carbon accounting is essential in this process, as it tracks emissions reductions and helps prevent greenwashing.
Role in Net-Zero Goals
Carbon credits are instrumental in helping companies meet their net-zero commitments. Many businesses, unable to fully eliminate their emissions in the short term, rely on purchasing carbon credits to offset their residual emissions. This strategy allows them to continue their operations while working toward long-term sustainability goals. Incorporating carbon credits into ESG reporting enables companies to transparently track progress toward net-zero while maintaining accountability.
결론
Carbon credits play a pivotal role in global efforts to combat climate change, offering a practical solution for offsetting emissions. Whether in the voluntary or mandatory markets, carbon credits enable businesses and individuals to take responsibility for their carbon footprints and contribute to a more sustainable future. The voluntary carbon market allows companies to meet internal ESG goals, while the compliance market ensures that industries adhere to government regulations through cap-and-trade systems. Both markets face challenges, but their growth underscores the increasing global emphasis on emissions reduction.
In addition to reducing emissions, carbon credits are integral to achieving corporate net-zero goals and fulfilling ESG reporting requirements. However, transparency and proper carbon accounting are critical to maintaining credibility. As more companies adopt carbon credit strategies, ensuring accurate reporting and third-party verification is essential for demonstrating true climate impact.
At Seneca ESG, we provide AI-powered tools that streamline carbon accounting and help businesses develop effective strategies for achieving carbon neutrality. Our solutions make it easier to track emissions, manage carbon credits, and report progress with confidence. As regulatory pressures increase and businesses strive to meet sustainability goals, leveraging advanced technology is crucial for staying ahead.
If you’re ready to take control of your carbon strategy, contact Seneca ESG today to learn how our solutions can help you navigate the complexities of carbon credits and ensure your business is on track to meet its environmental targets.
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[2] https://offsetguide.org/understanding-carbon-offsets/what-is-a-carbon-offset/
