Key Questions on Carbon Markets
What is a carbon credit?
A carbon credit is a certified instrument corresponding to one metric ton of carbon dioxide (tCO2), or equivalent greenhouse gases (“GHGs”), that has been removed from or prevented from entering the atmosphere.
The CO2 equivalent (“CO2e”) of other GHGs (e.g., methane, nitrous oxide, fluorinated gases) is determined by measuring its global warming potential (i.e., the amount of heat the gas traps in the atmosphere over time) relative to that of CO2.
Carbon credits are traded on the Voluntary Carbon Market (“VCM”). Individuals or companies can purchase credits to compensate for their emissions. When a credit is used for this purpose, it becomes an offset. It is moved to a register of retired credits, or retirements, and it is no longer tradable.
What is a carbon project?
Carbon credit projects are activities that generate carbon credits. Projects fall into two main categories, both of which can involve nature-based or technology-based solutions:
- Avoidance or Reduction: These projects avoid or reduce the amount of CO2/GHGs that enter the atmosphere. Examples include the prevention of deforestation, forest degradation or land conversion; improved forestry and farming practices; the distribution of fuel-efficient cookstoves; higher energy efficiency; and the avoidance of landfill waste. All forms of avoided deforestation use the Reducing Emissions from Deforestation and Forest Degradation (“REDD+”) framework developed by the UNFCC.
- Removal or Sequestration: These projects remove or sequester the amount of CO2/GHGs already in the atmosphere. Examples include reforestation or afforestation, direct air carbon capture and storage (“DACCS”), bioenergy with carbon capture and storage (“BECCS”), and biochar.
Do carbon credits represent actual climate impact?
The International Carbon Reduction & Offset Alliance (“ICROA”) has a Code of Best Practice for ensuring carbon credits have high integrity. Carbon credits should at a minimum be:
Real: The emission reductions or removals and the project activities that generate them must have genuinely taken place.
Measurable: The emission reductions or removals must be quantifiable, using a recognized methodology, against a credible emissions baseline.
Permanent: : The emission reductions or removals must not be reversed after credits have been issued. If non-permanence is a material issue (e.g., wildfires) then buffer pools must usually be established to account for the risk.
Additional: The emission reductions or removals and the project activities that generate them would not have existed in the absence of carbon markets, and they demonstrate impact beyond the business-as-usual scenario.
Independently Verified: The emission reductions or removals must be monitored, reported, and verified to a reasonable level of assurance by an independent third-party body accredited under a recognized standard.
Unique: No more than one carbon credit can be associated with the reduction or removal of one metric ton of carbon dioxide equivalent (CO2e).
Leakage Accounted for and Minimised: The project activities must not cause an increase in emissions elsewhere, and monitoring and mitigation measures for leakage must be operational.
No Net Harm: The project activities must not violate the laws and regulations of the context, and safeguards must be in place to minimise any environmental and social damage.
Further efforts are underway to enhance the credibility and integrity of the market. The Integrity Council for the Voluntary Carbon Market (“ICVCM”) is establishing the Core Carbon Principles (“CCPs”) which are intended to be a trustworthy, thorough, and accessible global threshold standard for high-integrity carbon credits. These CCPs provide a guarantee that verified credits generate real, additional climate impact, while avoiding detrimental environmental and social side effects.
The first draft of the CCPs was released in July 2022. An official version will be published in Q1 2023, alongside an Assessment Framework, and Assessment Procedure which will provide guidance on whether carbon credits meet the criteria of the CCPs and outline a process for assessing and approving credits. After these publications, the ICVCM will start assessing carbon-crediting programs and methodologies.
How are carbon credits issued?
Carbon credits are assessed, verified, validated, issued, and registered by a set of independent standard bodies. The more common and internationally recognized of these include the Verified Carbon Standard (VCS) administered by Verra, the Gold Standard, Puro.earth, Plan Vivo, American Carbon Registry and Climate Action Reserve.
These standard bodies are responsible for outlining approved carbon accounting methodologies for carbon credit generation. They establish rigorous rules and criteria that all projects must adhere to in order to acquire accreditation. Each project’s emissions avoidance, reduction or removal activities and its environmental and social co-benefits are assessed against the requirements of the standard and one or more of its methodologies. Once a project has proven its compliance, the project is added to the standard’s registry and project developers are issued tradable carbon credits.
This oversight is vital for upholding the integrity of carbon credit projects, instituting accountability among developers, and ensuring credibility of the VCM.
What are the Compliance and Voluntary Carbon markets?
In response to the global climate change goals outlined in the United Nations Framework Convention on Climate Change (UNFCCC) and 1.5°C goal of the Paris 2015 Agreement, two broad types of carbon markets have emerged: compliance and voluntary.
In compliance (or regulated) carbon markets, entities obtain permits giving them the legal right to emit a specified amount of CO2 or equivalent GHGs to comply with regulations. These permits are called emissions or carbon allowances. A compliance carbon market often takes the form of an emissions trading system (ETS), also known as a cap-and-trade program. ETSs are jurisdictional, created and regulated by regional, national, or international regimes. The main sectors typically requiring compliance allowances include power stations, carbon-intense industries (oil refineries, iron/steel, cement, glass, nitric acid, lime, hydrogen, paper, and pulp), and aviation. Currently, there are three major ETSs around the world: The European Union’s ETS, The California Global Warming Solutions Act and The Chinese National Emission Trading System. The value of the global compliance carbon credit market reached ~$850 billion in 2021, a 2.5 times increase from 2020 .
Voluntary Carbon Markets (“VCMs”) function outside of jurisdictional compliance markets. VMCs allow individuals, companies, governments, and asset managers who have voluntarily committed to reduce their emissions to purchase carbon credits in compensation. The purchase of carbon credits is often one prong of a broader sustainability strategy to reach Net Zero. When a credit is used for this purpose, it becomes an offset. It is retired and is no longer tradable. The processes of verification, issuance, transfer, and retirement of voluntary carbon credits occur through a registry maintained by a recognized, third-party standard body. Today, the VCMs make up a small proportion of the total global carbon market, with a value of ~US$2 billion in 2021 , however, they are expected to grow to 5 times their current size by 2030 reaching a market size of $10-40 billion in value and 0.5-1.5 Gt CO2 in scale. This is comparable to the emissions of the aviation industry, which reached 1 Gt in 2019 .
 The voluntary carbon market: 2022 insights and trends. A report by Shell and BCG.
 Ecosystem Marketplace Insights Brief, The Art of Integrity, State of the Voluntary Carbon Markets 2022 Q3, Aug 2022, https://www.ecosystemmarketplace.com/publications/state-of-the-voluntary-carbon-markets-2022/
What is the role of the Voluntary Carbon Market in reaching Net Zero?
The Voluntary Carbon Market is playing a critical role in financing decarbonisation projects, contributing to the global transition to Net Zero. According to this McKinsey report, “carbon credits direct private financing to climate-action projects that would not otherwise get off the ground… And scaled-up voluntary carbon markets would facilitate the mobilization of capital to the Global South, where there is the most potential for economical nature-based emissions-reduction projects.”
With the urgency of the climate crisis, and rising consumer and societal pressures, ever-increasing numbers of corporates are pursuing decarbonisation strategies to achieve Net Zero. According to the Net Zero Tracker, organisations covering more than 90% of global GDP have made net zero commitments . Furthermore, as part of the Science Based Targets Initiative (SBTi), a total of 4,253 companies have set a science-based emissions reductions target or have committed to setting one by the end of 2024. This is an increase of 2,369 on the end of 2021 .
To achieve Net Zero, corporates need to prioritise avoiding and reducing their own value chain emissions. However, a portion of global emissions are ‘hard-to-abate’, which means these emissions are either prohibitively costly or impossible to reduce with currently available abatement technology. By offsetting their residual emissions using high-quality carbon credits, corporates can achieve Net Zero in accordance with the SBTi mitigation hierarchy. Additionally, SBTi recommends that corporates use high-quality carbon credits to contribute toward effective climate solutions beyond their value chains. Most carbon crediting programs also generate tangible co-benefits that support the advancement of the United Nations Sustainable Development Goals (SDGs), so corporates can simultaneously support other initiatives of their choice.
 Trove Research, Voluntary Carbon Market 2022 in Review Webinar
How does streaming carbon credits work?
A carbon credit stream is a contractual agreement whereby the stream purchaser (such as key Carbon) makes an upfront investment into a carbon credit project, in return for a share of future carbon credits generated. This initial investment may be followed by additional ongoing delivery payments to the project developer. The purchaser then sells these carbon credits to entities or corporates who require a multi-pronged strategy to achieve their net zero pledges.
For further detail on the streaming process, please look at our Business Model