Introduction

Maybe you have heard of the term carbon credits, but it is not so clear what they are exactly? They seem to play an important role in society’s efforts to reduce carbon emissions to the atmosphere and fight climate change. The global carbon market had a value of 229 billion euros in 2020 [1] , which is a significant value. But how does it work? Do not worry, we are going to explain.

Whether you are talking about cement, power, oil&gas industry, for all industries that have significant emissions of CO 2 , carbon credits already play an important role and this will become more and more important. All these industries are looking to decrease carbon footprint. In this post we are going to explain what carbon credits are and how it is related to carbon offsetting. We will also dive into carbon credit trading systems. There are trading systems set up by governments and there are voluntary trading systems for carbon credits. We will also describe developments in carbon credits in the different regions, Europe, US, Asia and Africa.

 

What are carbon credits?

According to one definition carbon credits are “permits that allow the owner to emit a certain amount of carbon dioxide or other greenhouse gases” [2]. A carbon credit represents the right to emit greenhouse gases equivalent to one ton of carbon dioxide. Companies can sell unused credits to other companies.
 

Compliance market

The Kyoto agreement from 1997 was the initiation of a cap-and-trade program for carbon dioxide emissions as a measure against climate change. The main principle is that there is a cap on the total emissions for a country or region. Companies are granted permits or credits ate the beginning, which is often done following a grandfathering principle: the permits for large companies are determined by their emissions at the beginning of the system.  The carbon credits prices are a result of market effects. As governments reduce the total emission cap over time, the number of carbon credits available in the market is reduced. Hence, the price will increase and the financial incentive for companies to reduce their CO2 emissions will be higher.

 

Experts say that in order for us to reach the 2°C climate goal, a carbon credit price is required of USD 40-80/tCO2e [3]. At the other hand in 2021, only 20% of global carbon emissions were priced and only 4% of the global emissions were priced above 40 USD. So there is still a long way to go.

 

The European Union’s Emissions Trading System (EU ETS) is currently the largest market for carbon credits. In 2020 it accounted for 90% of the global value [1].

 

In the USA there does not exist a trading system at national level. Credit systems are arranged on state level. California established a cape-and-trade program in 2006. The goals of that program were to reduce emissions to 1990 levels in 2020 (which was met in 2016 already), to be 40% below 1990 levels in 2030 and 80% below 1990 levels in 2050 [4]. There also exist two regional markets for carbon credits, (1) North America Western Climate Initiative and (2) Regional Greenhouse Gas Initiative. 

 

On the COP26 held in Glasgow in November 2021 countries agreed to create a global carbon credit trading market. Another important aspect was that 5% of the revenues generated from credits sold are placed in an  Adaptation Fund for developing countries.

 

Voluntary market

The term carbon offsets refers to the voluntary carbon market for emission reduction. Companies developing carbon emission reduction projects can monetize these by selling carbon offsets to companies buying them for corporate social responsibility reasons. The words ‘carbon credit’ and ‘carbon offset’ are sometimes used interchangeably which confuses the matter [5]. 

 

The carbon offset market amounted roughly 1 billion USD in 2020. Some examples of how such offsets are traded are:

• Directly between private companies

• On the Xpansive CBL platform (New York)

• On the AirCarbon Exchanger (Singapore)

 

Double counting

One problem with the voluntary trading occurs, when companies claim these offsets in their own carbon emission footprint. Since the reduction still counts in the country where the climate project is based, this would lead to double counting.

 

The issue of double counting for the compliance market was a topic during COP26 in Glosgow in 2021. It was sovled by a rigid system of double-entry bookkeeping. The country where the credit is issued removes it from its greenhouse gas inventory so that the buyer can count it towards their climate target. However, for the voluntary carbon market the problem is still there since they do not fall under jurisdiction of the UN climate change secretariat (UNFCCC) [6].

During COP27 in Sharm el-Sheikh the decision was made to create a system of contribution units. The wording clearly conveys the idea that it contributes to reducing carbon emissions of the host party. And that also means a change in how the buying company handles and reports these units. Rather than a company claiming to offset its emissions or calling its products/services carbon-neutral, it would rather express its contribution to mitigation efforts in a given country by financially supporting a climate project.

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Why are carbon credits Important?

Carbon credits are a crucial tool in the fight against climate change as they aim to incentivize the reduction of greenhouse gas emissions. The goal is to create a financial mechanism that encourages emissions reductions by placing a price on carbon emissions, thereby creating economic incentives to adopt cleaner technologies and practices.

 

Here's why carbon credits are important:

 

• Emissions Reduction: Carbon credits provide a market-based approach to reducing emissions. By putting a price on carbon, they encourage industries and organizations to invest in cleaner technologies, energy efficiency, and sustainable practices in order to reduce their emissions and thereby lower their overall costs.

• Innovation and Investment: The prospect of earning revenue from selling carbon credits encourages innovation in low-carbon technologies and practices. This drives investments into research and development of renewable energy sources, carbon capture and storage, and other sustainable solutions.

• Global Cooperation: Carbon credits facilitate international cooperation in addressing climate change. Countries with emission reduction commitments under international agreements (such as the Kyoto Protocol or the Paris Agreement) can meet their targets more efficiently by purchasing carbon credits from other countries or entities that have exceeded their emission reduction goals.

• Balancing Economic Growth and Environmental Goals: Carbon credits allow for a balance between economic growth and environmental protection. Industries can continue to grow while also adopting measures to reduce their carbon footprint, helping to transition to a more sustainable economy.

• Financial Support for Developing Countries: Carbon credit projects in developing countries can attract funding and technology transfer from developed nations, assisting in their sustainable development and climate adaptation efforts.

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Examples of projects that reduced carbon footprint

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EXAMPLE 1: OMV Refinery