How Does a Carbon Credit Work?

A carbon credit is a tradable certificate that represents a unit of reduction or removal of greenhouse gas emissions. It is one part of a system that rewards lower GHG emissions with money, to encourage companies to reduce their own pollution levels and to offset the emissions of other organisations that cannot achieve their own reductions. It is also an essential element of a growing global marketplace designed to support low carbon technologies.

The carbon.credit market is split into two key sectors, the voluntary market and the compliance market. In the voluntary sector, organisations like oil and energy companies purchase carbon credits to cover their own unavoidable emissions or to help them meet more ambitious climate targets than they are able to deliver through internal reductions alone.

In this sector, there are thousands of carbon projects around the world generating carbon credits for their impacts, earning money from those who need to buy them. For example, a farmer that plants trees earns cash from the corporation buying their credits to offset its own greenhouse gases; while middlemen, who are responsible for the project design and administration and handle the finance for these transactions, earn an income from managing the project.

To be valid, a carbon credit must be created by a project that is verified to ensure it has the potential to generate its corresponding emissions reduction. This is done through the process of accreditation by a carbon'standards' organisation. These organisations are typically NGOs and follow a set of rules for each type of project – for example, reforestation projects must follow a certain standard for how much CO2 they will absorb over time. Once a project has been accredited, its credits are entered into a 'carbon registry' - a giant database holding all the details for each credit such as its standard, methodology, geography and vintage (date of issuance).

Once a credit has been issued it can be bought and sold on the voluntary carbon market by organisations, like big businesses that want to take responsibility for their full footprint or offset their emissions from other sources. Purchasing carbon credits is often seen as a way for them to demonstrate their commitment to climate action and improve their public image. In the compliance markets, governments regulate how many GHGs a company can emit and they require those that go over to buy credits.

Credits are redeemed or retired once they have been used to cover a tonne of emissions. This can be triggered either by the company that earned them or by a carbon'market-based mechanism' such as a cap and trade program. Once a credit is retired, it can no longer be traded and so is taken out of circulation.

There are also intermediaries in the carbon market that link supply and demand, like brokers and retail traders. They buy bundles of credits, usually from a retailer trader, and then sell them on to the end buyers, typically charging a fee for their services.