What are carbon credits? How to include carbon removals in your sustainability strategy

Carbon credits, also known as CO₂ certificates, originated as part of global policies to combat climate change by promoting the reduction and removal of greenhouse gas emissions.

Today, with an increasing number of companies committed to reaching Carbon Neutrality or Net Zero, the carbon credit market continues to grow, proving to be an important tool in the process of companies’ ecological transition.

A considerable push in this direction is now also coming from the new European CSRD(Corporate Sustainability Reporting Directive), which requires companies to report in detail on their sustainability performance, including environmental impacts and strategies to reduce greenhouse gas emissions. This is where carbon removals play a key role: carbon credits can be used by companies as a carbon offset to mitigate their residual ‘hard-to-abate’ emissions and demonstrate an active commitment to reducing their carbon footprint.

Indeed, the European Sustainability Reporting Standards (ESRS), the set of new European sustainability reporting standards (E 1-7 GHG removals and GHG mitigation projects financed through carbon credits) recognize that financing carbon removal projects outside the corporate value chain by purchasing high quality carbon credits can contribute largely to climate change mitigation. However, companies included within the scope of the CSRD will have to report their emissions separately from any purchased carbon credit to ensure transparency and prevent misrepresentation of data.

The Science Based Targets initiative also foresees the possibility of offsetting a small part of the hard-to-abate residual emissions with carbon credits. Thus, offsetting greenhouse gas emissions through the carbon credit system must always be considered as complementary to, and not a substitute for, a company’s decarbonization strategy.

The concept of carbon credits took official shape with the Kyoto Protocol adopted in 1997 and entered into force in 2005. This international treaty aimed to reduce greenhouse gas emissions by industrialized countries. Three key mechanisms introduced by the Kyoto Protocol established the basis for the carbon credit market:

• International Emission Trading (IET): countries with emission reduction obligations could trade emission permits (or carbon credits) with each other.
• Clean Development Mechanism (CDM): Allowed industrialized countries to finance emission reduction projects in developing countries and receive carbon credits in return.
• Joint Implementation (JI): Allows industrialized countries to implement emission reduction projects in other industrialized countries.

In 2005, the European Union launched the EU ETS, a regulated market covering sectors such as energy and aviation. At the same time in those years, the VCM (Voluntary Carbon Market) was created, a market in which companies and individuals could offset their emissions by financing reforestation or renewable energy projects.

Later, in 2015, the Paris Agreement (Art. 6) strengthened the trading of carbon credits, which are referred to as ‘mitigation outcomes’ in the document, by incentivising flexible strategies to reduce emissions.

In recent years, criticisms regarding greenwashing and transparency have led to calls for stricter carbon removal certification standards and the adoption of blockchain systems to ensure the integrity of projects, in a market that is nevertheless set to grow. According to a McKinsey analysis, the total projected demand for carbon credits from Carbon Dioxide Removal (CDR) projects could offset up to 100 million tonnes of CO₂ by 2030.

The Kyoto Protocol established the basis for both compliance and voluntary carbon markets, setting the stage for the evolution of hybrid market models involving both private and public sector initiatives to regulate and support voluntary carbon trading.

Carbon credits are a type of permit that allows the owner to emit a specific amount of carbon dioxide or other greenhouse gases (GHGs).

These credits, also known as carbon allowances, are part of a broader strategy to reduce a company’s overall GHGs emissions into the atmosphere

By limiting the amount of emissions that can be released, carbon credits incentivize companies to invest in sustainable projects and technologies that compensate their carbon footprint, thereby contributing to the global effort to combat climate change.

The mechanism behind carbon credits is simple: CO₂ emitters finance projects that reduce or absorb an equivalent volume of greenhouse gases from the atmosphere within the Voluntary Carbon Market (VCM). These projects range from reforestation, which sequesters CO₂, to renewable energy plants such as solar or wind power, which avoid the use of fossil fuels, to carbon capture and storage, a technology that captures CO₂ and stores it safely.

Producing Carbon Credits

Carbon credits can be produced through a variety of processes that reduce, capture, and store emissions. There are two main types of carbon offsetting projects: nature-based solutions and technology-based solutions.

• Nature-based solutions are based on natural processes, such as reforestation or forest conservation to absorb CO₂ from the atmosphere
• Technology-based solutions use innovative technologies, such as renewable energy projects, which replace fossil fuel-based energy sources with wind or solar energy and reduce carbon emissions. Energy efficiency improvements in industrial processes and buildings also contribute to the generation of carbon credits by lowering energy consumption and emissions. Additionally, that capture and store carbon and methane, such as carbon capture and storage (CCS) technologies.

Projects within the VCM are certified by bodies such as Verra, Gold Standard or Plan Vivo, which register the reduced or avoided emissions and issue corresponding credits. Each carbon credit is therefore equivalent to one tonne of CO₂ not emitted or removed from the atmosphere.

Credits can be traded on regulated or voluntary markets. Once used to offset emissions by businesses, governments or individuals, they are cancelled in a public registry, ensuring transparency and preventing multiple use of the same credit.

The carbon credit markets are specific systems where corporations, governments and buyers can buy and sell carbon credits.

There are two main categories of carbon markets: the compliance market and the voluntary carbon market.

• The Compliance Carbon Market (CCM) is a regulated entity with various players ensure that companies adhere to specific environmental standards and contribute to national and international climate goals.An example is the EU ETS, a regulated market covering sectors such as energy and aviation.
• Voluntary Carbon Market (VCM) is an expanding sector that enables companies and individuals to purchase carbon credits on a voluntary basis.By participating in the voluntary carbon market, businesses and individuals can support a wide range of projects that reduce or remove greenhouse gases from the atmosphere, thereby playing a crucial role in the global effort to combat climate change.

  Unlike compliance markets, the voluntary carbon market is not regulated by governments, offering flexibility for participants to offset their emissions according to their sustainability goals.

  The VCM is expected to grow significantly in the coming years as more companies and individuals seek to reduce their carbon footprint and contribute to climate action.

Carbon Offsetting is the practice through which companies offset their greenhouse gas emissions by investing in projects that reduce or remove CO₂ from the atmosphere.

Since greenhouse gases are dispersed evenly in the atmosphere, emission reductions are beneficial to the climate regardless of where they occur. When these reductions equal the emissions generated, so-called ‘Carbon Neutrality’ is achieved.

To be effective, offsetting CO₂ emissions must fulfill specific criteria. In particular, projects must be concrete and measurable, capable of delivering greenhouse gas reductions that can be demonstrated through sound scientific methods. They must also be additional, i.e. provide emission reductions that would not have been achieved without the initiative and ensuring other environmental or social co-benefits, and they also have to be permanent and leakage-free, i.e. without generating emissions elsewhere.

Finally, for offsets to be valid, they must be monitored and certified by independent and credible bodies, ensuring that the climate benefits are real and lasting. A growing number of organisations provide quality standards to ensure the transparency and effectiveness of these projects, which are an essential component of climate neutrality strategies.

When it comes to climate change mitigation, it is crucial to distinguish between two types of approaches: Carbon Removal and Carbon Avoidance. 

Both approaches are strategic in the fight against climate change: Carbon avoidance offers an immediate impact by preventing new emissions, while Carbon removal is essential in the long term to remove already accumulated emissions.

Companies can leverage carbon credits to demonstrate their commitment to corporate social responsibility (CSR).

By purchasing voluntary carbon offsets companies can balance their emissions and reduce their carbon footprint, showcasing their dedication to environmental sustainability, but also deciding to support projects that support social development and local people’s empowerment.

This proactive approach not only helps in mitigating climate change but also enhances the company’s public image. Consumers and stakeholders increasingly value businesses that take tangible actions to reduce greenhouse gas emissions and contributing to create a positive impact for people and the planet.

Incorporating carbon credits into CSR strategies allows companies to align their operations with global sustainability goals and build a reputation as responsible corporate citizens.