What are Carbon Credits?

Carbon credits, also known as carbon offsets, are an integral part of today's climate policy landscape. They represent a reduction or removal of one ton of carbon dioxide (CO2) from the atmosphere, contributing to the global effort to combat climate change. Understanding carbon credits is essential for any stakeholder in the carbon market, from individual investors to multinational corporations.

Carbon credits are broadly categorized into two types: voluntary credits and compliance credits.

Voluntary Credits

• Definition: Voluntary credits are issued to projects that actively remove or reduce CO2 from the atmosphere. Examples of such projects include reforestation initiatives, renewable energy installations like solar farms, and various other carbon reduction strategies.

• Market Dynamics: These credits are not mandated by law but are often purchased by corporate entities as part of their Corporate Social Responsibility (CSR) programs or to market themselves as carbon-neutral or carbon-negative.

Compliance Credits

• Definition: Compliance credits, on the other hand, are part of a regulatory system where governments require companies to acquire permits to emit CO2. They must purchase these credits if their emissions exceed a certain cap set by regulatory bodies, such as under the European Union Emissions Trading System (EU ETS).

• Market Dynamics: The compliance market is significantly larger than the voluntary market, accounting for the vast majority of the carbon credit market. These credits are fundamental to schemes that aim to cap and reduce industry-level emissions over time.