What are carbon credits?

Carbon credits or offsets refer to tradable certificates permitting industries one tonne of carbon dioxide equivalent (CO2e) emissions¹ and are typically created under an emission trading system (ETS).² The ETS limits the total amount of greenhouse gas (GHG) emissions that industries can release. The USA’s Clean Air Act Amendment 1990 for Sulphur Dioxide (SO2e) was the world’s first trading system to set emissions standards, implement permits, and create a cap and trade system.³ In 2005, the European Union (EU) introduced a similar mechanism for CO2e under the European Union Emissions Trading System (EU ETS).⁴

These certificates are tradeable and traceable.⁵ Companies that emit more GHG than their permissible limit must purchase carbon credits from those that emit below their limits, thus creating a market for these instruments. The system creates a financial incentive for companies to reduce their GHG emissions, as they can sell their carbon credits in the market. These credits have a unique identification number allowing them to be tracked from creation to retirement. Tracking is essential to ensure the integrity of the system and prevent fraud.

Carbon credit and market

Carbon credits may be traded in either the compliance or the voluntary market. Compliance carbon markets are created and regulated by national, regional, or international carbon reduction regimes.⁶ Entities operating in this market can purchase carbon credits to comply with the regulations. In contrast, voluntary carbon markets operate based on self-governance and are not legally mandated or enforced. These markets enable businesses, governments, and other organisations to voluntarily offset their carbon emissions in order to satisfy their own sustainability goals or to demonstrate their commitment to lowering their carbon footprint. In contrast, companies can purchase carbon credits from the voluntary market to enhance their reputation or achieve their emissions reduction targets.

In 2020, the total compliance market size reached USD 261 billion, with 10.3 GT CO2 traded in the compliance market. Though the voluntary market is smaller than the compliance market, estimated at USD 400 million in 2020, it is projected to grow substantially to USD 10 billion–USD 25 billion by 2030.⁷ Estimates peg the carbon markets to reach USD 2,408 billion by the end of 2027.⁷

Figure 1: The global carbon credit market is estimated to be valued at USD 2,408 billion by 2027



Source: Coherent Market Insights⁷

The significance of carbon credits is likely to increase over the coming years as countries increasingly align with global climate commitments such as the Paris Agreement and work towards their own net-zero targets.⁷

Who should care?

●         Policymakers

●         Businesses with emissions

●         Investors