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1. Background
Publication date: 03 Mar 2023
gx In depth INT2023-02
With the increasing focus on climate change and carbon emissions, companies are starting to take steps to reduce or absorb their carbon emissions. Complete elimination of carbon emissions from operations through mitigation methods is not always possible. This drives demand for carbon offsets to offset all or part of the remaining emissions generated by an entity’s operations or in its value chain.
1.1. What is a carbon credit?
A carbon credit is an emission unit issued by a carbon crediting programme that represents an emission reduction or removal of one metric tonne of CO2 or an equivalent amount of other greenhouse gases. They are uniquely serialised, issued, tracked and cancelled by means of an electronic registry.
Certified carbon credits typically take the form of transferable or tradable instruments and are certified by governments or independent certification bodies.
1.2. Compliance versus voluntary carbon markets
Carbon credits can be used by companies to meet:
- compliance requirements, such as a net emission cap or the cap under an Emission Trading Scheme or ETS (also referred to as ‘cap and trade’) where companies are typically allocated emission allowances based on their targeted levels of emissions; or
- voluntary emission targets. This is called the voluntary carbon market or VCM.
Carbon credits used to offset emissions voluntarily are often referred to as ‘carbon offset credits’ or ‘carbon offsets’. In this publication they will be referred to as carbon offsets.
1.3. Life cycle of a carbon offset
The life cycle of a carbon offset in the VCM can be summarised as:
- Generation of carbon offsets: A carbon offset project developer (Project Developer) registers an offset project with a carbon offset registry under a carbon offset program. The emissions reduction will be measured using a specified methodology. The Project Developer will implement the project and maintain records quantifying the emission reductions achieved. These are often validated and verified by government or independent certification bodies in order for the carbon offsets to be certified. Certified carbon offsets are issued by a carbon offset registry to the registry account of the Project Developer.
- Transfer of carbon offsets: The carbon offsets are tradeable or transferable between accounts with the same registry. The ownership of the carbon offsets can be transferred from Project Developers to intermediaries and ultimate end users. These transactions are usually facilitated by carbon brokers, private carbon trading platforms and carbon exchanges.
- Retirement of carbon offsets: The end user is required to instruct the registry to ‘retire’ the carbon offsets when they report them as a reduction of their emissions. This stops the carbon offsets from being used again by another entity.
The following diagram shows the VCM and the parties involved in a simple form.
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