Carbon Credits — Allowances or Offsets?
It’s been nearly 30 years since the world began trading carbon credits as a way to limit emissions. But emissions have done nothing but rise since then. What are the different types of carbon credits and do they really help?
A Short History of Carbon Credits (kind of)
1997, Kyoto, Japan. The predecessor to the Paris Climate agreement has just been signed by governmental leaders from around the world. It’s called the Kyoto Protocol and it’s going to stop climate change. Well, maybe not. But it is going to create a carbon credit market, which will eventually become a multi-billion-dollar industry.
Two Carbon Markets: Regulatory Credits and Voluntary Credits
Flash forward to 2022. The Kyoto Protocol had good intentions but in reality, it allowed industrialized countries to pollute even more without curbing emissions. The carbon credit market has expanded more than we could have imagined and is still growing.
According to a McKinsey Sustainability report, by 2030, the market for carbon credits could be worth more than 50 billion USD¹. But the terms and uses of carbon credits are more confusing than ever: the first thing to understand is the difference between regulatory carbon credits and voluntary carbon offsets.
- The Regulatory Market
Carbon credits issued by governments to companies in high carbon pollution sectors, like aviation and energy are part of the regulatory carbon market. It is sometimes called the cap-and-trade system, although different regulatory agencies may have different terms. One carbon credit gives the company permission (or credit) to emit 1 metric ton of carbon dioxide into the atmosphere — or the equivalent in other dangerous greenhouse gasses. For companies emitting more than their allowance, they must buy more allowances or pay a fine. For companies emitting less than their allowance, they may sell their excess carbon allowances.
Carbon credit trading is regulated by governments. There are 65 different carbon pricing systems worldwide. For example, in the European Union, credit trading takes place under the EU Emissions Trading System (EU ETS). Or in California, credit trading happens under the Cap and Trade system, and credits are referred to as ‘allowances.’
- The Voluntary Carbon Market
Regulatory carbon market only includes some industries. But other players want access to the carbon market. Companies aiming to reach net-zero carbon emissions frequently buy “carbon offsets”. Offsetting carbon means taking voluntary actions to capture carbon emissions. It might be planting trees, investing in organizations that reduce carbon emissions or buying voluntary (offset) carbon credits. This means they invest in enough carbon offsets to negate the emissions their activities produce. This has created a carbon offset market that trades separately from the carbon allowance market.
The important thing to remember about the difference between carbon allowances and offsets is that carbon allowances are required for certain industries, while trading carbon offsets is voluntary.
Regulatory or Wild West
Another difference between carbon allowances and offsets is their flexibility. Allowances are heavily regulated, and the certification process is slow. The offsets market is, on the other hand, a bit like the Wild West. There is sometimes worryingly little verification or auditing in issuing carbon credits. The traceability can be dodgy, and irresponsible issuance of carbon credits can result in more environmental damage. But, on the bright side, users of the market are becoming more stringent, and the market is progressively setting its own accepted standards of play.
So which is best?
Which type of carbon credit market will save the planet from a climate crisis? Probably neither². But both will help, especially if commitment to ensuring the efficacy of the carbon credit is taken. Humanity must cut carbon emissions and fast. But on the other side of things, we also need to develop viable, transparent, and impactful carbon credits. These carbon credits can be a force for good, if companies go the extra step and choose to invest in a carbon credit market that helps restore balance to the carbon cycle and help regenerate our planet.