Posted: October 2, 2023

Carbon Credits: Everything You Need to Know

The case for net-zero has never been stronger. We’re feeling the impacts of climate change every day — and scientific consensus, embodied by the Paris Agreement, is clear: limiting global temperature increases between 1.5 and 2 degree Celsius will significantly limit the worst outcomes of climate change.

This consensus helps explain the growing alignment between climate science, consumer demand, and government oversight:

  • In the past five years, 85% of consumers have modified their shopping behavior in the pursuit of greater sustainability.
  • Government regulations surrounding companies’ carbon emissions have become stricter, and are expected to continue in that vein.

As a result, more and more companies are looking for ways to reduce and mitigate their own carbon emissions, and committing to net-zero goals.

One of the primary tools to achieve net-zero today are carbon credits. When combined with other emission-reduction strategies, carbon credits can help businesses achieve their climate goals.

What Are Carbon Credits?

Carbon credits are the transaction instruments of the verified voluntary carbon market. One tradable carbon credit equals one tonne of carbon dioxide or the equivalent amount of a different greenhouse gas (often called CO2e) reduced, sequestered or avoided.

graphic showing what a carbon credit isFor reference, the average American generates about 17 tonnes of CO2 each year.

Purchasing carbon credits enables businesses to mitigate their operational emissions and adhere to any emissions limits laid out by their governments, or by their own internally-set targets.

Are Carbon Credits and Carbon Offsets the same thing?

The terms are related and highly relevant to each other, but they aren’t quite the same thing.

Carbon projects are efforts to avoid, or remove and sequester, carbon emissions (more on carbon projects later). All carbon offsets come from carbon credits. However, a carbon credit only becomes a carbon offset if it is used to compensate for an emission that occurs elsewhere. This process is called the ‘retiring’ of a carbon credit.

It’s important to note that while every carbon offset comes from a carbon project, not every project creates carbon credits.

Why do Carbon Credits Exist?

More than ever, the global economy has to shift to a low-carbon model. But global greenhouse gas (GHG) emissions are still increasing — and even with the most aggressive decarbonization plans, a significant amount of GHG emissions will remain unavoidable in the short term.

Carbon projects, and the credits they generate, can help mitigate these unavoidable emissions from our daily lives by avoiding or capturing CO₂ all over the world. Carbon offsetting is one of the tools in a patchwork of solutions that help us on the path to net zero.

A Brief History of Carbon Credits

Carbon credits have only been around for a few decades. They were introduced in 1997 with the Kyoto Protocol, an international agreement to reduce CO2 emissions and other greenhouse gasses in the atmosphere.

Carbon credits gained even more traction after the Paris Agreement of 2015. This legally binding international climate change treaty has been adopted by nearly 200 countries. Its primary goal is to keep global warming below two degrees Celsius over pre-industrial temperatures, so participating countries are encouraged to mitigate their carbon emissions as much as possible.

Recently, carbon credits have seen a surge in prominence due to growing public pressure on companies and governments to more urgently address climate change.

Why are Carbon Credits Important?

Through carbon offsetting, we can support many critical climate mitigation initiatives such as reforestation and forest conservation efforts, renewable energy projects in developing countries, and the provision of clean and efficient cooking options to rural communities across the world — to name but a few. All of these activities play a role in the fight against climate change.

How are Carbon Credits Created?

Carbon credits are created by carbon projects. Any projects that reduce, avoid, destroy, or capture carbon emissions can help generate the carbon credits that, upon retirement, become carbon offsets.

Key Players in the Creation of Carbon Projects

There are several parties involved in the development, funding, and maintenance of carbon projects. In broad strokes, these key players include:

  • Project developers, who provide the supply of carbon credits
  • Private companies, who purchase carbon credits to mitigate their carbon emissions
  • Investors and intermediaries, who both finance projects and purchase credits
  • Regulators, who set the requirements that projects must fulfill to generate tradable carbon credits — including the carbon standards, who certify, issue, and register credits
  • Indigenous Peoples and local communities (IPLCs), who may hold land, forest, or carbon rights, or have customary access to land where emission mitigation takes place

The Carbon Project Lifestyle

Bringing high-quality carbon projects to life is difficult, time-intensive, and involves bringing together all of the stakeholders discussed above — but all of this work is necessary to make sure all parties, and our planet, benefit from the project.

Here’s a high-level overview of the different phases of the carbon project cycle:

  1. Planning; project developers will choose a VCM carbon standard and follow their approved methodology.
  2. Design; proponents of a project prepare documentation according to the guidelines of the carbon standard they hope will issue their credits.
  3. Validation; an independent (not the carbon standard) third-party audits the design documents.
  4. Registration; the project is registered under the chosen carbon standard.
  5. Implementation; the project becomes a reality, and so do its climate benefits.
  6. Monitoring; project developers are responsible for ensuring the emission reductions are actually happening as described in the project documents
  7. Verification; those monitoring reports get reviewed by an independent third party auditor and the carbon standard under which the project is registered.
  8. Issuance; the carbon credits from the projects are finally issued by the carbon standard.

8 step Lifecycle of a carbon project visualThese bodies play a crucial role in ensuring the integrity of the VCM — we support the work they do, and all offset credits within our portfolio are issued by one of the four leading standards: the Verified Carbon Standard, the Gold Standard, the Climate Action Reserve, and the American Carbon Registry.

Types of Carbon Projects

There are two major project classifiers used in the VCM today.

Nature-based vs. Non Nature-based Projects

One of the major classification systems used in the VCM is nature and non-nature based projects.

Nature-based projects include activities such as forestry projects, agricultural projects, and wetlands projects. They typically capture or avoid carbon dioxide emissions through the planting of new trees and plants or by the carbon not released through the protection of forests and oceans.

Non nature-based projects (also known as technology-based projects) involve things like renewable energy and direct air capture (DAC) projects. They capture or avoid carbon dioxide emissions through manmade technologies.

graphic showing the different types of nature and non-nature based carbon projects

Carbon Avoidance vs Carbon Removal Projects

Another lens through which some in the VCM view carbon projects is ‘removal and avoidance.’

Carbon removal projects focus on natural and technological solutions to pull existing carbon dioxide out of the atmosphere. Examples include reforestation and direct air capture (DAC) projects.

Carbon avoidance projects seek to reduce or eliminate carbon emissions from being generated in the first place. Examples include forest conservation and renewable energy projects.

(Note, there are a few project types that don’t fit neatly into either, such as regenerative agriculture or grassland management projects.)

venn diagram of carbon removal and avoidance projectsYou can find a detailed breakdown of the different types of carbon projects in this guide.

Are Certain Projects Types Better than Others?

There are debates within the VCM and the broader climate discourse about the efficacy of some projects over others. Certainly, there are significant differences between them, and as a result they vary in terms of benefits and challenges.

At Catona Climate, we particularly specialize in nature-based solutions; but our Carbon Program has credits from all types of projects. Ultimately, we care more about the credibility and efficacy of specific projects versus somewhat arbitrary classification methods. And given the urgency of the fight against climate change, we need to use every tool in the toolkit.

How Do Carbon Credits Work?

Because carbon credits are equal to one tonne of CO2 or CO2e, companies that have calculated their carbon footprint know how much carbon they’re responsible for emitting in a set time period — therefore they can purchase the specific number of carbon credits they need to mitigate their footprint.

Ideally, this footprint should represent a company’s unavoidable emissions — they should only look to carbon credits as a solution once they’ve reduced their emissions as much as possible.

What are the Carbon Markets?

Carbon credits are used in two different types of markets: the compliance market and the voluntary market.

  • Compliance carbon markets — The compliance market, also known as the involuntary market or cap-and-trade market, is regulated by governments. Companies participating in the compliance market are mandated to do so because their industries are known for producing high greenhouse gas emissions. The compliance market is currently worth $850 billion. There are over 60 compliance markets across the globe. Some of the largest ones are in the European Union, Canada, Australia, and China.
  • Voluntary carbon markets — As its name suggests, this market is purely voluntary. Companies and individuals can participate in it if they want to pursue greater sustainability or reach net zero. Currently, the voluntary market is still smaller than the compliance market, but it's growing rapidly. In 2021, the voluntary market was valued at $2 billion. It’s projected to be worth as much as $50 billion by 2030.

Note: In the United States, 13 states mandate cap-and-trade markets, though most only apply to a few specific economic sectors. However, President Biden rejoined the Paris Agreement of 2015, which sets emissions standards and encourages emissions trading for participating countries. In turn, more compliance markets may be cropping up in the U.S. in the near future.

Carbon Credits in the Compliance Market

In the compliance market, the government enacts cap-and-trade regulations. These regulations give businesses limits, or caps, on how much greenhouse gasses they can emit. Companies’ emissions caps are based on the regulatory limits of their size and operational efficiencies.

If a company cannot stay within its carbon emissions cap, it can purchase carbon credits to mitigate its excess emissions and stay compliant. On the other hand, if a company manages to stay below its emissions cap with ease, it can sell its carbon credits to other companies and make a profit on those assets. When companies calculate their total carbon emissions, it's important to consider all three scope emissions:

  • Scope 1 emissions are the direct emissions from a company’s operating facilities and vehicles.
  • Scope 2 emissions are the indirect emissions necessary to run a company — for example, the emissions of its electricity supplier.
  • Scope 3 emissions are the broadest and hardest to calculate — they include emissions from any upstream or downstream business activities outside of scope 1 and 2.

Over time, carbon emission caps are lowered gradually to put additional pressure on companies to reduce their scope 1, 2, and 3 emissions.

Carbon Credits in the Voluntary Market

Since the voluntary market is optional, companies and individuals usually enter it for environmentally-conscious reasons.

For instance, a company may want to purchase carbon credits to achieve publicly-made net zero or carbon neutrality goals. Carbon neutrality means that a company offsets all of the carbon it emits by purchasing enough credits to mitigate their unavoidable emissions. Becoming carbon neutral can display a company’s dedication to protecting the planet and enhance its reputation with sustainability-minded consumers.

Likewise, an individual may purchase carbon credits to do their part to help the planet and minimize their carbon footprint.

How Much do Carbon Credits Cost?

It depends.

Carbon credits of different origin or quality have different prices. Some factors at play:

  • Newer credits tend to be more valuable than older ones.
  • Prices can be affected by power asymmetries and the ability of parties to negotiate.
  • Investors may lock in lower prices for future credits, particularly if they share the risk of project failure.
  • Additional certifications can drive the price of a credit higher.
  • The higher the quality of a credit, the more valuable it is.

Are Carbon Credits Effective at Mitigating Climate Change?

Carbon credits should be a key tool in our fight against climate change, in theory. But what about in practice?

It ultimately depends on the quality of the carbon credits.

At a minimum, worthwhile carbon offsetting projects are carefully vetted and officially certified by private entities known as ‘carbon standards,’ or ‘carbon registries,’ and they provide requirements to guide project developers. These bodies play a crucial role in ensuring the integrity of the VCM; companies and individuals who invest in these credits can be more confident that they impact real-world emissions reductions.

The four leading standards in the VCM are the Verified Carbon Standard (VCS), the Gold Standard (GS), the Climate Action Reserve (CAR), and the American Carbon Registry (ACR). And those four standards have been vetted and accepted by International Carbon Reduction and Offset Alliance (ICROA) and Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) for their rigor and reliability to verify high-quality carbon credits.

Companies like Catona Climate take things a step further by vetting all of our partner carbon offset projects through our own rigorous approach. That’s why only 20% of the projects we evaluate actually meet our criteria and become a part of our Carbon Program.

Visual describing Aspiration's commitment to a higher standard and our process for evaluating potential carbon credit projects

What are High-Quality Carbon Credits?

Every asset class has its share of lower-quality stuff — think junk bonds or penny stocks.

Carbon credits are no different. While many great carbon projects deliver real climate impact, there are also bad actors out there.

In our view, high-quality carbon credits are those that share the following 7 characteristics:

  1. Real; that is, the greenhouse gas mitigation must have already happened, and be transparently quantified, before a credit can be recognized and applied.
  2. Additional; meaning the carbon mitigation wouldn’t have happened on its own (without capital poured into it from carbon offsetting).
  3. Monitored, Reported, and Verified (MRV); GHG claims must be monitored and reported, and then verified by an independent third party.
  4. Account for Leakage; which means making sure there is no unintended increase in GHGs, or shifting of emissions from one place to another.
  5. Permanent; GHG mitigation resulting from the project is on a long enough timescale so as to be considered permanently abated or removed (at least several decades).
  6. Do No Harm; the project should safeguard against any negative environmental or socioeconomic impacts.
  7. Have Co-Benefits; the best projects offer many additional benefits beyond reducing or removing carbon. Co-benefits can be environmental, social, or economic in nature, and often align with the UN's Sustainable Development Goals.

characteristics of high quality carbon credits

What are the Criticisms of Carbon Credits?

Because not all projects are created equally, this has rightfully led to questions about the quality and efficacy of carbon projects and the credits they generate.

But by being aware of both fair and unfair criticisms, the VCM as a whole can grow and adapt.

The main criticisms of carbon credits are as follows:

  • Carbon credits have no real impact on the environment
  • Carbon credits allow companies to engage in greenwashing
  • Carbon credits are a “free pass to pollute” that lets companies avoid reducing their own emissions
  • Technological solutions won’t work…or they’re the only thing that will
  • Reforestation alone can’t solve the climate crisis
  • Carbon avoidance isn’t as valuable as carbon removal
  • Carbon projects have a negative impact on local communities

We have responses to all of these criticisms in our carbon credit mythbusting guide here, which we highly encourage you to review.

But suffice it to say, our stance is this: we need carbon credits. Any viable path to a livable planet runs through carbon avoidance and removal. Our job is to make sure that the projects we are involved in are of the highest quality.

What's Next for Carbon Credits and the VCM?

New policies. More media attention. Better technology.

These are just a few of the myriad elements that affect the rapidly-evolving VCM. Carbon credits are still a relatively new asset class, and the markets are undergoing maturation.

Some of the things we expect to happen include;

  • More regulation and quality alignment will bring more legitimacy
  • Prices of (quality) assets will keep climbing
  • Forward offtake agreements will be used more often

For much more on our predictions for the VCM in 2023 and beyond, see our separate post on the subject.

Where Does Catona Climate Fit in the Carbon Credit Lifecycle?

We’re involved throughout the lifecycle of carbon projects and our role changes depending on the project’s needs.

Predominantly we finance the development of projects from ideation and implementation, and sell forward credits from the projects in which we invest to organizations that have a demand for high-quality credits to achieve net zero or fulfill other climate ambitions.

We may also be an offtaker (i.e. buyer) of future credits, or purchase credits on the spot market (i.e. immediately available) once the credits have already been issued.

For long-term financed projects, we remain closely engaged with project partners and continue to support implementation, monitoring, reporting, and verification activities.

Catona Climate: Vetted, High-Quality Carbon Credits for Business

Carbon credits provide companies with a powerful tool to offset their unavoidable carbon emissions. If your business is looking to purchase effective credits that will have a tangible benefit for the environment, get in contact with the carbon experts at Catona Climate.Through evaluations from our experts and state-of-the-art monitoring systems in place, we carefully vet our carbon credit suppliers before we match them with our clients. We also monitor their quality on an ongoing basis, including in-person site visits and remote-sensing technology.

Net zero is possible — and Catona Climate can help take you there. Get in touch with us today.

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