Carbon credits are tradable ‘points’ that are part of efforts to incentivize emission reduction via cap-and-trade, a market-based solution limiting the number of emissions permits available. This scheme gives organizations the right to emit a limited amount of greenhouse gases equivalent to the number of permits they possess. Polluters exceeding their permitted emissions are thus forced to purchase carbon credits from other polluters looking to sell their excess/developed credits.
How is carbon traded?
Under the scheme, the local government/authority sets emission caps according to industry and the local socio-economic situation and accordingly decides appropriate penalties if organizations fail to abide. By acquiring credits facilitated by the trading channel known as the Emissions Trading System (ETS), organizations unable to act adequately on decarbonization demands can compensate for their greenhouse gas emissions.
Organizations can also trade their credits with other organizations where immediate elimination of carbon emissions is not an option, ultimately reducing emissions collectively. A nation/organization gets a set number of permits for a fixed duration and hence declines in value over time. To compensate for this loss of value and maintain their license to operate, companies are encouraged to find innovative ways of reducing their GHG emissions. Such a crediting system thus allows participating organizations to catalyze their transition to renewables and other sustainable practices. Moreover, trading allows for the monetization of actions taken to improve environmental performance, thereby providing organizations with another source of revenue. This may encourage organizations to invest in capital that reduces emissions.
Can I develop carbon credits?
Credits can be developed by proving that there is a reduction of emissions with respect to the ‘business-as-usual’ or baseline scenario for the organization determined through GHG inventorization. For every MTCO2e (metric tons of CO2 equivalent) reduced, the credit developer obtains one credit. Decarbonization pathways applicable for credit development include increasing renewable energy or energy efficiency, improving waste disposal, and/or modifying land use (e.g. reforestation, ecosystem restoration).
Credits can be developed either in compliance with international instruments or voluntarily for market consumption. Credits generated from compliance-mandated emission reductions, known as Certified Emission Reductions (CERs), are governed by the Clean Development Mechanism (CDM) of the United Nations Framework Convention on Climate Change (UNFCCC) or European Union-ETS (EU-ETS). The Delhi Metro for example plans to produce up to 6,00,000 CERs from renewable energy, emission reduction, and energy efficiency projects [1].
Voluntary credits, meanwhile known as Voluntary Emission Reductions (VERs), while similar to CDM projects but cannot be used to meet international and national emissions obligations but are purely for trading. VER development is often driven by CSR, ESG, certification, and reputation considerations. In essence, a CER can be purchased by organizations looking for voluntary offsets, whereas a VER will not be accounted as fulfilling compliance. Other similar certificates exist – such as Renewable Energy Certificates (RECs), where one is issued for every 1MWh of renewable energy fed into the grid. Another such governmental example is in Indore, earning up to ₹50 lakhs from bio-methanation projects.
The certification for emission reduction is obtained from standards organizations such as the Gold Standard (GS) and Voluntary Certification Standard (VCS). The project design and monitoring plan are initially validated, alongside which the outcome of mandatory stakeholder consultations are also attached. Once validated, the project design is then inspected by certified third parties, known as Designated Operational Entities (DOEs) for CER projects and Validation & Verification Bodies (VVBs) for VER projects. They conduct site visits and desk reviews of project files to verify the plan and its implementation. Once the project has been certified, credit development begins. There are periodic inspections or reviews conducted by the DOEs/VVBs to ensure adherence to the implementation plan. Credits are handed over for the period once the implementation verification report is reviewed and approved by the standard. Oftentimes VVBs also have DOE certifications and hence can inspect both projects.
How are credits traded?
Credits can be traded either from primary (direct from the developer) or secondary markets (resold in carbon marketplaces). For CERs, this marketplace is usually the EU-ETS, the United Nations’ carbon platform Climate Neutral Now, or other certified marketplaces. VERs, on the other hand, can be sold on Voluntary Carbon Markets (VCMs), which are highly decentralized and driven by private initiatives of project developers, investors, and civil society groups. VCMs can be used by governments to promote emission reductions beyond compliance, and also to incentivize finance flows into important sectors. Gujarat is launching the first carbon trading market in 2022, the first such market in emerging economies outside China.
The ETS presents unique opportunities to developing economies (a.k.a. Non-Annex I countries in the Kyoto Protocol) since developed nations (a.k.a. Annex I countries) have much larger per capita emissions and thus are major markets for credits. Since the expenses incurred in credit development are significantly lower in developing nations, the ETS helps channel investment from the ‘global north’ towards the ‘global south,’ thereby providing opportunities for credit developers to increase their incomes. Since many carbon offset projects, inter alia reforestation, ecosystem restoration, and biomass projects, do not necessarily require intensive technology and/or capital, credit development has already proven to be a viable additional income source for rural and semi-urban households. One such example that demonstrates this massive socio-economic and environmental potential is that of the Indian startup ‘Nurture.farm’, which produced and sold 20,000 credits to various buyers worldwide [2]. Their model of employing 2,500 small-holder farmers, reduced the environmental impact of paddy cultivation. They also are processing a crop residue management program to prevent over 420,000 acres of farmland from being burnt. This would thus prevent around 2,000 MT of particulate matter from being released into the atmosphere. Moreover, this also ties in with many social justice considerations such as ‘carbon leakage’ and ‘environmental colonialism,’ as while Non-Annex I countries do not have any legally binding emission reduction targets, there are concerns that Annex I countries may take advantage of this to shift production away from their homelands and thereby lead to the deepening of socio-environmental inequalities.
Challenges and Criticisms
Yet, some challenges still exist, including the pricing of credits. While it is estimated that the socio-environmental cost of every unit of GHGs put into the atmosphere is between $11-$212, it can be seen that carbon pricing models often use a project cost-based approach (known as the Fairtrade Minimum Pricing Model) to price credits at between €8-€15 [3]. Many standards also include a €1 Fairtrade Premium payable by the buyer, which is given directly to the community to improve climate change adaptation and resilience [4]. It is important to contextualize these prices – it is estimated that carbon pricing has to be at least between $40-$80 by conservative measures to meet the 2°C targets of the Paris Agreement. Other criticisms of emissions trading revolve around the urgency of measures required to combat climate change. The cap-and-trade system, it is argued, allows financially well-off organizations to continue emitting at close to business-as-usual levels since they can buy credits to offset without actually acting towards carbon reductions. Many also argue that emissions trading is a climate stabilization policy and not a radical reform policy looking to restructure society and consumption at their roots, which seems more like the need of the hour. Indeed, policies such as carbon taxes are proven to be better at reducing emissions systemically, though it is to be noted that every such solution comes with inertia against change and its own set of economic constraints and socio-environmental concerns.
Author’s Take | While emissions trading may not be a comprehensive or even extensive carbon solution, it is indeed among the more palatable solutions on offer. It is true that it benefits those who can develop or fund carbon offsets at scale, but it is also true that it presents immense socio-economic opportunities for low-income populaces in developing economies. Climate action is a constant trade-off between better living conditions, economic benefit, and environmental conservation. Organizations interested in socio-environmental impact and looking to capitalize on market trends can benefit from the popularization of carbon credits development and trading.
About the authors Krishnakumar Ramachandran | Krishna is a Biosystems Engineer and Biotechnologist with a background in sustainability, biobased transition, bioplastics and biofuels, energy, agribusiness, and natural resources. Having worked in R&D and having started up, he ‘transitioned’ to sustainability to make a tangible impact to people and the environment. As a freelancer, he works with sustainability consultancies in ESG, GHG accounting, carbon offsets and credits, and tech-advisory. He writes articles on sustainability strategy, corporate sustainability, energy transition risks.