Carbon Credits Explained: All You Need to Know

Carbon Credits Explained: All You Need to Know

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Grace Smoot

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Stay impactful,

One tool to reduce global carbon emissions and maintain a sustainable planet for future generations is a form of carbon pricing called carbon credits. So, we had to ask: What are carbon credits really, and could they help us mitigate climate change?

Carbon credits are tradable certificates or permits that set a maximum level of carbon emissions for industries, companies, or countries. They do not directly reduce your carbon footprint and are only effective if set according to global standards. Yet, they are one tool to mitigate climate change.

Keep reading to find out all about what carbon credits are, the impact you can have with them both individually and globally, their benefits and drawbacks, and why they may not be the most effective way to mitigate climate change.

The Big Picture of Carbon Credits

Carbon emissions already have a price tag attached to them, but it is our environment that pays the price, not the emitters. Carbon pricing seeks to resolve this issue and make emitters pay for their carbon emissions. And one form of carbon pricing comes in the form of carbon credits. 

Carbon credits are tradable certificates or permits that give companies, industries, or countries the right to emit 1 tonne (1,000kg) of carbon dioxide (CO2) or the equivalent amount of a different greenhouse gas (GHG). 

Carbon Credit: a unit used in carbon trading that represents the right of a business, factory, etc. to release 1000 kilograms of carbon dioxide into the environment”

Cambridge Dictionary

Carbon credits are a form of climate currency, meaning they are subject to supply and demand and can be bought and sold through a cap-and-trade market. This market limits how much total CO2 can be emitted. Cap-and-trade markets became established after the Kyoto Protocol, an international treaty, set a maximum amount of GHG emissions that could be released into the atmosphere, both globally and nationally. 

Each entity operating under a cap-and-trade program is issued a certain number of carbon credits each year. They can purchase more if their emissions exceed what was issued, and they can sell unused credits to other entities if their emissions are less than what was issued. 

What carbon credits areCarbon credits are tradable certificates or permits that give companies, industries, or countries the right to emit 1 tonne (1,000kg) of CO2 or the equivalent amount of a different GHG.
How carbon credits workCarbon credits cap how much CO2 can be emitted by an entity. This cap on emissions can be gradually reduced over time, leading to less and less overall emissions.
The impact of carbon credits on your own emissionsCarbon credits do not directly reduce your carbon footprint. 
The impact of carbon credits on global emissionsCarbon credits mitigate the problem, but they do not work at the core issue of reducing overall CO2 emissions.
The overall effectiveness of carbon credits on reducing carbon emissionsImproper reporting and discrepancies in maximum GHG levels between countries limits carbon credit effectiveness on a global scale. 
The main benefits of carbon creditsCarbon credits can reduce GHG emissions, protect ecosystems, incentivize the switch to green energy, support green jobs, and promote energy independence.
The main drawbacks of carbon creditsImproper reporting and discrepancies in maximum GHG levels between countries limits carbon credit effectiveness on a global scale. 

How Do Carbon Credits Work

Carbon credits operate by setting an upper limit on carbon emissions, which pre-determines the amount of total emissions reduction but leaves the price of emissions up to the market to decide.

How Do Carbon Credits Reduce Carbon Emissions

The goal of carbon credits is to reduce carbon emissions to mitigate climate change.

  • Carbon credits represent indirect emission reductions. Putting a cap on emissions and decreasing this cap over time reduces carbon emissions over time, preventing CO2 from entering the atmosphere.

When you hear the words “carbon credit”, think about the term “allowance”. Carbon credits represent the maximum amount of CO2 an entity is allowed to emit. This cap on CO2 emissions slowly decre ases over time, forcing entities to emit less and less CO2 to stay within the boundaries of the cap. Companies with high levels of emissions can continue to operate, but only at an increased cost.

Illustration of global annual CO2 emissions
Our World in Data: Annual CO2 Emissions

To ensure a healthy planet for future generations, we must reduce our carbon emissions. And one way to do this is by utilizing carbon credits.

What Impact Do Carbon Credits Have on Your Own Carbon Emissions

One of the best ways we can aid in the fight against global climate change is to reduce our carbon footprint. And to do this we first have to reduce our carbon emissions. 

  • Carbon credits do not directly reduce your carbon footprint. 

Carbon credits do not directly reduce your own carbon emissions. Setting a limit on how much carbon emissions are allowed is an indirect method of emission reduction because companies can continue to emit as long as they pay the price. Coupled with direct measures of emission reductions, such as reducing individual energy usage and consumption, carbon credits can become more effective. 

What Impact Do Carbon Credits Have on Global Carbon Emissions

Every year we pump over 36 billion tons of CO2 into the atmosphere, fueling climate change. This causes temperature and sea-level rise, melting of sea ice, changing precipitation patterns, and ocean acidification. Carbon credits aim to reduce global emissions and mitigate these negative environmental effects.

  • Carbon credits mitigate the problem, but they don’t work at the core issue of reducing overall CO2 emissions. 

Carbon credits do not have a significant impact on global carbon emissions. Although they may incentivize companies to reduce their CO2 emissions, the immediate effect of reducing emissions under the cap-and-trade system is to benefit a company’s bottom line. The direct goal of carbon permits is not to reduce greenhouse emissions or support sustainable energy projects, but rather for companies to make money. 

The COVID-19 pandemic triggered the largest decrease in energy-related carbon emissions since World War II, a decrease of 2 billion tonnes. However, emissions rebounded quickly and rose by 6% in 2021 to 36.3 billion tonnes, their highest ever level. This indicates that the earth is still warming at an accelerated rate, and still not enough is being done to implement direct carbon reduction measures.

Illustration of annual CO2 emissions globally
Our World in Data: Annual total CO2 emissions

How Effective Are Carbon Credits in Reducing Carbon Emissions

Carbon credits can be effective at reducing carbon emissions under certain conditions.

Carbon credits have faced criticism because most industries lack the technology that monitors and determines their amount of CO2 emissions. This makes it easier for companies to cheat on their emissions reports and say they are emitting less than they actually are. 

Also, different countries have different standards and caps for CO2 emissions. If the cap is set too high, then companies are not incentivized to reduce emissions. But set the cap too low, and companies will be overly burdened to reduce emissions. And the extra cost will be passed down to consumers as a result.

What Are the Main Benefits and Drawbacks of Carbon Credits

Carbon credits have benefits and drawbacks that are important to understand before you decide whether or not to utilize them. 

What Are the Main Benefits of Carbon Credits 

Using carbon credits can reduce our consumption of and reliance on fossil fuels (i.e., coal, oil, and natural gas) which can reduce the effects of global warming by limiting global GHG emissions. But they also come with various environmental benefits:

  1. Reduces GHG emissions: By setting a cap on emissions, carbon credits reduce overall emissions down to the cap. And those entities who reduce beyond the cap are incentivized to do so through the use of tradable credits. 
  1. Protects Ecosystems: Reducing GHG emissions promote healthy ecosystems, which have been linked with cleaner air, water, and food. Protecting forest habitats increases carbon sequestration and defends against erosion. Protecting agricultural land ensures a robust, secure, and prosperous food system. Protecting aquatic ecosystems ensures a readily available supply of fresh water. Lastly, protecting biodiversity protects human health because many plants and animals are used in modern medicines
  1. Incentivizes the switch to green energy: Carbon credits incentivize companies to switch to greener energy sources including solar, wind, hydro, and geothermal energy. They do not emit CO2, nitrogen oxides, sulfur dioxides, or mercury into the atmosphere, soil, or water. And these pollutants are known to contribute to the thinning of the ozone layer, global sea-level rise, and the melting of our world’s glaciers.
  1. Supports Green Jobs: The renewable energy sector employed 12 million people worldwide in 2020, with solar energy making up the bulk of those jobs. Renewable energy jobs continue to increase as we start to realize just how beneficial renewable energy is for our environment. 
  1. Promotes energy independence: Switching from fossil fuels to green energy promotes energy independence. Being able to produce your electricity without the aid of foreign countries is an important step in becoming self-sufficient. 

What Are the Main Drawbacks of Carbon Credits 

As with everything, carbon credits come with drawbacks that must be understood in order to implement them properly.

  1. Companies can cheat the system: Most industries lack the technology that monitors and determines their amount of CO2 emissions. This makes it easier for companies to cheat on their emissions reports and say they are emitting less than they actually are. Then they receive the benefits without actually putting in the work. 
  1. Inconsistent standards: Because different countries have different standards and caps on emissions, there is no universal agreement on how much emission reduction is needed. And setting a cap too high or low can be problematic. 
  1. Wealthy companies can avoid the cap: Companies with high levels of emissions can choose to operate despite the cap, as long as they have the money to do so. 

Why Are Carbon Credits Important to Fight Climate Change

As outlined in the Paris Climate Agreement, we must cut current GHG emissions by 50% by 2030 and reach net zero by 2050. Carbon credits are important to meet this target because they are a way to reduce carbon emissions. This mitigates the effects of climate change, which has a positive cascade effect on public health and plant and animal diversity. In addition, it boosts the global economy and leads to innovative, more environmentally-friendly solutions.

However, carbon credits should not be used as a panacea for climate change. Relying on them solely is impractical because the immediate effect of reducing emissions under the cap-and-trade system is to benefit a company’s bottom line. 

In the long term, direct methods of carbon footprint reduction are much more effective. Reducing your household, travel, and lifestyle carbon footprint can go a long way in the fight against climate change!

What are Better Alternatives to Carbon Credits

If used correctly, carbon credits can provide environmental, economic, and social benefits beyond reducing carbon emissions. They have the potential to instigate meaningful environmental change and begin to reverse some of the effects of climate change. 

However, we can’t let this method be a guilt-free way to reduce carbon emissions. Carbon credits must be used in conjunction with carbon reduction measures until the industry has time to invest, develop, and refine more sustainable innovations. 

These reduction measures don’t have to involve drastic changes either. Actions that may seem small can have a big impact because those small changes add up! You can reduce your carbon footprint in three main areas of your life: household, travel, and lifestyle. 

Reduce your household footprint:

Reduce your travel footprint:

  • Walk or bike when possible: The most efficient ways of traveling are walking, bicycling, or taking the train. Using a bike instead of a car can reduce carbon emissions by 75%. These forms of transportation also provide lower levels of air pollution.

Reduce your lifestyle footprint:

  • Switch to Renewable Energy Sources: The six most common types of renewable energy are solar, wind, hydro, tidal, geothermal, and biomass energy. They are a substitute for fossil fuels that can reduce the effects of global warming by limiting global carbon emissions and other pollutants.
  • Recycle: Recycling uses less energy and deposits less waste in landfills. Less manufacturing and transportation energy costs means fewer carbon emissions generated. Less waste in landfills means less CH4 is generated.
  • Eat less meat and dairy: Meat and dairy account for 14.5% of global GHG emissions, with beef and lamb being the most carbon-intensive. Globally, we consume much more meat than is considered sustainable, and switching to a vegan or vegetarian diet could reduce emissions. 
  • Take shorter showers: Approximately 1.2 trillion gallons of water are used each year in the United States just for showering purposes, and showering takes up about 17% of residential water usage. The amount of water consumed and the energy cost of that consumption are directly related. The less water we use the less energy we use. And the less energy we use, the less of a negative impact we have on the environment.

Because carbon credits are an indirect way and not a direct way of reducing emissions, they alone will not be enough to reduce global carbon emissions significantly. Direct measures of emission reductions, such as reducing individual energy use and consumption, are better alternatives to carbon credits.

Related: Are you interested in learning why reducing your carbon footprint is so important? Check it out in this article here: “4 Main Reasons Why Reducing Your Carbon Footprint Is Important

Final Thoughts

Carbon credits are tradable certificates or permits that give companies, industries, or countries the right to emit 1 tonne (1,000kg) of CO2. Although they do not reduce your carbon footprint directly, when implemented properly they can reduce global GHG emissions, promote energy independence, and incentivize the switch to green energy. In order to be effective, carbon credits must adhere to global standards. The level of the cap also must be set carefully.

Carbon credits are a good place to start if you want to get into the carbon-emission reduction game, but in order to be effective in the long term, we must not rely on them solely. Cutting emissions from the source is the best way to reduce our carbon footprint and provide the highest environmental benefits.

Stay impactful,

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Grace Smoot

Grace loves to research and write about all things related to climate action and sustainability. She holds a Bachelor’s of Science degree in Environmental Biology and works as an Environmental Survey Technician. Outside of work, she loves to work out, play soccer, and take her dog for long walks.

Did you know that the internet is a huge polluter of the environment? But fortunately not this site. This site is powered by renewable energy and all hosting-related CO2 emissions are offset by three times as many renewable energy certificates. Find out all about it here.

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