Carbon offsets (also referred to as carbon credits) can be generated by any type of project that reduces or removes greenhouse gas (GHG) emissions beyond a business-as-usual scenario. Projects generating carbon credits are typically grouped into two categories: (i) avoidance / reduction projects, such as forest conservation, renewable energy or methane capture and (ii) removal / sequestration projects, such as reforestation/afforestation, wetland restoration or direct air capture technology. An individual, government, organization or company can purchase carbon credits to offset their carbon emissions.
The vintage year of the offset refers to the year the emission reduction occurred. Some projects will issue offsets every year, while some will issue offsets in multi-year increments. An offset can be resold but once it has been permanently sold to an end user who wants to claim the offset’s impact, it can no longer be resold. To ensure that it is not, an offset must be listed as retired on a registry that keeps track of the issuance and retirement of offsets.
Carbon offsets can either be traded on the voluntary markets, where buyers and sellers trade on their own volition, or as part of certain compliance markets, where government regulations require emitters to either reduce their emissions, use allocated carbon allowances or purchase compliance credits or carbon offsets.
All offset projects must create a measurable, trackable, permanent and independently verified reduction in GHG emissions that would not have occurred in the absence of the revenue generated from the offset. To ensure that emissions reductions or removals are real and “additional,” meaning they would not have been achieved without carbon finance, the vast majority of carbon offset projects use third-party verified standards to approve their carbon credits.
For example, some offsets traded on compliance markets are created based on crediting mechanisms governed by international climate treaties and administered by international institutions, such as Clean Development Mechanism or Joint Implementation projects. On the voluntary markets, the vast majority of projects follow rules and procedures set out by independent third-party organizations, such as the Gold Standard and the Verified Carbon Standard, which together audit and accredit about 80% of the offsets in the voluntary market.
Carbon offsets are often used by corporations to meet the goals of their climate policies. According to the NewClimate Institute, more than 1,500 companies worldwide have announced plans to achieve net-zero emissions by 2050 or earlier and align themselves with the Paris Agreement. In order to achieve these goals, some high emitting industries, such as oil, mining, airlines and steel, will need to rely on carbon offsets since a large share of their emissions cannot be abated with current technologies. Carbon offsets are anticipated to be instrumental in achieving decarbonization when low-carbon alternatives are not available, too expensive or hard to scale.
Ecosystem Marketplace estimates that the amount of carbon credits traded in the voluntary carbon markets in 2020 was 188 Mt CO2e for a total market value of US$473 million. Forestry and land use projects represented the majority of transactions (64% by value), followed by renewable energy projects (17%). A growing number of corporations that are looking to use “nature-based solutions” to offset their GHG emissions have created a demand for forest carbon credits. Forest carbon credit projects include improved forest management (IFM), avoided conversion (AC) of forestland to a non-forest use and afforestation/reforestation (AR).
We believe that the demand for carbon offsets will rise in the future as more companies adopt climate action plans, which are increasingly being required by shareholders, regulators and customers. In 2021, participation in the voluntary carbon markets increased significantly with a record US$1 billion in transactions by November 9, 2021, which represented approximately 0.3 Gt CO2e. McKinsey & Company forecast that demand for voluntary carbon credits could grow approximately 15 times from commitment levels estimated in 2020 to 1.5 to 2 Gt CO2e and be worth up to US$50 billion a year by 2030. By 2050, demand could increase approximately 100 fold to 7 to 13 Gt CO2e per year.