Voluntary Carbon Markets: Building a Strategic Approach to Carbon Credits

Stemming from a shared interest in catalyzing positive change, ENGIE Impact and the Consumer Goods Forum (CGF) formed a partnership to share best practices and knowledge to provide companies with the agency to address key sustainability challenges and become more competitive and resilient in the long term. The result was a series of masterclasses on decarbonization measures every company should be considering as they undertake their complex journey to Net Zero.

The first topic concerns widely known but frequently misunderstood concepts – carbon projects, carbon credits, carbon offsetting and the voluntary carbon market (VCM). While there is widespread skepticism about the efficacy of carbon credits and offsetting, when deployed correctly they are valid strategic tools for companies committed to meaningful decarbonization. That is why we are providing some foundational knowledge to demystify the carbon project, credit, and offsetting space, to clarify how the carbon market works, and to foster confidence in organizations’ ability to successfully navigate the market and avoid potential pitfalls. It is critical for companies thinking about entering this market to understand its complexities and the impact its anticipated growth and evolution will have on future decision-making.

A Word on Carbon Markets

Our discussion refers solely to the VCM, not compliance and regulatory markets. The latter are markets where governments and companies use a cap-and-trade system of emissions ‘allowances’ to meet regulatory and national climate change targets, while the VCM is open for anyone to purchase carbon credits to compensate for (offset) their emissions, supporting their climate change commitments, bolstering their reputation and spurring investment in vulnerable communities or climate technologies.

Both markets are relatively new and have faced challenges over the past twenty years, with the VCM undergoing rapid transformation since Net Zero started gaining traction about five years ago. Many new initiatives have been launched to build trust, drive quality, and create a pathway to supply the carbon credits needed to attain Net Zero targets.

Highlighting the importance of carbon credits, the IPCC (Intergovernmental Panel on Climate Change) includes them as a lever in all their modeled pathways to Net Zero. But carbon markets are still at a relatively nascent stage, making it challenging to deliver billions of tons of emissions reductions annually. Their ongoing development also makes them difficult to navigate, as they are still fragmented and complex, with multiple standards and jargon to be aware of.

What You Should Know About Carbon Markets

Despite uncertainty about the credibility of quality supply and criticisms of greenwashing, the increase in demand for carbon credits is well underway, creating an urgency to act. Unless one intends to avoid the carbon market altogether – a strategy we do not recommend – it is imperative to prioritize engagement with projects providing verifiably high-quality offsets.

Familiarity with the basic components of the carbon system is the first step to navigating what can be a confusing landscape and ensuring one's strategy is sound.

At the core of the carbon market system are carbon projects that have been validated against a carbon standard and either reduce or avoid emissions being released into the atmosphere, or remove emissions already present in the atmosphere. Following an independent verification process, emission reduction projects generate carbon credits in the form of certificates which can be traded on the VCM to finance those projects. A carbon credit represents one metric ton of CO₂ removal, reduction, or avoidance.

Under Any Standard, There Are Similar Procedures To Certify Carbon Projects

Three fundamental criteria underpin all quality carbon credits.

1. First, it must have a real, measurable carbon impact – an emissions reduction, removal, or avoidance – that has been quantified using a recognized methodology against a credible baseline or business-as-usual scenario.
2. Second, additionality, means that the project generating the credits would not have occurred without the finance (or prospect thereof) generated by the sale of carbon credits. Credits from a project that already has a viable business case without a subsidy from the sale of the carbon credits are not additional, as the emissions would have been avoided even without the sale of credits. From a regulatory standpoint, the project being funded must not be mandated by law or planning regulations. If it’s mandated, then it’s obligatory and cannot be additional or generate tradeable emission certificates.
3. Third, carbon projects must be independently audited against an established, internationally recognized standard, such as the Verified Carbon Standard or Gold Standard. Each time a carbon project developer wants to issue credits, they must retain an independent auditor to verify the emissions. After this process is completed, a carbon credit is issued in a standard public registry which tracks the credit (the ton of carbon removed or avoided) from generation through to retirement.

Once on the registry, the credit is made available for sale. The purchase of that credit is not carbon offsetting, as is commonly assumed. Offsetting occurs when purchased carbon credits are ‘retired’ and used to compensate for emissions in an annual carbon footprint for example. Once retired the carbon credit is permanently removed from the market and cannot be sold or transferred again. A purchased carbon credit may be retired directly or held for a later date. The act of offsetting is the process of canceling a sufficient number of carbon credits to meet a climate or environmental claim.

The Carbon Credit Lifecycle in Five Steps

Offsetting does not reduce a corporate carbon footprint but can be used to support a climate commitment. The key impact for an organization is that they address what are called ‘residual emissions’, which are hard to abate and cannot be reduced in any other way, either because their abatement is uneconomic or technically unfeasible.

By addressing these emissions, offsetting enables an organization to take responsibility for all the emissions it generates.

Offsets Deliver Benefits Beyond Carbon Reductions

Two questions are often posed: “Does offsetting actually achieve anything?” and “Is offsetting just a way to buy my way out of my emissions impact without changing my behavior?” To these, we respond that there is no pathway to global Net Zero without the use of carbon markets to finance otherwise unviable projects, often in the developing world. Secondly, research shows that companies that have used credits in the past six years have an internal decarbonization rate twice as high as those that have not.

Beyond the carbon reduction that offsets provide, they also generate co-benefits, which are additional benefits that go beyond climate impact. A useful way to identify these benefits is to show how carbon credits intersect with the United Nations’ Sustainable Development Goals (SDGs). The mechanism of carbon credits generally addresses several SDGs, starting with SDG 7 – Affordable and clean energy – and SDG 13 – Climate Action (take urgent action to combat climate change and its impacts) – but often include several more. They can be divided into three categories of benefits:

Environmental

Many carbon projects generate a range of positive environmental benefits that favor climate adaptation outcomes. Carbon projects aimed at forest conservation and reforestation projects help protect, restore, and promote sustainable use of terrestrial ecosystems, preserve biodiversity, combat desertification, and halt land degradation (SDG 15) while projects such as mangrove afforestation provide coastal protection and prevent erosion and storm surges, creating new marine habitats (SDG 14).

Economic

Nearly all carbon projects have an economic impact, creating jobs and contributing to economic growth (SDG 8), while carbon credits on the voluntary market incentivize businesses to innovate and develop new technologies to lower their carbon impact (SDG 9). For instance, mini-grid rural electricity projects create both skilled and unskilled employment opportunities for local communities during the construction and operation phases.

Social

Consider a seemingly innocuous practice like using traditional fuels for cooking. It can take up to six hours a day to collect firewood and cook with it every day, and impacts about a quarter of all households globally, as some two billion people still use traditional fuels. Firewood as a fuel source is not only polluting and unhealthy (SDG 3) but traps women and children in poverty (SDG 1) and denies them access to education (SDG 4) and employment (SDG 8). Projects providing cleaner cookstoves address all of these issues, as well as gender inequality (SDG 5).

A great advantage of purchasing carbon credits is that organizations can tailor their selection of projects to reflect the issues they are concerned with as part of their social engagement, as well as the location of those projects. An organization may have a particular interest in the Brazilian rain forest or have suppliers in Africa or Asia and want to support projects that benefit those regions.

Financing and Assessing Carbon Projects

We are aware that confidently wading into the VCM is easier said than done. From the criteria to consider when assessing a carbon credit to the volatile pricing characteristic of the VCMs to the exposure to risk from some nature-based avoided deforestation projects, companies must consider multiple factors and be aware of several stakeholders and enablers that facilitate the market process before embarking on this journey. Let’s take a brief look at the evolving world of stakeholders that comprise the VCM.

Supply Side

On the supply side, projects need capital to get off the ground. Groups of investors will regularly fund these projects early on, assuming some of the equity and risk for a financial return. Developers design and deliver carbon projects, in conjunction with various stakeholder groups, generating carbon credits and selling them through intermediaries. Sometimes the developer and investor are the same, both owning and running the project. The registries and accreditors provide project standards and methodologies for project developers, while the standards (e.g., Verified Carbon Standard, Gold Standard) manage the registries that track carbon credit issuances, transfers, and retirements.

Then there are initiatives such as the Integrity Council for the Voluntary Carbon Market (ICVCM), which aims to address the integrity of the voluntary carbon market that enables investors and buyers to confidently support high-quality credits as part of comprehensive climate strategies. Independent auditors validate and verify the integrity and quality of carbon projects against a carbon standard’s methodology. Finally, we have the third-party credit raters that assess the likelihood that credits issued by a carbon project actually delivered on its claims of avoiding or removing one MtCO₂ or other greenhouse gas (GHG) emissions.

Demand Side

On the demand side, we find a similar cast of enablers managing the huge increase in demand over the past five years. A strategic adviser like ENGIE Impact will provide a carbon credit buyer with a holistic approach to procurement and carbon project portfolio composition and management. One can also go directly to carbon credit brokers or retailers who advise and transact on one’s behalf like a commodity broker. There are also carbon exchanges, which are like typical commodity markets, offering a trading platform or a commodity exchange for carbon credits. They aim to increase transparency and enable access to a wide range of carbon projects, while insurers offer insurance products to cover various project risks typically aimed at investors or buyers putting capital at risk.

Added Reputational Value

Companies that are really looking to lean into climate change, to go beyond a license-to-operate position of just having a science-based target, and genuinely take responsibility for all their emissions, will need to offset. Positioning those offsets correctly and showing that your organization is going beyond what is required to meet its carbon contribution is where the added reputational value really lies. And that's just from a carbon perspective, irrespective of all the other socio-economic, biodiversity, and adaptation benefits mentioned above. Being aware of the carbon credit criteria to fulfill and potential stumbling blocks to avoid are critical first steps on the path to building a robust carbon strategy.