Carbon Credits Explained: A Guide for Valuation and Investment in Environmental Projects

“The people who are crazy enough
to think they can change the world
are the ones who do.” – Steve Jobs

 

Seemingly, that is the mindset of the leaders who drafted the Paris Agreement. The ambitious aim of the Agreement is to strengthen the global response to the threat of climate change by keeping a global temperature rise this century well below 2 degrees Celsius (above pre-industrial levels) and to pursue efforts to limit the temperature increase even further to 1.5 degrees Celsius. As we become more aware of the urgent need to combat climate change, the concept of carbon credits to reduce CO2 emissions has gained significant attention as a way to offer individuals and organizations the opportunity to take responsibility for their carbon emissions.

In this blog, we will unravel the mystery behind carbon credits, explain the distinction between carbon credits and carbon offsets, and delve into the differences between the voluntary carbon and regulatory carbon markets.

As you consider how to monetize your natural assets or invest in environmental projects, it makes sense to understand how a carbon credit is created and the importance of purchasing high-quality carbon credits that are accurately priced based on precise and reliable data.

So, let’s embark on this journey.

Understanding How Carbon Credits Are Created

Carbon credits are a unit of measurement used to quantify the reduction or removal of greenhouse gas (GHG) emissions. One carbon credit is typically equivalent to one metric tonne of carbon dioxide (CO2) emissions or its equivalent in other GHGs. Carbon credits get generated through projects and activities that reduce or sequester emissions. When a project successfully reduces or removes emissions, it is issued a corresponding number of carbon credits.

Carbon Credits vs. Carbon Offsets

Although often used interchangeably, carbon credits and carbon offsets have distinct meanings.

Carbon Credits

Carbon credits are bought, sold, and traded on the carbon market. Purchasing carbon credits allows organizations to compensate for their emissions by supporting projects that offset those emissions. Think of a carbon credit as a school permission slip: an organization can “skip class” by going on a field trip instead.

Carbon Offsets

Carbon offsets are broader and can include purchasing carbon credits or through investing/participating in emission reduction projects. For this discussion, we’ll use the term carbon credits.

The Carbon Credit Market – the Players

As mentioned earlier, carbon credits can be bought and sold through supply and demand.

• Suppliers may be for-profit or not-for-profit private project developers, local private or community landowners looking to undertake an environmental improvement project. Municipalities, public agencies, or national governments may use carbon credits to monetize their natural assets.
• On the demand side, private companies may be looking to offset their GHG emissions or to achieve broader corporate climate goals. Governments, non-governmental organizations (NGOs), and individuals may seek credits to offset emissions from airline flights, events, or the production of goods and services.
• Investors and financial institutions may take a role on both the demand and supply side.
• Indigenous communities may hold title to or access rights to the land where carbon reduction activities happen.
• Lastly, there are regulators. This brings us to a discussion of voluntary emission reduction (VER) and certified emissions reduction (CER).

 

Voluntary vs. Regulatory Markets

Carbon credits are exchanged in voluntary and regulatory markets, each serving different purposes.

Voluntary Market

The voluntary market allows individuals, businesses, and organizations to take voluntary action in reducing their carbon footprint (CO2 emissions) beyond their regulatory obligations. Participants can purchase carbon credits to demonstrate their commitment to environmental sustainability by supporting impactful projects. Third-party organizations can serve as the body that facilitates the buying and selling of credits, places a value on the credits, and oversees the marketplace.

Regulatory Market

The regulatory market operates under governmental regulations and compliance. Some governments have implemented cap-and-trade systems to incentivize industries to reduce emissions. In this scenario, companies are assigned emission allowances and can trade carbon credits to meet a compliance obligation. The regulatory market aims to enforce emission reduction targets and encourage industries to implement cleaner practices. Whether participating in the voluntary or regulatory market, the goal remains the same: mitigate climate change by taking responsibility for carbon emissions.

How is the Carbon Credit Value Determined?

The voluntary market uses the basics of supply and demand to determine pricing. Therefore, pricing can vary from location to location and per the type of carbon credit (for example, clean energy vs. forestry). Carbon offsets are often used as a pricing mechanism. In carbon offsets, the value of a project (eg. planting trees or building a CO2 capture mechanism that pulls CO2 from manufacturing plants before it enters the atmosphere) is determined for every tonne of CO2 removed or reduced. Pricing in 2021, for example, ranged from a few US dollars to $15-20 USD. However, the voluntary market has no regulatory oversight. This means it is subject to misuse or mismanagement.

The regulated market prices vary by the governmental regulator. For example, today’s price in California, the only US state to use a cap-and-trade system, is $29.26. In the European Union, the price is 81.81 Euros, the price in China is $7.87, and in Australia, it is $34.75. The factors that go into the pricing for voluntary and regulated markets have a significant impact.

Pricing Factors for Carbon Credits

A few factors that can impact carbon credit pricing include:

Vintage – Newer carbon credits are considered more valuable because they are issued with the most up-to-date standards. Older carbon credits may represent GHG emission reductions or removals from activities that no longer need the finance incentives from the voluntary carbon market.

• Higher quality carbon credits – Projects that include data monitoring and verification of the impact represent real, measurable GHG emission reductions or removals.
• Projects that have associated benefits (social or ecological) provide additional value.

Projects that can meet one or more of these factors typically require additional upfront investment and can demand a higher price for the carbon credits.

Organizations and governments sell carbon credits through carbon credit brokers or retailers in the voluntary market. Governments control and regulate the carbon credits in their location. The European Union ETS market is the largest in the world. Others include California, Australia, China, Korea, and New Zealand.

Nature-Based Carbon Credits

Our upcoming carbon credit blogs for forestry, agriculture, and wetlands contain additional details on how nature-based carbon credits can be used and how they are valued. In short, nature-based carbon credits in the voluntary market are separated into three tiers:

• Tier 1 – The most basic form of carbon credit generated by projects whose quality and additionality are not verified. Additionality refers to whether the reduction would not have happened without the carbon credit.
• Tier 2 – Carbon credits are validated and verified by an independent third-party organization. However, the project may not be eligible for certification under more rigorous standards.
• Tier 3 – The highest level of carbon credit in the voluntary market. Carbon credits are validated and verified by a third-party organization using more rigorous monitoring and measurement. The extent that data integrity and accuracy exist matters here. These activities have clearly defined additionality and permanence (where the carbon reduction or sequestration benefits last 5, 10, 15, or 20 years). These projects may involve complex land use changes and additional social or ecological benefits.

The Importance of Data in Carbon Credit Pricing

As you can see, carbon credits from projects that are rigorously monitored can extract the highest price. As a government, land owner, business, or financial institution interested in monetizing natural assets or investing in environmental projects, you must consider the accuracy and integrity of the data used to determine the value of carbon credits or “green” bond programs.

This is where Laconic provides its most unique value. Until now, no system has been able to collect and continually monitor environmental data. Laconic’s integrated Environmental Intelligence service and SADAR™ platform, is the first comprehensive system that collects and analyzes data providing the critical insights needed for strategic decision-making in environmental projects.

Data Sources

When evaluating a nature-based asset, various sources and sensors are used. This includes satellites, drones, ground-based sensors, ground survey teams, and data from aquatic surface and sub-surface sensors. Laconic uses more than 24 monitoring domains, 54 environmental data inputs, 10 data pedigree elements, and 6 Ecosystem thematic accounts to generate enormous amounts of real-time data with high fidelity.

Data Integration, Cataloging & Analysis

These rich data sets can be integrated with additional data from other sensor or technology sources and be unified for cataloging and analysis, enhancing data quality and accuracy. SADAR™ also provides analysis giving you the insights needed for deciding how to value nature-based projects and the carbon credits that can be achieved.

As our environment changes daily, continual monitoring and a verified data audit trail are required to ensure the monetary value of nature-based carbon credits.

Additional reading:

How do Carbon Credits Work in Forestry?
How do Carbon Credits Work in Agriculture?
How do Carbon Credits Work in Wetlands?
How do Carbon Credits work with Biodiversity?

Changing the world by reducing global temperatures is worthy of our time. Carbon credits offer the incentives and financial support needed for funding CO2 reduction/removal projects. Investing in carbon credits of the highest quality backed by data ensures the projects are the most impactful.

Learn more about Laconic’s Environmental Intelligence platform, SADAR, and our Natural Capital Monetization service.