Carbon credits explained: an industry veteran breaks down how they actually work
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Carbon credits explained: an industry veteran breaks down how they actually work

Carbon credits explained: an industry veteran breaks down how they actually work

As environmental concerns have continued to grow over the years, carbon credits have entered the spotlight as a popular instrument that incentivizes businesses to support clean development projects and offset their own emissions.

From establishing wind power systems in India to ensuring potable water in Ethiopia, developers of clean initiatives can finance their projects using proceeds from the sale of carbon credits, which companies purchase to offset their own emissions.

But from the perspective of someone outside of the supply chain, it can be difficult to visualize how carbon credits actually work — they’re intangible, yet seem to have monetary value and have the ability to do environmental good.

Some common questions about carbon credits:

1. How do these credits guarantee that emissions are actually being offset?

2. How are carbon credits priced?

3. Who is making money on carbon credits?

4. How are carbon credits allowing the private sector to keep emissions in check where the public sector leaves off?

To answer these questions and more, I spoke with Margaret Kim, the CEO of Gold Standard, which facilitates the certification, administration and exchange of carbon credits between project developers and companies, and has become one of the most prominent authorities in carbon emissions reductions.

Margaret Kim, CEO of Gold Standard | Credit: Gold Standard
Margaret Kim, CEO of Gold Standard | Credit: Gold Standard

Our conversation has been edited for length and clarity.

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Arjun Gangakhedkar: Regulators and businesses themselves are often the most obvious players in hitting lower emissions targets. How can others in the private sector also participate?

Margaret Kim: The climate crisis is a global challenge; everyone has a role to play in solving it. Civil society can help in continually raising expectations for ambition and ensuring accountability for our businesses, institutions, and even our policymakers. They can both “name and shame,” as well as “name and fame” — giving recognition to those who go above and beyond.

Individuals can do the same — aligning their lifestyle and political choices with those who are working toward a climate-secure future. Investors probably wield the most influence. If the largest asset managers say they require climate risk disclosure and management, or even go further by offering preferential terms for positive impact, you’ll see a lot of companies fall in line. 

How does Gold Standard approach finding the right companies to sell carbon credits to?

Our primary focus is ensuring integrity in the climate protection projects certified to Gold Standard and the carbon credits they issue. In 2017, we introduced a platform where individuals and small businesses could purchase Gold Standard-certified carbon credits.

This was to address several challenges in the market: 1) Provide a means to project developers to sell their credits without relying exclusively on intermediaries, 2) Inform the public about sustainable carbon prices that allow developers to maintain and expand their projects, while also creating a sufficient incentive for the buyer to further reduce their emissions, and 3) Do all of this in a simple, user-friendly and transparent way. 

How do companies differentiate themselves from others that also sell carbon credits?

There are two levels here: 1) The quality of the credits and 2) How the sales or transactions happen. Carbon credits are as strong as the underlying standards, which as a baseline for credibility must ensure that projects are ‘additional’ (would not have happened in the absence of carbon finance), are real, measurable, unique, permanent and independently verified.

Gold Standard goes further than these minimum requirements and ensures that projects follow social and environmental safeguards to avoid unintended negative outcomes, as well as provide verified benefits to local communities and ecosystems to a minimum of three of the UN’s Sustainable Development Goals.

Consultancies or other third party sellers often market a range of credits. The most trusted of these market intermediaries are those that are clear about the verified impacts of different projects and are transparent about their pricing and how much of the purchase price reaches the project developers. They should also be able to point to a digital record of a company’s purchase on the respective standards’ public registries. 

So let’s say a company buys some offsets and they’ve sent Gold Standard the agreed-upon rate. Now what? What’s Gold Standard’s process for making those offsets happen?

Carbon markets operate on the basis of ‘results-based finance.’ This means that carbon credits represent outcomes (emission reductions) that have already happened and have been verified.

In this model, the project developer takes on all the financial risk and makes the initial investment required to develop and certify the project. Once their project impacts have been independently verified and certified, the project is issued with carbon credits. The sale of these credits enables project developers to recoup costs, repay loans, and maintain and expand the project activity. This ‘payment for performance’ approach provides those supporting the project (e.g. purchasing carbon credits) with the highest assurance that the outcomes have been achieved.

In some cases, companies will make forward purchases, usually in collaboration with a project developer or a market intermediary that represents a project developer. In this case, they generally use a legal agreement called an “Emission Reduction Purchase Agreement” (ERPA) that includes provisions for delivery risk. 

How do companies like Gold Standard price its carbon credits?

The carbon market generally prices credits based on dynamics of supply and demand. Sometimes it’s strictly a result of trends in company preference, but common factors include how much a project costs to develop and/or the value of the beyond-climate benefits it delivers. We believe that both should be considered. In our online platform, we start with the Fairtrade minimum price to cover project costs as the minimum and then factor in the economic value associated with the development benefits, according to assessments from environmental economists. 

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A common concern about carbon offsets is that they rely on certain imprecise calculations. Can you speak about that?

The potential for precision varies on both the corporate footprint accounting side and the carbon offsetting side, and conservative principles should be used to account for uncertainty in both cases. For example, a company measuring its Scope 2 (electricity) emissions will likely have precise numbers from meter readings. Similarly, a renewable energy climate protection project will yield precise emission reduction calculations. 

In carbon offsetting, community based projects are more challenging to monitor because they require home visits and surveys of users in remote communities. So the methodologies account for this by requiring statistically significant samples and also discounting the number of emission reductions depending on uncertainty. In this way, carbon offsetting projects can actually provide more rigorous or conservative calculations in many instances than company footprint calculations.

In your experience, are there particular industries that buy a particularly large amount of offsets from Gold Standard? Are they the same industries that pollute the most or are there some companies that buy significant offsets just to be environmental stewards?

Companies that fall under compliance obligations, for example, utilities or heavy industry within the European Emissions Trading Scheme or under the California Air Resources Board, buy large volumes of carbon credits. However, because compliance buyers often seek the lowest cost credits and Gold Standard’s quality requirements lead to higher prices per credit, these industries purchase Gold Standard credits with less regularity.

In the voluntary space, where companies are often purchasing carbon credits as part of their climate strategies or broader commitments to sustainability, they often go for Gold Standard because credits deliver more impact above and beyond climate. In some cases, companies buy a portfolio of credits but choose to showcase the Gold Standard projects in their marketing because of our strong brand reputation. 

One of Gold Standard’s main goals is to actualize the objectives of the Paris Climate Accord. But a big point of contention for a lot of people is that the Paris Accord isn’t legally binding. So if that’s the case, how do we get companies to willingly participate in meeting emissions targets, particularly if it means their operations need to slow or scale down to do so?

We expect that countries that meet their commitments find diplomatic or economic ways — both carrots and sticks — to incentivize the freeriders. You see this in the EU considering a border tax adjustment. But it’s not enough. This is where civil society and individuals (or the lamentable term “consumers”), and investors are so important. We know that business can innovate when it has incentives to. When investors and individuals reward businesses that voluntarily reduce emissions beyond their compliance obligations, or punish those who don’t, that creates pressure to change.  

So is the future more similar to one where we place a hard emissions cap on companies (a legally binding version of the Paris Agreement so-to-speak) or is it one where we financially incentivize the ecosystem in the private sector to stay within emissions targets?

The cap is a blunt and arguably simpler instrument, assuming there is political will to enact it. And if not applied globally, it can make the more climate-conscious less competitive. At Gold Standard, we believe this should be the reset to a new paradigm, where business can “Grow to Zero” — that is, reach net-zero carbon emissions while still creating value, not only for shareholders, but also for the good of society and the ecosystems we rely on. To do this, putting incentives in the right place is critical. We need a new generation of ‘carrots and sticks’ to drive change to the world we want. 

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