· 7 min read
This article is part of illuminem's Carbon Academy, the ultimate free and comprehensive guide on key carbon concepts
1. Definition
Carbon credits are typically generated through projects or activities that reduce or remove greenhouse gas emissions, and each credit represents one metric ton of carbon dioxide equivalent (CO₂e) that has been mitigated. Each carbon credit is the equivalent of 1 tonne of CO₂ avoided or removed.
The credits are purchased by companies, individuals, and other entities to offset GHG emissions or otherwise contribute to carbon dioxide emissions abatement. Carbon Credits are primarily traded in the Voluntary Carbon Market. The prices of carbon credits are determined by the types and quality of carbon projects as well as the demand for credits from those projects.
2. Carbon credit lifecycle
2.1. Main Stages
It typically takes several years before carbon credits are actually issued. To progress from initial project planning through production, verification, certification, and the issuance of carbon credits. For example, newly planted trees require years to reach a size sufficient to ensure significant carbon absorption. This process consists of three stages (see also the VCM piece).
- A project developer oversees the delivery of the carbon offset project, selecting the methodology it will adhere to
- Standards bodies and verifiers evaluate the validity of the project proposal. Upon successful verification and approval, carbon credits are issued
- The project developer subsequently sells the allocated carbon credits to entities seeking to offset their emissions or contribute to climate solutions, often businesses
2.2. Carbon credits retirement
a) What is carbon credit retirement?
Retiring a carbon credit indicates that it has been used, that the carbon benefit it represents has been claimed by the entity that purchased it – it is taken off the carbon market, and cannot be sold or traded again.
Once the carbon benefit which the credit represents has taken place, the carbon credit is retired in its registry to indicate that it has been used – again ensuring the purchase and impact is traceable, and avoiding any double counting.
Retiring a carbon credit is a way to ensure that the environmental benefit it represents is permanently recognized. Once retired, the carbon credit cannot be sold, transferred, or otherwise used to offset emissions again. This process is crucial for maintaining the integrity and effectiveness of carbon offset programs and standards.
b) Purchase vs. retirement
When a buyer acquires carbon credits, the positive impacts of these credits are not immediately linked to the purchasing act. Instead, the buyer retains ownership of these credits until they decide to retire them.
Carbon credits have the potential to be traded, at times multiple times, among various market participants. This implies that carbon credits may persist, unretired, for a certain period. In order to avoid double counting, it is key to distinguish between these two timelines on carbon offset certificates.
Upon retirement, carbon credits are irrevocably withdrawn from circulation and become ineligible for resale. Once a retirement has been executed, the buyer is free to claim the positive impacts the credits represent. When a credit is retired, the carbon offset it represents is permanently removed from market circulation. This effectively marks the credit’s ‘life’ since it cannot be used or claimed again.
Only the stakeholder who retires the credit can claim the emission reduction towards its climate targets and they can only do so once. Retirement is extremely important for driving credibility, preventing the benefits of credit from being claimed multiple times.
3. Types of Carbon Credits
Carbon credits vary not only in relation to the projects they are linked with but also in terms of their issuance timing. Two distinct types of credits exist in this context:
3.1. Ex-post credits
- Ex-post credits represent an emission reduction/removal that has already occurred. The activity that removes or reduces emissions has already happened and verified.
- ex-post carbon credits may be retired immediately after the purchase
a) Example
- Carbon Capture and Storage (CCS) Projects: After a CCS project is operational and has captured a certain amount of carbon dioxide emissions from industrial processes, the actual data on carbon capture is measured and verified. Carbon credits are then issued based on the verified results.
- Forestry Projects: the forest has already grown, has removed and stored the planned amount of carbon emissions, and can thus be eligible for ex-post credits based on the achieved carbon sequestration over a specific period.
b) Pros and Cons
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Pros: The buyer faces reduced risk as the project has already been successful and its impact has already been verified by the issuing entity of the carbon credits. Carbon credits can be retired after they are sold.
Ex-post carbon credits often originate from projects whose climate impact has already been measured and verified. This constitutes a positive aspect for buyers, too, who want to count these verified credits towards their climate targets.
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Cons: While ex-post credits provide accurate estimates of their impact, the types of projects they are linked to may not often contribute towards net-zero or net-negative targets as much as ex-ante or pre-purchase carbon credits (see below).
3.2. Ex-ante credits
- Ex-ante credits are issued before the carbon benefit takes place, based on the expected benefit that they will generate in the future.
- You will still receive a carbon certificate as proof of your purchase, but ex-ante credits cannot be retired until the claimed benefit has taken place.
a) Example
- Renewable Energy Projects: a wind farm or solar power project that is operational, but no estimates regarding the amount of carbon emissions that will be avoided through the generation of clean energy. Credits can be retired when the project’s carbon benefit is known.
- Afforestation and Reforestation Projects: When new forests are planted (afforestation) or depleted forests are restored (reforestation), estimates are made regarding the amount of carbon that these trees will sequester as they grow. Credits are issued but will not be retired until trees have successfully grown.
- Energy Efficiency Projects: Before implementing energy efficiency measures in buildings, industries, or transportation, estimates are made regarding the reduction in carbon emissions that will result from using less energy. Credits are generated based on these ex-ante calculations.
b) Pros and Cons
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Pros: Ex-ante credits allow the buyer to finance the project in its early stages and directly contribute to its success.
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Cons: Because the impact has not yet happened, there is some risk that the project may fall short of its expected outcomes. In this respect, it becomes crucial to prioritize high-quality projects.
Verification and monitoring are crucial aspects of ex post carbon credits, but even more so in the case of ex ante credits given that their climate impact is still to be realized.
3.3. Pre-purchase credits
- Pre-purchase carbon credits are sold today, but are not actually yet issued. This essentially represents a promise from an early-stage carbon project that they will issue carbon credits in the future, once the project is up and running – often the only way to buy carbon removals today. Pre-purchase carbon credits are sold today, but are not actually yet issued.
- Like ex-ante credits, pre-purchase carbon credits cannot be retired until the claimed impact has taken place
a) Example
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A Direct Air Carbon Capture and Storage (DACCS) project that is still in the design or construction phase: carbon credits can be issued when the plant is operational and be removed only when the carbon benefit has accurately been estimated.
b) Pros and Cons
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Pros: Pre-purchase credits are usually associated with early-stage and innovative projects, often technological carbon removal initiatives (e.g. DACCS), which hold immense potential, but are not easy to scale up in the short term and require huge financial commitment.
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Cons: Similarly to ex-ante carbon credits, there are a few risks associated with this type of carbon credits for buyers since the benefits of the project have not been measured or verified, or the project may not even be operational yet.
4. Conclusion
In our previous articles, we discussed the differences between nature-based and tech-based solution credits, as well as the distinctions between reduction and removal. The additional categorization of ex-ante, ex-post, and pre-purchase carbon credits further underscores the complexity of the carbon credit landscape.
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