Carbon Credits: What They Are and How They Work in Real Life?

Why Carbon Credits Matter?

Carbon credits have become a critical tool for addressing climate change. As businesses and governments commit to ambitious emissions reduction targets, carbon credits offer a mechanism to account for emissions that cannot yet be eliminated. For business professionals, understanding how carbon credits function, who trades them, and how they are verified is crucial. This article explains the concept of carbon credits, how they work in real markets, the players involved, and their growing impact on corporate climate strategies.

Understanding Carbon Credits

A carbon credit represents one metric ton of carbon dioxide or its equivalent in other greenhouse gases that has either been removed from the atmosphere or prevented from being emitted. The core idea is that while some emissions may be unavoidable in the short term, businesses can balance these emissions by supporting projects elsewhere that actively reduce or remove emissions. Carbon credits are divided into two broad categories: compliance credits and voluntary offsets. Compliance credits are used in government-mandated systems, often known as cap-and-trade programs. These systems establish a cap on total emissions, and companies receive or purchase credits that allow them to emit a certain amount. If they emit less, they can sell excess credits. If they exceed their allowance, they must purchase additional credits or face penalties. Voluntary credits, on the other hand, are used by organizations and individuals seeking to offset their emissions as part of a broader sustainability or carbon neutrality effort, without a legal obligation.

How Carbon Markets Operate?

In practice, carbon credits are central to both regulated and voluntary carbon markets. In compliance markets such as the European Union Emissions Trading System (EU ETS), companies in high-emitting sectors like energy, manufacturing, and aviation are required to account for their emissions through allowances. These credits can be traded in the market, incentivizing companies to reduce their emissions where it is most cost-effective. Since its launch in 2005, the EU ETS has helped reduce industrial emissions by nearly 47%. China’s national Emissions Trading Scheme, launched in 2021, now covers over 2,000 power companies and is already the world’s largest carbon market by volume. These markets are not only tools for compliance but also mechanisms for innovation, allowing companies that overperform on emissions reduction to profit by selling their excess allowances.

The Role of Voluntary Markets

The voluntary carbon market is different. Here, credits are generated by projects that either avoid emissions—such as renewable energy developments and improved cookstove distribution—or remove emissions, like reforestation and soil carbon sequestration. Companies purchase these credits to offset emissions they can’t eliminate through internal measures. For example, Microsoft has committed to becoming carbon negative by 2030 and is actively purchasing credits from high-quality carbon removal projects, including bioenergy with carbon capture and storage (BECCS) and direct air capture initiatives. Shell buys large volumes of nature-based offsets to offer customers "carbon-neutral" fuels, pairing traditional fossil fuels with offsets from forest conservation projects.

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Who Buys and Sells Carbon Credits?

The buyers of carbon credits vary widely. Large corporations are the most active participants, driven by net-zero targets, investor pressure, and customer expectations. Tech companies like Microsoft and Google, consumer brands like Nestlé and Unilever, and even airlines such as Qatar Airways and Delta have incorporated carbon credits into their sustainability strategies. Governments also use carbon credits to meet international climate commitments. For instance, under the Paris Agreement’s Article 6, countries like Switzerland have struck bilateral agreements to purchase credits from developing nations, such as Ghana, which generates credits through improved cookstove initiatives.

On the other side of the transaction are the sellers—organizations or developers running emissions-reduction projects. These include renewable energy developers, forest conservation groups, and innovators in carbon capture technologies. To ensure the credibility of a carbon credit, the reduction or removal it represents must be measurable, reportable, and verifiable. This is achieved through a structured process known as MRV: Measurement, Reporting, and Verification. Projects must establish a baseline scenario, quantify the emissions reduced or removed, and submit this data to an independent verifier. Only after successful verification can a project issue credits on a recognized registry.

Ensuring Quality Through Standards

Several standards exist to maintain the integrity of carbon credits. These include Verra’s Verified Carbon Standard (VCS), the Gold Standard, the American Carbon Registry, and the Climate Action Reserve. These bodies provide detailed protocols for calculating emissions reductions, ensuring additionality (that the reductions wouldn’t have happened without the project), and addressing concerns like permanence and leakage. For example, a forest conservation project must demonstrate that the forest was under threat of deforestation, that it has been preserved, and that the carbon benefits will be maintained over time.

Why Businesses Use Carbon Credits?

Carbon credits are especially valuable for helping businesses meet interim climate goals. While many companies have committed to net-zero by 2040 or 2050, achieving complete decarbonization takes time. Carbon credits allow them to address unavoidable emissions now while investing in long-term changes like energy efficiency, electrification, or supply chain transformations. For instance, a logistics company may offset emissions from diesel trucks today while transitioning to electric fleets over the next decade.

Addressing Criticism and Risks

However, carbon credits are not without criticism. One major concern is the quality of credits. Not all projects deliver the emissions reductions they claim. Some forest offset projects have been accused of issuing credits for forests that were never truly at risk or have since been cut down. To address this, buyers must conduct due diligence, choosing credits certified by credible standards and supported by transparent data. The Integrity Council for the Voluntary Carbon Market (ICVCM) and other emerging initiatives aim to standardize what constitutes a "high-quality" credit.

Another concern is over-reliance on offsets. Critics argue that some companies use credits as a substitute for real emissions reductions, thereby delaying meaningful climate action. Best practice suggests a clear hierarchy: reduce emissions as much as possible, then offset the remainder. Frameworks like the Science Based Targets initiative (SBTi) recommend that carbon credits be used only for residual emissions after a company has made substantial internal reductions. Transparency in reporting is also crucial. Companies should disclose both their gross emissions and the extent to which offsets are used, rather than presenting a neutral carbon footprint without context.

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Expanding International Cooperation

International cooperation is also expanding the use of carbon credits. The aviation industry’s CORSIA program (Carbon Offsetting and Reduction Scheme for International Aviation) requires airlines to offset emissions growth beyond 2020 levels by purchasing eligible credits. This program is expected to offset between 2.5 and 4 billion tonnes of CO2 by 2035. Meanwhile, countries are increasingly exploring Article 6 mechanisms under the Paris Agreement, which allow for the transfer of emissions reductions across borders. In 2022, Ghana and Switzerland completed the first such transaction, where Switzerland financed clean cooking solutions in Ghana in exchange for credits toward its national targets.

Case Studies from Around the World

United States: California Cap-and-Trade Program

California operates one of the most advanced carbon markets in the U.S. through its cap-and-trade program, which covers major industries including power, oil, and manufacturing. Since its launch in 2013, the program has enforced a declining cap on emissions and allows regulated entities to trade allowances. It also accepts a limited number of offset credits from approved projects such as forest management and methane capture. The system has generated over $19 billion in auction revenue, much of which is reinvested in clean energy and community resilience projects. Companies like Chevron and Pacific Gas & Electric participate actively, managing their compliance through a combination of internal reductions and credit purchases.

Europe: Microsoft and Climeworks Partnership

In Europe, Microsoft has partnered with Climeworks, a Swiss company specializing in direct air capture (DAC) technology. Climeworks removes CO2 directly from the atmosphere and stores it underground in basalt rock formations in Iceland. Microsoft signed one of the largest carbon removal deals to date, agreeing to purchase over 11,000 tons of carbon removals. This partnership supports Microsoft’s goal to be carbon negative by 2030 and demonstrates how European technology and American corporate demand can align in the voluntary carbon market.

Asia: China’s National Carbon Market

China launched its national carbon trading system in 2021, initially covering over 2,000 power sector companies. With emissions allowances distributed based on output benchmarks, firms that operate efficiently can sell surplus credits, while less efficient plants must buy additional credits or improve performance. The market quickly became the largest in the world by volume. The Chinese government plans to expand coverage to additional sectors such as cement and steel. This initiative is a major step in China’s goal to peak carbon emissions before 2030 and reach carbon neutrality by 2060.

The Business Case for Carbon Credits

As the carbon market matures, businesses have more options than ever to integrate carbon credits into their sustainability strategies. Platforms for buying and selling credits are becoming more transparent and user-friendly. Some companies now go beyond offsetting operational emissions and use credits to address historical emissions or supply chain impacts. Microsoft, for example, has pledged to offset all emissions it has generated since its founding in 1975.

In conclusion, carbon credits are a powerful tool for climate action, offering flexibility and financial incentives to reduce global emissions. They enable companies to balance unavoidable emissions while supporting broader environmental goals. But their effectiveness depends on integrity. High-quality credits, transparent reporting, and a commitment to genuine emissions reductions are essential. For business leaders, carbon credits should be seen not as a way to delay action, but as a complement to an ambitious, science-based decarbonization pathway. When used responsibly, they can drive investment into climate solutions and help businesses deliver real, measurable impact.

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