How Can Carbon Credits Help Address Climate Change?

1. What is a carbon credit?

A carbon credit is a certificate representing one metric ton of carbon dioxide or similar greenhouse gases (GHGs) that was either prevented from being emitted into the atmosphere or removed from the atmosphere through carbon-reduction projects. Carbon credits are either required by governmental regulations or bought by companies and individuals voluntarily. The voluntary carbon market (VCM) was developed to help businesses and individuals to achieve ambitious commitments to reduce global greenhouse gas emissions by offsetting their residual emissions. Carbon offset registries, such as Verra and Gold Standard, develop standardized protocols for project registration, monitor available credits, and ensure that credits aren’t allocated to multiple entities. To register a project with a registry, developers must demonstrate that the credits are real, permanent, additional, measurable, independently verified, and unique. Once an entity claims credit to offset its footprint, the credit is retired from the registry and can no longer be sold.  

2. Unprecedented pressure on corporates to make net-zero commitments

Nearly 200 countries have endorsed the Paris Agreement, a legally binding international treaty on climate change. It commits to limiting the global average temperature increase to below 2-degrees Celsius above pre-industrial levels at a minimum—and ideally, keeping to the science-based 1.5-degree increase scenario. The latter would reduce the odds of triggering climate change’s most consequential and irreversible effects. Reaching that target, however, would require cutting GHG emissions by 50% of current levels by 2030 and 100% of current levels by 2050. Over the last two years, many companies have risen to the occasion: according to the Net Zero Tracker, one-third of the world’s largest publicly traded companies had net zero targets in 2022, up from one-fifth in 2020. Stakeholders are increasingly pressuring companies to measure and report their progress in line with science-based targets.

Commitments by companies and cities account for 25% of global CO2 emissions and over 50% of GDP.

In order to reach these pledges, companies will first have to reduce both their direct and indirect carbon footprints. Given current technological constraints, reducing emissions beyond a certain point will be prohibitively expensive for many companies. To achieve their decarbonization targets, these companies will have to offset their footprint using carbon offsets. Some companies, such as Microsoft, have gone even further and committed to retroactively removing all their carbon emissions since it was founded in 1975.

3. The role of carbon credits in the transition to net-zero

The voluntary carbon credit market has a central short- and long-term role in the transition to net-zero. In the short-term, the ability to sell carbon credits will direct investment toward emissions avoidance solutions. Generally speaking, emission avoidance is the lowest-cost solution to address the reduction of the global carbon footprint. These carbon offsets can be generated by different categories of projects, such as nature-based solutions (e.g., deforestation avoidance), resource recovery (e.g., methane emission avoidance from landfills or wastewater), renewable energy, agricultural solutions, and the avoidance of fossil-fuel based alternatives. In the long term, a robust carbon credit market can be crucial in neutralizing residual emissions through removal credits. Removal credits represent a decrease in carbon emissions compared to a baseline solution. A recent McKinsey report found that a minimum of 5 gigatons of negative emissions per annum will be needed to reach the Paris Agreement 2050 target. This could be achieved through a combination of nature-based solutions (e.g., reforestation and afforestation) and cutting-edge technologies that capture, use, and store carbon dioxide (e.g., direct air capture, bioenergy, biochar, CO2-enhanced oil recovery, microalgae). Carbon credits drive private financing to climate projects that otherwise would not have been initiated and are essential to lower the cost of emerging climate technologies. The scaling of the VCM would also mobilize capital to the Global South, where most nature-based projects are located. A recent Science article by the Crowther Lab at ETH Zurich showed that around 0.9 billion hectares of land worldwide would be suitable for reforestation. This is an area of the size of the United States with the ability to sequester 205 billion tons of carbon. Moreover, another research project identified an additional 2 billion hectares of existing degrading forest land that could be restored. Carbon credit projects also have important additional co-benefits such as biodiversity protection, pollution prevention, public-health improvements, and job creation.

4. Not all carbon credits are made equal

While the last two years have seen unprecedented growth in the voluntary carbon market, it is still in its infancy and lacks global governance. Not all carbon credits are made equal: many of the carbon credits available on the spot market today are low-quality. Because of the lack of standardization of methodologies and protocols, transparency, and verifiability, low-quality credits represent emissions avoidances or questionable reductions. Price is also an imperfect signal of quality; limited pricing data makes it challenging for buyers to know whether they are paying a fair price and for investors to assess the risks they expose themselves to. Protracted due diligence processes make the acquisition of carbon credits burdensome for both contracting parties. Notwithstanding the important role played by standard-setting organizations, brokers, ratings agencies, marketplaces, and exchanges in improving the governance of the VCM, Oka believes that insurance has a necessary role to play in de-risking the development of carbon credit-generating projects and the certificates associated with these credits.

Build Your Carbon Credit Insurance Portfolio

Connect with one of our experts to secure your carbon investments.