Carbon Credits: Understanding, Analyzing, Acting

There is a systematic confusion between carbon credits and emission allowances. However, the two markets are profoundly different. They do not overlap, and they aim for different objectives.

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Carbon credits are traded on the offset market. They represent one ton of CO2 that would have been avoided or absorbed thanks to the financing of a project - for example, planting trees, or installing LEDs instead of oil lamps. Thus, the objective of carbon credits is to finance projects: their success is measured by the importance of the financing flows they generate. In 2024, the entire volume traded on the carbon offset market, at the global level, was around 1.5 billion euros, for about 300 million tons of carbon (or 300 million credits). So we are talking about a very small market.

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Conversely, emission allowances are financial instruments issued by jurisdictions. Their objective is to put a price on greenhouse gas (GHG) emissions. It is a pricing mechanism, not a financing mechanism (although the revenues can be used to finance climate policies). At the global level, it is more than 1,000 billion euros of trading volume in 2024, covering 10 Gt.CO2. It is therefore a gigantic market.

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Homaio focuses solely on emission allowances, which are financial instruments - like a stock or a bond. We do not work on carbon credits, which are commodities, like a coffee maker or a pen. However, this article will discuss carbon credits to understand what they are, how they work, what their limitations are, and why they might interest you.

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What is a Carbon Credit?

Definition of Carbon Credits

A carbon credit represents the equivalent of one tonne of carbon dioxide (CO2​) removed from the atmosphere or avoided thanks to a specific project. This project can involve planting trees, whose growth will sequester carbon present in the atmosphere (absorption). Or it can involve replacing wood-burning stoves with photovoltaic stoves, and therefore avoiding the GHG emissions of the stoves that have been replaced (avoidance). One can immediately imagine the difficulty in measuring the amount of CO2​ actually avoided or absorbed by a project, and in guaranteeing the permanence of this impact over time!

The idea is simple in appearance: finance a GHG emission reduction project somewhere to offset residual emissions elsewhere. Thus, if you take a plane for your vacation, you might be tempted to "offset" these emissions by financing projects somewhere in the world. It's a bit like modern papal indulgences!

In theory, this allows capital (your money, or that of your company) to be directed towards projects beneficial for the climate.

But this apparent simplicity masks a much more complex reality: not all carbon credits are created equal, and their effectiveness largely depends on the rigor with which they are generated, certified, and monitored. Thus, the carbon credit that comes from a tree planting project is not the same as the one that comes from solar stoves. There are in fact hundreds of categories of projects, and thousands of different credits.

Talking about carbon credits is a bit like talking about cars: between a golf cart and a Ferrari, there's a world of difference! It's not something standardized or homogeneous.

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Where do Carbon Credits Come From?

The origin of carbon credits dates back to the 1990s, in the context of international climate negotiations. The Kyoto Protocol, adopted in 1997, introduced for the first time the possibility for states and companies to offset part of their GHG emissions through reductions achieved elsewhere, via mechanisms such as the Clean Development Mechanism (CDM).

The objective is that so-called developed countries can finance GHG absorption or avoidance projects in so-called developing countries: the former have the capital but little opportunity to reduce their own emissions at low cost, while the latter have less capital but plenty of "cheap" avoidance or absorption solutions. And, after all, it makes sense to finance the cheapest projects, because a tonne of CO2​ in India has the same impact as a tonne of CO2​ in the United States: what matters is avoiding it, not at what price this avoidance is achieved. If the United States has the money and India has the avoidance opportunities, then promoting this financial flow seems self-evident!

This principle gave rise to a market for buying and selling carbon credits between, on the one hand, developers of compensation projects (those who plant trees or install photovoltaic stoves) and, on the other hand, buyers of carbon credits – individuals or companies – who wish to offset their emissions. Nothing compels these actors to do so – no regulations – which explains why we call it the voluntary carbon market. There is also no regulation on what is or is not a carbon credit, or who has the right or not the right to issue them. Thus, neither supply nor demand is regulated. If tomorrow you want to sell carbon credits, you can! You just need to find a buyer.

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The Main Characteristics of Carbon Credits

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There are many types of carbon credits: a study by Ecosystem Marketplace identified 150. Some are more or less permanent: for example, the capture and storage of carbon in the form of a supercritical fluid can be considered permanent. In any case, all must satisfy five fundamental criteria:

Additionality

A central concept of the Voluntary Carbon Market (VCM), additionality means that the underlying projects could not have come into being without the funding from the sale of carbon credits. In other words, these projects would not be viable on their own, all other things being equal (in the absence of specific regulations, public subsidies, or other favorable policies). Carbon credits should not replace existing funding, but rather complement it: without this, they do not generate a net environmental benefit. If credits are allocated to activities that would have taken place anyway, the process loses all meaning.

Evaluating additionality is particularly difficult. It requires defining a baseline scenario, that is, what would have happened in the absence of the project, and measuring the difference between the actual impact of the project and this baseline scenario. It also requires proving that the project would not have come into being without the sale of carbon credits. A large part of the criticism leveled at carbon credits precisely concerns this notion of additionality, because establishing a baseline scenario is extremely complex (and even then, the word is weak: it is actually a counterfactual).

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Quantification

The GHG emission reductions generated by a project must be quantified accurately and systematically, without overestimation.

Auditability

There must be independent assurance that the GHG emission reductions claimed by a project are real and correctly measured.

Permanence

The climate benefit associated with the project must be sustainable over time, without risk of reversibility. This is particularly critical for forestry or agricultural sequestration projects: a fire, a disease, or logging can wipe out years of carbon capture efforts in a few days. In this context, the notion of "permanence" must be taken literally. Some projects introduce compromises on the effective duration, recognizing that guaranteeing eternal sequestration presents major practical constraints.

Unique Ownership

It is essential to establish clear property rights in order to avoid double issuance, double counting, or double use of the emission reductions associated with a given credit.

A distinction is also made between ex ante and ex post carbon credits. When a credit is issued ex ante, that is, before the project is fully operational, the quantification is based on a forecast model and not on empirical observations, which can lead to overestimation. Conversely, when a credit is issued ex post, that is, after the implementation of the project, it becomes more difficult to demonstrate additionality, since the project already exists independently of the sale of credits.

The degree to which a credit satisfies these five criteria — each lying more on a spectrum than being a binary answer — determines what is called its quality. Of course, this notion of quality is itself subjective, because it is based on largely interpretable characteristics. This accumulation of subjectivity contributes to making the voluntary carbon market particularly opaque and fundamentally problematic. Moreover, there has been a phenomenal amount of scandals, accusations of greenwashing, and studies demonstrating that the vast majority of carbon credits issued had, in fact, no impact whatsoever.

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How Carbon Credits Work

And it is partly for this reason that a whole value chain has been structured between supply and demand, between the project developer and the final buyer who will offset their emissions. And on each link of this chain, there are dozens, sometimes hundreds of different companies.

The buyer (individual or company) naturally wants to obtain a certain guarantee: that the carbon credit they buy truly represents the avoidance or removal / reduction of one tonne of CO2​. This is where the registry comes in.

The Registry

The registry fulfills four main functions:

1. Define the standards that a project developer must comply with for their claims of emission avoidance or removal to be considered valid. The registry is not responsible for validating the projects themselves: it only defines the validation standards. As we will see later, validation is carried out by independent third parties.
2. Issue carbon credits to developers whose projects have been successfully verified. The carbon credit bears the name of the issuing registry: for example, Verified Carbon Units (VCUs) for Verra, Verified Emission Reductions (VERs) for Gold Standard, or Climate Reserve Tonnes (CRTs) for Climate Action Reserve. When a credit is issued, it receives a vintage year. Older vintages generally tend to sell for less than recent vintages, partly because of the – debatable – idea that older credits are of lower quality (because they haven't found a buyer, because methodologies have evolved, or because their additionality is questionable).

3. Retire carbon credits. A retired credit is a credit that has been "used" by a buyer (individual or company) to claim carbon offsetting. The distinction between a traded credit and a retired credit is essential, because – as we will see later – many intermediaries can be involved between the initial seller and the final buyer. It is therefore important to know whether a credit is simply resold or truly used.
4. Maintain a public registry of carbon credits issued, traded, and retired.

To build trust, a project developer chooses a registry, complies with its standards, follows its carbon accounting methodology, and requests official recognition of its emission reductions or removals. If the claims are accepted, the carbon credits are issued by the registry.

The standards are called "methodologies" or "protocols": these are precise procedures that define how to measure, verify, and quantify reductions or removals.

The main global registries are Verra, the Gold Standard, the American Carbon Registry and Climate Action Reserve.
These four registries represent the majority of carbon credits issued worldwide, although there are a multitude of smaller secondary registries. In France, Inuk and Riverse can be mentioned. Isometric  is another fairly recent registry that is beginning to emerge. 

The verifiers

While the standards define the rules, it is accredited independent companies that carry out the verification and monitoring of projects on behalf of the registries. Each registry maintains a list of authorized validation and verification bodies, with specific rules on their operation.

These bodies can in turn subcontract to individual verifiers. Although independent, these verifiers are directly mandated and paid by the project developers, which raises questions of alignment of interests. Increasingly, Measurement, Reporting, and Verification (MRV) platforms offer digital services to automate verification with technological solutions. They sometimes create their own quality standards or their own scores to evaluate credits. Multiplying the actors in a young and still unstable market generates increasing entropy: more noise, less clarity. And this is not necessarily a good thing.

The trading platforms

Trading platforms have developed to connect buyers and sellers.

However, the majority of transactions (in credit volume) continue to be done over the counter (OTC). Faced with the lack of standardization, the diversity of registries, and the fragmentation of rules and verifications, the platforms are trying to bring more transparency and fluidity to the market.

For companies, the French platform ClimeFi is a serious player working on permanent carbon removals.

The resellers

These are brokers, wholesalers, or traders who buy credits in bulk from developers to resell them to final buyers. The initial sale between developer and reseller is well recorded in the registry, but the credits are not retired until they are claimed by the final buyer.

There can be several successive sales before the credit is used. Resellers can also distribute their credits via the trading platforms mentioned above.

The consultants

Faced with a young, complex, and opaque market, many companies call on specialized consulting firms to enter the voluntary carbon market.

These consultants help them identify relevant credits, structure their offset strategy, and, at a minimum, assess their carbon footprint and the volume of credits needed.

Other Other Stakeholders

This value chain assumes that the buyer knows their carbon footprint and knows exactly how many tonnes they want to offset. However, this is not always the case. Many actors (digital tools, specialized firms) therefore offer carbon footprint calculation and monitoring services.

Finally, there are also rating agencies that evaluate the quality of carbon credits, adding an additional layer of analysis to a market that sorely needs it.

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Why and How to Buy Carbon Credits?

Is it a purchase or an investment? 

Carbon credits are not financial products. They are not easily traded, they are neither fungible nor standardized, and they lose value over time. They are marketable goods, consumer goods. So you can buy carbon credits, but "investing in carbon credits" is absolute nonsense. There is no liquid secondary market for carbon credits, nor any hope of future capital gains. If you want to invest while actually reducing emissions, then turn instead to the emission allowance markets. Homaio, for example, makes the European emission allowance market accessible to private investors.

On the other hand, if you want to buy them to offset your emissions, it can, in a few specific cases, make some sense. Be careful though: it has been shown that the vast majority of carbon credits have absolutely no effect on the absorption or avoidance of greenhouse gases. This partly explains why the market has never really taken off.

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When to offset emissions 

We have seen that carbon credits, in theory, serve to offset emissions. However, this does not mean that overall emissions decrease! We could very well offset 100% of greenhouse gas emissions, without the total amount of GHGs emitted decreasing. Carbon credits do not prevent emissions, they only shift reductions, often future and uncertain ones.

This is why we often hear that offsetting should be the last step, once all other emission reduction options have been exhausted.

Thus, offsetting your plane flight for a vacation doesn't make much sense: 100% of flights could be offset, but this will not prevent global warming. There are many reasons for this. Here are two:

• The emissions related to air travel are emitted today, and therefore have an immediate effect on global warming. The emissions avoided or absorbed will be gradual tomorrow: the time it takes for the tree to grow, or for the photovoltaic stove to be installed, and so on. This carbon temporality is completely ignored by the offset market.
• Furthermore, there is a virtually unlimited supply of offset projects, so their existence does not lead to a decrease in the absolute amount of greenhouse gases. Thus, we could offset the 50 Gt.CO2​ emitted each year, but these would still be emitted. And offsetting does not prevent emissions from growing tomorrow to 80 Gt.CO2​ or 100 Gt.CO2​, nor does it prevent the concentration of CO2​ in the atmosphere from increasing.

Also, the best thing is not to take the flight, as long as we have not found a solution to fly without emitting greenhouse gases.

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How much does a carbon credit cost? 

There are as many carbon credits as there are absorption or avoidance projects, and therefore as many different prices. They can range from a few dozen cents to several hundred euros. The Allied Offsets website attempts to track the average market price as well as the general activity of credit issuance and retirement. Their index, which tracks the 500 most important projects, gives an average price between $3 and $5 per credit.

It should be noted that the fragmentation of the value chain leads to an overlap of fees and therefore only a portion of the credit cost goes to the project developer at the end of the chain. This part can be more or less significant depending on the practices of the intermediaries. This is a criterion to take into account when choosing your carbon credit, the objective being of course to maximize the financing of the project rather than its intermediation.

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Some Tips to Guide Your Carbon Credit Purchase

Buying carbon credits to offset your emissions can quickly become an obstacle course. Homaio does not operate in this market, so we have no lessons to give. On the other hand, it is a distant, turbulent cousin, and we end up knowing some of its usual antics. Therefore, here is our advice for buying carbon credits while minimizing the risks of fraud or greenwashing:

• Prefer absorption to avoidance. Avoidance is based on baseline scenarios and depends on methodological rigor as well as the variables taken into account. Absorption is more easily quantifiable and closer to a physical reality.

• Verify that the funded project ensures the permanence of the absorption. Thus, forestry projects are generally unreliable because they are subject to hazards such as forest fires, drought, or diseases.
• Ensure that the registry is reputable and has not experienced any recent scandals. A simple Google search is often enough to rule out a large part of known frauds.
• Check what share is returned to the project and what share is retained by the intermediaries.

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