BUS 103 DePaul University Accounting Questions

CARBON CREDITAND CARBON OFFSET
FUNDAMENTALS
Areta A. Jez, Brad D. Alexander,
and Ayaz R. Shaikh
TABLE OF
CONTENTS
About the Authors…………………………………………………………………………………………………………………… 3
Glossary of Key Market Terms…………………………………………………………………………………………………4
I.
Introduction…………………………………………………………………………………….. 8
II.
Creation of Carbon Credits and the Establishment of Carbon Markets………………… 9
III.
Carbon Credits Versus Carbon Offsets…………………………………………………….. 13
IV.
Carbon Markets……………………………………………………………………………….. 15
V.
Valuing Carbon Offsets…. …………………………………………………………………… 18
VI.
Lifecycle of a Carbon Offset……………………………………………………………….. 20
VII. Opportunities and Risks for Stakeholders………………………………………………… 24
Endnotes…………………………………………………………………………………………….. 25
Carbon Credit and Carbon Offset Fundamentals // 2
ABOUT THE AUTHORS
Areta A. Jez, Associate, Energy & Sustainability and Projects & Infrastructure Practices
AAJez@mintz.com | +1.212.692.6788
Areta is an Associate in the Projects & Infrastructure practice and the Energy &
Sustainability group at Mintz. She focuses her practice on the development, financing,
and acquisition of renewable energy and sustainable infrastructure projects. Her
experience includes projects in the solar, offshore wind, geothermal, biofuels, waste,
and wastewater treatment sectors. Prior to joining Mintz, Areta was a projects associate
at an international law firm. Areta has worked at the US Department of State and the
International Development Law Organization in Rome.
Brad D. Alexander, Associate, Energy & Sustainability and Projects & Infrastructure Practices
BDAlexander@mintz.com | +1.415.696.5256
Brad is an attorney in the Projects & Infrastructure practice and the Energy &
Sustainability group at Mintz. He advises sponsors and developers on a range of energy
and infrastructure projects. Brad currently advises on renewable energy, storage,
biofuels, and sustainable infrastructure projects, as well as cleantech companies and
investors in connection with financings, M&A, and commercial agreements. Brad has
experience globally with a focus on developing markets. Before joining Mintz, Brad was a
senior associate at a global law firm and, prior to that, was based in Southeast Asia as a
projects associate for another global law firm.
Ayaz R. Shaikh, Chair, Projects & Infrastructure Practice
Member, Energy & Sustainability Practice
AShaikh@mintz.com | +1.202.434.7318
Ayaz is the Chair of the Projects & Infrastructure practice at Mintz and a Member in
the firm’s Energy & Sustainability group. A widely recognized projects lawyer with
experience in over 40 countries spanning five continents, Ayaz’s practice encompasses
Project Finance and M&A representations across a spectrum of energy and infrastructure
sectors. He advised on some of the first independent power projects (IPPs) in Asia,
the Middle East, and Latin America, and helped to establish the framework, concession
structure, or model agreements for projects in a country. Today, Ayaz’s practice focuses
entirely on renewable energy, sustainable infrastructure, and climate-related mandates.
He is a frequent panelist and has published extensively, including a book on Project
Finance Fundamentals and the chapter on “International Project Finance” in PLI’s
International Corporate Practice treatise.
Relevant to this paper, Ayaz advised the World Bank in a pioneering transaction in
2001 aimed at operationalizing the carbon market–based frameworks under the Kyoto
Protocol. In that capacity, he helped to structure and craft the first Emission Reduction
Purchase Agreement or “ERPA” for use in the maiden investment by the World Bank’s
Prototype Carbon Fund for a waste management project in Latvia. Widely used, the
ERPA set the precedent and formed the foundational basis for the creation and sale of
renewable attributes, including present-day Renewable Energy Certificates or RECs.
Carbon Credit and Carbon Offset Fundamentals // 3
GLOSSARY OF KEY MARKET TERMS
Term
Meaning
Additionality
A reduction in GHG Emissions is deemed “additional” only if
the reduction would not have taken place in the absence of the
incentive created by the voluntary carbon offset market. Achieving
“additionality” increases the value of the carbon offset.
Avoidance Projects
One of the two main types of projects that produce carbon credits
or offsets. Avoidance projects avoid the release of GHG Emissions
into the atmosphere by reducing activities that tend to emit large
numbers of GHG Emissions or by protecting natural resources.
Carbon Credits
Tradeable permits that each represent the right to emit one metric
ton of carbon dioxide or other greenhouse gases.
Carbon Offsets
Measures of the amount of carbon avoided or permanently
removed from the atmosphere. A carbon offset represents one
metric ton of carbon dioxide or equivalent greenhouse gases
avoided or removed.
Certified Emissions
Reduction (CER) Credit
Relating to the Kyoto Protocol, a marketable carbon credit
generated by the Clean Development Mechanism (CDM) that
represents the equivalent of offsetting one metric ton of carbon
dioxide. A CER can be traded or sold to count towards meeting an
industrialized country’s GHG Emissions–reduction targets under
the Kyoto Protocol.
The Clean Development
Mechanism (CDM)
One of three market-based mechanisms introduced by the Kyoto
Protocol to assist countries in finding ways to meet their GHG
Emissions reductions targets. The CDM allowed industrialized
countries to implement an emissions reduction project in a
developing country and, in doing so, generate a marketable
Certified Emissions Reduction (CER) credit.
Climate Reserve Tons
(CRTs)
Tradeable carbon offsets issued by the Climate Action Reserve in
the voluntary carbon market.
Compliance Carbon
Markets
One of two categories of carbon markets that allows participants
to buy and sell carbon credits or carbon offsets to comply
with rules or regulations imposed by regulatory or governance
organizations.
Carbon Credit and Carbon Offset Fundamentals // 4
GLOSSARY OF KEY MARKET TERMS contd.
Term
Meaning
Core Carbon Principles
A framework and assessment procedure for identifying and issuing
carbon offsets released by the Integrity Council for the Voluntary
Market in 2022.
Corresponding
Adjustments
An accounting mechanism that requires a host country to deduct
(or “un-count”) a sold carbon offset from its own NDCs so that
the buyer country can count the offset against its NDCs. This
mechanism was established at Glasgow with the ratification of
Article 6 of the Paris Agreement and seeks to address doublecounting.
Double Counting
The idea that multiple entities are claiming benefits from the same
carbon offset.
Emissions Reduction
Purchase Agreement
(ERPA)
A legally binding contract between buyers and sellers of carbon
offsets.
Environmental, Social
and Governance (ESG)
Objectives
Objectives set within a company in order to manage the
organization’s impact on social and environmental sustainability
directly. The trading of carbon offsets in the voluntary market can
help companies meet their ESG objectives.
Glasgow Climate Change
Conference
A 2021 climate conference that ratified Article 6 of the Paris
Agreement.
Greenhouse Gas (GHG)
Emissions
The release of gases that contribute to the greenhouse effect via
human activity. Both carbon credits and carbon offsets aim to
reduce GHG Emissions.
The International Emissions
Trading (IET) Mechanism
One of three market-based mechanisms introduced by the Kyoto
Protocol to assist countries in finding ways to meet their targets.
The IET mechanism allowed industrialized countries with unused,
excess carbon allowances to sell these excess allowances to other
industrialized countries that exceeded their targets.
Carbon Credit and Carbon Offset Fundamentals // 5
GLOSSARY OF KEY MARKET TERMS contd.
Term
Meaning
Internationally Transferred
Mitigation Outcomes
(ITMOs)
One of two market-based approaches provided under Article 6
of the Paris Agreement that allows countries to meet their NDC
obligations by trading for and acquiring carbon offsets earned
from the reduction of GHG Emissions. ITMOs are the new unit
of carbon reduction established by the Paris Agreement for
international carbon markets that will replace CERs established
under the Kyoto Protocol.
Joint Implementation (JI)
One of three market-based mechanisms introduced by the Kyoto
Protocol to assist countries in finding ways to meet their targets.
The JI allows industrialized countries to collaborate jointly with
each other in pursuing and implementing emissions reduction
projects in order to meet their Kyoto targets.
Kyoto Protocol
An international treaty that came into effect in 2005, setting
legally binding targets for 37 industrialized countries to limit or
reduce their overall greenhouse gas emissions.
Nationally Determined
Contributions (NDCs)
National plans highlighting climate change mitigation, including
climate-related targets for greenhouse gas emission reductions.
The Paris Agreement requires each country to create and submit
NDCs on a five-year cycle.
Removal Projects
One of two main types of projects that produce carbon credits or
offsets. Removal projects are aimed at removing GHG Emissions
already released into the atmosphere by using nature-based and
or technology-based methods.
Retirement
The process whereby a carbon offset is used and removed,
meaning that the carbon offset can no longer be sold or traded
on any exchange. Retirement occurs after the reduction in GHG
Emissions has been deducted from the final owner’s carbon
footprint.
Paris Agreement
A legally binding, international treaty on climate change adopted
in 2015 that effectively replaced the Kyoto Protocol. The Paris
Agreement called on both industrialized and developing countries
to set and meet emissions goals.
Carbon Credit and Carbon Offset Fundamentals // 6
GLOSSARY OF KEY MARKET TERMS contd.
Term
Meaning
Sustainable Development
Mechanism (the SDM)
One of two market-based approaches provided under Article 6
of the Paris Agreement that allows countries to meet their NDC
obligations by trading for and acquiring carbon offsets earned
from the reduction of GHG Emissions. The SDM aims to reduce
overall global GHG Emissions.
Validation and Verification
Body (VVB)
An independent third party pre-approved by the carbon offset
registry that conducts an audit of the project design during the
auditing stage of the carbon offset certification process.
Verified Carbon Units
(VCUs)
Tradeable carbon offsets issued by Verra in the voluntary market.
Verified Emission
Reductions (VERs)
Tradeable carbon offsets issued by the American Carbon Registry
in the voluntary market.
Vintage of a Carbon Offset
The year GHG Emissions reductions for an issued offset were
deemed to have occurred. The vintage of a carbon offset can be
indicative of the quality of the carbon offset and its underlying
project, and thus is a principal factor in determining the carbon
offset’s value.
Voluntary Carbon Markets
One of two categories of carbon markets. Voluntary carbon
markets allow for the trading of carbon offsets that are not bought
or sold on the compulsory carbon markets to meet GHG Emissions
requirements imposed by regulatory bodies. Most carbon offsets
are traded in voluntary markets and cannot be used to achieve
GHG Emissions reduction targets under an applicable compliance
regime. Certain carbon offsets, however, are permitted to be used
to achieve compliance with a compulsory regime.
Carbon Credit and Carbon Offset Fundamentals // 7
I. INTRODUCTION
As the need to reduce the emission of greenhouse
gases has grown more urgent over the last quarter
century, key stakeholders across the globe
have sought to forge effective paths to make a
measurable difference in the health of the planet.
Starting in the 1990s with the Kyoto Protocol,
governments and multilateral organizations led
the way by creating avenues for countries to
participate in carbon reduction efforts through
the use of carbon credits and carbon offsets. The
mechanisms introduced by the Kyoto Protocol led
to the creation of global and regional compulsory
compliance regimes requiring both countries
and corporate entities to limit their carbon
emissions. Beyond these mandatory regimes, the
sharp rise in public concern over the climate has
increasingly catalyzed companies to take steps
to reduce their carbon emissions on a voluntary
basis. In order to reach their goals, companies are
turning to voluntary carbon markets, where they
are able to invest in renewable energy projects
that generate carbon offsets, as well as purchase
and sell carbon offsets, as a means of contributing
to the removal of carbon from the atmosphere.
Activity surrounding voluntary carbon markets
has expanded steadily since their introduction,
with current estimates projecting that the market
for carbon offsets may be worth over US$50
billion by 2050.i
Despite the growing importance of both carbon
credits and offsets, the fundamentals of these
tradeable units and their associated markets are
still not well understood by most. This article
seeks to provide a broad overview of carbon
credits and carbon offsets in order to facilitate
a better awareness of the growth and practical
workings of these markets. It commences by
surveying the establishment and evolution of
carbon markets stemming from the entry into the
Kyoto Protocol in the late 1990s. It then delves
into the distinctions between carbon credits and
carbon offsets, as well as the difference between
compulsory and voluntary carbon markets.
The article includes a brief journey through the
typical lifecycle of a carbon offset, from creation
to retirement. It concludes with a few broad
observations regarding the opportunities and
risks presented by the carbon markets.
Carbon Credit and Carbon Offset Fundamentals // 8
II. CREATION OF CARBON CREDITS AND THE
ESTABLISHMENT OF CARBON MARKETS
The focus on carbon credits as a means of
combating climate change is relatively new.
The concept of an international carbon market
was first established by the Kyoto Protocol in
1997. Initially signed by 180 countries, the Kyoto
Protocol came into effect in 2005, setting legally
binding targets for 37 industrialized countries
to limit or reduce their overall greenhouse gas
emissions (“GHG Emissions”) by an average of at
least 5% below their respective 1990 levels during
the period of 2008-2012.1
The Kyoto Protocol imposed these binding
targets only on industrialized countries in express
recognition of the responsibility they bear for
the state of the climate as a result of their GHG
Emissions over the course of a century-and-ahalf of robust industrialization. Conversely, the
Kyoto Protocol provided developing countries
with voluntary targets or, in the case of China and
India, exemptions from targets altogether.
While industrialized countries were directed to
meet their targets principally through national
measures orchestrated by governmental fiat, the
Kyoto Protocol also introduced three marketbased mechanisms to assist countries in finding
ways to meet their targets. These mechanisms
also aimed to encourage participation in emission
reduction efforts by the private sector and by
developing countries exempted from Kyoto’s
binding targets.
These market-based mechanisms were:
•
The Clean Development Mechanism (“CDM”)
•
Joint Implementation (“JI”)
•
The International Emissions Trading (“IET”)
mechanism.
1
The Kyoto Protocol’s compliance mechanism is considered among the most robust ever adopted for a
multilateral agreement. The compliance mechanism consists of a facilitative branch that provides advice and
assistance to parties to encourage compliance, and an enforcement branch empowered to take hard actions. The
enforcement branch determines three different forms of non-compliance: (1) with the emission targets, (2) the
methodological and reporting requirements, and (3) the eligibility requirements for participation in the Kyoto
Protocol’s flexibility mechanisms. The Kyoto Protocol also requires a non-complying country to take specific
actions depending on the nature of non-compliance. For example, in the case of non-compliance with emission
targets, the Kyoto Protocol requires the offending country to make up the difference between its actual emissions
and its target obligations, plus an additional 30% deduction, in the next compliance period. Meaning that, for
every metric ton of emissions by which a country exceeds its Kyoto Protocol target, its allocation of emissions for
the subsequent compliance period would be lowered by an additional 1.3 metric tons as a penalty. Whether this
penalty has had any effect in deterring non-compliance is questionable, however, as it is unclear how a country
could be forced to meet its obligations under a subsequent period if it has already failed to meet its commitments
under a prior one. Additionally, since countries negotiate their own commitments under the Kyoto Protocol, a noncomplying country could negotiate a less-stringent target for the next commitment period to accommodate for
the penalty, negating the impact that the enforcement mechanism would have on the country’s compliance.
Carbon Credit and Carbon Offset Fundamentals // 9
II. CREATION OF CARBON CREDITS AND THE
ESTABLISHMENT OF CARBON MARKETS contd.
The creation of these market-based mechanisms
introduced and established what ultimately
became known as the international carbon
market.
Article 12 of the Kyoto Protocol created the
framework for the CDM. The CDM allows any of
the 37 industrialized countries bound by the Kyoto
targets to implement an emissions reduction
project in a developing country and, in doing
so, generate a marketable Certified Emissions
Reduction (“CER”) credit. Each CER represents
the equivalent of offsetting one metric ton of
carbon dioxide and can be traded or sold to count
towards meeting an industrialized country’s GHG
Emissions reduction targets under Kyoto.
Article 7 of the Kyoto Protocol established the
JI, a mechanism similar to the CDM. Under the JI,
industrialized countries could jointly collaborate
with other industrialized countries in pursuing
and implementing emissions reduction projects
in order to meet their Kyoto targets.
The IET, an international trading program, sprung
from Article 17 of the Kyoto Protocol. The IET
allowed industrialized countries with unused,
excess carbon allowances to sell these excess
allowances to other industrialized countries that
had otherwise exceeded their targets.
In order to operationalize the market-based
frameworks constituted by the Kyoto Protocol,
and specifically the CDM, and to spark the
development of the international carbon
market, a model Emissions Reduction Purchase
Agreement (“ERPA”) was crafted in 2001 under
the aegis of the World Bank.2 The advent of the
ERPA marked a seminal event in the evolution of
carbon markets as it allowed buyers and sellers of
CERs to memorialize the transaction in a legally
binding contract. While each ERPA is uniquely
tailored to the requirements of the project with
which it is associated, most ERPAs contain
provisions that:
•
Specify the quantity and price of CERs to
be delivered to the buyer and related
payment schedules;
•
Provide for risk allocation and management
between the parties;
•
Delineate the consequences of non-delivery
and default; and
•
Specify the other obligations of the buyer
and the seller with regard to both the
transaction for the sale and purchase of
CERs and the underlying project giving rise
to the emission reduction credits.
Initially conceived to create a process for the
sale of CERs under the CDM, the ERPA grew in
use and importance globally over the years, and
ultimately came to form the basis for the sale of
other renewable attributes, including the sale of
Renewable Energy Certificates or RECs.ii
The second phase of carbon trading kicked off
in 2015 when 114 countries ratified the Paris
Agreement. The Paris Agreement effectively
replaced the Kyoto Protocol, whose binding
targets were set to expire in December 2020.iii
2
One of the authors of this article, Mintz partner Ayaz Shaikh, advised the World Bank in conceiving,
structuring, and drafting the model ERPA, and in its usage in the first investment of the World Bank’s Prototype
Carbon Fund (PCF). That investment was for the Liepaja Solid Waste Management Project in the Republic of Latvia
in 2001.
Carbon Credit and Carbon Offset Fundamentals // 10
II. CREATION OF CARBON CREDITS AND THE
ESTABLISHMENT OF CARBON MARKETS contd.
Whereas the Kyoto Protocol had set emissionreduction targets for industrialized countries only,
the Paris Agreement called on both industrialized
and developing countries to establish and meet
emissions goals. The Paris Agreement reflected
the growing urgency of the climate crisis and the
broad recognition that in order to be effective,
measures to combat climate change must be
pursued by all carbon emitters, regardless of
their varying culpability in creating the present
exigency. The Paris Agreement aimed to set an
outside limit for global warming to a point below
2 °C above pre-industrial levels, with the stated
aspiration of limiting the temperature increase to
a threshold of 1.5 °C above pre-industrial levels.
These limits were to be achieved by having
each country create and submit its plans for
climate action – known as Nationally Determined
Contributions (“NDCs”) – on a five year cycle.
and its predecessor mechanisms is that the SDM
seeks to reduce overall global GHG Emissions,
while the CDM and JI had essentially shifted the
location of GHG Emissions without necessitating
an overall reduction in GHG Emissions. Under the
CDM and JI, each metric ton of carbon reduction
achieved by a developing country and measured
by the creation of a CER – the credits issued by
the CDM under the Kyoto Protocol – allowed
an industrialized country to emit one additional
metric ton of carbon. Any offsets created by
projects traded on the SDM, on the other hand,
must result in an overall reduction of global GHG
Emissions without allowing for a corresponding
increase in GHG Emissions elsewhere. In addition,
the offsets traded pursuant to the SDM must be
over and beyond what a country has committed
under its NDCs.
One of the key elements of the Paris Agreement
can be found in the all-important Article 6, the
provisions of which established two new marketbased mechanisms for creating and trading
carbon offsets: the Sustainable Development
Mechanism (the “SDM”) and the internationally
transferred mitigation outcomes (“ITMOs”).
These market-based approaches provided
under Article 6 allowed countries to meet their
NDC obligations by trading for and acquiring
carbon offsets earned from the reduction of GHG
Emissions produced by qualifying projects.iv
Article 6.4 established the SDM, a centralized
carbon market that allows trading of carbon offsets
created by specific projects implemented jointly
by countries party to the Paris Agreement. Article
6.4 aimed to replace the offsetting mechanism
provided under Kyoto’s CDM, as well as the
collaboration mechanism provided under Kyoto’s
JI. The most notable difference between the SDM
Article 6.2 of the Paris Agreement provided for
the international trading of ITMOs, which are the
new unit of carbon reduction for international
carbon markets intended to replace the CERs
established under the Kyoto Protocol. ITMOs are
used by countries to meet their respective NDCs:
countries that have met or exceeded their NDC
goals can trade their excess ITMOs with countries
Carbon Credit and Carbon Offset Fundamentals // 11
II. CREATION OF CARBON CREDITS AND THE
ESTABLISHMENT OF CARBON MARKETS contd.
that lag behind in meeting their commitments,
with the caveat that the selling country must
make a corresponding adjustment in its NDCs to
“uncount” the ITMO it is trading. In order to ease
the transition to the new trading mechanisms
created under Article 6.2, certain CERs generated
between 2013 and 2020 were to be eligible for
conversion into ITMOs and to count towards a
country’s NDC commitments.v
As is now well-known, however, the effectuation of
these Paris Agreement standards proved difficult.3
While broad guidelines as to the implementation
of Article 6 of the Paris Agreement were adopted
during the initial UN Conference of the Parties in
2015, these guidelines failed to establish how the
implementation of Article 6 would be handled in
practice. It was not until delegates convened at
the Glasgow Climate Change Conference in 2021
that the rulebook for the official implementation
of Article 6 was finally ratified.
The Glasgow Conference sought to bolster the
integrity of carbon offsets and inspire confidence
in the carbon markets by proposing new rules
covering both the procedures and benchmarks
governing the creation, trading, and tracking of
carbon offsets. Prior to the introduction of Article
6 of the Paris Agreement and its ratification at the
Glasgow Conference, no clear standards existed
delineating how carbon offsets would be tracked.
The absence of any cognizable standards led to
a risk of double counting the same carbon offset
towards the satisfaction of NDCs in two separate
countries – once by the seller country that hosted
and generated the carbon offset, and once by a
buyer country that purchased the carbon offset.
One of the primary achievements of the Article
6 rulebook is that it addressed this issue through
an accounting mechanism called corresponding
adjustments. Under this accounting mechanism,
if a host country authorizes the sale of a carbon
offset from a qualifying project to a buyer
country, then the host country must deduct (or
“un-count”) the carbon offset from its own NDCs
so that the buyer country can then count the
offset against its NDCs. The rulebook for Article
6 also introduced new standards to verify the
quantity and quality of GHG Emission reductions
produced by a project in order to ensure that
projects that generate offsets actually lead to a
measurable reduction in global GHG Emissions.
These rules aimed to add transparency to the
overall process of trading in carbon offsets.vi
3
The abrupt withdrawal of the United States from the Paris Agreement baffled other signatories and dealt
a crippling blow to efforts at implementing its aims.
Carbon Credit and Carbon Offset Fundamentals // 12
III. CARBON CREDITS VERSUS CARBON OFFSETS
The term “carbon credit” is often used
interchangeably to refer to both carbon credits
and carbon offsets. While carbon credits and
carbon offsets both refer to a transferrable
instrument that represents a certain amount of
GHG Emissions (generally one metric ton), carbon
credits and carbon offsets are not the same. In
the simplest terms, carbon credits represent the
right to emit a certain amount of GHG Emissions,
whereas carbon offsets represent the removal
of a certain amount of GHG Emissions from the
atmosphere.4 The summary descriptions below
identify the main characteristics of carbon
credits and carbon offsets, highlighting the key
distinctions between them.
A. Carbon Credits
A carbon credit is a tradeable permit, much like
a permission slip, that represents an entity’s
right to emit one metric ton of carbon dioxide
or other greenhouse gases into the atmosphere.
Carbon credits are created and issued by a
regulatory body in charge of implementing and
overseeing a compliance market in a particular
jurisdiction, such as a cap-and-trade system.
Under a compliance market, certain entities that
emit carbon dioxide or other greenhouse gases
are legally mandated to participate and meet
the market’s emissions limits. These entities
are awarded carbon credits that allow them to
continue to emit carbon dioxide up to a certain
limit, which is typically reduced periodically. If
an entity maintains its GHG Emissions below the
specified limit, it may not need all of the carbon
credits it has been issued. In that case, the entity
may sell any excess credits to another entity that
needs them.vii Carbon credits are generally traded
in compliance markets.
B. Carbon Offsets
Like a carbon credit, a carbon offset represents
one metric ton of carbon dioxide or equivalent
greenhouse gases. Unlike carbon credits,
however, carbon offsets measure the amount of
carbon that has been avoided or permanently
removed from the atmosphere. Carbon offsets
can be created by either:
•
Avoidance or reduction projects such as
renewable energy, methane capture, or other
such facilities; or
•
Removal or sequestration projects such as
reforestation, direct carbon capture, or
similar enterprises.
Most of the demand for carbon offsets comes
from entities that have voluntarily set GHG
Emissions reduction targets that can be met either
by reducing their own GHG Emissions directly or
by effectively paying someone else to implement
4
The phrase “offset credits” or simply “credits” is often used when discussing carbon offsets in the voluntary
market. For purposes of this paper, we will continue to use the term “offset” to refer to those units generated by
the removal of carbon emissions.
Carbon Credit and Carbon Offset Fundamentals // 13
III. CARBON CREDITS VERSUS CARBON OFFSETS contd.
measures that reduce GHG Emissions.viii While
carbon offsets are generally traded in voluntary
markets, certain carbon offsets can serve as an
alternative mechanism to meet GHG Emissions
caps in compliance markets if such carbon offsets
are approved by the compliance market.
Notably, many regulatory schemes permit carbon
offsets to be used to satisfy the requirements of
the compliance regime. In the California Carbon
Market, for example, companies can invest in
qualifying projects and use the resulting offsets
towards a portion of their predetermined
compliance obligations for the year. Similarly,
under the Paris Agreement, ITMOs (which
represent offsets from a qualifying project) can
be applied against a country’s NDC targets.
Hence, even in compliance markets, the tradeable
unit may sometimes represent a carbon offset.
The table below summarizes the key distinctions
between carbon credits and carbon offsets.
Key Distinctions Between
Carbon Credits and Carbon Offsets
Carbon Credits
Carbon Offsets
What do they represent?
The right to emit a certain amount of GHG
Emissions (generally one metric ton). Carbon
credits function like a permission slip that
allows carbon emitters to continue to emit
carbon dioxide up to a certain limit, which is
typically reduced periodically under the
mandates of the compliance regime.
Carbon offsets represent the removal of
a certain amount of GHG Emissions from
the atmosphere (generally one metric
ton).
How are they created?
Carbon credits are issued to carbon emitters
(countries and corporations) by a regulatory
body with oversight over a particular
compliance market.
The underlying emissions reductions
giving rise to a carbon offset are created
by projects that avoid, reduce, remove,
or sequester carbon from the
atmosphere. The offsets themselves are
issued by organizations that certify and
track such emission reductions.
Are they transferable?
Yes.
Yes.
How are they used or
traded?
Credits are used by carbon emitters mandated
by regulatory bodies to cap their emissions.
Carbon emitters with emissions lower than
their prescribed cap can sell or trade their
credits to carbon emitters whose carbon
emissions exceed their prescribed limits.
Corporations, governments, and
individuals who seek to reduce their
carbon footprint can purchase, trade,
and sell carbon offsets.
Where can they be used
and traded?
Carbon credits can only be traded in
compliance markets (discussed in Part IV
below).
Carbon offsets are most often traded in
voluntary markets (discussed in Part IV
below), but certain carbon offsets can
serve as an alternative mechanism to
meet GHG Emissions caps in compliance
markets.
Carbon Credit and Carbon Offset Fundamentals // 14
IV. CARBON MARKETS
The carbon markets consist of two entirely
distinct types of markets:
•
Compliance (or compulsory) markets; and
•
Voluntary markets
The summary descriptions below identify the
main characteristics of each of these markets and
highlight the key distinctions between them.
A. Compliance Markets
As their name suggests, compliance markets,
which are also referred to as mandatory or
regulatory markets, allow participants to buy and
sell carbon credits or carbon offsets in order to
comply with certain rules or regulations pertaining
to their emissions (e.g., the GHG Emissions
targets agreed to in the Kyoto Protocol). In
compliance markets, governments or multilateral
institutions set requirements that compel certain
entities (private entities or governments) to
participate in complying with the market’s
constraints. These constraints typically include a
“cap” on the allowable amount of GHG Emissions
produced by the market participants, requiring
those entities that exceed the imposed limits to
purchase additional carbon credits from entities
with excess allowances.ix Compulsory markets
are often referred to as “cap-and-trade” markets.
The compliance market is regulated through
international, regional, or sub-national carbon
reduction schemes, such as the ITMO-trading
mechanism created pursuant to Article 6.2 of the
Paris Agreement, the European Union Emissions
Trading Scheme (EU-ETS), and the California
Carbon Market.x Note that in the United States,
no national carbon market exists: the California
Carbon Market is the country’s only formal capand-trade program.xi
As previously noted, compulsory markets allow
the use of certain offsets under carbon reduction
schemes in order to achieve compliance with the
regime’s requirements. Accordingly, each carbon
reduction scheme under the compliance market
specifies a unit (e.g., CERs under the Kyoto
Protocol, ITMOs under the Paris Agreement,
etc.) that can be transferred between parties
subject to the regulations under that scheme.
Each unit generally represents one metric ton
of carbon dioxide. These units are generated in
the implementation phase of a project and are
issued once the reduction has been validated and
credited. For example, under the CDM (which
is now being phased out), projects wishing to
offer CERs in the market were required to have
their GHG Emissions reductions validated by
designated operational entities (validators and
verifiers) and registered by the CDM Executive
Board to ensure that real and measurable GHG
Emissions reductions are achieved.xii
Under the Paris Agreement, projects can create
ITMOs when GHG Emissions are reduced
or removed in one country, logged in such
country’s national greenhouse gas inventory,
Carbon Credit and Carbon Offset Fundamentals // 15
IV. CARBON MARKETS contd.
and the reduction is then transferred to another
country’s national greenhouse gas inventory
after a corresponding adjustment removing the
reduction from the selling country’s greenhouse
gas inventory. These transfers can happen either
at the governmental or corporate level, and
the process must be overseen by a supervisory
body tasked with reviewing recognized credits.
The details of actualizing such processes are
expected to emerge in the coming years.
B. Voluntary Markets
Voluntary markets operate outside of but in
parallel with compulsory markets, allowing the
trading of carbon offsets that are not bought or
sold on the compulsory markets to meet GHG
Emissions requirements imposed by regulatory
bodies.xiii Unlike CERs or ITMOs, carbon offsets
traded in voluntary markets cannot be used to
achieve NDCs or other GHG Emissions reduction
targets under an applicable compliance regime
such as the Paris Agreement. However, carbon
offsets that are traded in the voluntary market
can be used to support corporate or individual
environmental commitments, and are valuable
as they help companies supplement their GHG
Emissions reduction efforts and achieve their
climate change goals or other Environmental,
Social and Governance (“ESG”) objectives.xiv
Companies and individuals can acquire or
purchase carbon offsets traded in the voluntary
market directly from projects, companies, or
carbon funds. As in the compulsory market, all
carbon offsets that are traded in the voluntary
market must be verified by an independent third
party and must be developed and calculated
according to one of the existing standards.xv
Before a project can sell carbon offsets in the
voluntary market, the project must first enroll
and be registered with a voluntary carbon offset
program, often also referred to as a registry. There
are several voluntary carbon offset programs that
register projects in the United States, including
the American Carbon Registry, Verified Carbon
Standard (Verra), the Gold Standard Impact
Registry, and the Climate Action Reserve.5 Each
program has its own criteria, methodologies,
and protocol for quantifying the GHG Emissions
reductions of a project, but programs often look
to international sustainability programs as well as
domestic certification standards for registration
standards and requirements.xvi
5
The American Carbon Registry was founded in 1996 and was the first private, voluntary carbon offset
registry in the United States. The American Carbon Registry has since grown to oversee the registration of offset
projects around the globe. Separately, the American Carbon Registry also oversees California’s compliance carbon
market.
Verra was established in 2005 and is the world’s most used voluntary carbon offset program, having registered
over 1,800 GHG Emissions reduction projects.
The Gold Standard, founded in 2003, verifies GHG Emissions reduction projects based on standards in the Paris
Agreement and in the United Nations Sustainable Development Goals.
The Climate Action Reserve, which started in 2008 in California, has since grown to focus on ensuring transparency
in the voluntary carbon offset market in North America.
Carbon Credit and Carbon Offset Fundamentals // 16
IV. CARBON MARKETS contd.
Once a project is certified and registered by such
a program, the program issues carbon offsets
to the project. Each program uses different
terminology for the tradeable carbon offsets
it issues. For example, the American Carbon
Registry calls its carbon offsets Verified Emission
Reductions (“VERs”), while the carbon offsets
issued by the Climate Action Reserve are called
Climate Reserve Tons (“CRTs”). CRTs can be
converted into Verified Carbon Units (“VCUs”)
and transferred to a VCU registry run by Verra.
After carbon offsets are issued, they can then be
traded on various trading platforms, which work
similarly to stock and commodity exchanges. The
main voluntary carbon offset trading platforms
include the American Carbon Registry and Verra
(each of which runs its own trading platform),
APX Inc., and Markit. Trading on the American
Carbon Registry and Verra is limited to carbon
offsets verified and issued under these programs,
while carbon offsets traded on Markit and APX
can be sourced from various programs that
register and verify carbon offsets.xvii
The table below highlights the key distinctions
between compulsory and voluntary markets.
Compliance Markets Versus Voluntary Markets: Key Distinctions
Compliance Markets
Voluntary Markets
Is participation
mandatory or optional?
Mandatory. Carbon emitters (both countries
and corporations) are legally required to
participate.
Optional. Corporations, governments,
and individuals who voluntarily seek to
reduce their carbon footprint over and
beyond the requirements imposed in
compulsory markets can participate.
How is it regulated?
Compliance markets are regulated through
international, regional, or sub-national carbon
reduction schemes, such as the ITMO-trading
mechanism created pursuant to Article 6.2
of the Paris Agreement, the European Union
Emissions Trading Scheme (EU-ETS), and the
California Carbon Market.
Voluntary markets are administered
through voluntary carbon offset
registries, such as the American Carbon
Registry, Verified Carbon Standard
(Verra), Gold Standard Impact Registry,
and Climate Action Reserve.
What types of units can
be traded?
Mostly carbon credits, but carbon offsets are
sometimes permitted.
Carbon offsets only.
Carbon Credit and Carbon Offset Fundamentals // 17
V. VALUING CARBON OFFSETS
All carbon offsets are not valued equally. The
value of a carbon offset depends on multiple
factors, including, among others, the carbon
offset’s vintage, the type of project that produced
the carbon offset, and whether the carbon offset
can be certified.xviii
A carbon offset’s vintage, meaning the year GHG
Emissions for the issued offset were avoided, can
be indicative of the quality of the carbon offset
as well as the underlying project giving rise to the
offset, and thus is a principal factor in determining
the carbon offset’s value. Older vintages are
often less expensive than more recent vintages.
A few reasons account for this difference in
value, including principally the concerns that (i)
older vintages are still on the market because
the project that produced the carbon offset is of
a lower quality, or (ii) the older projects giving
rise to the offset did not truly achieve the aim
of “additionality,” meaning that such projects
did not result in reductions of GHG Emissions
that were “additional” to those that would have
occurred anyway in the absence of a market for
carbon offsets.xix
The concept of additionality bears further
explanation. A reduction of GHG Emissions
is deemed “additional” only if the reduction
would not have taken place in the absence of
the incentive created by the voluntary carbon
offset market. These additional reductions can
be contrasted to measures that would have
taken place anyway due to other factors driving
the decision of the entity or project undertaking
the emissions reduction action. For example, the
following measures would not be deemed to
achieve additionality:
•
Measures undertaken due to compliance
requirements in the compulsory market, such
as under a mandated cap-and-trade
program;
•
Measures mandated due to another law,
such as the requirements for landfill
operators in California to install carbon
capture equipment; or
•
Measures pursued due to profitability or
other rational commercial reasons, such as
making an investment in energy-saving solar
panels.xx
In practice, however, it is difficult to evaluate
whether reductions of GHG Emissions are
truly additional, given that such reductions
are commonly undertaken in pursuit of other
opportunities. For example, if an offshore wind
project is cost-competitive without the need to
garner revenue from carbon offset sales, that
project is not strictly deemed to be “additional”
because the project may have been pursued
regardless of the potential revenue from the
offsets. If the decision to pursue the project or the
reductions of GHG Emissions was not decisively
influenced by the opportunity to sell carbon
Carbon Credit and Carbon Offset Fundamentals // 18
V. VALUING CARBON OFFSETS contd.
offsets, the project or reduction remains at risk of
being deemed not to achieve additionality.
The type of project also affects the value of a
carbon offset. The two main types of projects that
produce carbon offsets are removal projects and
avoidance projects. Removal projects focus on
removing GHG Emissions that have already been
released into the atmosphere, by using naturebased methods like reforestation or technologybased methods such as carbon capture.
Avoidance projects, on the other hand, focus
on avoiding the release of new GHG Emissions
into the atmosphere by reducing activities that
tend to emit large amounts of GHG Emissions or
by protecting natural resources, such as carbon
sinks, that naturally sequester GHG Emissions.
Other examples of avoidance projects include
renewable energy projects that displace fossilfuel emissions from conventional power plants,
such as wind, solar, hydroelectric, geothermal,
and similar types of renewable facilities. Carbon
offsets generated by removal projects are
typically more expensive than those generated
by avoidance projects.xxi
and assessment procedure for identifying and
issuing carbon offsets. According to the Integrity
Council, this framework is intended to “provide a
credible, rigorous, and readily accessible means
of identifying high-quality carbon credits that
create real, additional, and verifiable climate
impact with high environmental and social
integrity.”xxii The public consultation period for
the Core Carbon Principles ended in September
2022, and the framework is expected to become
effective in the beginning of 2023.
The verification standards used by the applicable
registry issuing a carbon offset can also impact
an offset’s value. For example, a carbon offset
issued by a registry whose requirements meet
or exceed the then-applicable international
standards would be more valuable than one
issued by a registry with more lenient standards.
To counter such differences in value and to
regiment the standards implemented by
registries, the Integrity Council for the Voluntary
Market, an independent governance organization
for the voluntary market, released its draft Core
Carbon Principles in July 2022, a framework
Carbon Credit and Carbon Offset Fundamentals // 19
VI. LIFECYCLE OF A CARBON OFFSET
The end value of a carbon offset arises when the
offset is retired, meaning that the offset has been
purchased and the reduction in GHG Emissions
has been deducted from the final buyer’s carbon
footprint. Since carbon offsets can be traded (as
discussed in Section IV above and further in this
section below), a single carbon offset can be
owned by multiple parties over the course of its
existence. A carbon offset, however, can only be
retired once. After a carbon offset is retired, it
can no longer be sold or traded, thus preventing
double counting. Notably, just holding a carbon
offset does not entitle a party to claim it has
contributed to any environmental benefit. Only
the final owner that retires the carbon offset
is entitled to make the claim that its offset has
reduced GHG Emissions.
Once a project developer decides to embark on
a project that will produce carbon offsets, but
before a carbon offset is retired and its benefit
is realized, a carbon offset goes through many
stages in its lifecycle. While this lifecycle can vary
(often marginally) depending on the carbon offset
registry that certifies and ultimately issues the
carbon offset, certain facets of a carbon offset’s
lifecycle are common to most registries. This
basic lifecycle of a carbon offset is summarized
below and explained in more detail in this
Section VI.
Typical Stages in a Carbon Offset’s
Lifecycle
A.
Design and Screening: A project sponsor
conceives, structures, and designs a carbon
offset project and submits the design to a
carbon offset registry, such as the American
Carbon Registry or Verra, for initial screening.
B.
Initial Compliance Audit: Once the project
design
passes
the
initial
screening
stage, the project design is audited
by a third-party verifier to confirm
compliance with registry requirements.
C.
Project Development, Financing, and
Implementation: After confirmation of
compliance with registry requirements
by the third-party verifier, the project sponsor
develops,
finances,
constructs,
and
commences commercial operations of the
project.
D.
Operations Audit: After a certain period
of commercial operations, the project is
audited by a third-party verifier to ensure
that GHG Emissions reductions are
proceeding according to the verified and
approved project design. The third-party
verifier prepares a report for review by the
registry that summarizes the verifier’s
findings.
E.
Certification and Issuance: The registry
reviews the report prepared by the third-
Carbon Credit and Carbon Offset Fundamentals // 20
VI. LIFECYCLE OF A CARBON OFFSET contd.
party verifier. If GHG Emissions reductions
are occurring as planned, as stated in the
third-party verifier’s report, the registry
issues an impact statement, which is
essentially a certification that GHG Emissions
reductions have occurred, which in turn
leads to the issuance of carbon offsets to the
project sponsor / owner.
F.
G.
Offset Trading Phase: The project sponsor /
owner sells the carbon offset into the
market. Such a sale can often happen
through a wholesaler, but the carbon offset
remains listed on the relevant registry, which
continues to track its ownership. The carbon
offset may subsequently be further sold or
traded, until the time it is ultimately retired.
Retirement: An end consumer purchases and
“retires” the carbon offset, and the retirement
is then noted on the relevant registry.
During the certification process with a
carbon offset registry, project sponsors must
demonstrate that their project displays the
following six features:
1.
The project will produce measurable results.
2.
The project will prevent leakage, meaning
that GHG Emissions are actually reduced
rather than re-allocated elsewhere.
3.
The project’s GHG Emissions reductions
are additional (meaning, as noted above, that
the emissions occurred because of the
incentive provided by the voluntary carbon
market and would not have occurred in the
absence of the voluntary carbon market).
4.
The reductions in GHG Emissions are
permanent and will be kept out of the
atmosphere for a reasonable length of time.
5.
The development of the project is consistent
with the chosen registry’s methodologies,
protocols, and procedures.
6.
The project has been independently verified
by a third party to confirm compliance with
the registry’s requirements.xxiii
As a first step of the certification process, a
project sponsor must design a carbon offset
project and ensure that its design complies with
the certification methodology and standards
established by the sponsor’s chosen carbon
offset registry, such as the American Carbon
Registry, Verra, or the Climate Action Reserve,
for the type of project being developed. For
example, certification methodology for carbon
capture projects will vary from the certification
methodology established for reforestation
projects.
Once a project is designed, but before
development of the project commences, the
project sponsor must present the design to
undergo screening at the chosen carbon offset
registry in the form of a report outlining how the
project will meet all of the registry’s certification
requirements. The report must also specify the
geographical boundaries of the project and the
project’s duration. Once the registry concludes its
screening process, the process then advances to
the audit stage. In this stage, the project sponsor
selects an independent third party pre-approved
by the registry — referred to as a validation
and verification body (“VVB”) — to conduct an
Carbon Credit and Carbon Offset Fundamentals // 21
VI. LIFECYCLE OF A CARBON OFFSET contd.
audit of the project design in order to confirm
compliance with the registry requirements and to
verify that the reductions in GHG Emissions will
be real and measurable. During this process, the
VVB conducts a site visit and a desktop review of
the sponsor’s project design.xxiv
imposed, the registry will issue an impact
statement, which is essentially a certification that
GHG Emissions reductions have occurred. This
leads to the issuance of a carbon offset to the
project sponsor’s account on the relevant registry.
The project sponsor can then hold, sell, or retire
the offset at its discretion. Each carbon offset is
issued a unique serial number to promote ease in
tracking and to prevent double counting once a
carbon offset is retired.xxv
If the holder of a carbon offset chooses to
If the VVB confirms that the project meets the
registry’s requirements, the registry approves
the project, and the sponsor is able to proceed
with project development, financing, and
construction. Once the project has reached
the commercial operations stage and has been
operating for a certain period of time (which
time period may vary depending on the type of
project involved), the project undergoes another
round of validation and verification by the VVB to
ensure the project is performing as expected. If
the project is operating as designed, the VVB will
issue a report to the registry that summarizes the
findings of its audit. The registry then reviews the
VVB’s report, and if it agrees that GHG Emissions
reductions have actually occurred pursuant to
the methodologies applied and requirements
sell the issued offset, the holder can do so in
several ways. While most sales occur through a
wholesaler after an offset has been created and
certified, offsets can also be sold before they are
even officially certified as offsets. In some cases,
potential offsets are sold to purchasers that
invest directly into the underlying project giving
rise to the GHG Emissions reductions in return
for the rights to all or a portion of the carbon
offsets generated and eventually certified by the
project. Such a transaction allows the purchaser
to acquire the carbon offsets “at cost” and more
fundamentally ties the purchaser to the project
from its inception. Because of the many phases
that a project must undergo before credits can be
issued and delivered – including project design,
screening, development, financing, construction,
and operation – this type of strategy also has
a longer lead time (often about three to five
years).xxvi
In other cases, investors who choose not to
invest directly into a project from its inception or
during its development stage can enter directly
into offset purchase contracts with project
sponsors. These contracts generally take the
form of ERPAs, as originally introduced pursuant
Carbon Credit and Carbon Offset Fundamentals // 22
VI. LIFECYCLE OF A CARBON OFFSET contd.
to the Kyoto Protocol and discussed in Section
II above. The structure of an ERPA can vary
greatly. For example, ERPAs can be structured
as options contracts that specify either that
the buyer has the right, but not the obligation,
to buy offsets for a fixed price at a certain time
in the future, or that the seller (i.e., the project
owner) has the right, but not the obligation, to
sell offsets for a fixed price at a certain time in
the future. Regardless of their structure, ERPAs
provide project sponsors with the assurance
that they will be able to sell a certain number of
carbon offsets. Buyers can also lock in belowmarket prices and avoid the transaction costs
associated with direct investment into a project
(since negotiating a single ERPA is less involved
than negotiating an equity interest in a project
and the associated diligence over an entire suite
of project documentation), as well as avoid the
substantial risk exposure from early-stage project
participation. However, the lead time involved in
such transactions can still be long, averaging two
to three years before credits are delivered.xxvii
For purchasers looking to purchase only a small
number of carbon offsets, an easier option may
be to go through a retailer or an environmental
commodity exchange. This process is fairly quick
and straightforward, as it provides purchasers
with immediate access to a variety of projects and
offsets. Retail traders purchase carbon offsets in
bulk directly from sellers and bundle those offsets
into portfolios for sale to end-buyers. Most retail
traders maintain accounts with registries that
certify projects and create offsets, as well as
“retire” the purchased offsets on behalf of the
end buyer on such registries. Environmental
commodity exchanges also work with carbon
offset registries to list offsets for sale and enable
their transfers. Some exchanges even facilitate
trades of carbon offsets via carbon tokens
enabled by blockchain technologies. Purchasing
through a retailer or exchange does come with
downsides, however, as it can be difficult to
obtain the information needed to assess carbon
credit quality accurately, given that retailers and
exchanges generally do not screen for an offset’s
quality.xxviii
Regardless of how a carbon offset is acquired,
once the end consumer purchases the carbon
offset and elects to retire it, a transaction record
is generated, and the unique serial number
associated with a carbon offset is marked as
“retired” on the relevant registry. This removes
the carbon offset from the voluntary market,
meaning that the carbon offset can no longer
be sold or traded on any exchange. This process
bolsters the integrity of carbon markets, as it
ensures that the benefits produced by carbon
offsets are not double counted and that the
ultimate purchaser is the only one that can claim
a reduction in its carbon footprint.
Carbon Credit and Carbon Offset Fundamentals // 23
VII. OPPORTUNITIES AND RISKS FOR STAKEHOLDERS
Carbon credits and offsets have catapulted to
the forefront of the global efforts to address
climate change. Programs and mechanisms
for the issuance and trading of carbon offsets
abound, and the carbon markets appear poised
to grow exponentially over the next few decades.
Yet, concerns relating to the quality of carbon
offsets, their impact on the environment, and
the integrity of the carbon-trading mechanisms
continue to linger.
Some critics argue that projects generating carbon
offsets fail to make any measurable difference in
the health of the environment because many of
these projects fail to produce permanent benefits.
For example, hundreds of thousands of acres of
trees planted in California that were meant to
sequester carbon were destroyed during the 2021
wildfires in the area, releasing the very carbon
they had sequestered. Others raise concerns
over “additionality” predicated on the practical
difficulties in discerning whether the voluntary
carbon markets actually incentivized the
investment into a particular emissions reduction
project, or whether other factors actually drove
the decision to invest (such as the potential
cost savings arising from the installation of solar
panels). Others still emphasize the prospect
of double counting credits, uncertain that the
mechanisms described in this paper can prevent
multiple parties from claiming benefits stemming
from the same carbon offset. And yet others
voice frustration that the standards imposed by
the various platforms for trading carbon offsets
on the voluntary market lack uniformity, leading
to questions about the quality of certain offsets.
These concerns highlight the inherent risks that
project sponsors and investors assume when
investing substantial capital, time, and effort into
emission reduction projects. The lengthy span
between the initial design phase of a project and
the issuance of carbon offsets can discourage
both project sponsors and investors in light of
the potential risk that a project could ultimately
lead to low-value offsets being produced, or no
offsets being issued at all. Questions around the
stability of the voluntary carbon market, opaque
pricing dynamics, and a changing regulatory
and governance landscape can also discourage
potential participants seeking to invest in projects
with more stability.
Acknowledging these concerns and recognizing
that the growing demand for carbon offsets
requires immediate attention, both governance
and private organizations are racing to set
standards to improve the quality, transparency,
and integrity of offsets, as well as the platforms
on which offsets are traded. As regulators
and governance organizations work to set
standards for carbon credits and carbon offsets,
stakeholders across the spectrum stand to benefit
from the anticipated boom in the ever-changing
de-carbonization industry.
All potential stakeholders would indeed benefit
from better-defined carbon markets. Companies
Carbon Credit and Carbon Offset Fundamentals // 24
VII. OPPORTUNITIES AND RISKS FOR STAKEHOLDERS contd.
may find it easier to meet their ESG goals with
greater certainty, even in the face of increasing
scrutiny over reporting requirements as the
number of carbon offsets in the market increases
and as participants gain greater confidence in
the programs and mechanisms that comprise the
market. Increased confidence in these markets
would also encourage the type of development
that could lead to the protection of biodiversity,
a reduction in pollution, and gains in other public
health benefits, as well as create employment
opportunities and channel funding into developing
countries where renewable energy projects
are increasingly located. With the heightened
attention on sustainability, project sponsors and
investors may have greater access to lower-cost
and more stable financing arrangements, making
carbon offset projects more feasible and more
attractive. The sooner any lingering issues are
fully addressed, the greater the prospect that
the carbon markets will inspire the substantial
investments in climate-related projects required
to achieve the global targets essential to achieve
sustainability.
Carbon Credit and Carbon Offset Fundamentals // 25
ENDNOTES
i
Graham J. Stuart, “COP26 – Prospects for Carbon Offsets and Markets,” Baker McKenzie publication, September 30,
2021, https://www.bakermckenzie.com/en/insight/publications/2021/09/cop26-prospects-for-carbon-offsets-and-markets.
ii
James Chen and Caitlin Clarke, “Emissions Reduction Purchase Agreement (ERPA),” Investopedia, April 27, 2022,
https://www.investopedia.com/terms/e/erpa.asp.
iii
Gold Standard.
iv
Nicolas J.S. Lockhart, Maureen M. Crough, Dominic Coppens, Katherine Connolly, and Jason J. Lawler, “The
Opportunities and Risks of Carbon Credits on the Pathway to Net Zero,” Sidley, March 2022, https://www.sidley.com/en/
insights/publications/2022/03/the-opportunities-and-risks-of-carbon-credits-on-the-pathway-to-net-zero.
v
Cristina Brooks and Kevin Adler, “COP26: Article 6 rulebook updated, but remains work in progress,” HIS Markit
publication, November 15, 2021, https://cleanenergynews.ihsmarkit.com/research-analysis/cop26-article-6-rulebook-updatebut-remains-work-in-progress.html.
vi
Nicolas J.S. Lockhart, et al.
vii
Will Kenton, “Carbon Credits and How They Can Offset Your Carbon Footprint,” Investopedia, November 19, 2021,
https://www.investopedia.com/terms/c/carbon_credit.asp.
viii
Christy Rivera and Adrienne Sebring, “Carbon offsets as a potential source of revenue,” Norton Rose Fulbright
publication, February 28, 2022, https://www.projectfinance.law/publications/2022/february/carbon-offsets-as-a-potentialsource-of-revenue/.
ix
Graham J. Stuart.
x
Voluntary v. mandatory carbon credit market, Climate Trade, https://climatetrade.com/voluntary-market-andmandatory-carbon-credit-market/.
xi
The Ultimate Guide to Understanding Carbon Credits, CarbonCredits.com, https://carboncredits.com/the-ultimateguide-to-understanding-carbon-credits/.
xii
Voluntary v. mandatory carbon credit market.
xiii
Graham J. Stuart.
xiv
Voluntary v. mandatory carbon credit market.
xv
Voluntary v. mandatory carbon credit market.
xvi
Christy Rivera and Adrienne Sebring.
xvii
Christy Rivera and Adrienne Sebring.
xviii
Christy Rivera and Adrienne Sebring.
xix
Christy Rivera and Adrienne Sebring.
xx
Dee Lawrence, “The Concept Of Additionality In The Voluntary Carbon Market, Explained,” Forbes, October 1, 202,
https://www.forbes.com/sites/forbesnonprofitcouncil/2021/10/01/the-concept-of-additionality-in-the-voluntary-carbonmarket-explained/?sh=7f55f17a78ec.
xxi
Christy Rivera and Adrienne Sebring.
xxii
The Integrity Council for the Voluntary Carbon Market, Core Carbon Principles, Assessment Framework and
Assessment Procedure, July 2022, https://icvcm.org/wp-content/uploads/2022/07/ICVCM-Public-Consultation-FINAL-Part-1.
pdf.
xxiii
offset.
Thomas Herry, “Lifecycle of a carbon offset,” Fenix Carbon, https://www.fenixcarbon.com/learn/lifecycle-of-a-carbon-
xxiv
Requirements and Specifications for the Quantification, Monitoring, Reporting, Verification, and Registration of
Project-Based GHG Emissions Reductions and Removals, The American Carbon Registry Standard, November 2021, https://
americancarbonregistry.org/carbon-accounting/standards-methodologies/american-carbon-registry-standard/acrstandard-v7-0_final_dec2020.pdf.
xxv
Understanding Carbon Offsets, How to Acquire Carbon Offset Credits, The Carbon Offset Research and Education
program, https://www.offsetguide.org/understanding-carbon-offsets/how-to-acquire-carbon-offset-credits/.
xxvi
Understanding Carbon Offsets, How to Acquire Carbon Offset Credits.
xxvii
Understanding Carbon Offsets, How to Acquire Carbon Offset Credits.
xxviii
Understanding Carbon Offsets, How to Acquire Carbon Offset Credits.
Carbon Credit and Carbon Offset Fundamentals // 26
mintz.com
Boston | London | Los Angeles | New York | San Diego | San Francisco | Washington
BUSINESS FOR THE
SOCIAL GOOD -WEEK 6
Donley
AGENDA
•
•
General
•
Today is a D
•
Papers coming along
Income
•
Median vs. Mean
•
Quintiles
Poverty
•
Spring 2023
•
Thresholds
•
Cut offs
•
Shares
•
Basis
•
Lorenz Curve
•
Budget
•
Gini Index
•
Measures
•
Rates
•
Person vs. Family
•
Children, Seniors, …
Bus 103 Week 3 Donley
2
POVERTY THRESHOLDS 2022
Poverty Thresholds for 2022 by Size of Family and Number of Related Children Under 18 Years
(In dollars)
Related children under 18 years
Size of family unit
None
One person (unrelated individual):
Under 65 years……………………………….
65 years and over…………………………..
15,225
14,036
Two people:
Householder under 65 years……………
Householder 65 years and over……….
19,597
17,689
One
Two
Three
Four
Five
Six
Seven
20,172
20,095
Three people……………………………………..
22,892
23,556
23,578
Four people……………………………………….
30,186
30,679
29,678
29,782
Five people………………………………………..
36,402
36,932
35,801
34,926
34,391
Six people………………………………………….
41,869
42,035
41,169
40,339
39,104
38,373
Seven people…………………………………….
48,176
48,477
47,440
46,717
45,371
43,800
42,076
Eight people………………………………………
53,881
54,357
53,378
52,521
51,304
49,760
48,153
47,745
Nine people or more…………………………..
64,815
65,129
64,263
63,536
62,342
60,699
59,213
58,845
Source: U.S. Census Bureau, 2023.
Note: The source of the weighted average thresholds is the 2023 Current Population Survey Annual Social and Economic Supplement (CPS ASEC).
2023
Eight or
more
Bus 103 Week 6
56,578
3
BUDGET
Category
Monthly
Annual
Housing
Food
Transportation
Utilities
Clothing
Misc
Bus 103 Wk 6
4
POVERTY MEASURES
• Unit of Analysis
• Person or Family
• What counts
• Cash Income
• In-kind benefits
20XX
PRESENTATION TITLE
5
2021 POVERTY RATES
H T T P S : // W W W.C E N S U S.G O V/ D ATA / TA B L E S / T I M E – S E R I E S / D E M O / I N C O M E – P O V E RT Y/ C P S – P O V. H T M L
All people
All Races
Below 100%
20XX
All
income
levels
Below
100% of
poverty
(6)
Percentage
below 100%
of
poverty
(7)
Total
328,191
37,933
11.6
..Under 18 years
72,936
11,149
15.3
….Under 5 years
18,381
3,034
16.5
….5 to 17 years
54,555
8,115
14.9
..18 to 64 years
199,062
20,982
10.5
….18 to 24 years
28,981
4,154
14.3
….25 to 34 years
44,583
4,944
11.1
….35 to 44 years
43,190
4,147
9.6
….45 to 54 years
40,130
3,292
8.2
….55 to 59 years
21,004
2,066
9.8
….60 to 64 years
21,174
2,380
11.2
..65 years and over
56,193
5,802
10.3
….65 to 74 years
33,704
3,251
9.6
….75 years and over
22,489
2,551
11.3
PRESENTATION TITLE
6
POVERTY OVER TIME
https://www.census.gov/data/tables/timeseries/demo/income-poverty/historical-povertypeople.html
7
INCOME
• Unit of Analysis
Person
Family
Household
• Time Period
• Income Type
• Wealth
• Mean vs Median
20XX
PRESENTATION TITLE
8
INCOME MEASURES
https://www.census.gov/data/tables/2022/demo/incomepoverty/p60-276.html
• Median Family 2020 and 2021 A1
• Quintile Shares A3
• Earnings 2020 and 2021 A6
• Income Report 2021
• https://www.census.gov/library/publications/2022/de
mo/p60-276.html
20XX
PRESENTATION TITLE
9
BUSINESS FOR THE
SOCIAL GOOD -WEEK 6
Donley
AGENDA
•
•
General
•
Today is a D
•
Papers coming along
Income
•
Median vs. Mean
•
Quintiles
Poverty
•
Spring 2023
•
Thresholds
•
Cut offs
•
Shares
•
Basis
•
Lorenz Curve
•
Budget
•
Gini Index
•
Measures
•
Rates
•
Person vs. Family
•
Children, Seniors, …
Bus 103 Week 3 Donley
2
POVERTY THRESHOLDS 2022
Poverty Thresholds for 2022 by Size of Family and Number of Related Children Under 18 Years
(In dollars)
Related children under 18 years
Size of family unit
None
One person (unrelated individual):
Under 65 years……………………………….
65 years and over…………………………..
15,225
14,036
Two people:
Householder under 65 years……………
Householder 65 years and over……….
19,597
17,689
One
Two
Three
Four
Five
Six
Seven
20,172
20,095
Three people……………………………………..
22,892
23,556
23,578
Four people……………………………………….
30,186
30,679
29,678
29,782
Five people………………………………………..
36,402
36,932
35,801
34,926
34,391
Six people………………………………………….
41,869
42,035
41,169
40,339
39,104
38,373
Seven people…………………………………….
48,176
48,477
47,440
46,717
45,371
43,800
42,076
Eight people………………………………………
53,881
54,357
53,378
52,521
51,304
49,760
48,153
47,745
Nine people or more…………………………..
64,815
65,129
64,263
63,536
62,342
60,699
59,213
58,845
Source: U.S. Census Bureau, 2023.
Note: The source of the weighted average thresholds is the 2023 Current Population Survey Annual Social and Economic Supplement (CPS ASEC).
2023
Eight or
more
Bus 103 Week 6
56,578
3
BUDGET
Category
Monthly
Annual
Housing
Food
Transportation
Utilities
Clothing
Misc
Bus 103 Wk 6
4
POVERTY MEASURES
• Unit of Analysis
• Person or Family
• What counts
• Cash Income
• In-kind benefits
20XX
PRESENTATION TITLE
5
2021 POVERTY RATES
H T T P S : // W W W.C E N S U S.G O V/ D ATA / TA B L E S / T I M E – S E R I E S / D E M O / I N C O M E – P O V E RT Y/ C P S – P O V. H T M L
All people
All Races
Below 100%
20XX
All
income
levels
Below
100% of
poverty
(6)
Percentage
below 100%
of
poverty
(7)
Total
328,191
37,933
11.6
..Under 18 years
72,936
11,149
15.3
….Under 5 years
18,381
3,034
16.5
….5 to 17 years
54,555
8,115
14.9
..18 to 64 years
199,062
20,982
10.5
….18 to 24 years
28,981
4,154
14.3
….25 to 34 years
44,583
4,944
11.1
….35 to 44 years
43,190
4,147
9.6
….45 to 54 years
40,130
3,292
8.2
….55 to 59 years
21,004
2,066
9.8
….60 to 64 years
21,174
2,380
11.2
..65 years and over
56,193
5,802
10.3
….65 to 74 years
33,704
3,251
9.6
….75 years and over
22,489
2,551
11.3
PRESENTATION TITLE
6
POVERTY OVER TIME
https://www.census.gov/data/tables/timeseries/demo/income-poverty/historical-povertypeople.html
7
INCOME
• Unit of Analysis
Person
Family
Household
• Time Period
• Income Type
• Wealth
• Mean vs Median
20XX
PRESENTATION TITLE
8
INCOME MEASURES
https://www.census.gov/data/tables/2022/demo/incomepoverty/p60-276.html
• Median Family 2020 and 2021 A1
• Quintile Shares A3
• Earnings 2020 and 2021 A6
• Income Report 2021
• https://www.census.gov/library/publications/2022/de
mo/p60-276.html
20XX
PRESENTATION TITLE
9
CARBON CREDIT
AND CARBON OFFSET
FUNDAMENTALS
Areta A. Jez, Brad D. Alexander,
and Ayaz R. Shaikh
TABLE OF
CONTENTS
About the Authors…………………………………………………………………………………………………………………… 3
Glossary of Key Market Terms…………………………………………………………………………………………………4
I.
Introduction…………………………………………………………………………………….. 8
II.
Creation of Carbon Credits and the Establishment of Carbon Markets………………… 9
III.
Carbon Credits Versus Carbon Offsets…………………………………………………….. 13
IV.
Carbon Markets……………………………………………………………………………….. 15
V.
Valuing Carbon Offsets…. …………………………………………………………………… 18
VI.
Lifecycle of a Carbon Offset……………………………………………………………….. 20
VII. Opportunities and Risks for Stakeholders………………………………………………… 24
Endnotes…………………………………………………………………………………………….. 25
Carbon Credit and Carbon Offset Fundamentals // 2
ABOUT THE AUTHORS
Areta A. Jez, Associate, Energy & Sustainability and Projects & Infrastructure Practices
AAJez@mintz.com | +1.212.692.6788
Areta is an Associate in the Projects & Infrastructure practice and the Energy &
Sustainability group at Mintz. She focuses her practice on the development, financing,
and acquisition of renewable energy and sustainable infrastructure projects. Her
experience includes projects in the solar, offshore wind, geothermal, biofuels, waste,
and wastewater treatment sectors. Prior to joining Mintz, Areta was a projects associate
at an international law firm. Areta has worked at the US Department of State and the
International Development Law Organization in Rome.
Brad D. Alexander, Associate, Energy & Sustainability and Projects & Infrastructure Practices
BDAlexander@mintz.com | +1.415.696.5256
Brad is an attorney in the Projects & Infrastructure practice and the Energy &
Sustainability group at Mintz. He advises sponsors and developers on a range of energy
and infrastructure projects. Brad currently advises on renewable energy, storage,
biofuels, and sustainable infrastructure projects, as well as cleantech companies and
investors in connection with financings, M&A, and commercial agreements. Brad has
experience globally with a focus on developing markets. Before joining Mintz, Brad was a
senior associate at a global law firm and, prior to that, was based in Southeast Asia as a
projects associate for another global law firm.
Ayaz R. Shaikh, Chair, Projects & Infrastructure Practice
Member, Energy & Sustainability Practice
AShaikh@mintz.com | +1.202.434.7318
Ayaz is the Chair of the Projects & Infrastructure practice at Mintz and a Member in
the firm’s Energy & Sustainability group. A widely recognized projects lawyer with
experience in over 40 countries spanning five continents, Ayaz’s practice encompasses
Project Finance and M&A representations across a spectrum of energy and infrastructure
sectors. He advised on some of the first independent power projects (IPPs) in Asia,
the Middle East, and Latin America, and helped to establish the framework, concession
structure, or model agreements for projects in a country. Today, Ayaz’s practice focuses
entirely on renewable energy, sustainable infrastructure, and climate-related mandates.
He is a frequent panelist and has published extensively, including a book on Project
Finance Fundamentals and the chapter on “International Project Finance” in PLI’s
International Corporate Practice treatise.
Relevant to this paper, Ayaz advised the World Bank in a pioneering transaction in
2001 aimed at operationalizing the carbon market–based frameworks under the Kyoto
Protocol. In that capacity, he helped to structure and craft the first Emission Reduction
Purchase Agreement or “ERPA” for use in the maiden investment by the World Bank’s
Prototype Carbon Fund for a waste management project in Latvia. Widely used, the
ERPA set the precedent and formed the foundational basis for the creation and sale of
renewable attributes, including present-day Renewable Energy Certificates or RECs.
Carbon Credit and Carbon Offset Fundamentals // 3
GLOSSARY OF KEY MARKET TERMS
Term
Meaning
Additionality
A reduction in GHG Emissions is deemed “additional” only if
the reduction would not have taken place in the absence of the
incentive created by the voluntary carbon offset market. Achieving
“additionality” increases the value of the carbon offset.
Avoidance Projects
One of the two main types of projects that produce carbon credits
or offsets. Avoidance projects avoid the release of GHG Emissions
into the atmosphere by reducing activities that tend to emit large
numbers of GHG Emissions or by protecting natural resources.
Carbon Credits
Tradeable permits that each represent the right to emit one metric
ton of carbon dioxide or other greenhouse gases.
Carbon Offsets
Measures of the amount of carbon avoided or permanently
removed from the atmosphere. A carbon offset represents one
metric ton of carbon dioxide or equivalent greenhouse gases
avoided or removed.
Certified Emissions
Reduction (CER) Credit
Relating to the Kyoto Protocol, a marketable carbon credit
generated by the Clean Development Mechanism (CDM) that
represents the equivalent of offsetting one metric ton of carbon
dioxide. A CER can be traded or sold to count towards meeting an
industrialized country’s GHG Emissions–reduction targets under
the Kyoto Protocol.
The Clean Development
Mechanism (CDM)
One of three market-based mechanisms introduced by the Kyoto
Protocol to assist countries in finding ways to meet their GHG
Emissions reductions targets. The CDM allowed industrialized
countries to implement an emissions reduction project in a
developing country and, in doing so, generate a marketable
Certified Emissions Reduction (CER) credit.
Climate Reserve Tons
(CRTs)
Tradeable carbon offsets issued by the Climate Action Reserve in
the voluntary carbon market.
Compliance Carbon
Markets
One of two categories of carbon markets that allows participants
to buy and sell carbon credits or carbon offsets to comply
with rules or regulations imposed by regulatory or governance
organizations.
Carbon Credit and Carbon Offset Fundamentals // 4
GLOSSARY OF KEY MARKET TERMS contd.
Term
Meaning
Core Carbon Principles
A framework and assessment procedure for identifying and issuing
carbon offsets released by the Integrity Council for the Voluntary
Market in 2022.
Corresponding
Adjustments
An accounting mechanism that requires a host country to deduct
(or “un-count”) a sold carbon offset from its own NDCs so that
the buyer country can count the offset against its NDCs. This
mechanism was established at Glasgow with the ratification of
Article 6 of the Paris Agreement and seeks to address doublecounting.
Double Counting
The idea that multiple entities are claiming benefits from the same
carbon offset.
Emissions Reduction
Purchase Agreement
(ERPA)
A legally binding contract between buyers and sellers of carbon
offsets.
Environmental, Social
and Governance (ESG)
Objectives
Objectives set within a company in order to manage the
organization’s impact on social and environmental sustainability
directly. The trading of carbon offsets in the voluntary market can
help companies meet their ESG objectives.
Glasgow Climate Change
Conference
A 2021 climate conference that ratified Article 6 of the Paris
Agreement.
Greenhouse Gas (GHG)
Emissions
The release of gases that contribute to the greenhouse effect via
human activity. Both carbon credits and carbon offsets aim to
reduce GHG Emissions.
The International Emissions
Trading (IET) Mechanism
One of three market-based mechanisms introduced by the Kyoto
Protocol to assist countries in finding ways to meet their targets.
The IET mechanism allowed industrialized countries with unused,
excess carbon allowances to sell these excess allowances to other
industrialized countries that exceeded their targets.
Carbon Credit and Carbon Offset Fundamentals // 5
GLOSSARY OF KEY MARKET TERMS contd.
Term
Meaning
Internationally Transferred
Mitigation Outcomes
(ITMOs)
One of two market-based approaches provided under Article 6
of the Paris Agreement that allows countries to meet their NDC
obligations by trading for and acquiring carbon offsets earned
from the reduction of GHG Emissions. ITMOs are the new unit
of carbon reduction established by the Paris Agreement for
international carbon markets that will replace CERs established
under the Kyoto Protocol.
Joint Implementation (JI)
One of three market-based mechanisms introduced by the Kyoto
Protocol to assist countries in finding ways to meet their targets.
The JI allows industrialized countries to collaborate jointly with
each other in pursuing and implementing emissions reduction
projects in order to meet their Kyoto targets.
Kyoto Protocol
An international treaty that came into effect in 2005, setting
legally binding targets for 37 industrialized countries to limit or
reduce their overall greenhouse gas emissions.
Nationally Determined
Contributions (NDCs)
National plans highlighting climate change mitigation, including
climate-related targets for greenhouse gas emission reductions.
The Paris Agreement requires each country to create and submit
NDCs on a five-year cycle.
Removal Projects
One of two main types of projects that produce carbon credits or
offsets. Removal projects are aimed at removing GHG Emissions
already released into the atmosphere by using nature-based and
or technology-based methods.
Retirement
The process whereby a carbon offset is used and removed,
meaning that the carbon offset can no longer be sold or traded
on any exchange. Retirement occurs after the reduction in GHG
Emissions has been deducted from the final owner’s carbon
footprint.
Paris Agreement
A legally binding, international treaty on climate change adopted
in 2015 that effectively replaced the Kyoto Protocol. The Paris
Agreement called on both industrialized and developing countries
to set and meet emissions goals.
Carbon Credit and Carbon Offset Fundamentals // 6
GLOSSARY OF KEY MARKET TERMS contd.
Term
Meaning
Sustainable Development
Mechanism (the SDM)
One of two market-based approaches provided under Article 6
of the Paris Agreement that allows countries to meet their NDC
obligations by trading for and acquiring carbon offsets earned
from the reduction of GHG Emissions. The SDM aims to reduce
overall global GHG Emissions.
Validation and Verification
Body (VVB)
An independent third party pre-approved by the carbon offset
registry that conducts an audit of the project design during the
auditing stage of the carbon offset certification process.
Verified Carbon Units
(VCUs)
Tradeable carbon offsets issued by Verra in the voluntary market.
Verified Emission
Reductions (VERs)
Tradeable carbon offsets issued by the American Carbon Registry
in the voluntary market.
Vintage of a Carbon Offset
The year GHG Emissions reductions for an issued offset were
deemed to have occurred. The vintage of a carbon offset can be
indicative of the quality of the carbon offset and its underlying
project, and thus is a principal factor in determining the carbon
offset’s value.
Voluntary Carbon Markets
One of two categories of carbon markets. Voluntary carbon
markets allow for the trading of carbon offsets that are not bought
or sold on the compulsory carbon markets to meet GHG Emissions
requirements imposed by regulatory bodies. Most carbon offsets
are traded in voluntary markets and cannot be used to achieve
GHG Emissions reduction targets under an applicable compliance
regime. Certain carbon offsets, however, are permitted to be used
to achieve compliance with a compulsory regime.
Carbon Credit and Carbon Offset Fundamentals // 7
I. INTRODUCTION
As the need to reduce the emission of greenhouse
gases has grown more urgent over the last quarter
century, key stakeholders across the globe
have sought to forge effective paths to make a
measurable difference in the health of the planet.
Starting in the 1990s with the Kyoto Protocol,
governments and multilateral organizations led
the way by creating avenues for countries to
participate in carbon reduction efforts through
the use of carbon credits and carbon offsets. The
mechanisms introduced by the Kyoto Protocol led
to the creation of global and regional compulsory
compliance regimes requiring both countries
and corporate entities to limit their carbon
emissions. Beyond these mandatory regimes, the
sharp rise in public concern over the climate has
increasingly catalyzed companies to take steps
to reduce their carbon emissions on a voluntary
basis. In order to reach their goals, companies are
turning to voluntary carbon markets, where they
are able to invest in renewable energy projects
that generate carbon offsets, as well as purchase
and sell carbon offsets, as a means of contributing
to the removal of carbon from the atmosphere.
Activity surrounding voluntary carbon markets
has expanded steadily since their introduction,
with current estimates projecting that the market
for carbon offsets may be worth over US$50
billion by 2050.i
Despite the growing importance of both carbon
credits and offsets, the fundamentals of these
tradeable units and their associated markets are
still not well understood by most. This article
seeks to provide a broad overview of carbon
credits and carbon offsets in order to facilitate
a better awareness of the growth and practical
workings of these markets. It commences by
surveying the establishment and evolution of
carbon markets stemming from the entry into the
Kyoto Protocol in the late 1990s. It then delves
into the distinctions between carbon credits and
carbon offsets, as well as the difference between
compulsory and voluntary carbon markets.
The article includes a brief journey through the
typical lifecycle of a carbon offset, from creation
to retirement. It concludes with a few broad
observations regarding the opportunities and
risks presented by the carbon markets.
Carbon Credit and Carbon Offset Fundamentals // 8
II. CREATION OF CARBON CREDITS AND THE
ESTABLISHMENT OF CARBON MARKETS
The focus on carbon credits as a means of
combating climate change is relatively new.
The concept of an international carbon market
was first established by the Kyoto Protocol in
1997. Initially signed by 180 countries, the Kyoto
Protocol came into effect in 2005, setting legally
binding targets for 37 industrialized countries
to limit or reduce their overall greenhouse gas
emissions (“GHG Emissions”) by an average of at
least 5% below their respective 1990 levels during
the period of 2008-2012.1
The Kyoto Protocol imposed these binding
targets only on industrialized countries in express
recognition of the responsibility they bear for
the state of the climate as a result of their GHG
Emissions over the course of a century-and-ahalf of robust industrialization. Conversely, the
Kyoto Protocol provided developing countries
with voluntary targets or, in the case of China and
India, exemptions from targets altogether.
While industrialized countries were directed to
meet their targets principally through national
measures orchestrated by governmental fiat, the
Kyoto Protocol also introduced three marketbased mechanisms to assist countries in finding
ways to meet their targets. These mechanisms
also aimed to encourage participation in emission
reduction efforts by the private sector and by
developing countries exempted from Kyoto’s
binding targets.
These market-based mechanisms were:
•
The Clean Development Mechanism (“CDM”)
•
Joint Implementation (“JI”)
•
The International Emissions Trading (“IET”)
mechanism.
1
The Kyoto Protocol’s compliance mechanism is considered among the most robust ever adopted for a
multilateral agreement. The compliance mechanism consists of a facilitative branch that provides advice and
assistance to parties to encourage compliance, and an enforcement branch empowered to take hard actions. The
enforcement branch determines three different forms of non-compliance: (1) with the emission targets, (2) the
methodological and reporting requirements, and (3) the eligibility requirements for participation in the Kyoto
Protocol’s flexibility mechanisms. The Kyoto Protocol also requires a non-complying country to take specific
actions depending on the nature of non-compliance. For example, in the case of non-compliance with emission
targets, the Kyoto Protocol requires the offending country to make up the difference between its actual emissions
and its target obligations, plus an additional 30% deduction, in the next compliance period. Meaning that, for
every metric ton of emissions by which a country exceeds its Kyoto Protocol target, its allocation of emissions for
the subsequent compliance period would be lowered by an additional 1.3 metric tons as a penalty. Whether this
penalty has had any effect in deterring non-compliance is questionable, however, as it is unclear how a country
could be forced to meet its obligations under a subsequent period if it has already failed to meet its commitments
under a prior one. Additionally, since countries negotiate their own commitments under the Kyoto Protocol, a noncomplying country could negotiate a less-stringent target for the next commitment period to accommodate for
the penalty, negating the impact that the enforcement mechanism would have on the country’s compliance.
Carbon Credit and Carbon Offset Fundamentals // 9
II. CREATION OF CARBON CREDITS AND THE
ESTABLISHMENT OF CARBON MARKETS contd.
The creation of these market-based mechanisms
introduced and established what ultimately
became known as the international carbon
market.
Article 12 of the Kyoto Protocol created the
framework for the CDM. The CDM allows any of
the 37 industrialized countries bound by the Kyoto
targets to implement an emissions reduction
project in a developing country and, in doing
so, generate a marketable Certified Emissions
Reduction (“CER”) credit. Each CER represents
the equivalent of offsetting one metric ton of
carbon dioxide and can be traded or sold to count
towards meeting an industrialized country’s GHG
Emissions reduction targets under Kyoto.
Article 7 of the Kyoto Protocol established the
JI, a mechanism similar to the CDM. Under the JI,
industrialized countries could jointly collaborate
with other industrialized countries in pursuing
and implementing emissions reduction projects
in order to meet their Kyoto targets.
The IET, an international trading program, sprung
from Article 17 of the Kyoto Protocol. The IET
allowed industrialized countries with unused,
excess carbon allowances to sell these excess
allowances to other industrialized countries that
had otherwise exceeded their targets.
In order to operationalize the market-based
frameworks constituted by the Kyoto Protocol,
and specifically the CDM, and to spark the
development of the international carbon
market, a model Emissions Reduction Purchase
Agreement (“ERPA”) was crafted in 2001 under
the aegis of the World Bank.2 The advent of the
ERPA marked a seminal event in the evolution of
carbon markets as it allowed buyers and sellers of
CERs to memorialize the transaction in a legally
binding contract. While each ERPA is uniquely
tailored to the requirements of the project with
which it is associated, most ERPAs contain
provisions that:
•
Specify the quantity and price of CERs to
be delivered to the buyer and related
payment schedules;
•
Provide for risk allocation and management
between the parties;
•
Delineate the consequences of non-delivery
and default; and
•
Specify the other obligations of the buyer
and the seller with regard to both the
transaction for the sale and purchase of
CERs and the underlying project giving rise
to the emission reduction credits.
Initially conceived to create a process for the
sale of CERs under the CDM, the ERPA grew in
use and importance globally over the years, and
ultimately came to form the basis for the sale of
other renewable attributes, including the sale of
Renewable Energy Certificates or RECs.ii
The second phase of carbon trading kicked off
in 2015 when 114 countries ratified the Paris
Agreement. The Paris Agreement effectively
replaced the Kyoto Protocol, whose binding
targets were set to expire in December 2020.iii
2
One of the authors of this article, Mintz partner Ayaz Shaikh, advised the World Bank in conceiving,
structuring, and drafting the model ERPA, and in its usage in the first investment of the World Bank’s Prototype
Carbon Fund (PCF). That investment was for the Liepaja Solid Waste Management Project in the Republic of Latvia
in 2001.
Carbon Credit and Carbon Offset Fundamentals // 10
II. CREATION OF CARBON CREDITS AND THE
ESTABLISHMENT OF CARBON MARKETS contd.
Whereas the Kyoto Protocol had set emissionreduction targets for industrialized countries only,
the Paris Agreement called on both industrialized
and developing countries to establish and meet
emissions goals. The Paris Agreement reflected
the growing urgency of the climate crisis and the
broad recognition that in order to be effective,
measures to combat climate change must be
pursued by all carbon emitters, regardless of
their varying culpability in creating the present
exigency. The Paris Agreement aimed to set an
outside limit for global warming to a point below
2 °C above pre-industrial levels, with the stated
aspiration of limiting the temperature increase to
a threshold of 1.5 °C above pre-industrial levels.
These limits were to be achieved by having
each country create and submit its plans for
climate action – known as Nationally Determined
Contributions (“NDCs”) – on a five year cycle.
and its predecessor mechanisms is that the SDM
seeks to reduce overall global GHG Emissions,
while the CDM and JI had essentially shifted the
location of GHG Emissions without necessitating
an overall reduction in GHG Emissions. Under the
CDM and JI, each metric ton of carbon reduction
achieved by a developing country and measured
by the creation of a CER – the credits issued by
the CDM under the Kyoto Protocol – allowed
an industrialized country to emit one additional
metric ton of carbon. Any offsets created by
projects traded on the SDM, on the other hand,
must result in an overall reduction of global GHG
Emissions without allowing for a corresponding
increase in GHG Emissions elsewhere. In addition,
the offsets traded pursuant to the SDM must be
over and beyond what a country has committed
under its NDCs.
One of the key elements of the Paris Agreement
can be found in the all-important Article 6, the
provisions of which established two new marketbased mechanisms for creating and trading
carbon offsets: the Sustainable Development
Mechanism (the “SDM”) and the internationally
transferred mitigation outcomes (“ITMOs”).
These market-based approaches provided
under Article 6 allowed countries to meet their
NDC obligations by trading for and acquiring
carbon offsets earned from the reduction of GHG
Emissions produced by qualifying projects.iv
Article 6.4 established the SDM, a centralized
carbon market that allows trading of carbon offsets
created by specific projects implemented jointly
by countries party to the Paris Agreement. Article
6.4 aimed to replace the offsetting mechanism
provided under Kyoto’s CDM, as well as the
collaboration mechanism provided under Kyoto’s
JI. The most notable difference between the SDM
Article 6.2 of the Paris Agreement provided for
the international trading of ITMOs, which are the
new unit of carbon reduction for international
carbon markets intended to replace the CERs
established under the Kyoto Protocol. ITMOs are
used by countries to meet their respective NDCs:
countries that have met or exceeded their NDC
goals can trade their excess ITMOs with countries
Carbon Credit and Carbon Offset Fundamentals // 11
II. CREATION OF CARBON CREDITS AND THE
ESTABLISHMENT OF CARBON MARKETS contd.
that lag behind in meeting their commitments,
with the caveat that the selling country must
make a corresponding adjustment in its NDCs to
“uncount” the ITMO it is trading. In order to ease
the transition to the new trading mechanisms
created under Article 6.2, certain CERs generated
between 2013 and 2020 were to be eligible for
conversion into ITMOs and to count towards a
country’s NDC commitments.v
As is now well-known, however, the effectuation of
these Paris Agreement standards proved difficult.3
While broad guidelines as to the implementation
of Article 6 of the Paris Agreement were adopted
during the initial UN Conference of the Parties in
2015, these guidelines failed to establish how the
implementation of Article 6 would be handled in
practice. It was not until delegates convened at
the Glasgow Climate Change Conference in 2021
that the rulebook for the official implementation
of Article 6 was finally ratified.
The Glasgow Conference sought to bolster the
integrity of carbon offsets and inspire confidence
in the carbon markets by proposing new rules
covering both the procedures and benchmarks
governing the creation, trading, and tracking of
carbon offsets. Prior to the introduction of Article
6 of the Paris Agreement and its ratification at the
Glasgow Conference, no clear standards existed
delineating how carbon offsets would be tracked.
The absence of any cognizable standards led to
a risk of double counting the same carbon offset
towards the satisfaction of NDCs in two separate
countries – once by the seller country that hosted
and generated the carbon offset, and once by a
buyer country that purchased the carbon offset.
One of the primary achievements of the Article
6 rulebook is that it addressed this issue through
an accounting mechanism called corresponding
adjustments. Under this accounting mechanism,
if a host country authorizes the sale of a carbon
offset from a qualifying project to a buyer
country, then the host country must deduct (or
“un-count”) the carbon offset from its own NDCs
so that the buyer country can then count the
offset against its NDCs. The rulebook for Article
6 also introduced new standards to verify the
quantity and quality of GHG Emission reductions
produced by a project in order to ensure that
projects that generate offsets actually lead to a
measurable reduction in global GHG Emissions.
These rules aimed to add transparency to the
overall process of trading in carbon offsets….

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