Chapter 8: How are carbon credits generated?

Carbon credits are tradable, certified greenhouse gas (GHG) emission reductions or removals. Carbon standards issue carbon credits to registry accounts. Each voluntary carbon market (VCM) carbon credit represents one ton of GHG emissions removed from the atmosphere or one ton of GHG that has not been emitted, as compared to a baseline.

How do baseline-and-credit systems work?

GHG emission reductions or removals are measured using VCM protocols and methodologies. The VCM generates carbon credits through a baseline-and-credit system that compares actual GHG emissions to a counterfactual baseline emissions scenario. The differences between actual and counterfactual emissions are accounted for as GHG emission reductions and removals that would not have occurred in a business-as-usual scenario.

To generate carbon credits in the VCM, project or program proponents (i.e., the public or private entities designing the mitigation activities) must demonstrate that project or program activities lead to GHG emission reductions and removals beyond those that would have occurred in the absence of the carbon activity. A baseline or reference level must be developed, against which emission reductions or removals are quantified. Baselines describe a counterfactual scenario that will not actually occur, but would have occurred in an alternative reality without the VCM project or program. This makes the definition of conservative reference scenarios essential for the credibility of baselines.

Standards require that programs and projects pass an additionality test to demonstrate that project or program activities face barriers that would prevent them from otherwise going ahead. In other words, activities and credits are additional if they would not have happened in the absence of carbon finance. To demonstrate additionality, program or project proponents must follow the rules, procedures, and methodologies of the VCM Standard under which they choose to certify their activities.

How does government action relate to VCM baselines?

National policies, laws, and regulations must be taken into account when testing additionality and developing baselines. For example, if there is regulation in place to require certain emission reduction practices—and strong enforcement of those regulations—then VCM projects that seek to provide incentives for those same practices would not be additional, as the regulated emission reductions would have likely taken place in the absence of the VCM project. In the case of jurisdictional programs, some standards require governments to show that ‘additional’ policies and measures have been adopted to achieve GHG emission reductions and removals below jurisdictional reference levels.

Under the Paris Agreement, all countries have the obligation to develop increasingly comprehensive and ambitious Nationally Determined Contributions (NDCs) that inform national climate targets and plans. This presents an essential challenge for carbon market mechanisms because additionality may need to consider the host country’s NDC. However, NDCs are often aspirational statements that are not backed by concrete policies and implementation plans. NDCs are also often conditional on additional financing. NDCs that are not being implemented may not need to be considered in VCM baselines or additionality tests.

Governments can encourage the development of VCM projects in sectors or regions where VCM activities would clearly be additional. This is the case for sectors or regions not yet adequately covered by government regulation. Governments can also encourage VCM projects in sectors that are covered by conditional NDC targets, which depend on external financing. In this way, government engagement with the VCM can ensure that VCM projects complement public efforts to mitigate climate change.

What does the VCM project or program cycle look like?

The process through which VCM projects or programs are designed, climate benefits are generated, and carbon credits are issued and traded is called the project or program cycle. This project or program cycle generally consists of the steps shown in Figure 8.2 and described in more detail below. The cycle for standards that certify projects (e.g., Verified Carbon Standard and Gold Standard) and the cycle for those that certify jurisdictional programs (e.g., Jurisdictional and Nested REDD+ — JNR— and Architecture for REDD+ Transactions The REDD+ Environmental Excellence Standard—ART/TREES) follow comparable steps. A distinct feature of ART/TREES is that program proponents—called participants—must be a national government or subnational entity with jurisdiction. JNR also requires jurisdictional-level proponents, and provides different requirements for nested or jurisdictional projects or programs.

Planning: Private or public proponents of mitigation activities choose a VCM standard and an approved methodology with which to develop the project or program activities. Stakeholders are identified. Feasibility studies and stakeholder consultations may be conducted or initiated during this step.

Design: Proponents prepare the project or program documentation according to the guidelines of the carbon standard under which they wish for the climate benefits from a project or program to be certified. The documentation must demonstrate that the VCM project has applied the chosen methodologies correctly and met the associated requirements.

Validation: To be registered, a project or program must be validated by an independent third-party auditor, often known as a Validation/Verification Body (VVB). Validation reports are submitted following an audit of the activity design documents, which typically includes a site visit and consultation with stakeholders.

Registration: Prior to registration, validation reports are reviewed by the standard. A project or program is registered if it meets the rules and requirements of the standard under which it is certified. Projects can begin implementation after registration.

Implementation: A project or program is implemented as laid out in the documents submitted for registration and validation.

Monitoring: Project or program activities are monitored to ensure that emission reductions are generated as described in project documents. Project developers prepare and follow a monitoring plan and record emissions reductions in periodic monitoring reports.

Verification: Project or program periodic monitoring reports are verified by an independent, third-party auditor and by the carbon standard under which the project is certified. Verification is required for the issuance of carbon credits.

Issuance: After the regulatory body of the carbon standard approves credit issuances, carbon credits are deposited into the proponent’s account on the registry of the carbon standard. Carbon credits can be sold, traded, retired, and canceled after they have been issued. The terms of the sale are established in an Emission Reductions Purchase Agreement (ERPA). The sale of carbon credits is recorded in the registry of the carbon standard, which enables the transfer of credits between accounts and the tracing of transactions.

Authors: Charlotte Streck, Melaina Dyck and Danick Trouwloon
Figures and visuals: Leo Mongendre
Design: Sara Cottle

Date of publication: December 2021

The Voluntary Carbon Market Explained (VCM Primer) is supported by the Climate and Land Use Alliance (CLUA). The authors thank the reviewers and partners that generously contributed knowledge and expertise to this Primer.