Carbon Credits Simplified: A Guide to How They Work and Why They Matter

In an era of growing environmental consciousness, businesses and governments alike are seeking effective solutions to combat climate change. One such tool that has gained global traction is the carbon credit. But what exactly are carbon credits, and why should businesses care about them?

Carbon credits not only encourage organizations to reduce greenhouse gas emissions but also offer an opportunity to align with global sustainability goals. With the global carbon credit market valued at $479.41 billion in 2023 and projected to grow at a staggering CAGR of 39.4% to reach $4,734.35 billion by 2030 (Grand View Research), it’s clear that this mechanism is becoming increasingly central to sustainability strategies.

This blog simplifies the concept of carbon credits, explains how they work, explores their importance for businesses, and examines India’s position in this rapidly evolving space.

What Are Carbon Credits?

Carbon credits are a way to put a price on carbon emissions. Each credit represents permission to emit one metric ton of carbon dioxide (or an equivalent amount of another greenhouse gas). They are designed to limit how much greenhouse gas can be released while encouraging businesses to adopt cleaner practices.

Think of it as a ticket system: companies get a set number of tickets (credits) that allow them to release a limited amount of emissions. If a company uses fewer tickets than it has, it can sell the extra ones to another company that needs more. For example, a power plant that upgrades its machinery to emit less carbon can sell its extra credits to another company that’s still working on reducing emissions.

At the heart of carbon credits are two main goals:

1. Protect the Environment: By limiting the total number of emissions, carbon credits help slow climate change.
2. Reward Sustainability: Companies that lower their emissions not only help the planet but also gain financial benefits by selling their extra credits.

How Do Carbon Credits Work?

Carbon credits operate on a simple yet effective principle: limit and trade. Here’s how it works:

1. Setting the Cap: A governing body (like a government or international organization) establishes a limit on greenhouse gas emissions for industries or regions.
2. Allocating Credits: Companies receive or purchase carbon credits, each representing permission to emit one ton of carbon dioxide or equivalent.
3. Trading Excess Credits: If a company reduces its emissions and doesn’t use all its credits, it can sell the surplus to another company struggling to stay within its limits.
4. Paying for Exceeding Limits: Companies exceeding their allocated emissions must buy additional credits, effectively paying a price for polluting more.

Let’s take the example of Tesla. According to carboncredits.com Tesla earned around $1.79 billion in 2023 by selling carbon credits to automakers striving to meet emissions regulations. One notable buyer is Fiat Chrysler, which used these credits to offset its excess emissions and comply with environmental standards.

The carbon credit system ensures that emissions stay within the overall cap while incentivizing businesses to adopt greener practices and create financial value from sustainability efforts.

Why Should Businesses Care About Carbon Credits?

For businesses, carbon credits are more than just a tool for compliance—they’re an opportunity to lead in sustainability while unlocking financial and reputational benefits. Here’s why they matter:

1. Reduce Carbon Footprint:
   Companies that buy carbon credit tend to be on a path to becoming climate leaders. Ecosystem Marketplace found that nearly 60% of carbon credit buyers reported faster year-on-year decarbonisation, compared with companies that do not participate in carbon markets.
2. Save Money:
   Companies that lower their emissions can sell unused credits, turning environmental responsibility into a revenue stream.
   Example:
   A textile company that installs solar panels not only reduces its energy costs but also generates surplus credits to sell.
3. Build a Positive Reputation:
   Consumers and investors increasingly favor businesses that prioritize sustainability. In fact, according to a survey by Nielsen, products making ESG-related claims averaged 28% cumulative growth over the past five-year period, versus 20% for products that made no such claims.
   By engaging in carbon credit markets, companies can demonstrate their commitment to a greener future and strengthen trust among stakeholders.
4. Stay Ahead of Regulations:
   As governments worldwide impose stricter emission limits, understanding and participating in carbon credit markets can help businesses remain compliant and avoid potential penalties.
5. Attract Investment:
   With sustainability-linked financing on the rise, businesses with clear carbon reduction strategies are better positioned to attract green investments. According to IETA, over $36 billion was invested globally in carbon credit projects between 2012 and 2022, highlighting the growing financial commitment to emissions reduction.

In today’s climate-conscious world, carbon credits aren’t just about balancing emissions—they’re about staying competitive in a market that values sustainability.

How Much Is a Carbon Credit Worth?

The value of a carbon credit varies widely, depending on factors like the type of project, its location, and market demand.

1. Project Type:
   Credits from renewable energy projects may cost less than those from advanced technologies like carbon capture and storage.
   Example:
   A credit from a wind farm project might be priced at $10, while one from a reforestation project could cost $25 due to its long-term environmental benefits.
2. Certification and Quality:
   Credits with certifications from trusted organizations like Gold Standard or Verra are often worth more because they meet rigorous standards for emission reductions.
3. Market Dynamics:
   In voluntary markets, prices range from as low as $1 to over $100 per ton, depending on supply and demand. In compliance markets, prices are often higher due to stricter regulations. For instance, compliance markets dominated the market in 2023, accounting for 99.6% of the share, while voluntary markets are projected to grow at a CAGR of 21.2% (Astute Analytica).

Where Does India Stand?

India, the world’s third-largest emitter of greenhouse gases, has been making significant strides toward addressing climate change. India has 1,451 projects registered or under consideration across leading carbon registries like Verra and Gold Standard, with about 163 million credits retired by May 2023 (Down to Earth).

With its ambitious goal of achieving net-zero emissions by 2070, the country is shaping its policies and markets to drive sustainable development.

1. Carbon Credit Trading Scheme (CCTS):
   This is a key initiative which aims to establish a unified carbon market in India. This system allows companies to trade carbon credits, encouraging industries to reduce emissions while promoting cleaner practices. The scheme reflects India’s commitment to balancing economic growth with environmental responsibility.
2. India’s Current Status in the Global Market:
   India’s emerging carbon market is gaining attention for its affordability and focus on renewable energy and reforestation projects. With its vast potential in solar and wind power, the country is well-positioned to generate credits that are both impactful and cost-effective.

   According to Grand View Research, India’s voluntary carbon market (VCM) was valued at approximately $1.2 billion in 2023 and is projected to grow significantly, potentially reaching $1.16 billion by 2030. Furthermore, India accounted for around 17% of the global supply of carbon credits in 2022, making it a major exporter in the decentralized voluntary market. (Dhrishtiias).

3. Opportunities for Businesses:
   For businesses, this represents a significant opportunity. By investing in India’s carbon market, companies can support large-scale renewable energy and reforestation initiatives while meeting their sustainability targets.

   According to Down to Earth, renewable energy projects constitute a significant portion of India’s carbon credit offerings with 675 registered projects generating approximately 268 million credits. Indian solar parks are now generating carbon credits that multinational companies like Google (Energy Watch) purchase to offset their emissions, underscoring India’s growing role in the global carbon credit market.

Let’s Sum it Up: Why Are Carbon Credits the Talk of the Town?

Carbon credits offer businesses a practical and meaningful way to take responsibility for their environmental impact. By reducing emissions, trading credits, and aligning with global sustainability goals, companies can not only comply with regulations but also play a critical role in combating climate change.

For businesses in India, the opportunities are particularly compelling. With initiatives like the Carbon Credit Trading Scheme (CCTS) and the nation’s growing focus on renewable energy and reforestation, India is emerging as a key player in the global carbon market. Companies have the chance to leverage affordable and impactful credits while contributing to the country’s net-zero ambitions.

Now is the time for businesses to act. Start by assessing your carbon footprint, exploring participation in carbon markets, and identifying ways to reduce emissions. Whether through direct purchases or investments in emission-reducing projects, engaging with carbon credits is more than a step toward compliance, it’s a step toward a sustainable and competitive future.