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Carbon Offsets vs Carbon Credits: Differences Explained

By Laurel Tincher · March 15, 2023 · 7 minute read

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Carbon Offsets vs Carbon Credits: Differences Explained

Carbon offsets and carbon credits are both accounting mechanisms to measure greenhouse gas pollution, reduction, and removal, and they act like a system of checks and balances. While the terms “carbon offsets” and “carbon credits” are often used interchangeably, they are actually two distinct products that each serve a different purpose.

What Is the Purpose of Carbon Offsets and Carbon Credits?

The overall goal of these mechanisms is to reduce emissions, and to remove the greenhouse gases that have already been emitted to the atmosphere.

In countries with a carbon tax, businesses must pay a levy based on the amount of carbon emissions from their business operations. A carbon tax is designed to encourage companies to reduce the amount of carbon — also known as CO2 emissions.

There are two types of carbon taxes: a tax on quantities of greenhouse gases emitted, and a tax on carbon-intensive goods and services such as gasoline production.

For the companies or industries with higher emissions that wish to avoid paying carbon taxes, carbon offsets and carbon credits provide a way to effectively lower their existing emissions or pollution.

How Are Carbon Offsets Different From Carbon Credits?

The main difference between carbon credits and offsets is that a carbon credit gives one entity the right to emit carbon through the use of a “credit” purchased from another source. A carbon offset represents a more direct reduction of emissions, where the removal of carbon pollution by one entity helps offset the carbon emissions of another.

For investors who are interested in Socially Responsible Investing (SRI), it can be helpful to gauge a company’s environmental commitment, by understanding how they manage their carbon emissions.

Why Do Companies Need Carbon Offsets and Credits?

There are a few different reasons why companies and individuals buy carbon offsets and carbon credits. Some companies have set specific carbon reduction goals; some governments have cap-and-trade programs where they place limits on the amount of greenhouse gas emissions (GHGs) companies can emit.

But if companies can’t reduce their emissions enough to reach their ESG goals or government mandates, they have to purchase carbon credits or carbon offsets from companies that have an excess because they were able to reduce below the capped amount.

What Is a Carbon Credit?

When a company reduces its greenhouse gas emissions, it can earn carbon credits which may then be traded to other companies which need to offset their own emissions. Essentially a carbon credit gives the purchaser permission to emit a ton of carbon, say, because another entity has emitted less carbon pollution and effectively has a credit that they can sell.

This system presents opportunities for investors as well. Individuals can invest in the carbon credit market in a few different ways, including direct investment in low-carbon companies, or via exchange-traded funds (ETFs).

What Is a Carbon Offset

Companies and individuals buy carbon offsets in the voluntary market in order to ‘offset’ their carbon footprint.

When someone purchases an offset, that means a ton of carbon was removed or not emitted. This could be through installing solar panels, direct air capture, or another method typically involving renewable energy.

Recommended: Guide to Sustainable Investing

Carbon Offsets

Carbon offsets are fairly straightforward, because they involve a direct purchase of carbon reduction by an entity that needs to effectively reduce their own emissions.

Carbon Offsets Definition

Basically, a carbon offset cancels out the CO2 emissions that were produced in one place by reducing them in another place.

A carbon offset represents one metric ton of carbon emissions. The purchase of an offset goes directly towards emissions reduction projects.

How Carbon Offsets Work

If a company wants to offset the emissions created from their supply chain, they could buy carbon offsets from another entity that is actively working to reduce emissions. Those offsets might support the installation of renewable energy such as wind and solar, either preventing future emissions or reversing ones that have already occurred.

For example, many airlines now purchase carbon offsets to reduce their company’s overall carbon footprint. Essentially, rather than reducing one’s own emissions, a carbon offset reduces emissions somewhere else in the world.

Investors can support the innovations taking place by investing in green companies and green stocks worldwide.

Carbon Offsets vs Carbon Removal

Carbon removal involves taking CO2 out of the atmosphere or oceans and storing it. There are several ways of doing this, such as direct air capture and mineralization.

When carbon gas is emitted, it remains in the carbon cycle for centuries unless actively removed. So basically carbon removal attempts to reverse the damage that has already been done, and carbon offsets compensate for the damage currently being done and prevent more damage from being done in the future.

Examples of Carbon Offsets

Carbon offset projects exist all over the world. Quality offsets are certified by third parties who ensure that the carbon emissions being avoided or removed are legitimate. Requirements for certification are stringent to ensure that the offsets actually have a real impact.

Examples of carbon offset projects might include:

•   Solar power projects

•   Wind farms

•   Methane recapture operations

•   Reducing deforestation

•   Reducing the use of wood burning stoves

The downside of carbon offsets is that they don’t reduce one’s own emissions and basically give people and companies permission to keep emitting carbon.

Companies can also use them for greenwashing efforts, in order to appear more sustainable than they really are. Global carbon emissions continue to rise year after year despite reduction efforts. However, offsets do support the growth of renewable energy, they can help create jobs and support sustainable innovation.

Recommended: 27 Ways to Invest in a Potentially Carbon-Free Future

Carbon Credits

So what are carbon credits vs. carbon offsets? While they sound similar, they serve different purposes.

Carbon Credits Definition

A carbon credit represents the right to emit one metric ton of carbon dioxide. These credits are used by companies, industries, and governments. The majority of carbon credits are bought and sold through cap-and-trade systems between different companies and brokers.

The goal of carbon credits is to make emitting carbon more expensive, incentivizing companies to work towards emitting less on their own.

How Carbon Credits Work

In a cap-and-trade system, companies receive a certain amount of carbon credits depending on their size, industry, and other factors.

•   The government sets caps for each industry and comes up with penalties for companies that go over the allotted amount.

•   If a company can’t stay under the cap, they buy credits so they don’t have to reduce their own emissions.

•   Conversely, if a company manages to emit less than the cap amount they can sell credits to other companies or they can hold onto them for future use.

Credits can be traded and sold, but when a company actually claims the emission reduction represented by the credit, then the credit is ‘retired’ and can no longer be traded. This prevents double counting where companies could claim the same emission reduction multiple times.

Over time, the government lowers the cap for each industry, incentivizing companies to reduce their emissions so they can cut costs.

Examples of Carbon Credits

There are a few examples of successful cap-and-trade programs:

•   European Union: The EU cap-and-trade program started in 2005. By 2016 the total emissions within the program had been reduced by 26%.

•   China: China has its own version of a cap-and-trade program that includes more than 2,600 companies. The program started in 2017 and is predicted to result in significant emissions reductions.

•   California: Within the first three years of California’s cap-and-trade program, emissions were reduced by 8%.

The Takeaway

Carbon credits are not the same as carbon offsets. Carbon credits are tradable certificates that give companies the right to emit tons of CO2. Carbon offsets represent the reduction of CO2 emissions through verified projects.

Putting a price on carbon is one important way to create incentives for reducing emissions and investing in renewable energy. Carbon credits and carbon offsets are two mechanisms used for carbon pricing. Investors can add carbon credits to their portfolio through marketplaces and through ETFs.

If you’re interested in sustainable investing, consider stock investing app like SoFi Invest®. The online investing app lets you research, track, buy and sell stocks, ETFs, and other assets right from your phone. All you need is a few dollars to get started.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What are some examples of carbon offsets?

Examples of carbon offsets include projects that are building renewable energy systems, waste and landfill management, methane capture, and carbon-storing agricultural practices. Companies that want to offset their own emissions can buy these carbon offsets, effectively helping to negate their own pollution.

How do I invest in carbon credits?

Individuals can add carbon credits to their portfolio through certain exchange-traded funds (ETFs). These ETFs hold carbon credits along with other assets, and if the price of emitting carbon goes up the value of the credits can rise.

How much does it cost to offset 1 ton of CO2

The price of carbon offsets varies widely, generally between $1 and $50, sometimes higher.


Photo credit: iStock/BlackSalmon

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