When a company wants to offset their carbon footprint, they buy credits from carbon projects that reduce or remove greenhouse gases. The market system provides a price signal that tells everyone involved what the project is worth. But the process of putting a price on carbon is complex and the market can be volatile.

The voluntary carbon credit market operates largely unchecked by regulators and instead relies on a set of standards. Often these are established by NGOs that are respected in the industry. Carbon credits are based on specific projects and each credit represents one metric ton of reduced, avoided or removed GHG emissions. They are valid for use in a compliance scheme, such as the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), that has been agreed by international airlines. Once a credit has been used for this purpose, it is moved to a register for retired credits and is no longer tradable.

Carbon projects come in a range of shapes and sizes. For example, reforestation, land use change, natural resource conservation and energy efficiency all have the potential to be carbon projects. These projects must follow a rigorous due diligence process to ensure that they meet the requirements of their respective standards. These are then verified by a third-party auditor before the credits can be created and sold on the market.

There are a variety of buyers in the carbon market, but the most important are the companies that need to offset their emissions. They can be companies operating their own facilities or they can be entities such as airlines or electricity generators that are required to buy a certain percentage of credits under the CORSIA regime. These buyers are called ‘end buyers’ and they form a key market segment in the voluntary carbon market.

Another important market segment is the project developers that originate and manage carbon projects. These are organisations that have the skills and systems to assess carbon projects, source the best and create and manage portfolios of credits for end buyers.

While it is possible to trade carbon credits on a global basis, many markets operate at the state or city level. The most important of these is California’s state-wide cap-and-trade program, which aims to cut GHG emissions 40 percent below 1990 levels by 2030.

Carbon trading can be complicated, but there are clear benefits. A robust carbon market offers a way for businesses to make measurable, verifiable reductions in their GHG emissions and demonstrate they are doing so. At the same time, it provides a market mechanism that could help to drive innovation in low-carbon technologies.

The success of carbon markets will ultimately be down to the effectiveness of their monitoring and verification systems. Without the ability to monitor emissions, it is easy for businesses to evade their obligations, or even worse, to sell their credits to those who cannot comply with their emission caps. This is why it’s so important for governments and regulators to work together to ensure a strong, effective carbon market.