A Guide to Understanding Carbon Credits

What Are Carbon Credits?

A carbon credit represents the reduction or removal of one tonne of carbon dioxide or equivalent from the atmosphere.

These credits are generated by projects that either prevent the emissions from happening at the source or capture carbon that has already been released.

Through their commercialisation in the project-carbon market, carbon credits serve as a financial mechanism that channels investment into initiatives that deliver measurable environmental benefits and broader positive externalities.

The idea was first introduced in the late 1990s during the development of the Kyoto Protocol, a landmark international climate agreement. Later, in 2015 the Paris Agreement reinforced the role of market mechanisms in supporting climate action globally.

Alongside these government led initiatives the  Voluntary Carbon Market (VCM) began to develop. The VCM enables companies and individuals to take responsibility for their emissions by supporting high-impact climate projects through the purchase of carbon credits.

This can be done through the purchase of already existing credits in the spot market or through longer-term offtake agreements where companies commit to buying future carbon credits directly from projects.

The project-carbon market, therefore, encompasses not only the aforementioned VCM but also other government-led compliance schemes, like  Article 6 of the Paris Agreement or national carbon tax schemes that incorporate carbon credits into their regulatory frameworks.

Two Types of Carbon Credits: Reduction and Removal

Broadly, carbon credits fall into two categories.

Reduction credits

These credits are generated from projects that prevent new emissions from being released into the atmosphere. Examples include protecting rainforests from deforestation or supporting improved cookstove initiatives that use more efficient stoves and/or cleaner fuels than existing cooking practices.

Removal credits

These credits are generated from projects that actively extract carbon out of the atmosphere. Examples include reforestation or tech-based solutions such as direct air capture technologies.

A useful way to think about this distinction is through the “bathtub analogy”. Imagine our atmosphere as a bathtub filling with water (emissions).

Avoidance credits slow the flow of water from the tap, while removal credits are like using a cup to remove water from the bathtub. Both are critical and complimentary.

If we only slow the tap without using the cup, the tub may still eventually overflow; if we use the cup without slowing down the tap, we may never keep up and the tub will again overflow.

Both credit types play a critical role in a company’s carbon portfolio. Reduction credits drive immediate action by preventing emissions that would occur today, while removal credits channel investment into scaling the extraction of carbon from the atmosphere, an essential step for the long-term mitigation of the climate crisis.

It is important to emphasise that organisations should prioritise reducing their internal emissions first, and only then develop a diversified carbon portfolio to compensate for the hard-to-abate residual emissions.  

We shall return to this point in more detail later...

How Are Carbon Credits Issued? Understanding the process and jargon

The project-carbon market can quickly become a complex and jargon-filled space given the highly technical certification process that projects must go through to issue carbon credits.

Here is a simple summary of how this process works, and the different actors involved in this process.

Project developers

These are the organisations that design and implement carbon projects. They must prepare all the documentation which quantifies how their project will be reducing or removing emissions following specific science-based guidelines or ‘methodologies’ for the specific type of project they are developing. For example, for a reforestation project, the PDD (Project Design Document) must very carefully outline the number of emissions that the trees in question will capture, following rigorous scientific guidelines to do so.

Standards bodies

These are independent organisations (such as Verra, Gold Standard, or Puro.earth) that set out the methodologies which outline how projects must measure, monitor, and report their climate impact. These bodies review the project documentation and if they meet the requirements, carbon credits can be issued. Standards play a pivotal role because, as the name entails, they standardise the process that every project must follow. This commodifies credits and, in principle, ensures buyers are paying for one tonne of emissions removed or reduced regardless of where the project was developed and who it was developed by.

Verification & Validation Bodies (VBBs)

These are third-party auditors, who check that projects are delivering the emissions reductions or removals they claim before they are issued. They are essential as they provide independent confirmation that project developers are in fact mitigating what they say they are.

Investors & Offtakers

Investors provide the upfront capital that enables carbon projects to get off the ground, assuming early-stage project risk. This facilitates buyers in securing risk-managed offtake arrangements, allowing them to access high-quality projects with greater certainty around impact and price stability. At CFP we can provide this early-stage investment from our own balance sheet to bring a project from idea to issuance and deliver credits that meet our client’s preferences.

Additionality and how you're making a difference

A fundamental concept in carbon markets is the concept of additionality. This requires project developers to demonstrate that emissions reductions or removals would not have occurred without the financial inflows provided by carbon credits.

This way, buyers can be confident that every tonne of CO2 reduced or removed by a carbon project could only have been possible through their purchase of a carbon credit. In other words, the demand for carbon credits creates the financial incentive for carbon mitigation projects to come to life in the first place.

This principle is critical for driving meaningful climate action, as such projects often carry a green premium compared to unsustainable business-as-usual activities.

Carbon credits help bridge this cost gap.

For example, a cattle rancher in the Amazon has little economic reason to preserve the rainforest on his land and may instead clear trees to expand grazing areas and improve his livelihood.

However, in the case of a reforestation project, revenues from carbon credit sales can provide the necessary economic incentive for ranchers to shift towards activities with positive externalities such as replanting native trees and prioritising the regeneration and conservation of the rainforest. 

The Different Uses of Project-Based Carbon Credits

Corporate commitments and the Mitigation Hierarchy

The mitigation hierarchy provides a structured approach to corporate climate action. Companies should prioritise reducing emissions within their own operations and value chains (Scopes 1, 2, and 3).

Once these efforts are underway, carbon credits become an essential tool for addressing the residual emissions that have not yet been addressed.

By combining internal decarbonisation with high-quality credits, businesses can act on their entire footprint today while continuing to decarbonise their operations as they approach net zero emissions

This blended approach delivers immediate climate impact while sustaining progress toward long-term reductions.

Thoughtfully integrated, carbon credits complement internal measures and accelerate net-zero pathways by unlocking climate benefits now.

Microsoft illustrates this in practice: it aims to be carbon negative by 2030 by cutting Scope 1 and 2 emissions to near zero, halving Scope 3 from a 2020 baseline, and offsetting the rest with removals.

Since 2020, it has contracted nearly 69 million tonnes across 45 projects ranging from nature-based solutions to durable technologies such as BECCS, biochar, and enhanced rock weathering, with plans to procure around 5 million tonnes annually by 2030.

Carbon taxes

In some jurisdictions with carbon taxes, companies may be allowed to use certified carbon credits instead of paying the tax directly. For example, Colombia’s carbon tax permits the use of approved credits for compliance. Other countries that allow carbon credits for carbon tax compliance include Singapore, Chile, Mexico and South Africa.

National Emissions Trading Schemes (ETS)

National and regional emissions trading schemes such as those in Japan, South Korea and California allow the use of project-based carbon credits to meet compliance requirements.

CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation)

CORSIA is a global program requiring airlines to offset emissions from international flights above 2019 levels by purchasing approved carbon credits. It ensures the aviation sector addresses its climate impact alongside other reduction measures.

Read our guide on CORSIA, here.

Article 6 of the Paris Agreement

Article 6 establishes a framework for international cooperation on carbon markets, allowing countries and companies operating within them to use carbon credits called Internationally Transferred Mitigation Outcomes (ITMOs) to meet climate targets.

To learn more about Article 6 read more, here.

What We Do at CFP Energy

At CFP Energy, we provide organisations with comprehensive solutions across the full project-carbon value chain, be that for voluntary commitments or as part of a compliance scheme. Our services are designed to combine flexibility in the short term with long-term strategic impact.

Immediate access to quality credits

We offer both removal and reduction credits from a wide range of geographies and project types ensuring projects meet your sustainability criteria and deliver co-benefits such as biodiversity conservation and community engagement.

Tailored long-term offtake solutions

For organisations seeking longer term commitments with specific carbon projects, we provide bespoke offtake agreements with projects that are aligned with your objectives, whether that’s safeguarding endangered rainforests in the Amazon or assisting natural regeneration of native tree species in Argentina.

Project development from scratch

We partner with you to develop carbon projects from concept to issuance, carrying the early-stage risk on our balance sheet so you gain full transparency, site access, and confidence without financial early project risk.

Carbon taxes and ETS compliance

We support companies in navigating and fulfilling their obligations under carbon tax and Emissions Trading Scheme (ETS) jurisdictions, providing high-quality eligible credits that not only ensure compliance but also deliver meaningful cost efficiencies.

CORSIA support for airlines

For our aviation clients, we provide a range of tailored solutions to comply with Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) regulations, ensuring alignment with industry obligations and sustainability commitments.

By working with CFP Energy, you can embed carbon credits into your sustainability strategy with confidence, knowing that every credit represents measurable impact and aligns with your long-term climate commitments.

Final thoughts...

Carbon credits are an indispensable part of the equation in the fight against climate change. They allow companies to take responsibility for their carbon footprint and channel finance into bringing carbon projects to life.

Investments done today will accelerate climate action while companies continue to decarbonise their operations as they approach net zero emissions.