The World Resources Institute defines a carbon offset as “a unit of carbon dioxide-equivalent (CO2e) that is reduced, avoided, or sequestered to compensate for emissions occurring elsewhere”. There are two markets for carbon offsets, compliance schemes and voluntary schemes.
Compliance offsets are created and regulated by mandatory national, regional or international carbon reductions schemes such as the Clean Development Mechanism (CDM) regulated by the Kyoto Protocol and others operating independently from it such as the Regional Greenhouse Gas Initiative (RGGI) or the Western Climate Initiative (WCI). In the compliance market, companies, governments or other entities buy carbon offsets in order to comply with caps on the total amount of carbon dioxide they are allowed to emit.
The CDM is one of the three flexible mechanisms of the Kyoto Protocol (CDM, JI, Emissions Trading) with the aim of lowering the overall costs of achieving emissions targets. The CDM is the main offset program issuing products for the compliance market. This allows developed countries or Annex I parties to meet their binding emissions reduction targets by using an emission reduction project from a developing country or non-Annex I parties as defined by the Kyoto protocol. For each ton of CO2 emission reduced, the project will receive a tradable Certified Emissions Reduction (CER).
The voluntary market functions outside of the compliance market. This market offers individuals, companies or governments the ability to purchase carbon offsets to mitigate their own greenhouse gas emission from sources outside of the compliance markets. There are no unified rules and regulations for the voluntary carbon market, therefore, there has been an increasing importance placed on voluntary offset standards such as Gold Standard, Verified Carbon Standard (VCS) and ISO 14064. The aim is to provide some distinction on the environmental and social benefit of the project.
Carbon offset trading is facilitated by brokers, intermediaries and some exchange trading. For non-compliance offsets the bespoke nature of the projects, lack of defined market and the relatively low value of the product means over-the-counter trading is more popular.