Carbon Markets Explained: How Carbon Credits Work and Why They’re Criticised

Carbon markets are meant to make polluting cost money and cutting pollution pay. With carbon markets explained from first principles, this report sets out the difference between government-run compliance schemes and the voluntary trade in carbon credits, how a credit is actually created, what the Paris Agreement's Article 6 adds, what independent research has found about credit quality, and how India's own Carbon Credit Trading Scheme is being built.

What a carbon market is

A carbon market turns the right to emit, or a certified cut in emissions, into a tradable unit, usually one tonne of carbon dioxide equivalent (tCO₂e). A price on emissions is meant to push the cheapest cuts to happen first.

The World Bank's State and Trends of Carbon Pricing 2026, released in May 2026, counts 87 carbon pricing instruments (taxes and trading systems) covering just over 29% of global emissions. They raised more than USD 107 billion in 2025, up from below USD 30 billion in 2016, and the average direct carbon price was nearly USD 21 per tCO₂e. Carbon credit issuance rose 8% from 2024 to 2025, while credit prices declined slightly. The report named India and Viet Nam as the countries with the most significant developments in the past year.

Compliance markets and voluntary markets

Compliance markets: cap-and-trade

In a compliance market, the law requires covered companies to hold units for their emissions. The best-known model is cap-and-trade. The EU Emissions Trading System, launched in 2005 and described by the European Commission as the world's first carbon market, works like this: a cap limits total emissions from covered installations and falls each year; each allowance gives the right to emit one tonne of CO₂ equivalent; allowances are mostly auctioned and can be traded; and companies must surrender enough allowances to cover their annual emissions or face heavy fines.

According to the Commission, the EU ETS covers about 40% of the EU's emissions, from power, industry, aviation and (since 2024) maritime transport. The 2023 revision set the cap to cut covered emissions by 62% by 2030 against 2005 levels; by 2023, power and industry emissions were about 47% below 2005.

Voluntary markets: carbon credits

In the voluntary market, no law forces anyone to buy. Companies buy credits from projects that claim to reduce or remove emissions, such as forest protection, cookstoves or methane capture, to support claims such as "carbon neutral". Independent standards, not governments, issue the credits. The largest, Verra's Verified Carbon Standard, issues Verified Carbon Units, each representing one tonne of CO₂ reduced or removed. Another long-running standard is the Gold Standard, which certifies emission reductions, removals and wider sustainable development impacts.

The voluntary market is far smaller. A Carbon Brief Q&A from 2023 cites estimates of a record USD 2 billion in 2021, against USD 851 billion of compliance trading that year.

How a carbon credit is created

A credit is not a measured tonne of gas. It is the difference between what a project says happened and what it says would have happened without it. That makes a few concepts central. The definitions below follow Carbon Brief's explainer and the ICVCM's Core Carbon Principles.

• Baseline. The estimate of emissions in the absence of the project. Carbon Brief calls setting it "the big problem" for offset projects, because the counterfactual cannot be observed directly.
• Additionality. Whether credit revenue was the deciding factor in the project going ahead. If a wind farm would have been built anyway because it is already cheaper than coal, its credits do not represent extra cuts.
• Permanence. Whether the carbon stays out of the atmosphere. Forest carbon can be lost to fire, drought, logging or political change, while fossil CO₂ stays in the atmosphere for centuries.
• Leakage. Emissions that move elsewhere because of the project, for example when protecting one forest pushes logging into another.
• MRV. Monitoring, reporting and verification: how the project measures its results and how an independent auditor checks them.
• No double counting. The same tonne must not be claimed by two buyers or two countries.

Under Verra's standard, a draft project description goes out for 30 days of public comment, a third-party auditor validates it, the project is monitored, an auditor verifies the results, and only then are credits issued on the public Verra Registry. When a buyer uses a credit, it is "retired" so it cannot be sold again. Gold Standard runs its own public registry on the same principle.

Article 6 of the Paris Agreement

Article 6 lets countries cooperate on emission cuts, including by trading them. Its rules were largely completed at COP29 in Baku in November 2024. The Smith School at the University of Oxford gave a useful summary of the COP29 outcomes.

Article 6.2: country-to-country deals

Article 6.2 is a decentralised framework under which countries trade "internationally transferred mitigation outcomes" (ITMOs) that count towards their national climate targets (NDCs) and can support airline compliance under CORSIA. COP29 left countries wide flexibility on how deals are structured and authorised. The core accounting rule is that the seller country adjusts its own books so a transferred tonne is not counted twice.

Article 6.4: the UN crediting mechanism

Article 6.4 creates a centralised crediting mechanism, the Paris Agreement Crediting Mechanism, overseen by a UN Supervisory Body. The Oxford summary says its methodologies expect baselines to be adjusted downwards, use investment analysis as the main additionality test, and require reversals of stored carbon to be remedied, with a buffer pool for that risk.

The first credits under the mechanism were approved in early 2026 for a clean-cooking project in Myanmar that had moved over from the Kyoto-era Clean Development Mechanism. As reported in March 2026, the Supervisory Body chair said the stricter calculations produced about 40% fewer credits than the old mechanism would have. Credits authorised for South Korea can be used in the Korean Emissions Trading System, and more than 165 host-approved projects were reported to be in the transition pipeline.

Integrity initiatives

After repeated criticism, industry and civil society groups set up bodies to define what a high-quality credit is.

• ICVCM (Integrity Council for the Voluntary Carbon Market). In July 2023 it published ten Core Carbon Principles grouped under governance, emissions impact (including additionality, permanence and no double counting) and sustainable development. A credit can carry the CCP label only if both its programme is approved as "CCP-Eligible" and its methodology is "CCP-Approved". The first approvals in June 2024 covered seven methodologies for landfill gas and ozone-depleting substance destruction. By April 2026, nine programmes were CCP-Eligible, 38 of 59 assessed methodologies had been approved, and about 108 million credits could be CCP-labelled, citing MSCI data from March 2026.
• VCMI (Voluntary Carbon Markets Integrity Initiative). Where the ICVCM deals with the supply side, VCMI focuses on the demand side: what claims companies can credibly make when they use credits alongside their own emission cuts. Carbon Brief lists it among the main efforts to clean up the market.

The criticisms

The section below reports what researchers and journalists have found, attributed to each source. Standards bodies have disputed some findings, as noted.

Peer-reviewed evidence of over-crediting

Forest conservation (REDD+). A team led by Thales West studied voluntary avoided-deforestation projects in six countries on three continents, comparing each project's claimed baseline with deforestation in matched control areas. The preprint, later published in the journal Science in 2023, concluded that "most projects have not reduced deforestation", that those which did reduced it far less than claimed, and that baseline methods need urgent revision.

Several project types. A 2024 meta-analysis in Nature Communications by Benedict Probst and colleagues combined 14 studies covering 2,346 projects, roughly one-fifth of all credits issued to date (almost one billion tonnes). As summarised by the Max Planck Society, it found that less than 16% of credits issued to the evaluated projects represented real emission reductions.

The authors also found that for HFC-23 and SF₆ destruction, factories generated more waste gas when they could earn credits for destroying it, an example of a perverse incentive.

A credit is not a measured tonne of gas. It is the gap between what happened and an estimate of what would have happened otherwise.

Journalistic investigations

In January 2023, a nine-month investigation by the Guardian, Die Zeit and the non-profit newsroom SourceMaterial, summarised by Carbon Brief, reported that more than 90% of Verra's rainforest offset credits were likely "phantom credits" that did not represent genuine reductions. Verra strongly disputed the conclusions.

Criticisms of Article 6

The Oxford Smith School summary warned that the flexibility in Article 6.2 could reduce transparency and that Article 6 does not distinguish reductions from removals, which it said risks "NDC washing".

India's Carbon Credit Trading Scheme

Legal basis

India amended the Energy Conservation Act, 2001 in 2022 to create a carbon market. According to a government reply in the Lok Sabha in December 2024, the Energy Conservation (Amendment) Act, 2022 empowers the Central Government, in consultation with the Bureau of Energy Efficiency (BEE), to specify a carbon credit trading scheme. The Carbon Credit Trading Scheme (CCTS) was notified by S.O. 2825(E) on 28 June 2023 and amended by S.O. 5369(E) on 19 December 2023. Each Carbon Credit Certificate represents one tonne of CO₂ equivalent, according to BEE's Indian Carbon Market page.

Two mechanisms

As the Ministry of Power told the Lok Sabha in December 2025, the CCTS works through:

• A compliance mechanism. Emission-intensive industries designated as obligated entities must meet greenhouse gas emission intensity (GEI) targets. Those that beat their targets earn Carbon Credit Certificates; those that fall short must buy them.
• An offset mechanism. Non-obligated entities may voluntarily register projects that reduce, remove or avoid emissions to receive certificates. BEE lists energy, industries, agriculture, waste handling and disposal, forestry and transport as Phase I sectors.

India's market sets targets per unit of output (for example tonnes of CO₂e per tonne of cement), not an absolute cap. Total emissions can therefore rise if output grows, as long as intensity falls.

Obligated sectors and targets

GEI targets were first notified in October 2025 for aluminium, cement, chlor-alkali, and pulp and paper (282 obligated entities). A notification on 13 January 2026 added petroleum refineries, petrochemicals, textiles and secondary aluminium, taking the total to 490. These sectors moved over from the earlier Perform, Achieve and Trade (PAT) energy efficiency scheme; thermal power plants have not. BEE also lists iron and steel and fertiliser for inclusion, and a draft iron and steel amendment was open for comment as of October 2026.

The International Carbon Action Partnership (ICAP) summarises the notified targets in its profile of the Indian scheme. Targets apply to financial years 2025-26 and 2026-27, against a 2023-24 baseline, and are reset every three years. ICAP's average reduction rates to 2026-27 are below.

ICAP also reports that a shortfall attracts an environmental compensation charge of twice the average certificate trading price in that compliance year, that unlimited banking is allowed but borrowing is not, and that offset credits cannot currently be used for compliance.

Who runs it

Status as of October 2026

CERC notified its Terms and Conditions for Purchase and Sale of Carbon Credit Certificates Regulations, 2026 on 27 February 2026, as reported by SolarQuarter. Trading is to take place on power exchanges, expected monthly, with a floor price and a forbearance (ceiling) price approved by CERC for compliance certificates. A Bar & Bench column of 18 October 2026 said certificates were expected to be issued in October and trading to begin in November 2026. No official confirmation of a first trade was found for this report.

The scheme is linked to India's climate pledges. The government said in May 2023 that the market would help meet the NDC goal of cutting the emissions intensity of GDP by 45% by 2030 against 2005 levels. ICAP notes India's updated NDC raises this to 47% by 2035. ICAP also states that the Indian scheme is not linked with any other system.

Carbon pricing is one part of a wider industrial shift that also depends on supply chains for clean technology; our report on critical minerals such as lithium, cobalt and rare earths covers that side.

What remains uncertain

This section is analysis, not settled fact.

• India's price level. No market price had been discovered as of October 2026, and where certificates trade between the floor and ceiling will set the strength of the incentive.
• Target stringency. Whether intensity cuts of a few per cent go beyond normal efficiency gains will only be clear after several years of verified data.
• The offset mechanism. Several BEE offset documents, including a non-permanence risk tool, were still drafts as of October 2026.
• Article 6 and voluntary demand. It is unclear how strictly the 165-plus transition projects will be reviewed, and whether buyers will pay enough for higher-integrity credits to change which projects get built.

The bottom line

Compliance schemes such as the EU ETS rest on a legal limit. Voluntary credits rest on estimates of what would otherwise have happened, and peer-reviewed studies have found those estimates often too generous. Integrity labels and Article 6.4 are attempts to tighten the accounting. India has chosen an intensity-based compliance market for 490 industrial entities, and its credibility will depend on how tight the targets are, how strictly emissions are verified, and what price the market settles at.

Frequently asked questions

Is a carbon credit the same as an emissions allowance?

No. An allowance is a permit to emit one tonne under a capped compliance scheme. A credit certifies that a project reduced or removed one tonne compared with a baseline.

Can individuals in India trade Carbon Credit Certificates?

The CCTS is designed for obligated industrial entities and registered non-obligated entities, with trading on CERC-regulated power exchanges. Check CERC's regulations and BEE's portal for who can register.

Does buying credits make a company carbon neutral?

That depends on the quality of the credits and on what the company has cut itself. Research such as Probst et al. (2024) found many credits overstate their impact, which is why bodies like the ICVCM and VCMI set quality and claims standards.

Sources

1. Direct carbon pricing covers nearly one-third of global emissions (State and Trends of Carbon Pricing 2026), World Bank, 2026.
2. About the EU ETS, European Commission, accessed 2026.
3. Verified Carbon Standard, Verra, accessed 2026.
4. Gold Standard, Gold Standard, accessed 2026.
5. In-depth Q&A: Can 'carbon offsets' help to tackle climate change?, Carbon Brief, 2023.
6. Core Carbon Principles, Integrity Council for the Voluntary Carbon Market, accessed 2026.
7. Integrity Council announces first high-integrity CCP-labelled carbon credits, ICVCM, 2024.
8. Continually improving the independent carbon markets together, ICVCM, 2026.
9. Article 6 in focus: Outcomes from COP29, Smith School of Enterprise and the Environment, University of Oxford, 2024.
10. UN carbon market issues first-ever Paris Agreement credits for Myanmar clean cooking project, Changemakr Asia, 2026.
11. Action needed to make carbon offsets from tropical forest conservation work for climate change mitigation (West et al., preprint), arXiv, 2023.
12. Climate impact of carbon crediting projects is substantially overestimated (on Probst et al., Nature Communications 15, 9562), Max Planck Society, 2024.
13. Revealed: more than 90% of rainforest carbon offsets by biggest provider are worthless, analysis shows (daily brief), Carbon Brief, 2023.
14. Indian Carbon Market (Lok Sabha reply), Press Information Bureau, 2024.
15. Framework for Carbon Credit Trading Scheme (CCTS), Press Information Bureau, 2025.
16. Government notifies Greenhouse Gas Emission Intensity Targets for 208 more carbon-intensive industries, Press Information Bureau, 2026.
17. Ministry of Power and MoEFCC to develop Carbon Credit Trading Scheme for decarbonisation, Press Information Bureau, 2023.
18. Indian Carbon Market, Bureau of Energy Efficiency, accessed 2026.
19. Indian Carbon Credit Trading Scheme, International Carbon Action Partnership, accessed 2026.
20. CERC notifies 2026 regulations to formalise India's carbon credit trading market, SolarQuarter, 2026.
21. Green becomes the new gold: India's carbon market opens for business, Bar & Bench, 2026.