What is decarbonization?

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Decarbonization is a critical response to climate change. It comprises two elements: first, reducing the amount of CO₂ and other greenhouse gases that are released into the atmosphere, and second, actively removing CO₂ from the atmosphere, whether at the point of emissions (point source capture) or from the air (direct air capture, or DAC).

But how does decarbonization work more broadly, and what can companies do to contribute meaningfully to carbon reduction and removal? In this Explainer, we’ll delve into the financial and technical approaches used to limit and remove the carbon in our atmosphere.

What are carbon markets?

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Badrinath Ramanathan is a senior partner and managing partner of McKinsey’s Singapore office, where Oliver Tonby is a senior partner; Cindy Levy is a senior partner in the London office; Clint Wood and Luciano Di Fiori are partners in the Houston office, where Brandon Stackhouse is a senior asset leader; Mark Patel is a senior partner in the Bay Area office; and Peter Mannion is a partner in the Dublin office.

A carbon market is a funding mechanism to support decarbonization, whereby organizations trade emissions allowances to achieve their reduction targets. The vast majority of funding provided by carbon markets is allocated to processes that remove carbon from the atmosphere through either natural climate solutions (NCS) or technical means, such as DAC.

Carbon markets are one of the most important tools for tackling climate change. By offsetting their emissions via carbon markets, companies can play a key role in removing carbon from the atmosphere and achieving the global goal of net-zero emissions set out in the 2015 Paris Agreement on climate change.

A growing number of companies with long-term carbon reduction strategies are turning to carbon markets to hold themselves accountable for their more immediate carbon footprints. As a result, the demand for carbon credits is expected to increase 15 times by 2030—and 100 times by 2050, according to the Taskforce on Scaling Voluntary Carbon Markets, a private-sector-led initiative informed by McKinsey knowledge and advisory support. Within the next decade, the overall market for carbon credits is estimated to be more than $50 billion.

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What are carbon credits?

Carbon credits are certificates affirming that certain amounts of greenhouse gas emissions have been removed from the atmosphere. Companies can purchase these credits either to meet short-term emissions reduction targets or to fully eliminate emissions to achieve net-zero targets. In either case, the price of carbon credits ranges from about $10 to $1,000 per ton¹ of CO₂. Nature-based solutions, including reforestation, fall toward the lower end of this spectrum, at about $10 to $25 per ton of CO₂. Tech-based removal—including techniques such as DAC and bioenergy with carbon capture and storage—costs more, about $100 to $1,000 per ton of CO₂.

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What are the types of carbon markets?

There are two main types of carbon markets:

Compliance carbon markets are financial markets where mandatory national, regional, or international entities trade and regulate carbon allowances, or the amount of carbon that a company or entity is allowed to emit. These markets play an increasingly visible role in the world’s efforts to reduce emissions. As of 2021, compliance markets had a value of more than $100 billion and an annual trading turnover of more than $250 billion.
Voluntary carbon markets are markets through which carbon credits are bought, sold, and traded to compensate for greenhouse gas emissions. When a company makes a net-zero commitment, it frequently purchases carbon credits to offset its greenhouse gas emissions. According to McKinsey senior partner Badrinath Ramanathan, voluntary carbon markets are “still nascent,” with a total value of about $300 million as of 2022. Voluntary carbon markets need to be significantly scaled to contribute meaningfully to climate action.

The largest carbon market is in the European Union, and it has evolved significantly since it was created more than 20 years ago. Ramanathan says there are other sizable carbon markets in the United States (one in California and another on the East Coast), as well as a few in New Zealand and a relatively new one in China.

How can stakeholders unlock the full potential of carbon markets?

We’ve seen that carbon markets, and the NCS they fund, have significant potential to address climate change and nature loss. But buyers, suppliers, investors, and regulators still have some doubts about the efficacy of carbon markets. “We need people to come together and recognize the importance of getting this right, and soon,” says McKinsey senior partner Joshua Katz, “so capital can flow to NCS.”

Here are six ways that organizations can overcome these challenges and create more certainty in this space:

Define net-zero and corporate claims. NCS can help organizations in various sectors transition toward a net-zero pathway, and ultimately achieve net zero—but organizations should start by clarifying exactly the role NCS can play for them in this journey.
Highlight good practices for supply. Organizations that have had success with NCS should highlight their success stories so that others are inspired to follow the same course.
Send a demand signal. High-emitting companies should come together to prioritize NCS credits with high cobenefits.
Improve market architecture. Improvements could include creating carbon reference contracts, which would define the cobenefits of NCS.
Create regulatory clarity. Overcoming political barriers requires stakeholder collaboration, international consensus building, and coherent policy frameworks that are in line with international climate goals.
Build trust. A coalition of high-level champions could amplify best practices, highlight advances in measurement and verification to increase the credibility of carbon markets, and endorse scientific advances toward net-zero certification.

What is CCUS?

CCUS stands for carbon capture, utilization, and storage. This suite of technologies addresses CO₂ emissions at point source industrial and power facilities by capturing, concentrating, and purifying the CO₂. The CO₂ is then compressed for transport to the location where it will be stored or used, typically via pipeline networks but sometimes by ship, truck, or rail. Captured CO₂ can be permanently stored underground in saline aquifers or oil and gas reservoirs. It can also be used as a feedstock for manufacturing processes, in which CO₂ can displace another form of carbon as an input.

CCUS technologies offer solutions for many hard-to-abate sectors that rely on energy from fossil fuels, such as electric power, cement, and hydrogen production. CCUS can also help with activities that are vital to our daily lives and economic growth, says McKinsey senior partner Mark Patel: “Things like heating and lighting and the materials we use.”

Once carbon is captured, it can be permanently stored (CCS) or utilized by converting it into products (CCU). “The concept of CO₂ removal is, if we can’t entirely cut out the activities that are causing emissions, then let’s instead find other mechanisms in which we can remove carbon dioxide, or gases that are equivalent to carbon dioxide … and capture it, contain it, store it, or permanently remove it,” Patel says.

For countries to achieve their current net-zero commitments, CCUS uptake needs to expand by 120 times its current levels by 2050. This will take a great deal of effort and investment to deploy at scale, which we are starting to see in some new industries and contexts. While this may mean that CCUS is less attractive to some investors, it also means there is a lot of room for growth. McKinsey estimates that annual investment in CCUS could reach $175 billion by 2035.

What’s the state of the CCUS industry?

CCUS has emerged as an economically viable decarbonization lever across Europe and the United States. In 2023 alone, the capacity of all CCUS facilities under development has grown to over 420 million tons of CO₂ per annum, an increase of more than 40 percent since 2022.

Project pipelines are ambitious: over the next six years, CCUS capacity is expected to expand about 60 times in Europe and nine times in the United States, but only a small number of projects are fully funded to date. About 15 percent of the announced projects are in conventional segments, such as gas processing; the rest are in newer segments, including cement and hydrogen.

Here are five factors that will be critical to CCUS development moving forward:

Subsidies and regulatory interventions. In Europe and North America, tax credits, direct subsidies, and price support mechanisms are beginning to stimulate the industry. Product standards that mandate certain volumes of green commodities are equally important.
Coordination among industry players. Cooperation is important when undertaking the time- and capital-intensive tasks of building large new pipeline and storage networks for CO₂. The lessons learned from existing industry clusters will need to be quickly imparted to the next generation of projects so they can get going faster.
Willingness to pay for lower-carbon-intensity products. Businesses and consumers will likely have to pay premium prices for green products, especially zero- or near-zero-carbon products.
Valuation of CO₂ as a feedstock. The sale of CO₂ as a product offers a revenue source that could offset the cost of capture. CO₂ is already used in industrial processes, including oil recovery and food processing. But there remain further opportunities to monetize captured CO₂.
Voluntary carbon markets. Some CCUS can generate negative emissions, which can be monetized in voluntary carbon markets through negative-emissions credits.

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What are some nature-based carbon removal solutions?

NCS are nature-based actions that either reduce or sequester greenhouse gas emissions. Here are four such methods for capturing and storing CO₂:

Wetland and peatland restoration. The potential benefits include increased biodiversity, better water quality, reduced flood risk, and opportunities for ecotourism. The potential challenges include greenhouse gas emissions that could be released during the restoration process, as well as the complexity of long-term monitoring and management.
Cropland, grassland, and agroforestry. Cropland and grassland management could enhance CO₂ uptake from soils, while agroforestry could help remove CO₂ from the atmosphere. The benefits could include increased biodiversity, better soil fertility, and improved agricultural productivity. The challenges could include quantifying and monitoring carbon sequestration.
Reforestation and afforestation. The potential benefits of planting trees in deforested or never-forested land include increased biodiversity and ecosystem resilience, while the potential challenges could be increased demand for nonforested land and the release of sequestered CO₂.
Blue-carbon management. The benefits of enhancing CO₂ uptake and storage in ocean and coastal ecosystems, such as mangrove forests and seagrass meadows, could include improved marine ecosystems and coastal resilience. The challenges could include regulatory uncertainty in international waters, as well as monitoring, reporting, and verification issues.

What are some technology-based carbon removal solutions?

Here are six promising technology-based removal methods for capturing and storing CO₂:

Biochar and bio-oil are produced from biomass, a general term for organic matter used as fuel. Biochar is spread to improve soil quality, and bio-oil is injected underground. The benefits could include more fertile soil; the challenges could include increased demand for biomass feedstock and land.
Ocean alkalinity enhancement is when alkaline substances are added to the ocean to enhance its natural propensity to absorb CO₂. Related challenges may include unintended impacts on marine ecosystems, due to increased alkalinity, as well as regulatory uncertainty in international waters.
Enhanced weathering occurs when rocks and minerals are broken down to increase surface area, speeding up the natural processes that enable them to store carbon from the atmosphere. Improved agricultural productivity may be a benefit; the challenges could include a potential increase of trace metals that enter local ecosystems.
Bioenergy with CCS is a process whereby sustainably sourced biomass produces biofuels, electricity, heat, and pulp. The CO₂ emitted during these processes is captured and stored. The benefits could include new revenue streams from generating coproducts, while the challenges might include increased demand for biomass feedstock and land.
Direct ocean capture is where the acid derived from ocean electrodialysis is used to chemically extract CO₂ from surface water. The extracted CO₂ is then placed in long-term storage, a technology that could counter ocean acidification but could also require a lot of energy to use.
DAC and storage involves air passing through a solid or liquid chemical filter that binds to CO₂, removing it from the air. Concentrated CO₂ is stored in underground geological formations. This solution could be deployed across a diverse range of geographies but would require high energy and water usage.

A carbon removal industry capable of deploying both nature- and technology-based removal solutions could be worth up to $1.2 trillion by 2050. But timely action will be required to achieve this potential value.

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