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A carbon credit is a generic term for any tradable certificate or permit representing the right to emit a set amount of carbon dioxide or the equivalent amount of a different
greenhouse gas A greenhouse gas (GHG or GhG) is a gas that absorbs and emits radiant energy within the thermal infrared range, causing the greenhouse effect. The primary greenhouse gases in Earth's atmosphere are water vapor (), carbon dioxide (), methane ...
(tCO2e). Carbon credits and carbon markets are a component of national and international attempts to mitigate the growth in concentrations of
greenhouse gas A greenhouse gas (GHG or GhG) is a gas that absorbs and emits radiant energy within the thermal infrared range, causing the greenhouse effect. The primary greenhouse gases in Earth's atmosphere are water vapor (), carbon dioxide (), methane ...
es (GHGs). One carbon credit is equal to one tonne of carbon dioxide, or in some markets, carbon dioxide equivalent gases. Carbon trading is an application of an
emissions trading Emissions trading is a market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants. The concept is also known as cap and trade (CAT) or emissions trading scheme (ETS). Carbon emissi ...
approach. Greenhouse gas emissions are capped and then markets are used to allocate the emissions among the group of regulated sources. The goal is to allow market mechanisms to drive industrial and commercial processes in the direction of low emissions or less carbon intensive approaches than those used when there is no cost to emitting
carbon dioxide Carbon dioxide ( chemical formula ) is a chemical compound made up of molecules that each have one carbon atom covalently double bonded to two oxygen atoms. It is found in the gas state at room temperature. In the air, carbon dioxide is t ...
and other GHGs into the atmosphere. Since GHG mitigation projects generate credits, this approach can be used to finance carbon reduction schemes between trading partners around the world. There are also many companies that sell carbon credits to commercial and individual customers who are interested in lowering their
carbon footprint A carbon footprint is the total greenhouse gas (GHG) emissions caused by an individual, event, organization, service, place or product, expressed as carbon dioxide equivalent (CO2e). Greenhouse gases, including the carbon-containing gases carbo ...
on a voluntary basis. These
carbon offset A carbon offset is a reduction or removal of emissions of carbon dioxide or other greenhouse gases made in order to compensate for emissions made elsewhere. Offsets are measured in tonnes of carbon dioxide-equivalent (CO2e). One ton of carb ...
ters purchase the credits from an investment fund or a carbon development company that has aggregated the credits from individual projects. Buyers and sellers can also use an exchange platform to trade, which is like a stock exchange for carbon credits. The quality of the credits is based in part on the validation process and sophistication of the fund or development company that acted as the sponsor to the
carbon project Business action on climate change includes a range of activities relating to climate change, and to influencing political decisions on climate change-related regulation, such as the Kyoto Protocol. Major multinationals have played and to some e ...
. This is reflected in their price; voluntary units typically have less value than the units sold through the rigorously validated
Clean Development Mechanism The Clean Development Mechanism (CDM) is a United Nations-run carbon offset scheme allowing countries to fund greenhouse gas emissions-reducing projects in other countries and claim the saved emissions as part of their own efforts to meet internat ...
. The European Union's carbon credits traded from $7.78 to $25.19 averaging $16.21 per tonne in 2018. Although it remains in development, it is anticipated that the value and trading of carbon credits will continue to grow particularly as several governments have committed to " green recoveries" following the
COVID-19 pandemic The COVID-19 pandemic, also known as the coronavirus pandemic, is an ongoing global pandemic of coronavirus disease 2019 (COVID-19) caused by severe acute respiratory syndrome coronavirus 2 (SARS-CoV-2). The novel virus was first identi ...
recession In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...
.


Definitions

The Collins English Dictionary defines a carbon credit as “''a certificate showing that a government or company has paid to have a certain amount of carbon dioxide removed from the environment''”. The Environment Protection Authority of Victoria defines a carbon credit as a “''generic term to assign a value to a reduction or offset of greenhouse gas emissions.. usually equivalent to one tonne of carbon dioxide equivalent (-e).''” The
Investopedia Investopedia is a financial media website headquartered in New York City. Founded in 1999, Investopedia provides investment dictionaries, advice, reviews, ratings, and comparisons of financial products such as securities accounts. Investopedia h ...
Inc investment dictionary defines a carbon credit as a “''permit that allows the holder to emit one ton of carbon dioxide''”..which “''can be traded in the international market at their current market price''”.


Types

There are two types of credits. Voluntary emissions reduction (VER) is a carbon offset that is exchanged in the over-the-counter or voluntary market for credits. Certified emissions reduction (CER) relies on emission units (or credits) created through a regulatory framework with the purpose of offsetting a project's emissions.


Background

The burning of fossil fuels is a major source of
greenhouse gas emissions Greenhouse gas emissions from human activities strengthen the greenhouse effect, contributing to climate change. Most is carbon dioxide from burning fossil fuels: coal, oil, and natural gas. The largest emitters include coal in China and ...
, especially for power, cement, steel, textile, fertilizer and many other industries which rely on fossil fuels (coal, electricity derived from coal, natural gas and oil). The major greenhouse gases emitted by these industries are
carbon dioxide Carbon dioxide ( chemical formula ) is a chemical compound made up of molecules that each have one carbon atom covalently double bonded to two oxygen atoms. It is found in the gas state at room temperature. In the air, carbon dioxide is t ...
,
methane Methane ( , ) is a chemical compound with the chemical formula (one carbon atom bonded to four hydrogen atoms). It is a group-14 hydride, the simplest alkane, and the main constituent of natural gas. The relative abundance of methane ...
,
nitrous oxide Nitrous oxide (dinitrogen oxide or dinitrogen monoxide), commonly known as laughing gas, nitrous, or nos, is a chemical compound, an oxide of nitrogen with the formula . At room temperature, it is a colourless non-flammable gas, and ha ...
, hydrofluorocarbons (HFCs), etc., all of which increase the atmosphere's ability to trap infrared energy and thus affect the
climate Climate is the long-term weather pattern in an area, typically averaged over 30 years. More rigorously, it is the mean and variability of meteorological variables over a time spanning from months to millions of years. Some of the meteorologi ...
. The concept of carbon credits came into existence as a result of increasing awareness of the need for controlling emissions. The IPCC (
Intergovernmental Panel on Climate Change The Intergovernmental Panel on Climate Change (IPCC) is an intergovernmental body of the United Nations. Its job is to advance scientific knowledge about climate change caused by human activities. The World Meteorological Organization (WMO) ...
) has observed that:
''Policies that provide a real or implicit price of carbon could create incentives for producers and consumers to significantly invest in low-GHG products, technologies and processes. Such policies could include economic instruments, government funding and regulation'',
while noting that a tradable permit system is one of the policy instruments that has been shown to be environmentally effective in the industrial sector, as long as there are reasonable levels of predictability over the initial allocation mechanism and long-term price. The mechanism was formalized in the
Kyoto Protocol The Kyoto Protocol was an international treaty which extended the 1992 United Nations Framework Convention on Climate Change (UNFCCC) that commits state parties to reduce greenhouse gas emissions, based on the scientific consensus that (part ...
, an international agreement between more than 170 countries, and the market mechanisms were agreed through the subsequent Marrakesh Accords. The mechanism adopted was similar to the successful US
Acid Rain Program The Acid Rain Program is a market-based initiative taken by the United States Environmental Protection Agency in an effort to reduce overall atmospheric levels of sulfur dioxide and nitrogen oxides, which cause acid rain. The program is an imple ...
to reduce some industrial pollutants.


Emission allowances

Under the
Kyoto Protocol The Kyoto Protocol was an international treaty which extended the 1992 United Nations Framework Convention on Climate Change (UNFCCC) that commits state parties to reduce greenhouse gas emissions, based on the scientific consensus that (part ...
, the 'caps' or
quotas Quota may refer to: Economics * Import quota, a trade restriction on the quantity of goods imported into a country * Market Sharing Quota, an economic system used in Canadian agriculture * Milk quota, a quota on milk production in Europe * Indi ...
for
Greenhouse gases A greenhouse gas (GHG or GhG) is a gas that absorbs and emits radiant energy within the thermal infrared range, causing the greenhouse effect. The primary greenhouse gases in Earth's atmosphere are water vapor (), carbon dioxide (), methane ...
for the developed Annex 1 countries are known as Assigned Amounts and are listed in Annex B. The quantity of the initial assigned amount is denominated in individual units, called
Assigned amount units An assigned amount unit is a tradable "Kyoto unit" or "carbon credit" representing an allowance to emit greenhouse gases comprising "one metric tonne of carbon dioxide equivalent, calculated using global warming potentials". Assigned amount units a ...
(AAUs), each of which represents an allowance to emit one
tonne The tonne ( or ; symbol: t) is a unit of mass equal to 1000  kilograms. It is a non-SI unit accepted for use with SI. It is also referred to as a metric ton to distinguish it from the non-metric units of the short ton ( United State ...
of carbon dioxide equivalent, and these are entered into the country's national registry. In turn, these countries set quotas on the emissions of installations run by local business and other organizations, generically termed 'operators'. Countries manage this through their national registries, which are required to be validated and monitored for compliance by the
UNFCCC The United Nations Framework Convention on Climate Change (UNFCCC) established an international environmental treaty to combat "dangerous human interference with the climate system", in part by stabilizing greenhouse gas concentrations in th ...
. Each operator has an allowance of credits, where each unit gives the owner the right to emit one tonne of
carbon dioxide Carbon dioxide ( chemical formula ) is a chemical compound made up of molecules that each have one carbon atom covalently double bonded to two oxygen atoms. It is found in the gas state at room temperature. In the air, carbon dioxide is t ...
or other equivalent
greenhouse gas A greenhouse gas (GHG or GhG) is a gas that absorbs and emits radiant energy within the thermal infrared range, causing the greenhouse effect. The primary greenhouse gases in Earth's atmosphere are water vapor (), carbon dioxide (), methane ...
. Operators that have not used up their quotas can sell their unused allowances as carbon credits, while businesses that are about to exceed their quotas can buy the extra allowances as credits, privately or on the open market. As demand for energy grows over time, the total emissions must still stay within the cap, but it allows industry some flexibility and predictability in its planning to accommodate this. Since 2005, the Kyoto mechanism has been adopted for CO2 trading by all the countries within the
European Union The European Union (EU) is a supranational union, supranational political union, political and economic union of Member state of the European Union, member states that are located primarily in Europe, Europe. The union has a total area of ...
under its European Trading Scheme (EU ETS) with the
European Commission The European Commission (EC) is the executive of the European Union (EU). It operates as a cabinet government, with 27 members of the Commission (informally known as "Commissioners") headed by a President. It includes an administrative body ...
as its validating authority. From 2008, EU participants must link with the other developed countries who
ratified Ratification is a principal's approval of an act of its agent that lacked the authority to bind the principal legally. Ratification defines the international act in which a state indicates its consent to be bound to a treaty if the parties inten ...
Annex I As of June 2013, there are 192 parties to the Kyoto Protocol to the United Nations Framework Convention on Climate Change, which aims to combat global warming. This total includes 191 states (189 United Nations member states as well as the Coo ...
of the protocol, and trade the six most significant
anthropogenic Anthropogenic ("human" + "generating") is an adjective that may refer to: * Anthropogeny, the study of the origins of humanity Counterintuitively, anthropogenic may also refer to things that have been generated by humans, as follows: * Human i ...
greenhouse gases. In the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
, which has not ratified Kyoto, and
Australia Australia, officially the Commonwealth of Australia, is a sovereign country comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands. With an area of , Australia is the largest country by ...
, whose ratification came into force in March 2008, similar schemes are being considered. By permitting allowances to be bought and sold, an operator can seek out the most cost-effective way of reducing its emissions, either by investing in 'cleaner' machinery and practices or by purchasing emissions from another operator who already has excess 'capacity'. Through ETSs, the price of carbon is driven by emissions limits and the number of carbon allowances in circulation. These markets create a price for the impact of carbon emissions. ETS markets are regulated by governmental organizations and trading in these markets is tracked by the IHS Markit's Global Carbon Index, which provides a benchmark that track carbon credits future contracts globally. Investors participate in these markets by buying shares in highly specialized funds that buy an assortment of contracts to track index like The KraneShares Global Carbon ETF (KRBN).


Kyoto's 'Flexible mechanisms'

A tradable credit can be an emissions allowance or an assigned amount unit which was originally allocated or auctioned by the national administrators of a Kyoto-compliant cap-and-trade scheme, or it can be an
offset Offset or Off-Set may refer to: Arts, entertainment, and media * "Off-Set", a song by T.I. and Young Thug from the '' Furious 7: Original Motion Picture Soundtrack'' * ''Offset'' (EP), a 2018 EP by singer Kim Chung-ha * ''Offset'' (film), a 200 ...
of emissions. Such offsetting and mitigating activities can occur in any developing country which has ratified the Kyoto Protocol, and has a national agreement in place to validate its
carbon project Business action on climate change includes a range of activities relating to climate change, and to influencing political decisions on climate change-related regulation, such as the Kyoto Protocol. Major multinationals have played and to some e ...
through one of the
UNFCCC The United Nations Framework Convention on Climate Change (UNFCCC) established an international environmental treaty to combat "dangerous human interference with the climate system", in part by stabilizing greenhouse gas concentrations in th ...
's approved mechanisms. Once approved, these units are termed
Certified Emission Reduction Certified Emission Reductions (CERs) are a type of emissions unit (or carbon credits) issued by the Clean Development Mechanism (CDM) Executive Board for emission reductions achieved by CDM projects and verified by a DOE (Designated Operational E ...
s, or CERs. The Protocol allows these projects to be constructed and credited in advance of the Kyoto trading period. The Kyoto Protocol provides for three mechanisms that enable countries or operators in developed countries to acquire greenhouse gas reduction credits * Under
Joint Implementation Joint Implementation (JI) is one of three flexibility mechanisms set out in the Kyoto Protocol to help countries with binding greenhouse gas emissions targets (the Annex I countries) meet their treaty obligations. Under Article 6, any Annex I coun ...
(JI) a developed country with relatively high costs of domestic greenhouse reduction would set up a project in another developed country. * Under the
Clean Development Mechanism The Clean Development Mechanism (CDM) is a United Nations-run carbon offset scheme allowing countries to fund greenhouse gas emissions-reducing projects in other countries and claim the saved emissions as part of their own efforts to meet internat ...
(CDM) a developed country can 'sponsor' a greenhouse gas reduction project in a developing country where the cost of greenhouse gas reduction project activities is usually much lower, but the atmospheric effect is globally equivalent. The developed country would be given credits for meeting its emission reduction targets, while the developing country would receive the capital investment and
clean technology Clean technology, in short cleantech, is any process, product, or service that reduces negative environmental impacts through significant energy efficiency improvements, the sustainable use of resources, or environmental protection activities. Cl ...
or beneficial change in land use. * Under International
Emissions Trading Emissions trading is a market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants. The concept is also known as cap and trade (CAT) or emissions trading scheme (ETS). Carbon emissi ...
(IET) countries can trade in the international carbon credit market to cover their shortfall in
Assigned amount units An assigned amount unit is a tradable "Kyoto unit" or "carbon credit" representing an allowance to emit greenhouse gases comprising "one metric tonne of carbon dioxide equivalent, calculated using global warming potentials". Assigned amount units a ...
. Countries with surplus units can sell them to countries that are exceeding their emission targets under Annex B of the Kyoto Protocol. These
carbon project Business action on climate change includes a range of activities relating to climate change, and to influencing political decisions on climate change-related regulation, such as the Kyoto Protocol. Major multinationals have played and to some e ...
s can be created by a national government or by an operator within the country. In reality, most of the transactions are not performed by national governments directly, but by operators who have been set quotas by their country.


Emission markets

For trading purposes, one allowance or CER is considered equivalent to one
metric ton The tonne ( or ; symbol: t) is a unit of mass equal to 1000  kilograms. It is a non-SI unit accepted for use with SI. It is also referred to as a metric ton to distinguish it from the non-metric units of the short ton (United States ...
of CO2 emissions. These allowances can be sold privately or in the international market at the prevailing market price. These trade and
settle Settle or SETTLE may refer to: Places * Settle, Kentucky, United States * Settle, North Yorkshire, a town in England ** Settle Rural District, a historical administrative district Music * Settle (band), an indie rock band from Pennsylvania * ''S ...
internationally and hence allow allowances to be transferred between countries. Each international transfer is validated by the
UNFCCC The United Nations Framework Convention on Climate Change (UNFCCC) established an international environmental treaty to combat "dangerous human interference with the climate system", in part by stabilizing greenhouse gas concentrations in th ...
. Each transfer of ownership within the European Union is additionally validated by the European Commission. Climate exchanges have been established to provide a
spot market The spot market or cash market is a public financial market in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market, in which delivery is due at a later date. In a spot market, settle ...
in allowances, as well as
futures Futures may mean: Finance *Futures contract, a tradable financial derivatives contract *Futures exchange, a financial market where futures contracts are traded * ''Futures'' (magazine), an American finance magazine Music * ''Futures'' (album), a ...
and
options Option or Options may refer to: Computing *Option key, a key on Apple computer keyboards *Option type, a polymorphic data type in programming languages *Command-line option, an optional parameter to a command *OPTIONS, an HTTP request method ...
market to help discover a market price and maintain
liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liq ...
. Carbon prices are normally quoted in
Euro The euro ( symbol: €; code: EUR) is the official currency of 19 out of the member states of the European Union (EU). This group of states is known as the eurozone or, officially, the euro area, and includes about 340 million citizens . ...
s per tonne of carbon dioxide or its equivalent (CO2e). Other greenhouse gasses can also be traded, but are quoted as standard multiples of carbon dioxide with respect to their
global warming potential Global warming potential (GWP) is the heat absorbed by any greenhouse gas in the atmosphere, as a multiple of the heat that would be absorbed by the same mass of carbon dioxide (). GWP is 1 for . For other gases it depends on the gas and the time ...
. These features reduce the quota's financial impact on business, while ensuring that the quotas are met at a national and international level. Currently there are five exchanges trading in carbon allowances: the
European Climate Exchange The European Climate Exchange (ECX) managed the product development and marketing for ECX Carbon Financial Instruments (ECX CFIs), listed and admitted for trading on the ICE Futures Europe electronic platform. For a time it was a subsidiary of the ...
, NASDAQ OMX Commodities Europe, PowerNext, Commodity Exchange Bratislava and the European Energy Exchange. NASDAQ OMX Commodities Europe listed a contract to trade offsets generated by a CDM
carbon project Business action on climate change includes a range of activities relating to climate change, and to influencing political decisions on climate change-related regulation, such as the Kyoto Protocol. Major multinationals have played and to some e ...
called Certified Emission Reductions (CERs). Many companies now engage in emissions abatement, offsetting, and sequestration programs to generate credits that can be sold on one of the exchanges. At least one private electronic market has been established in 2008: CantorCO2e. Carbon credits at Commodity Exchange Bratislava are traded at special platform - Carbon place. Managing emissions is one of the fastest-growing segments in financial services in the
City of London The City of London is a city, ceremonial county and local government district that contains the historic centre and constitutes, alongside Canary Wharf, the primary central business district (CBD) of London. It constituted most of London f ...
with a market estimated to be worth about €30 billion in 2007. Louis Redshaw, head of environmental markets at
Barclays Capital Barclays () is a British multinational universal bank, headquartered in London, England. Barclays operates as two divisions, Barclays UK and Barclays International, supported by a service company, Barclays Execution Services. Barclays traces ...
predicts that "Carbon will be the world's biggest commodity market, and it could become the world's biggest market overall."


Setting a market price for carbon

Unchecked, energy use and hence emission levels are predicted to keep rising over time. Thus the number of companies needing to buy credits will increase, and the rules of
supply and demand In microeconomics, supply and demand is an economic model of price determination in a Market (economics), market. It postulates that, Ceteris paribus, holding all else equal, in a perfect competition, competitive market, the unit price for a ...
will push up the market price, encouraging more groups to undertake environmentally friendly activities that create carbon credits to sell. An individual allowance, such as an Assigned amount unit (AAU) or its near-equivalent European Union Allowance (EUA), may have a different market value to an offset such as a CER. This is due to the lack of a developed secondary market for CERs, a lack of homogeneity between projects which causes difficulty in pricing, as well as questions due to the principle of supplementarity and its lifetime. Additionally, offsets generated by a
carbon project Business action on climate change includes a range of activities relating to climate change, and to influencing political decisions on climate change-related regulation, such as the Kyoto Protocol. Major multinationals have played and to some e ...
under the Clean Development Mechanism are potentially limited in value because operators in the EU ETS are restricted as to what percentage of their allowance can be met through these flexible mechanisms. Yale University economics professor
William Nordhaus William Dawbney Nordhaus (born May 31, 1941) is an American economist, a Sterling Professor of Economics at Yale University, best known for his work in economic modeling and climate change, and one of the 2 recipients of the 2018 Nobel Memoria ...
argues that the price of carbon needs to be high enough to motivate the changes in behavior and changes in economic production systems necessary to effectively limit emissions of
greenhouse gases A greenhouse gas (GHG or GhG) is a gas that absorbs and emits radiant energy within the thermal infrared range, causing the greenhouse effect. The primary greenhouse gases in Earth's atmosphere are water vapor (), carbon dioxide (), methane ...
.
Raising the price of carbon will achieve four goals. First, it will provide signals to consumers about what goods and services are high-carbon ones and should therefore be used more sparingly. Second, it will provide signals to producers about which inputs use more carbon (such as coal and oil) and which use less or none (such as natural gas or nuclear power), thereby inducing firms to substitute low-carbon inputs. Third, it will give market incentives for inventors and innovators to develop and introduce low-carbon products and processes that can replace the current generation of technologies. Fourth, and most important, a high carbon price will economize on the information that is required to do all three of these tasks. Through the market mechanism, a high carbon price will raise the price of products according to their carbon content. Ethical consumers today, hoping to minimize their “carbon footprint,” have little chance of making an accurate calculation of the relative carbon use in, say, driving 250 miles as compared with flying 250 miles. A harmonized carbon tax would raise the price of a good proportionately to exactly the amount of CO2 that is emitted in all the stages of production that are involved in producing that good. If 0.01 of a ton of carbon emissions results from the wheat growing and the milling and the trucking and the baking of a loaf of bread, then a tax of $30 per ton carbon will raise the price of bread by $0.30. The “carbon footprint” is automatically calculated by the price system. Consumers would still not know how much of the price is due to carbon emissions, but they could make their decisions confident that they are paying for the social cost of their carbon footprint.
Nordhaus has suggested, based on the
social cost of carbon The social cost of carbon (SCC) is the marginal cost of the impacts caused by emitting one extra tonne of greenhouse gas (carbon dioxide equivalent) at any point in time, inclusive of 'non-market' impacts on the environment and human health. Th ...
emissions, that an optimal price of carbon is around $30(US) per ton and will need to increase with inflation.
The social cost of carbon is the additional damage caused by an additional ton of carbon emissions. ... The optimal carbon price, or optimal carbon tax, is the market price (or carbon tax) on carbon emissions that balances the incremental costs of reducing carbon emissions with the incremental benefits of reducing climate damages. ... a country wished to impose a carbon tax of $30 per ton of carbon, this would involve a tax on gasoline of about 9 cents per gallon. Similarly, the tax on coal-generated electricity would be about 1 cent per kWh, or 10 percent of the current retail price. At current levels of carbon emissions in the United States, a tax of $30 per ton of carbon would generate $50 billion of revenue per year.


How buying carbon credits propose to reduce emissions

Carbon credits create a market for reducing greenhouse emissions by giving a monetary value to the cost of polluting the air. Emissions become an internal cost of doing business and are visible on the
balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...
alongside
raw materials A raw material, also known as a feedstock, unprocessed material, or primary commodity, is a basic material that is used to produce goods, finished goods, energy, or intermediate materials that are feedstock for future finished products. As feeds ...
and other liabilities or
assets In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ...
. For example, consider a business that owns a factory putting out 100,000 tonnes of greenhouse gas emissions in a year. Its government is an Annex I country that enacts a law to limit the emissions that the business can produce. So the factory is given a quota of say 80,000 tonnes per year. The factory either reduces its emissions to 80,000 tonnes or is required to purchase carbon credits to offset the excess. After costing up alternatives the business may decide that it is uneconomical or infeasible to invest in new machinery for that year. Instead it may choose to buy carbon credits on the open market from organizations that have been approved as being able to sell legitimate carbon credits. We should consider the impact of manufacturing alternative energy sources. For example, the energy consumed and the carbon emitted in the manufacture and transportation of a large wind turbine would prohibit a credit being issued for a predetermined period of time. * One seller might be a company that will offer to offset emissions through a project in the developing world, such as recovering methane from a swine farm to feed a power station that previously would use fossil fuel. So although the factory continues to emit gases, it would pay another group to reduce the equivalent of 20,000 tonnes of carbon dioxide emissions from the atmosphere for that year. * Another seller may have already invested in new low-emission machinery and have a surplus of allowances as a result. The factory could make up for its emissions by buying 20,000 tonnes of allowances from them. The cost of the seller's new machinery would be subsidized by the sale of allowances. Both the buyer and the seller would submit accounts for their emissions to prove that their allowances were met correctly.


Credits versus taxes

Carbon credits and carbon taxes each have their advantages and disadvantages. Credits were chosen by the signatories to the Kyoto Protocol as an alternative to
carbon tax A carbon tax is a tax levied on the carbon emissions required to produce goods and services. Carbon taxes are intended to make visible the "hidden" social costs of carbon emissions, which are otherwise felt only in indirect ways like more sev ...
es. A criticism of tax-raising schemes is that they are frequently not hypothecated, and so some or all of the taxation raised by a government would be applied based on what the particular nation's government deems most fitting. However, some would argue that carbon trading is based around creating a lucrative artificial market, and, handled by free market enterprises as it is, carbon trading is not necessarily a focused or easily regulated solution. By treating emissions as a market
commodity In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a co ...
some proponents insist it becomes easier for businesses to understand and manage their activities, while economists and traders can attempt to predict future pricing using market theories. Thus the main advantages of a tradeable carbon credit over a carbon tax are argued to be: * the price may be more likely to be perceived as fair by those paying it. Investors in credits may have more control over their own costs. * the flexible mechanisms of the Kyoto Protocol help to ensure that all investment goes into genuine sustainable carbon reduction schemes through an internationally agreed validation process. * some proponents state that if correctly implemented a target level of emission reductions may somehow be achieved with more certainty, while under a tax the actual emissions might vary over time. * it may provide a framework for rewarding people or companies who plant trees or otherwise meet standards exclusively recognized as "green." The advantages of a carbon tax are argued to be: * possibly less complex, expensive, and time-consuming to implement. This advantage is especially great when applied to markets like gasoline or home heating oil. * perhaps some reduced risk of certain types of cheating, though under both credits and taxes, emissions must be verified. * reduced incentives for companies to delay efficiency improvements prior to the establishment of the baseline if credits are distributed in proportion to past emissions. * when credits are grandfathered, this puts new or growing companies at a disadvantage relative to more established companies. * allows for more centralized handling of acquired gains * worth of carbon is stabilized by government regulation rather than market fluctuations. Poor market conditions and weak investor interest have a lessened impact on taxation as opposed to carbon trading.


Creating carbon credits

The principle of supplementarity within the Kyoto Protocol means that internal abatement of emissions should take precedence before a country buys in carbon credits. However it also established the
Clean Development Mechanism The Clean Development Mechanism (CDM) is a United Nations-run carbon offset scheme allowing countries to fund greenhouse gas emissions-reducing projects in other countries and claim the saved emissions as part of their own efforts to meet internat ...
as a Flexible Mechanism by which capped entities could develop measurable and permanent emissions reductions voluntarily in sectors outside the cap. Many criticisms of carbon credits stem from the fact that establishing that an emission of CO2-equivalent greenhouse gas has truly been reduced involves a complex process. This process has evolved as the concept of a
carbon project Business action on climate change includes a range of activities relating to climate change, and to influencing political decisions on climate change-related regulation, such as the Kyoto Protocol. Major multinationals have played and to some e ...
has been refined over the past 10 years. The first step in determining whether or not a
carbon project Business action on climate change includes a range of activities relating to climate change, and to influencing political decisions on climate change-related regulation, such as the Kyoto Protocol. Major multinationals have played and to some e ...
has legitimately led to the reduction of measurable and permanent emissions is understanding the CDM methodology process. This is the process by which project sponsors submit, through a Designated Operational Entity (DOE), their concepts for emissions reduction creation. The CDM Executive Board, with the CDM Methodology Panel and their expert advisors, review each project and decide how and if they do indeed result in reductions that are additional In recent years, software tools have been developed to aid in carbon credit creation, such as in relation to
forest conservation Sustainable forest management (SFM) is the management of forests according to the principles of sustainable development. Sustainable forest management has to keep the balance between three main pillars: ecological, economic and socio-cultural. ...
, and
solid waste Municipal solid waste (MSW), commonly known as trash or garbage in the United States and rubbish in Britain, is a waste type consisting of everyday items that are discarded by the public. "Garbage" can also refer specifically to food waste, ...
or wastewater management. Forests can be used to create credits, often involving the use of geospatial analytical systems to calculate the
carbon offset A carbon offset is a reduction or removal of emissions of carbon dioxide or other greenhouse gases made in order to compensate for emissions made elsewhere. Offsets are measured in tonnes of carbon dioxide-equivalent (CO2e). One ton of carb ...
of preserving an area forest or a
reforestation Reforestation (occasionally, reafforestation) is the natural or intentional restocking of existing forests and woodlands ( forestation) that have been depleted, usually through deforestation, but also after clearcutting. Management A de ...
initiative.
REDD+ Redd is a Turkish rock band established in 1996 by tenor opera singer Doğan Duru and guitarist Berke Hatipoğlu under the name ''Ten''. They used to play at bars until they set up their own studio in 2004. Their first album, titled ''"50/50"' ...
is one example of a forest carbon credit initiative. REDD+ carbon credits for individuals and businesses may be purchased through carbon offset retailers like Carbonfund.org Foundation o
ACT4.io


Additionality and its importance

It is also important for any carbon credit (offset) to prove a concept called additionality. The concept of additionality addresses the question of whether the project would have happened in the absence of an intervention in the form of the price signal of carbon credits. Only projects with emissions below their baseline level, defined as emissions under a scenario without this price signal (holding all other factors constant), represent a net environmental benefit. Carbon projects that yield strong financial returns even in the absence of revenue from carbon credits; or that are compelled by regulations; or that represent common practice in an industry; are usually not considered additional. A full determination of additionality requires a careful investigation of proposed carbon offset projects. It is generally agreed that voluntary carbon offset projects must demonstrate additionality to ensure the legitimacy of the environmental stewardship claims resulting from the retirement of carbon credits (offsets).


Criticisms

The Kyoto mechanism is the only internationally agreed mechanism for regulating carbon credit activities, and crucially, includes checks for additionality and overall effectiveness. Its supporting organisation, the UNFCCC, is the only organisation with a global mandate on the overall effectiveness of emission control systems, although enforcement of decisions relies on national co-operation. The Kyoto trading period only applies for five years between 2008 and 2012. The first phase of the EU ETS system started before then, and is expected to continue in a third phase afterwards, and may co-ordinate with whatever is internationally agreed at but there is general uncertainty as to what will be agreed in Post–Kyoto Protocol negotiations on greenhouse gas emissions. As business investment often operates over decades, this adds risk and uncertainty to their plans. As several countries responsible for a large proportion of global emissions (notably USA, India, China) have avoided mandatory caps, this also means that businesses in capped countries may perceive themselves to be working at a competitive disadvantage against those in uncapped countries as they are now paying for their carbon costs directly. A key concept behind the cap and trade system is that national quotas should be chosen to represent genuine and meaningful reductions in national output of emissions. Not only does this ensure that overall emissions are reduced but also that the costs of emissions trading are carried fairly across all parties to the trading system. However, governments of capped countries may seek to unilaterally weaken their commitments, as evidenced by the 2006 and 2007 National Allocation Plans for several countries in the EU ETS, which were submitted late and then were initially rejected by the
European Commission The European Commission (EC) is the executive of the European Union (EU). It operates as a cabinet government, with 27 members of the Commission (informally known as "Commissioners") headed by a President. It includes an administrative body ...
for being too lax. A question has been raised over the grandfathering of allowances. Countries within the EU ETS have granted their incumbent businesses most or all of their allowances for free. This can sometimes be perceived as a protectionist obstacle to new entrants into their markets. There have also been accusations of power generators getting a 'windfall' profit by passing on these emissions 'charges' to their customers. As the EU ETS moves into its second phase and joins up with Kyoto, it seems likely that these problems will be reduced as more allowances will be auctioned. Some sources show that the UK financial service wins a lot from carbon credit trade (which is designed to be profitable). The profit is evident if one checks the statistics: London has secured dominance on the global carbon trading market, with net value $64bn in 2007, according to the report by International Financial Services London. London controlled about 90% of the exchange market (Carbon credit vs money) in 2007. London-based companies made about 59% of the purchases of Carbon credits issued by the UN. And some of the carbon credit's system creators are from the UK, for example, the economist, former Senior Vice-president of the
World Bank The World Bank is an international financial institution that provides loans and grants to the governments of low- and middle-income countries for the purpose of pursuing capital projects. The World Bank is the collective name for the Inte ...
and government economic advisor in the United Kingdom
Nicholas Stern, Baron Stern of Brentford Nicholas Herbert Stern, Baron Stern of Brentford, (born 22 April 1946 in Hammersmith) is a British economist, banker, and academic. He is the IG Patel Professor of Economics and Government and Chair of the Grantham Research Institute on C ...
who has founded a consultancy-trading agency "The Carbon Rating Agency (CRA)" on the Isle-of-Man (controlled by firm IDEAglobal Group where Stern was a Vice Chairman at that time) for carbon credit evaluation and rating. While the carbon credit system can be an effective way to regulat
carbon offsets by large institutions
in large developed countries, it does not do enough to combat climate change in
developing countries A developing country is a sovereign state with a lesser developed industrial base and a lower Human Development Index (HDI) relative to other countries. However, this definition is not universally agreed upon. There is also no clear agreem ...
. Developing countries would be unlikely to adopt a carbon credit system to curve their emissions. These countries often prioritize economic growth and poverty alleviation ove
lowering their fossil fuel use and carbon emissions rate


Fraud allegation

In 2019, a fraud trial began. Eight men were accused of a £7m carbon credit fraud at
Southwark Crown Court The Crown Court at Southwark, commonly but inaccurately called Southwark Crown Court, is one of two locations of the Crown Court in the London SE1 postcode area, along with the Crown Court at Inner London. Opened in 1983, the brick building is ...
in England. It was alleged that a fraud had been perpetrated on members of the public who were persuaded to make investments, including the purchase of carbon credits, which were 'effectively worthless'. The trial collapsed because the judge ruled that the prosecution's expert witness 'did not have any relevant qualifications'.


See also

* Biochar production *
Cap and trade Emissions trading is a market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants. The concept is also known as cap and trade (CAT) or emissions trading scheme (ETS). Carbon emission t ...
*
Carbon finance Carbon finance is a branch of environmental finance that covers financial tools such as carbon emission trading to reduce the impact of greenhouse gases (GHG) on the environment by giving carbon emissions a price. Financial risks and opportunitie ...
*
Carbon leakage Carbon leakage occurs when there is an increase in greenhouse gas emissions in one country as a result of an emissions reduction by a second country with a strict climate policy. Carbon leakage may occur for a number of reasons: * If the emissi ...
*
Carbon offset A carbon offset is a reduction or removal of emissions of carbon dioxide or other greenhouse gases made in order to compensate for emissions made elsewhere. Offsets are measured in tonnes of carbon dioxide-equivalent (CO2e). One ton of carb ...
*
Carbon project Business action on climate change includes a range of activities relating to climate change, and to influencing political decisions on climate change-related regulation, such as the Kyoto Protocol. Major multinationals have played and to some e ...
* Carbon Trade Watch *
Emissions trading Emissions trading is a market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants. The concept is also known as cap and trade (CAT) or emissions trading scheme (ETS). Carbon emissi ...
* Emissions Reduction Currency System * Energy speculation *
Flexible mechanisms Flexible mechanisms, also sometimes known as Flexibility Mechanisms or Kyoto Mechanisms, refers to emissions trading, the Clean Development Mechanism and Joint Implementation. These are mechanisms defined under the Kyoto Protocol intended to lower ...
*
Gold Standard (carbon offset standard) The Gold Standard (GS), or Gold Standard for the Global Goals, is a standard and logo certification mark program for non-governmental emission reductions projects in the Clean Development Mechanism (CDM), thVoluntary Carbon Marketand other climate ...
* Kyoto Protocol emissions trading * NORI token *
Priority Sector Lending Certificates Priority Sector Lending Certificates is a tool for promoting comparative advantages among banks while they meet their priority sector lending obligations in India. "Banks with a comparative advantage in lending to the priority sector should earn pri ...
*
Removal Units A Removal Unit (RMU) is a tradable carbon credit or 'Kyoto unit' representing an allowance to emit one tonne of greenhouse gases absorbed by a removal or carbon sink activity in an Annex I country. Removal Units are generated and issued by Kyoto ...
* Tree credits *
Verified Carbon Standard The Verified Carbon Standard (VCS), or Verra, formerly the Voluntary Carbon Standard, is a standard for certifying carbon emissions reductions. VCS is administered by Verra, a 501(c)(3) organization. History In 2005, carbon markets investment ...


References


External links


Carbon Finance International



What is Additionality? Part 1: A long standing problem, GHG Management Institute, Discussion Paper No. 001, (Jan 2012).
{{DEFAULTSORT:Carbon Credit Climate change policy Carbon finance