Carbon Credit

DEFINITION of 'Carbon Credit'

A carbon credit is a permit that allows the holder to emit one ton of carbon dioxide. Credits are awarded to countries or groups that have reduced their greenhouse gases below their emission quota. Carbon credits can be traded in the international market at their current market price.

BREAKING DOWN 'Carbon Credit'

The carbon credit system was one of the possible solutions that arose near the end of the 20th century, as people became more aware that human industrial activity - in particular, the burning of CO2-emitting fuels like coal, petroleum and natural gas - is responsible for global warming and environmental degradation. The premise of the system is that a government or another regulating body will be able to regulate the total tons of carbon dioxide which are emitted but will leave some flexibility as to how that is accomplished.

Carbon credit systems place a cost on carbon emissions by creating credits valued against one ton of hydrocarbon fuel. A carbon credit is essentially a permit that allows the receiver to burn an amount (usually one ton) of hydrocarbon fuel over a specified period of time. Credits can be granted to companies or other groups which take action to measurably reduce carbon emissions; reduce by a certain amount, and you get a carbon credit.

Examples of Carbon Credits

For example, if an environmentalist group plants enough trees to reduce emissions by one ton, the group will be awarded a credit. If a steel producer has an emissions quota of 10 tons but is expected to produce 11 tons, it could purchase this carbon credit from the environmental group. The carbon credit system looks to reduce emissions by having countries honor their emission quotas and offer incentives for being below them.

The Kyoto Protocol

Carbon credit proposals have been spearheaded by the International Panel on Climate Change (IPCC) as a market-oriented mechanism to slow carbon emissions. An international carbon credit system was ratified in conjunction with the Kyoto Protocol (which is currently ratified by 192 countries) and its market mechanisms clarified at the subsequent conference in Marrakesh. In addition to the legally binding goals of the Kyoto Protocol, there are also voluntary carbon credit markets, such as in some cities in the United States (which did not sign the treaty).

The Kyoto Protocol divides countries between industrialized and developing economies. Industrialized, or Annex I countries, operate in an emissions trading market which gives each country their own emissions standards to meet. If a countries exceeds their targets they can sell their surplus to countries that are haven't met their goals. The separate Clean Development Mechanism for developing countries issues carbon credits called Certified Emission Reductions (CER) that are issued for supporting sustainable development initiatives in developing countries and can be traded on a separate market.

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