What is 'Carbon Credit'

A carbon credit is a permit or certificate allowing the holder to emit carbon dioxide or other greenhouse gases. The credit limits the emission to a mass equal to one ton of carbon dioxide. The issuance of carbon credits aims to reduce the emission of greenhouse gases into the atmosphere.

BREAKING DOWN 'Carbon Credit'

Near the end of the 20th century, concerns about global warming and environmental degradation grew. The aim of the carbon credit system is the reduction of the release of harmful gases from industrial activity. Industrial production is deemed a significant contributor to increased greenhouse gases.

The backbone of the carbon credit system is a government or other regulating bodies that can attempt to limit the total tons of carbon dioxide emitted through the issuance and regulation of carbon credit. Carbon credit policies place a cost on carbon emissions by creating credits valued against one ton of hydrocarbon fuel. A carbon credit is fundamentally a permit that allows the receiver to burn a specified amount of hydrocarbon fuel over a specified period. The ceding of carbon credits are to companies or groups that act to reduce carbon emissions measurably. Companies or nations may trade carbon certificates to help balance total worldwide emissions.

An Example of Carbon Credits

Under the cap-and-trade or emissions program, a company emitting less than its capped limit may sell unused credits to a company exceeding its limit.  For example, Company A has a cap of 10 tons but produces 12 tons of emissions. Company B also has an emission cap of 10 tons but emits only eight, resulting in a surplus of two credits. Company A may purchase the additional credits from Company B to remain in compliance.  Without the purchased carbon credits, Company A would face penalties. When the fines exceed the cost to buy, the company will favor purchasing the credits.  However, sometimes the price to acquire the credits exceeds the fines.  As a result, some companies accept the penalties and continue operations and the emissions of hydrocarbons.

The Kyoto Protocol

The Intergovernmental Panel on Climate Change (IPCC) presented its carbon credit proposal as a market-oriented mechanism to slow worldwide carbon emissions. The ratification of the international carbon credit system is in agreement with the Kyoto Protocol with clarification of its market mechanisms at the subsequent conference in Marrakesh. In addition to the legally binding goals of the Kyoto Protocol, there are also voluntary carbon credit markets.

The Kyoto Protocol divides countries into industrialized and developing economies. Industrialized, or Annex 1 countries, operate in an emissions trading market giving each nation its own emissions standards to meet. If a country emits less than its target amount of hydrocarbons, it may sell its surplus credits to countries that do not achieve their Kyoto level goals through the Emission Reduction Purchase Agreement (ERPA). 

The separate Clean Development Mechanism for developing countries issues carbon credits called Certified Emission Reduction (CER). A developing nation may receive these credits for supporting sustainable development initiatives. The trading of CERs is on a separate marketplace.

RELATED TERMS
  1. Kyoto Protocol

    An international agreement that aims to reduce carbon dioxide ...
  2. Carbon Trade

    Carbon trade is an exchange of credits between nations designed ...
  3. Carbon Dioxide Tax

    A carbon dioxide tax is paid by businesses and industries that ...
  4. Emissions Reduction Purchase Agreement ...

    An Emissions Reduction Purchase Agreement (ERPA) is a legal document ...
  5. Tertiary Recovery

    Tertiary recovery is also known as enhanced oil recovery and ...
  6. Credit Limit

    Credit limit is the amount of credit that a financial institution ...
Related Articles
  1. Trading

    Carbon Trading: Action Or Distraction?

    These credits claim to allow buyers to reduce their carbon footprints. Find out how.
  2. Insights

    Could a Carbon Tax a Work?

    Nobel laureate and Clinton adviser is pushing for a national tax on carbon dioxide emissions. Could a carbon tax work?
  3. Investing

    5 Ways To Reduce Your Carbon Footprint

    We list some simple says of reducing your CO2 emission.
  4. Investing

    GE, BMW Join Google VC in 3D Startup (GE, GOOG)

    Strategic investors bank on the future of 3D manufacturing for industrial clients, as the $1 billion startup takes its cutting edge solutions global.
  5. Investing

    7 Ways Climate Change Affects Companies

    The SEC is now asking companies to report their climate impact in their books. Find out how this factor can affect a company's profitability
  6. Investing

    Vanguard International Explorer Investors Among Zacks Buy-Rated Clean Energy Funds

    Zacks is touting the Vanguard International Explorer Investors fund as a way to get exposure to companies lowering their carbon footprint.
  7. Personal Finance

    The Importance Of Your Credit Rating

    A great starting point for learning what a credit score is, how it is calculated and why it is so important.
  8. Personal Finance

    Take the Right Steps to Build Excellent Credit

    There are several things you can do to protect and improve your credit score.
  9. Investing

    Automakers Score a Win on Fuel-Efficiency Rules

    A loophole in fuel efficiency rules incentivizes auto companies to make larger, less-efficient cars.
  10. Personal Finance

    6 Ways To Build Credit Without A Credit Card

    It's definitely possible – if a bit more complicated – to build a credit history without traditional credit cards. Just follow these steps.
RELATED FAQS
  1. Revolving Credit vs Line of Credit

    Understand how to differentiate between a line of credit and a revolving credit account, their uses, and how both differ ... Read Answer >>
  2. How are available credit and credit limit different?

    Explore the difference between available credit and credit limit and the implications different account balances have on ... Read Answer >>
Trading Center