Carbon Credit

What Is a Carbon Credit?

A carbon credit is a permit that allows the owner to emit a certain amount of carbon dioxide or other greenhouse gases. One credit permits the emission of one ton of carbon dioxide or the equivalent in other greenhouse gases.

The carbon credit is half of a so-called "cap-and-trade" program. Companies that pollute are awarded credits that allow them to continue to pollute up to a certain limit. That limit is reduced periodically. Meanwhile, the company may sell any unneeded credits to another company that needs them.

Private companies are thus doubly incentivized to reduce greenhouse emissions. First, they must spend money on extra credits if their emissions exceed the cap. Second, they can make money by reducing their emissions and selling their excess allowances.

Key Takeaways

  • Carbon credits were devised as a mechanism to reduce greenhouse gas emissions.
  • Companies get a set number of credits, which decline over time. They can sell any excess to another company.
  • Carbon credits create a monetary incentive for companies to reduce their carbon emissions. Those that cannot easily reduce emissions can still operate, at a higher financial cost.
  • Carbon credits are based on the "cap-and-trade" model that was used to reduce sulfur pollution in the 1990s.
  • Negotiators at the Glasgow COP26 climate change summit in November 2021 agreed to create a global carbon credit offset trading market.

Understanding a Carbon Credit

The ultimate goal of carbon credits is to reduce the emission of greenhouse gases into the atmosphere. As noted, a carbon credit represents the right to emit greenhouse gases equivalent to one ton of carbon dioxide. According to the Environmental Defense Fund, that is the equivalent of a 2,400-mile drive in terms of carbon dioxide emissions.

Companies or nations are allotted a certain number of credits and may trade them to help balance total worldwide emissions. "Since carbon dioxide is the principal greenhouse gas," the United Nations notes, "people speak simply of trading in carbon."

The intention is to reduce the number of credits over time, thus incentivizing companies to find innovative ways to reduce greenhouse gas emissions.

Carbon Credits Today

Cap-and-trade programs remain controversial in the U.S. However, 11 states have adopted such market-based approaches to the reduction of greenhouse gases, according to the Center for Climate and Energy Solutions. Of these, 10 are Northeast states that banded together to jointly attack the problem through a program known as the Regional Greenhouse Gas Initiative (RGGI).

California's Cap-and-Trade Program

The state of California initiated its own cap-and-trade program in 2013. The rules apply to the state's large electric power plants, industrial plants, and fuel distributors.

The state claims that its program is the fourth largest in the world after those of the European Union, South Korea, and the Chinese province of Guangdong.

The cap-and-trade system is sometimes described as a market system. That is, it creates an exchange value for emissions. Its proponents argue that a cap-and-trade program offers an incentive for companies to invest in cleaner technologies in order to avoid buying permits that will increase in cost every year.

The U.S. Clean Air Act

The United States has been regulating airborne emissions since the passage of the U.S. Clean Air Act of 1990, which is credited as the world's first cap-and-trade program (although it called the caps "allowances").

The program is credited by the Environmental Defense Fund for substantially reducing emissions of sulfur dioxide from coal-fired power plants, the cause of the notorious "acid rain" of the 1980s.

Worldwide Carbon Credit Initiatives

The United Nations' Intergovernmental Panel on Climate Change (IPCC) developed a carbon credit proposal to reduce worldwide carbon emissions in a 1997 agreement known as the Kyoto Protocol. The agreement set binding emission reduction targets for the countries that signed it. Another agreement, known as the Marrakesh Accords, spelled out the rules for how the system would work.

The Kyoto Protocol divided countries into industrialized and developing economies. Industrialized countries, collectively called Annex 1, operated in their own emissions trading market. If a country emitted less than its target amount of hydrocarbons, it could sell its surplus credits to countries that did not achieve its Kyoto level goals, through an Emission Reduction Purchase Agreement (ERPA). 

The separate Clean Development Mechanism for developing countries issued carbon credits called a Certified Emission Reduction (CER). A developing nation could receive these credits for supporting sustainable development initiatives. The trading of CERs took place in a separate market.

The first commitment period of the Kyoto Protocol ended in 2012. The U.S. had already dropped out in 2001.

The Paris Climate Agreement

The Kyoto protocol was revised in 2012 in an agreement known as the Doha Amendment, which was ratified as of October 2020, with 147 member nations having "deposited their instrument of acceptance."

More than 190 nations signed on to the Paris Agreement of 2015, which also sets emission standards and allows for emissions trading. The U.S. dropped out in 2017 but subsequently rejoined the agreement in January 2020 under President Joe Biden.

The Paris Agreement, also known as the Paris Climate Accord, is an agreement among the leaders of over 180 countries to reduce greenhouse gas emissions and limit the global temperature increase to below 2 degrees Celsius (3.6 F) above preindustrial levels by the year 2100.

The Glasgow COP26 Climate Change Summit

Negotiators at the summit in November 2021 inked a deal that saw nearly 200 countries implement Article 6 of the 2015 Paris Agreement, allowing nations to work toward their climate targets by buying offset credits that represent emission reductions by other countries. The hope is that the agreement encourages governments to invest in initiatives and technology that protects forests and build renewable energy technology infrastructure to combat climate change.

For instance, Brazil's chief negotiator at the summit, Leonardo Cleaver de Athayde, flagged that the forest-rich South American country planned to be a major trader of carbon credits. "It should spur investment and the development of projects that could deliver significant emissions reductions," he told Reuters.

Several other provisions in the accord include zero tax on bilateral trades of offsets between countries and canceling 2% of total credits, aimed at reducing overall global emissions. Additionally, 5% of revenues generated from offsets will be placed in an adaptation fund for developing countries to help fight climate change. Negotiators also agreed to carry over offsets registered since 2013, allowing 320 million credits to enter the new market.

How Much Does a Carbon Credit Cost?

Carbon credits have different prices, depending on the location and market where they are traded. In 2019, the average price for carbon credits was $4.33 per ton. This figure spiked to as much as $5.60 per ton in 2020 before settling to an average of $4.73 the following year.

Where Can You Buy Carbon Credits?

There are several private companies that offer carbon offsets to companies or individuals seeking to reduce their net carbon footprint. These offsets represent investments or contributions to forestry or other projects with a negative carbon footprint. Buyers can also purchase tradable credits on a carbon exchange such as New York-based Xpansive CBL or Singapore's AirCarbon Exchange.

How Large Is the Carbon Credit Market?

Estimates of the size of the carbon credit market vary wildly, due to the different regulations in each market and other geographical distinctions. The voluntary carbon market, consisting largely of companies that buy carbon offsets for CSR reasons, had an estimated value of $1 billion in 2021, according to some figures. The market for compliance credits, related to regulatory carbon caps, is substantially larger, with estimates ranging as high as $272 billion for the year 2020.

Article Sources
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