What is Carbon Credit?

A “carbon credit” is a licence that sanctions any company or country to emit a certain amount of carbon dioxide or greenhouse gases like methane, nitrous oxide or hydrofluorocarbons over a given period. One carbon credit restricts the emission to one ton of carbon dioxide or equivalent amount of other greenhouse gases (tCO2e). A credit becomes tradeable as it helps in the reduction of net emissions.

How do they work?

The Kyoto Protocol has established the proportions of greenhouse gases (denominated in individual units) that each developed country could emit. These were called Assigned Amount Units (AAUs) and were corresponding to an allowance to emit a ton of CO2 or any equivalent amount of greenhouse gas. Each country then divided its quotas, assigning them to local businesses and organisations, setting a limit on the emissions of CO2 for each of them.

Any government or administrative body keen on limiting their carbon dioxide emissions could issue Carbon Credits. Carbon trading follows the norm of an emissions capping and trade approach, i.e., a market-based approach in which economic motivations are used to encourage reductions in the emissions of pollutants. Carbon Credits being tradable, when a credit is sold, the buyer is purchasing the seller’s allowance of emissions.

But who buys Carbon Credits? These are subscribed, on a voluntary basis, by any nation or company concerned about lowering its carbon footprint.

What are the types of Carbon Credits?

Major three types of carbon credits are:

Reduced emissions (i.e., energy efficiency measures)
Removed emissions (carbon capturing and planting forests)
Avoided emissions (refraining from cutting rainforests)

The Kyoto Protocol categorises nations into two groups according to the level of development: Industrialised and Developing economies. The first group functions in an emissions trading marketplace, assigning to each country a definite emissions standard to fulfill.

Suppose if a nation emits less than its aimed amount of CO2, it can sell the excess credits to other nations that do not meet their emission standards established by the Kyoto Code. This buying and selling of Carbon Credits is controlled by a legal contract called the ERPA (Emission Reduction Purchase Agreement).

Buyers and sellers can also run through an exchange platform to trade, which is like a stock exchange for carbon credits. In some situations, it is more cost-effective to pay a fine than to buy Carbon Credits due to its high price.

Another instrument, called Clean Development Mechanism, which is specifically for developing countries, issues Carbon Credits for backup sustainable development initiatives (these Carbon Credits are named Certified Emission Reduction, or CER).

Example:

Country A emits less than its target amount of CO2; this means that Company A has an excess of Carbon Credits. Country B, on the other hand, emits more than its target quantity of hydrocarbons, so either Country B pays a fine or tries to buy Carbon Credits from another nation. At this point, Nation A and Nation B get to an agreement and trade Carbon Credits: country A sells its surplus to country B, getting money as well as a positive image, while Country B buying Carbon Credits from Country A avoids paying a fine.

Summary

One carbon credit restricts the emission to one ton of carbon dioxide or equivalent amount of other greenhouse gases.
Buyers and sellers can also run through an exchange platform to trade, which is like a stock exchange for carbon credits.
Carbon credits create a marketplace for decreasing greenhouse emissions by assigning a monetary value to the cost of contaminating the air.

FAQs:

How are Carbon credits important?

Carbon credits are a constituent of national and international efforts to mitigate the progression in concentrations of greenhouse gases (GHGs).
The objective is to sanction market mechanisms to initiate industrial and commercial processes in the direction of little emissions or fewer carbon concentrated methodologies compared to those used, when there is no cost attached to GHGs being released into the atmosphere.
Another positive aspect about this approach is that groups can decide to use the emissions trading schemes in a flexible way, finding the best option to meet policy goals.
Unrestrained, energy use and hence emission ranks are forecasted to keep increasing over time. Thus, the number of corporations needing to buy credits will rise, and the rules of supply and demand will push up the market price, promising more groups to assume environment-friendly activities that create carbon credits ready to sell.
Carbon credits create a marketplace for decreasing greenhouse emissions by assigning a monetary value to the cost of contaminating the air. Emissions convert into an internal cost of doing business and are visible on the balance sheet, thus carbon credits also appear as assets.

Why is this concept criticised?

The Kyoto mechanism is the only internationally agreed mechanism for regulating carbon credit activities, and enforcement of decisions relies on national co-operation.
A query was raised over the allowances. Nation states have granted their incumbent businesses most or all of their budgets for free. This can occasionally be perceived as a protectionist hindrance to new entrants into their marketplaces.
While the carbon credit arrangement can be an operative way to control carbon balances by large institutions in developed countries, it does not do enough to battle climate change in developing countries.
Developing countries would be questionable to accept a carbon credit scheme to control their emissions. These nations often select economic growth and poverty mitigation over lowering their fossil fuel use.