How Carbon Credits Work

If you’re new to the world of carbon emissions, credits, offsets and trading – or even if you’re an old hand – it’s easy to be confused by some of the terminology that is thrown around.

The aim of the system of carbon credits is to limit the release of harmful greenhouse gases into the atmosphere; but what exactly is a carbon credit and how does this system work to prevent or minimize climate change?

What Is a Carbon Credit?

A carbon credit is a certificate or permit, usually issued to a company or organization that participates in a national or international carbon market. Sometimes known as a carbon allowance, it gives the owner the right to emit one tonne (metric ton) of carbon dioxide or equivalent greenhouse gas (CO2e) within a specified timeframe.

Depending on the specific market or trading scheme, carbon credits are either bought by participants, at a fixed price or by auction or allocated free of charge based on forecast carbon emissions.

How Does The System of Carbon Credits Work?

At a global level, the 1997 Kyoto Protocol is the international agreement that governs how much CO2e each country can emit. Participating nations agree on a maximum annual emission limit as part of their contribution towards curbing global warming.

The Protocol recognizes that countries differ in their ability to tackle climate change due to their varying levels of economic development. The participating countries are therefore categorized as Annex 1 (developed nations), considered largely responsible for historical emissions, and Non-Annex 1 (developing countries).

Only Annex 1 countries agree on an emissions limit, while Non-Annex 1 countries can earn carbon credits by investing in projects that reduce carbon emissions in their own countries. These carbon credits can be sold to Annex 1 countries, to allow them to emit more CO2e, thus promoting clean, sustainable development and generating income for the Non-Annex 1 countries.

How Does The Carbon Credit System Affect Businesses and Organizations?

As well as operating at the international level, many countries also operate national or regional carbon credit schemes, such as the European Union Emissions Trading Scheme (EU ETS), California’s greenhouse gas scheme or the Regional Greenhouse Gas Initiative (RGGI) in the northeastern United States. This effectively delegates some of the responsibility for a country’s emissions targets to its largest corporate emitters.

These schemes require mandated businesses to obtain a credit for each tonne of CO2e that they emit annually. Businesses who subsequently reduce their emissions can sell their excess carbon credits to other participants whose emissions have increased, thereby helping to finance emissions reduction measures.

Whether international, national or regional, a carbon credit gives each business or other organization the right to emit one tonne of CO2e within a given period. If the organization emits more CO2e than it has credits, it must buy extra carbon credits at the market rate.

The system enables organizations to evaluate the financial and other benefits of investing in their own carbon reduction measures to keep within agreed emissions limits, or allowing others to do so instead and buying additional credits at the going rate.

What Is The Relationship Between Carbon Offsets and Carbon Credits?

The Clean Development Mechanism (CDM) is one of the systems introduced under the Kyoto Protocol to help developing countries create sustainable development projects, and enable Annex 1 countries to achieve emissions targets by purchasing carbon credits.

Accredited CDM projects are awarded a Certified Emissions Reduction (CER) credit for each tonne of CO2e avoided. The CERs are also referred to as carbon offsets and are bought by businesses seeking to comply with the EU ETS and other regional schemes (compliance buyers) and traders, brokers and fund managers (speculators) as well as by Annex 1 governments (sovereign buyers).

Voluntary offsets (Voluntary Emissions Reduction – VER) or credits differ from CERs because they cannot be used for compliance purposes, either by nations or businesses, to meet obligations under the Kyoto Protocol.

Instead, voluntary offsets offer organizations the opportunity to neutralize their own emissions to meet corporate social responsibility (CSR) targets, improve public perception or respond to market pressure.

Should You Choose CER Credits or Voluntary Offsets?

The CDM/CER market is highly regulated by government agencies, with complex procedures and methodologies for project registration, and some types of projects are excluded, including many agriculture and forestry projects. CER credits are aimed at the global compliance market and the price per tonne is broadly the same wherever it is bought.

Voluntary offset projects follow rules prescribed by one of a small number of voluntary standard bodies. Although they are just as rigorous, different standards use different processes for verifying that emissions are genuinely reduced. This flexibility allows for greater innovation and experimentation, so a wider range of project types can be developed, including many smaller projects.

Progressive voluntary offset projects not only reduce emissions, but also deliver co-benefits, such as health improvements, employment or education for local communities, preservation of biodiversity, or other non-carbon impacts. The value of investing in such projects depends on the aims of the buyer, and prices for voluntary offsets may vary according to the combination of attributes for a specific project.

To learn more, read our article Carbon Offsets vs. Carbon Credits or contact NativeEnergy at [email protected]. to find a progressive voluntary offset project designed to benefit you and the wider community.