Carbon Credits

A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent (tCO2e) equivalent to one tonne of carbon dioxide.

Carbon credits and carbon markets are a component of national and international attempts to mitigate the growth in concentrations of greenhouse gases (GHGs). One carbon credit is equal to one tonne of carbon dioxide, or in some markets, carbon dioxide equivalent gases. 

Carbon trading is an application of an emissions trading approach. Greenhouse gas emissions are capped and then markets are used to allocate the emissions among the group of regulated sources.

The goal 
It is to allow market mechanisms to drive industrial and commercial processes in the direction of low emissions or less carbon intensive approaches than those used when there is no cost to emitting carbon dioxide and other GHGs into the atmosphere. Since GHG mitigation projects generate credits, this approach can be used to finance carbon reduction schemes between trading partners and around the world.

Units

The units which may be transferred under Article 17 emissions trading, each equal to one metric tonne of emissions (in CO2-equivalent terms), may be in the form of:
  • An assigned amount unit (AAU) issued by an Annex I Party on the basis of its assigned amount pursuant to Articles 3.7 and 3.8 of the Protocol.
  • A removal unit (RMU) issued by an Annex I Party on the basis of land use, land-use change and forestry (LULUCF) activities under Articles 3.3 and 3.4 of the Kyoto Protocol.
  • An emission reduction unit (ERU) generated by a joint implementation project under Article 6 of the Kyoto Protocol.
  • A certified emission reduction (CER) generated from a clean development mechanism project activity under Article 12 of the Kyoto Protocol.
Transfers and acquisitions of these units are to be tracked and recorded through the registry systems under the Kyoto Protocol.

  • There are also many companies that sell carbon credits to commercial and individual customers who are interested in lowering their carbon footprint on a voluntary basis. These carbon offsetters purchase the credits from an investment fund or a carbon development company that has aggregated the credits from individual projects. Buyers and sellers can also use an exchange platform to trade, such as the Carbon Trade Exchange, which is like a stock exchange for carbon credits. 


The quality of the credits is based in part on the validation process and sophistication of the fund or development company that acted as the sponsor to the carbon project. This is reflected in their price; voluntary units typically have less value than the units sold through the rigorously validated Clean Development Mechanism.

EMISSION MARKETS
  • For trading purposes, one allowance or CER is considered equivalent to one metric ton of CO2 emissions. 
  • These allowances can be sold privately or in the international market at the prevailing market price. 
  • These trade and settle internationally and hence allow allowances to be transferred between countries. 
  • Each international transfer is validated by the UNFCCC. 
  • Each transfer of ownership within the European Union is additionally validated by the European Commission.
  • Climate exchanges have been established to provide a spot market in allowances, as well as futures and options market to help discover a market price and maintain liquidity. 
  • Carbon prices are normally quoted in Euros per tonne of carbon dioxide or its equivalent (CO2e). 
  • Other greenhouse gasses can also be traded, but are quoted as standard multiples of carbon dioxide with respect to their global warming potential. 
  • These features reduce the quota's financial impact on business, while ensuring that the quotas are met at a national and international level.


Currently there are five exchanges trading in carbon allowances: 
  1. The European Climate Exchange, 
  2. NASDAQ OMX Commodities Europe, 
  3. PowerNext, 
  4. Commodity Exchange Bratislava and 
  5. TheEuropean Energy Exchange. 


Managing emissions is one of the fastest-growing segments in financial services in the City of London with a market estimated to be worth about €30 billion in 2007. Louis Redshaw, head of environmental markets at Barclays Capital predicts that "Carbon will be the world's biggest commodity market, and it could become the world's biggest market overall."

How it works

Investors are usually called out of the blue by salespeople promoting carbon credits, but contact can also come by email, post, word of mouth or at a seminar or exhibition.
You may be offered carbon credit certificates, voluntary emission reductions (VERs), certified emission reductions (CERs) or an opportunity to invest directly in a ’green‘ scheme or project that generates carbon credits as a return on investment.
Carbon credits and VERs certificates are often labelled as ’certified‘, but this certification is voluntary and involves a wide range of bodies and different quality standards that are not recognised by any UK compensation scheme.
The caller may claim carbon credits are ‘the new big thing’ in commodity trading, industries now have to off-set their emissions, the government is focusing on green developments or that it is a growing market.
But we have seen that investors are not making any money as they cannot sell or trade their carbon credits.


Credits versus taxes

  • Carbon credits and carbon taxes each have their advantages and disadvantages. 
  • Credits were chosen by the signatories to the Kyoto Protocol as an alternative to Carbon taxes. 
  • A criticism of tax-raising schemes is that they are frequently not hypothecated, and so some or all of the taxation raised by a government would be applied based on what the particular nation's government deems most fitting. 
  • However, some would argue that carbon trading is based around creating a lucrative artificial market, and, handled by free market enterprises as it is, carbon trading is not necessarily a focused or easily regulated solution.

By treating emissions as a market commodity some proponents insist it becomes easier for businesses to understand and manage their activities, while economists and traders can attempt to predict future pricing using market theories. 

Thus the main advantages of a tradeable carbon credit over a carbon tax are argued to be:
  • the price may be more likely to be perceived as fair by those paying it. Investors in credits may have more control over their own costs.
  • the flexible mechanisms of the Kyoto Protocol help to ensure that all investment goes into genuine sustainable carbon reduction schemes through an internationally agreed validation process.
  • some proponents state that if correctly implemented a target level of emission reductions may somehow be achieved with more certainty, while under a tax the actual emissions might vary over time.
  • it may provide a framework for rewarding people or companies who plant trees or otherwise meet standards exclusively recognized as "green."

The advantages of a carbon tax are argued to be:
  • possibly less complex, expensive, and time-consuming to implement. This advantage is especially great when applied to markets like gasoline or home heating oil.
  • perhaps some reduced risk of certain types of cheating, though under both credits and taxes, emissions must be verified.
  • reduced incentives for companies to delay efficiency improvements prior to the establishment of the baseline if credits are distributed in proportion to past emissions.
  • when credits are grandfathered, this puts new or growing companies at a disadvantage relative to more established companies.
  • allows for more centralized handling of acquired gains
  • worth of carbon is stabilized by government regulation rather than market fluctuations. Poor market conditions and weak investor interest have a lessened impact on taxation as opposed to carbon trading.