A carbon credit is a license or certificate that allows its holder, for example a company, to emit CO2 or other greenhouse gases. Each credit limits emissions to one tonne of CO2. The ultimate goal of carbon credits is to reduce greenhouse gas emissions into the atmosphere.
A carbon credit is essentially a permit issued by a government or other regulatory agency that allows its holder to burn a specified amount of hydrocarbon fuel for a specified period of time.
Each carbon credit is worth one ton of hydrocarbon fuel. Companies or countries are allotted a certain amount of credits and can trade them to help balance out total emissions worldwide. The United Nations notes, “Since CO2 is the main greenhouse gas,” “people simply call it carbon trading.”
The United Nations Intergovernmental Panel on Climate Change (IPCC) has developed a carbon credit proposal into a market-oriented mechanism to reduce carbon emissions worldwide.
A 1997 agreement known as the Kyoto Protocol, which sets binding emission reduction targets for the signatory countries, entered into force in 2005. Another agreement, the Marrakesh Agreement, sets forth the targets. rules about how the system should be implemented.
Countries are encouraged to achieve their targets through an emissions trading mechanism.
The first commitment period of the Kyoto Protocol ended in 2012, and the protocol was revised that year in an agreement known as the Doha Amendment, but has yet to be ratified. Meanwhile, more than 170 countries have signed the 2015 Paris Agreement, which also sets emissions standards and allows emissions trading.
A company participating in an emissions trading scheme may trade the unused portion of the credit to another company participating in the scheme that has net emissions over the limit.
Consider Company A as having a limit of 10 tons but producing 12 tons of emissions. Company B also has a 10 ton cap on emissions, but only emits 8 tones, leaving 2 extra credits available. To meet environmental standards, Company A can buy more credits from Company B. Company A will be fined if it fails to purchase those carbon credits. However, some businesses can decide to take the fines and carry on as usual if the cost of the credits is more than the government penalty.
Regulators can increase the allure of credit trading by raising fines. Additionally, they can lower the quantity of credits given annually, increasing their value in the emissions trading market and encouraging businesses to invest in clean technology because it will be less expensive than purchasing carbon credits or paying fines.