How do carbon credits work?

A carbon credit is a document or license given to a company or organization that participates in a national or international carbon market. It’s also known as a carbon allowance since it allows the owner to emit one tonne (metric ton) of carbon dioxide or equivalent greenhouse gas (CO2e) for a set period of time.

The 1997 Kyoto Protocol is an international agreement that establishes the maximum amount of CO2e that each country can emit on a global basis. Participating countries agree on a maximum yearly emission limit as part of their effort to combating global warming. The Protocol recognizes that the ability of countries to tackle climate change varies depending on their level of economic development. As a result, the participating countries are separated into two groups: Annex 1 (developed nations) and Non-Annex 1 (emerging nations), who are primarily responsible for past emissions (developing countries).

Non-Annex 1 countries can earn carbon credits by investing in initiatives that reduce carbon emissions in their own countries, but Annex 1 countries are the only ones who agree on an emissions cap. These carbon credits can be sold to Annex 1 countries, allowing them to emit more CO2e while also generating cash for Non-Annex 1 nations.

Many countries run national or regional carbon credit schemes, such as the European Union Emissions Trading Scheme (EU ETS), California’s greenhouse gas scheme, or the Northeastern United States’ Regional Greenhouse Gas Initiative, in addition to working at the international level (RGGI). Some of a country’s emissions targets are effectively transferred to the country’s largest corporate emitters.

Businesses that must participate in these programs must obtain a credit for each tonne of CO2e they emit each year. Businesses that reduce their emissions subsequently can sell their excess carbon credits to other participants who have increased their emissions, assisting in the funding of emissions reduction efforts.

A carbon credit, whether global, national, or regional, allows a company or other entity to emit one tonne of CO2e for a set period of time. If the organization’s CO2e emissions surpass the amount of carbon credits it owns, it will have to buy more at market rates. Businesses can examine the financial and other benefits of investing in their own carbon reduction measures to keep under agreed-upon emissions limits versus allowing others to do so and buying additional credits at market rates using this strategy.

There are a few topics that need to be explained as well. To begin with, no person or business can ever have a carbon footprint that is zero. As a result of what we eat and breathe, we make carbon dioxide. Agriculture, in fact, is one of the greatest sources of carbon emissions, accounting for more than the entire global transportation industry. As a result, global carbon emissions will never be decreased without a credit to balance the unavoidable carbon deficit.

Carbon credits, on the other hand, do not give you license to pollute. Carbon taxes are essentially a license to pollute, hence they do not result in a net reduction in CO2. Carbon credits do reduce greenhouse gas emissions on a net basis.

Carbon credits are issued by private-sector projects that reduce carbon emissions in a quantifiable way. Carbon credits are most appealing since they use “ex-post” accounting. In other words, they are based on results (in arrears). As a result, a carbon credit is not granted until the reduction in carbon emissions has been created and confirmed using internationally recognized criteria by internationally recognized auditors.

Carbon credits can be obtained through a variety of methods. Renewable energy is a type of energy that can be used to replace fossil fuel-based energy generation. Companies may plant trees, or even some species of fast-growing tall grasses, in previously damaged regions, which is known as reforestation. Carbon dioxide is absorbed by trees and grasses. Land-Use Management that is Improved A farmer could use an organic fertilizer instead of nitrogen-based fertilizers (nitrogen is a potent greenhouse gas) or rotate crops less frequently.

Projects must adhere to globally authorized standards, use internationally approved “carbon accounting methodology,” and be audited annually by a list of internationally approved independent auditors. These audits check the number of metric tonnes of carbon that were “sequestered” (absorbed) or averted (prevented), as well as the quantity of carbon credits that were issued. One metric tonne of carbon emissions is saved for every carbon credit created. The project developer receives the new carbon credit, which he or she may then sell to enterprises with carbon shortfalls.

Furthermore, independent parties such as the IHS Markit Registry and the APX Registry issue and track these carbon credits. These globally recognized registries serialize each carbon credit and tightly control the chain of custody, allowing the provenance of each credit to be verified and tracked as it moves from the carbon credit originator to a carbon credit broker or distributor, and finally to a carbon credit end-user.

When a carbon credit is purchased by an end-user (typically a corporation) to offset a carbon liability on their balance sheet, the registry “retires” the credit and issues a certificate to the end-user to prove that the emissions reduction credit has been “consumed” and can no longer be sold. This assures that there has been a complete carbon reduction or offset.

It’s also important to distinguish between carbon credits and carbon offsets. The primary premise behind credits and offsets is that it doesn’t matter where emissions are reduced because CO2 is the same gas everywhere on the earth. Both consumers and businesses benefit financially from reducing emissions wherever it is cheapest and easiest to do so, even if it does not include their own activities.

A carbon credit or offset, at its most basic level, is a reduction in or elimination of greenhouse gas (GHG) emissions that compensates for CO2 emitted elsewhere. The instruments do share two main characteristics. One tonne of carbon emissions is equal to one carbon credit or offset, and once acquired and CO2 is emitted, the credit is “retired” and cannot be sold or used again.

While the phrases “carbon credits” and “carbon offsets” are frequently used interchangeably, they relate to two separate products with two unique goals. Carbon credit refers to a reduction in GHGs released into the atmosphere, whereas carbon offset refers to the removal of GHGs from the atmosphere.

Consider a water source that has been contaminated by a neighboring chemical industry to help picture the difference. A “chemical offset” would entail removing chemicals from the water to aid in its purification. A “chemical credit” is paying another chemical firm to release fewer chemicals into the water while maintaining the same overall level of pollution. Is it as clear as mud? Great.

Let’s take a closer look at each of these products one by one. A fancy word for creating a carbon offset is “carbon sequestration.” Remember how a judge might order a jury to be sequestered, which means they must be isolated from the rest of the world. Carbon offsets function in the same way: CO2 emissions are lifted out of the atmosphere and locked away for a period of time.

Planting forests, blasting rock into tiny pieces, storing carbon in manufactured devices, trapping methane gas at a landfill, and the holy grail of carbon sequestration: using sophisticated technology to turn CO2 emissions into a consumable product are just a few of the methods being explored.

Independent firms create carbon offsets by removing CO2 emissions from the atmosphere. Companies that emit (or have emitted) CO2 are subsequently sold offsets. Offset-producing enterprises are, in a way, directly funded by GHG-emitting companies. The government, on the other hand, “creates” carbon credits in most cases. Governments impose a quota on the quantity of GHGs that businesses can emit, limiting them to a certain number of tons of CO2. Carbon credits are assigned to each of those tons.

Companies meet the cap by improving energy efficiency or switching to renewable energy sources to reduce the emissions produced in their operations. Businesses who are unable or unwilling to reduce their own emissions to become compliant can buy extra credits from an organization that reduces its overall emissions below what is needed by law.

It’s anyone’s guess whether international leaders will ever be able to reach an accord on a global scale. A group of unsung climate heroes is actually moving the needle in terms of motivating corporate behavior and leading to substantial carbon reductions.

The above graphic is from the Business Times. I think it gives a great crash course! A pic speaks a thousand words!

Check out my related post: How can companies go zero waste?

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