Carbon Credit - Explained
What is a Carbon Credit?
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Table of ContentsWhat is a Carbon Credit?How are Carbon Credits Used?
What is a Carbon Credit?
Corporations, individuals and countries need certificates or permits for emitting Greenhouse Gases including carbon dioxide. These certificates are referred to as the Carbon credits. The Greenhouse Gas Emission is measured in tonnes of carbon. The tonnes of carbon are audited and recorded in the carbon project register. The emission of one tonne of carbon dioxide or equivalent amount of other greenhouse gases is equal to 1 carbon credit. The system of issuing carbon credits was started to limit the emission of harmful greenhouse gases.
How are Carbon Credits Used?
Greenhouse gases are mainly produced by burning fossil fuels. Industries like cement, steel, power, textile fertilizer and many others use fossil fuels as the source of power and emit the greenhouse gases in the environment. The major greenhouse gases include carbon dioxide, methane, nitrous oxide, hydrofluorocarbons etc. All these gases lead to the increase of the ability to trap infrared energy by the atmosphere and adversely affect the environment. Towards the end of the 20th-century concern over climate change and global warming due to the emission of the greenhouse gases increased in many parts of the world. The mechanism of the carbon credit system was thus formulated to reduce the emission of such gases and its impact on the atmosphere. More than 170 countries signed an agreement under the Kyoto Protocol to formalize the mechanism. It was followed by the Marrakesh Accords for the agreement on market mechanisms. The mechanism took the successful US Acid Rain Program as the model for reducing industrial pollutants. Under the carbon credit policy, the purchaser is allowed to burn a specified amount of fossil fuel (hydrocarbon fuel) over a specific period of time against the acquired carbon credit. In the carbon credit system, the greenhouse gas emissions are converted to carbon dioxide equivalent unit to measure the volume. The heating potential of carbon dioxide is 1, compared to this, the heating potential of nitrous oxide is calculated as 310. The heating potential of different greenhouse gases are as follows-
- Carbon Dioxide = 1
- Methane = 21
- Nitrous oxide = 310
- Hydrofluorocarbons = 140 ~ 11700
- Perfluorocarbons = 6500 ~ 9200
- Sulfur hexafluoride = 23900
The emitter needs to purchase 310 carbon credits (per ton) to compensate for nitrous oxide heating potential. The Kyoto Protocol categorizes the countries into two sections: industrialized and developing economy. The industrialized countries are listed under Annex 1. These countries operate in an emission trading market. The caps or quotas for Greenhouse gases for these countries are referred to as Assigned amounts. Each of these countries has its own emission standards to meet. The system that specifies the limit of emitted greenhouse gases in a year by an organization is known as Cap-and-trade. If a country does not use all its carbon credits and emits less than the quota, it may sell the surplus credit to the countries that fail to achieve their Kyoto level goals. This transaction can be done through the Emission Reduction Purchase Agreement (ERPA). The policy for the developing economies is different under the protocol. The Clean Development Mechanism (CDM) issues carbon credits known as Certified Emission Reduction (CER). The trading of CER is done is a separate market. The developing nations are allowed to receive CER for supporting their sustainable development initiatives. The policy of carbon credits allocates a monetary value to the cost of polluting the environment. It is mentioned on the companys balance sheet along with other expenses. Suppose a factory situated in an industrialized nation emits 200,000 tonnes of greenhouse gas in a year and the law of the country limits the emissions that the company can produce in a year. If the permissible cap is 150,000 tonnes then either the company needs to reduce the emission to 150,000 tonnes in a year or they need to purchase carbon credits to cover the excess amount. If the company thinks investing in new machinery for reducing emission is uneconomical, they may buy the carbon credits.