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Carbon Credit – Definition

Carbon Credit Definition

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.

A Little More on What are Carbon Credits

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 company’s 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.

References for Carbon Credits

Academic Research on Carbon Credits

  • The potential of urban tree plantings to be cost effective in carbon credit markets, McHale, M. R., McPherson, E. G., & Burke, I. C. (2007). Urban Forestry & Urban Greening, 6(1), 49-60. The study compares the cost efficiency of four case studies situated in Colorado and uses a sensitivity analysis model to find out the variables that have the largest influences on cost effectiveness. The study concludes that some urban tree plantation in some specific locations may be proved to be a cost effective. The results of the analysis suggest the carbon assimilation rate influences the cost effectiveness most strongly. However, more effective projects can be created by altering the other variables, planting large-stature trees and minimizing costs.


  • Carbon credit for hydroelectric dams as a source of greenhouse-gas emissions: The example of Brazil’s Teles Pires Dam, Fearnside, P. M. (2013). Mitigation and Adaptation Strategies for Global Change, 18(5), 691-699. The paper argues for the reformation of Clean Development Mechanism regulations by eliminating credit for hydroelectric dams. It provides an example of the under construction Teles Pires Dam of Brazil to support its argument. Under the Kyoto Protocol, the carbon hydroelectric dams are granted carbon credits on the assumption that the dams would not be constructed without CDM funding and the dams would have minimal emission over the 7-10 years duration of the project. The paper claims both assumptions to be false, especially in the case of tropical dams.
  • Managing carbon footprints in inventory management, Hua, G., Cheng, T. C. E., & Wang, S. (2011). International Journal of Production Economics, 132(2), 178-185. This paper analytically and numerically examines the impact of carbon trading mechanism on the order decisions, carbon emissions and total cost of a firm. Carbon trade, carbon price, and carbon cap are taken into consideration while making the investigation. It provides managerial insights from the analytical results and makes some interesting observations.
  • Carbon credit and emission trading: Anaerobic wastewater treatment, Show, K. Y., & Lee, D. J. (2008). Journal of the Chinese Institute of Chemical Engineers, 39(6), 557-562. The paper discusses a scenario of reducing greenhouse gas emission based on methane recovery and utilization project. It provides an example analysis on reducing the emission of GHG and briefly discusses the future trend


  • Carbon trading, climate justice and the production of ignorance: ten examples, Lohmann, L. (2008). Carbon trading, climate justice and the production of ignorance: ten examples. Development, 51(3), 359-365. The paper outlines ten processes of production of ignorance by the new carbon markets. It specifically focuses on the Kyoto Protocol and the European Union Emissions Trading Scheme. The paper seeks an answer to the question that, once the climate justice is incorporated into a development and carbon market framework what would be the quest for it?
  • A new initiative to use carbon trading for tropical forest conservation, Laurance, W. F. (2007). Biotropica, 39(1), 20-24. The paper discusses a new initiative for formulating a viable carbon trading mechanism for protecting old-growth tropical forests. The initiative described in the article is led by a coalition of developing economies. The paper explains the reasons for the wide political acceptance of this initiative and presents some practical and political hurdles involved in forest carbon trading.
  • Neoliberalism and the calculable world: The rise of carbon trading, Lohmann, L. (2009). Upsetting the offset: the political economy of carbon markets, 25-40. The paper discusses the political economy of carbon markets in the neoliberal economic system. It criticizes the neoliberal market policies and discusses the rise of carbon trading.
  • Systems for carbon trading: an overview, Hasselknippe, H. (2003). Climate Policy, 3(sup2), S43-S57. Regional, national and international carbon trading systems are discussed in the paper. It provides a full overview of all existing trading schemes and proposals and aims at serving as a platform for further discussions on the development of the international carbon trading market. It carries out a comparative study on several design criteria to reach conclusions regarding the level of harmonization of these systems and to identify the convergence or divergence of important operational features.
  • The carbon consequences of thinning techniques: stand structure makes a difference, Hoover, C., & Stout, S. (2007). Journal of Forestry, 105(5), 266-270. This paper uses the results from a 25-year study of thinning in a northwestern Pennsylvania Allegheny hardwood stand to asses the impact of the thinning method on the carbon sequestration and merchantable volume production. The study observes plots were thinned to similar residual relative density by removing trees from different portions of the diameter distribution. The plots with a greater amount of production and carbon sequestration were thinned from below and the plots with lesser production and carbon sequestration were thinned from above of middle.

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