Carbon Credits

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Carbon Credits

Introduction

Carbon credits are financial abstractions, similar to money, that entitle their possessor to emit a certain amount of carbon dioxide (CO₂) or other greenhouse gases. They are created by governments and bought and sold on emissions trading markets. Participation by polluters in emissions trading markets may be voluntary, as with the Chicago Climate Exchange, or mandatory, as with the European Climate Exchange. The largest system of carbon credits and emissions trading was established by the Kyoto Protocol in 2005.

The term carbon credits is sometimes used interchangeably with the term carbon offsets, but the latter often refers to voluntary purchase by businesses or individuals of decreased CO₂ emissions in order to cancel out their own emissions (for example, paying a company to plant trees to cancel out the carbon released by one's air travel). Offsetting of this kind is not a tradable commodity but a one-time purchase made for reasons of conscience or public relations. It is discussed in the entry “Offsetting” in this set. In this article, only carbon credits that are a tradable commodity in a legally defined emissions trading system are discussed.

Historical Background and Scientific Foundations

In 1992, the United Nations Framework Convention on Climate Change (UNFCCC) committed all its signatories—-virtually every country in the world—to “formulate, implement, publish and regularly update national and, where appropriate, regional programmes containing measures to mitigate climate change by addressing anthropogenic emissions by sources and removals by sinks.” In 1997, to fulfill this earlier commitment, most countries signed the Kyoto Protocol to the UNFCCC.

The Kyoto Protocol defined targets for reduced greenhouse emissions from its industrialized signatories, namely, all the industrialized countries except the United States and Australia. Specifically, industrialized countries signing the protocol agreed to reduce their greenhouse emissions to 5.2% below 1990 levels by 2012. Countries could meet this goal either by actually reducing their emissions or by acquiring carbon credits that represented reductions elsewhere.

Kyoto provided three mechanisms by which signatories could obtain carbon credits: joint implementation, the Clean Development Mechanism, and emissions trading. Reductions or removals in one country can count as credits in another country that has paid or traded for them. These credits can be applied toward the receiving country's emission targets or quotas. For example, if a country is obliged under the protocol to emit no more than 1 million units of carbon but is actually emitting 1.1 million units, it can still meet its treaty obligation by obtaining 100,000 carbon credits through one or more of the following three mechanisms:

Joint implementation: Refers to implementation by a developed country of an emissions-reducing project or sink-enhancing project in another developed country. According to the United Nations, in practice, joint implementation means the building of emissions-reducing projects in countries formerly part of the Soviet Union, termed “transition economies,” using funds from Western European or other industrialized countries. Countries that sponsor projects that reduce emissions or increase uptake by carbon sinks receive credits—the more carbon is kept out of the atmosphere, the more credits are earned.
Clean Development Mechanism: Allows industrialized countries to earn carbon credits by funding projects in developing countries that either lower greenhouse emissions or enhance removals through sinks, particularly through increasing forests.

International emissions trading: Allows Kyoto signatory countries to buy and sell carbon credits internationally. In principle, a country that can keep a ton of carbon out of the atmosphere for less than the market price of a carbon credit can then sell its extra credits to countries for whom reducing emissions is more expensive than buying credits. In this way, emission reductions will happen where they are cheapest and all parties will benefit. The United States is the only industrialized country to have signed but not ratified (agreed formally to abide by) the Kyoto Protocol.

The Kyoto Protocol is an international cap-and-trade scheme. That is, it defines a limit on total emissions by the world's industrialized economies, then permits trade and transfer of carbon credits so that savings can happen where they are most profitable. The basic unit or tradable credit in all three of these mechanisms is the Kyoto Allocation Allowance Unit (or “unit”) and is equivalent to one metric ton (2,204 lb, 1,000 kg) of CO₂.

The word “equivalent” means that carbon credits do not necessarily stand only for emissions of CO₂. They may represent emissions of other gases, some containing carbon (e.g., methane, CH₄) and some not, such as nitrogen-oxygen compounds. Since CO₂ is the most important greenhouse gas, accounting for 63% of anthropogenic (human-caused) global warming, it is customary in climate science to translate emissions of non-CO₂ gases into the number of tons of CO₂ that would create an equal amount of global warming. For example, since methane is 21 times more powerful a greenhouse gas than CO₂, the right to emit 1/21 of a ton of methane would be marketed as a single carbon credit.

There are several different species of Kyoto carbon credits:

Assigned amount unit (AAU). Carbon credit issued to a polluter by an Annex I country from its treaty-assigned budget of credits. An AAU is, in effect, permission to emit one ton of carbon dioxide.
A removal unit (RMU). Carbon credit issued by an Annex I party for carbon reclaimed from the atmosphere, or not emitted to the atmosphere, by forestry and land-use practices. An operator who keeps one ton of greenhouse gas (carbon equivalent) out of the atmosphere through land use practices may, in effect, be issued the right to emit a ton of gas elsewhere.
Emission reduction unit (ERU). Carbon credit generated by a joint implementation project.
Certified emission reduction (CER). Carbon credit generated by an emissions-reduction project sponsored by an Annex I country in a non-Annex I country such as China.

The Kyoto Protocol is not the only legal setup for defining and trading carbon credits. The European Union and other groups of countries established smaller carbon markets before the protocol entered into force in February 2005. These systems were designed, however, to create regional markets that would link up with the global market defined by the protocol once it became operational, and so define their tradable carbon credits using Kyoto's terms. As of 2007, carbon credits were being traded on five European exchanges. On the European carbon market, the price of a carbon credit was, in mid-2007, around 20 euros (US$28).

After the ratification of the Kyoto Protocol by Russia in October 2004, the Kyoto-defined trade in carbon credits was forecast by investors in the financial industry to become one of the world's largest commodity markets, trading somewhere between $60 billion and $250 billion annually by 2008. By mid-2007, the market was still trading only $30 billion, but investment analysts were predicting that it could grow to as much as $1 trillion by 2017.

Impacts and Issues

The Kyoto Protocol has been criticized by most conservatives and libertarians as an ineffectual system for reducing greenhouse-gas emissions. Cap-and-trade schemes defining carbon credits as an international commodity, these critics say, are a form of top-down interference in markets and should be replaced by voluntary schemes that encourage, but do not require, reductions in emissions.

Carbon credits, as well as pollution credits of other kinds, have been criticized by environmentalists and political progressives as granting a right to pollute and so being essentially unethical. The Durban Declaration of 2004, signed by over 150 popular organizations, mostly from undeveloped nations in the global South, states that carbon trading “turns the Earth's recycling capacity into property to be bought or sold in a global market. Through this process of creating a new commodity— carbon—the Earth's ability and capacity to support a climate conducive to life and human societies is now passing into the same corporate hands that are destroying the climate” (quoted in Vallette et al., 2004).

WORDS TO KNOW

ANNEX I AND NON-ANNEX I COUNTRIES: Groups of countries defined by the United Nations Framework Convention on Climate Change (UNFCCC) of 1992. Annex I countries are industrialized countries who agreed, under the treaty, to reduce their greenhouse emissions. All non-Annex I countries were developing (poorer, less-industrialized) countries. Annex II countries were wealthy Annex I countries who agreed to help pay for greenhouse reductions by developing (poorer) countries.

ANTHROPOGENIC: Made by people or resulting from human activities. Usually used in the context of emissions that are produced as a result of human activities.

CAP AND TRADE: The practice, in pollution-control or climate-mitigation schemes, of mandating an upper limit or cap for the total amount of some substance to be emitted (e.g., CO₂) and then assigning allowances or credits to polluters that correspond to fixed shares of the total amount. These allowances or credits can then be bought and sold by polluters, in theory allowing emission cuts to be bought where they are most economically rational.

CARBON SINK: Any process or collection of processes that is removing more carbon from the atmosphere than it is emitting. A forest, for example, is a carbon sink if more carbon is accumulating in its soil, wood, and other biomass than is being released by fire, forestry, and decay. The opposite of a carbon sink is a carbon source.

CARBON TAX: Mandatory fee charged for the emission of a given quantity of CO₂ or some other greenhouse gas. Under a carbon taxation scheme, polluters who emit greenhouse gases must pay costs that are directly proportional to their emissions. The purpose of a carbon tax is to reduce greenhouse emissions. Carbon taxation is the main alternative to emissions trading.

EMISSIONS TRADING MARKET: System for trading in carbon credits, money-like units that entitle their owners to emit 1 ton of carbon dioxide or an equivalent amount of some other greenhouse gas. As of 2007, the most important emissions trading market was the European Union Emission Trading Scheme, with mandatory participation for large greenhouse polluters throughout the European Union (trading since 2005); in the United States, a smaller, voluntary market called the Chicago Climate Exchange (trading since 2003).

GREENHOUSE GASES: Gases that cause Earth to retain more thermal energy by absorbing infrared light emitted by Earth's surface. The most important greenhouse gases are water vapor, carbon dioxide, methane, nitrous oxide, and various artificial chemicals such as chlorofluorocarbons. All but the latter are naturally occurring, but human activity over the last several centuries has significantly increased the amounts of carbon dioxide, methane, and nitrous oxide in Earth's atmosphere, causing global warming and global climate change.

KYOTO PROTOCOL: Extension in 1997 of the 1992 United Nations Framework Convention on Climate Change (UNFCCC), an international treaty signed by almost all countries with the goal of mitigating climate change. The United States, as of early 2008, was the only industrialized country to have not ratified the Kyoto Protocol, which is due to be replaced by an improved and updated agreement starting in 2012.

Such critics urge that commodification through carbon credits should be replaced by what they term the “polluter pays principle,” whereby direct taxation or fines would be imposed on emitters in proportion to how much they emit. Carbon taxes are a form of polluter-pays system. Some environmentalists, as well as some fiscal conservatives, have accused the European carbon market and Kyoto global carbon market of being a scam that funnels profits to private investors without significantly reducing greenhouse emissions. These critics charge that emissions caps have been set so high that industries are not actually reducing their emissions significantly, if at all.

Primary Source Connection

In this press release, the Environment Secretary of the United Kingdom discusses a novel proposal under which each citizen of the U.K. would be issued personal carbon allowances. The goal of the plan is to reduce carbon emissions in the U.K. Individuals would have carbon credits deducted from their allowances for any activity that results in carbon emissions. People who exhaust their carbon allowance would be forced to buy credits from other individuals on an open market.

This text has been suppressed due to author restrictions.

BIBLIOGRAPHY

Periodicals

Chameides, William, and Michael Oppenheimer. “Carbon Trading Over Taxes.” Science 315 (2007): 1670.

Kanter, James. “Carbon Trading: Where Greed Is Green.” International Herald Tribune, June 20, 2007.

Web Sites

“Emission Impossible: Access to JI/CDM Credits in Phase II of the EU Emissions Trading Scheme.” World Wide Fund for Nature, UK, June 2007. < http://assets.panda.org/downloads/emission_impossible__final_.pdf> (accessed November 2, 2007).

“Emissions Trading.” United Nations Framework Convention on Climate Change Secretariat, June 22, 2007. < http://unfccc.int/kyoto_protocol/mechanisms/emissions_trading/items/2731.php> (accessed November 2, 2007).

Vallette, Jim, et al. “A Wrong Turn from Rio: The World Bank's Road to Climate Catastrophe.” Sustainable Energy and Economy Network, December 2004. < http://www.seen.org/PDFs/Wrong_turn_Rio.pdf> (accessed November 2, 2007).

Larry Gilman

Climate Change: In Context