Carbon credits are a key component of national and international attempts to mitigate

the growth in concentrations of greenhouse gases (GHGs). One Carbon Credit is equal to
one ton of Carbon. Carbon trading is an application of an emissions trading approach.
Greenhouse gas emissions are capped and then markets are used to allocate the emissions
among the group of regulated sources. The idea is to allow market mechanisms to drive
industrial and commercial processes in the direction of low emissions or less "carbon
intensive" approaches than are used when there is no cost to emitting carbon dioxide and
other GHGs into the atmosphere. Since GHG mitigation projects generate credits, this
approach can be used to finance carbon reduction schemes between trading partners and
around the world.

There are also many companies that sell carbon credits to commercial and individual
customers who are interested in lowering their carbon footprint on a voluntary basis.
These carbon offsetters purchase the credits from an investment fund or a carbon
development company that has aggregated the credits from individual projects. The
quality of the credits is based in part on the validation process and sophistication of the
fund or development company that acted as the sponsor to the carbon project. This is
reflected in their price; voluntary units typically have less value than the units sold
through the rigorously-validated Clean Development Mechanism[1].

There are two distinct types of Carbon Credits: Carbon Offset Credits (COC's) and
Carbon Reduction Credits (CRC's). Carbon Offset Credits consist of clean forms of
energy production, wind, solar, hydro and biofuels. Carbon Reduction Credits consists of
the collection and storage of Carbon from our atmosphere through biosequestration
(reforestation, forestation), ocean and soil collection and storage efforts. Both approaches
are recognized as effective ways to reduce the Global Carbon Emissions crises.

Contents
[hide]

• 1 Background
o 1.1 Emission allowances
o 1.2 Kyoto's 'Flexible mechanisms'
o 1.3 Emission markets
o 1.4 Setting a market price for carbon
• 2 How buying carbon credits can reduce emissions
o 2.1 Credits versus taxes
• 3 Creating Real Carbon Credits
o 3.1 Additionality and Its Importance
o 3.2 Criticisms
• 4 See also
• 5 References

• 6 External links
 [edit] Background
Burning of fossil fuels is a major source of industrial greenhouse gas emissions,
especially for power, cement, steel, textile, fertilizer and many other industries which rely
on fossil fuels (coal, electricity derived from coal, natural gas and oil). The major
greenhouse gases emitted by these industries are carbon dioxide, methane, nitrous oxide,
hydrofluorocarbons (HFCs), etc, all of which increase the atmosphere's ability to trap
infrared energy and thus affect the climate.

The concept of carbon credits came into existence as a result of increasing awareness of
the need for controlling emissions. The IPCC (Intergovernmental Panel on Climate
Change) has observed[2] that:

Policies that provide a real or implicit price of carbon could create incentives for producers and
consumers to significantly invest in low-GHG products, technologies and processes. Such
policies could include economic instruments, government funding and regulation,

while noting that a tradable permit system is one of the policy instruments that has been
shown to be environmentally effective in the industrial sector, as long as there are
reasonable levels of predictability over the initial allocation mechanism and long-term
price.

The mechanism was formalized in the Kyoto Protocol, an international agreement

[edit] Emission allowances

The Protocol agreed 'caps' or quotas on the maximum amount of Greenhouse gases for
developed and developing countries, listed in its Annex I [3]. In turn these countries set
quotas on the emissions of installations run by local business and other organizations,
generically termed 'operators'. Countries manage this through their own national
'registries', which are required to be validated and monitored for compliance by the
UNFCCC[4]. Each operator has an allowance of credits, where each unit gives the owner
the right to emit one metric tonne of carbon dioxide or other equivalent greenhouse gas.
Operators that have not used up their quotas can sell their unused allowances as carbon
credits, while businesses that are about to exceed their quotas can buy the extra
allowances as credits, privately or on the open market. As demand for energy grows over
time, the total emissions must still stay within the cap, but it allows industry some
flexibility and predictability in its planning to accommodate this.

By permitting allowances to be bought and sold, an operator can seek out the most cost-
effective way of reducing its emissions, either by investing in 'cleaner' machinery and
practices or by purchasing emissions from another operator who already has excess
'capacity'.
Since 2005, the Kyoto mechanism has been adopted for CO2 trading by all the countries
within the European Union under its European Trading Scheme (EU ETS) with the
European Commission as its validating authority[5]. From 2008, EU participants must link
with the other developed countries who ratified Annex I of the protocol, and trade the six
most significant anthropogenic greenhouse gases. In the United States, which has not
ratified Kyoto, and Australia, whose ratification came into force in March 2008, similar
schemes are being considered.

For trading purposes, one allowance or CER is considered equivalent to one metric tonne
of CO2 emissions. These allowances can be sold privately or in the international market at
the prevailing market price. These trade and settle internationally and hence allow
allowances to be transferred between countries. Each international transfer is validated by
the UNFCCC. Each transfer of ownership within the European Union is additionally
validated by the European Commission.

Climate exchanges have been established to provide a spot market in allowances, as well
as futures and options market to help discover a market price and maintain liquidity.
Carbon prices are normally quoted in Euros per tonne of carbon dioxide or its equivalent
(CO2e). Other greenhouse gasses can also be traded, but are quoted as standard multiples
of carbon dioxide with respect to their global warming potential. These features reduce
the quota's financial impact on business, while ensuring that the quotas are met at a
national and international level.

Currently there are five exchanges trading in carbon allowances: the Chicago Climate
Exchange, European Climate Exchange, Nord Pool, PowerNext and the European Energy
Exchange. Recently, NordPool listed a contract to trade offsets generated by a CDM
carbon project called Certified Emission Reductions (CERs). Many companies now
engage in emissions abatement, offsetting, and sequestration programs to generate credits
that can be sold on one of the exchanges. At least oneprivate electronic market has been
established in 2008: CantorCO2e[7].

Managing emissions is one of the fastest-growing segments in financial services in the

[edit] Setting a market price for carbon

This section includes a list of references, related reading or external links, but its
sources remain unclear