A carbon credit or carbon offset is a financial instrument. It's part of a market-based approach to carbon management. There are two common approaches to carbon trading, cap-and-trade and offset trading.
In a cap-and-trade system, every emitter of carbon is assigned a limit or cap on the amount of carbon that can be released. If you emit less than your limit, you receive a credit. If you emit more, you must reduce your emissions, or buy a credit from someone who already emits less.
One carbon offset represents a reduction of one tonne (metric ton) of carbon dioxide or its equivalent in other greenhouse gasses.
While the creation and verification of carbon offsets can be a complex process, the principle is straightforward.
When something is produced and less CO2 or greenhouse gasses are emitted than would be allowed, there is an opportunity to create a carbon credit.
For example:
- wind and solar power create electricity but emit less CO2 than, say, a coal-fired generator. Thus a business that generates wind or solar power also produces a carbon credit; or
- a manufacturing company invests in a new production process that reduces greenhouse gas emissions, possibly bringing the company's emissions below its limit ("cap"). This creates carbon credits that the company can sell to help recover their investment; or
- a company or individual plants trees to reforest an area. Since trees capture and store CO2 as they grow, this creates carbon credits that the company can sell to help recover their investment.
There are two main markets for carbon credits.
The Compliance Market
The majority of carbon offsets are bought and sold in a "compliance" market. A company may buy carbon credits to help meet limits or "cap" on the total amount of carbon dioxide they emit.
The Voluntary Market
The "voluntary" market is smaller than the compliance market. Individuals, companies, and even governments buy carbon credits to offset greenhouse gas emissions that they do not create directly.
- voluntary carbon credits are often used to offset the greenhouse gas emissions created by individual or business-related air travel; or
- companies might buy carbon offsets to compensate for the CO2 emitted when the electricity they use in their business is generated.
Both the compliance and voluntary markets for carbon offsets are growing.
In 2006, the last year for which verifiable numbers are available, about $5.5 billion of carbon offsets were purchased in the compliance market, representing about 1.6 billion metric tons of CO2 and greenhouse gas reductions.
In 2008, the voluntary market saw about $705 million of carbon offset sales, representing 123.4 million metric tons of CO2 and equivalent gasses.
Like a barrel of oil or a bushel of grain, the price of a carbon credit fluctuates based on different factors.
The major influences on the value of carbon credits include:
- taxes levied on carbon and greenhouse gas emissions;
- penalties charged on those who exceed their assigned emissions targets;
- the cost of meeting emissions targets, and
- the supply of and demand for carbon credits.
Like many countries, Canada does not have a CO2 tax and is establishing policies to deal with carbon credits. If present trends continue, it seems likely that carbon credits will be a growing currency in the future.