Carbon Credits

CARBON CREDITS

Carbon credits are a tradable permit scheme. They provide a way to reduce greenhouse gas emissions by giving them a monetary value. A credit gives the owner the right to emit one tonne of carbon dioxide. Carbon credits are generated as the result of an additional carbon project. A credit can be an emissions allowance which is allocated or auctioned by the administrators of a cap-and-trade program or an offset of Greenhouse Gas equivalent carbon dioxide emissions. An allowance, such as an European Union Allowance (EUA) generally has more value than an offset such as a Certified Emissions Reduction (CER). This is due to the lack of a developed secondary market for CERs, as well as due to the principle of supplementarity. An offset generated by a carbon project under Clean Development Mechanism (CDM) or Joint Implementation (JI) is limited in value by the fact that regulated entities in the EU ETS are limited as to what percentage of compliance can be accomplished via these flexible mechanisms.
International treaties such as the Kyoto Protocol set quotas on the amount of greenhouse gases countries can produce. Countries, in turn, set quotas on the emissions of businesses. Businesses that are over their quotas must buy carbon credits for their excess emissions, while businesses that are below their quotas can sell their remaining credits. By allowing credits to be bought and sold, a business for which reducing its emissions would be expensive or prohibitive can pay another business to make the reduction for it. This minimizes the quota's impact on the business, while still reaching the quota.
Credits can be exchanged between businesses or bought and sold in international markets at the prevailing market price.
There are many companies that sell carbon credits to commercial and individual customers who are interested in lowering their carbon footprint. These offset marketers 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 are based in part on the sophistication of the fund or development company that acted as the carbon project sponsor.
Background
In addition to the burning of fossil fuels, major industry sources of greenhouse gas emissions are cement, steel, textile, and fertilizer manufacturers. The main gases emitted by these industries are methane, nitrous oxide, hydrofluorocarbons (HFCs), etc, which increase the atmosphere's ability to trap infrared energy.
The concept of carbon credits came into existence as a result of increasing awareness of the need for pollution control. It was formalized in the Kyoto Protocol, an international agreement between 169 countries. Carbon credits are certificates awarded to countries that are successful in reducing emissions of greenhouse gases.
For trading purposes, one credit is considered equivalent to one tonne of CO2 emissions. Such a credit can be sold in the international market at the prevailing market price. There are at least four exchanges for carbon credits: the Chicago Climate Exchange, European Climate Exchange, NordPool, and PowerNext. Other companies, such as Green Horizons engage in reforestation programs to generate credits.
The Kyoto Protocol provides for three mechanisms that enable developed countries with quantified emission limitation and reduction commitments to acquire greenhouse gas reduction credits. These mechanisms are Joint Implementation (JI), Clean Development Mechanism (CDM) and International Emission Trading (IET). Recently, NordPool listed a contract to trade offsets generated by a CDM carbon project called Certified Emission Reductions (CERs).
Under JI, a developed country with relatively high costs of domestic greenhouse reduction would set up a project in another developed country that has a relatively low cost. Under CDM, a developed country can take up a greenhouse gas reduction project activity in a developing country where the cost of greenhouse gas reduction project activities is usually much lower. The developed country would be given credits for meeting its emission reduction targets, while the developing country would receive the capital and clean technology to implement the project. Under IET, countries can trade in the international carbon credit market. Countries with surplus credits can sell them to countries with quantified emission limitation and reduction commitments under the Kyoto Protocol.

How buying carbon credits attempts to reduce emissions
Carbon credits create a market for reducing greenhouse emissions by giving a monetary value to the cost of polluting the air. This means that carbon becomes a cost of business and is seen like other inputs such as raw materials or labor.
By way of example, assume a factory produces 100,000 tonnes of greenhouse emissions in a year. The government then enacts a law that limits the maximum emissions a business can have. So the factory is given a quota of say 80,000 tonnes. The factory either reduces its emissions to 80,000 tonnes or is required to purchase carbon credits to offset the excess.
A business would buy the carbon credits on an open market from organizations that have been approved as being able to sell legitimate carbon credits. One seller might be a company that will plant so many trees for every carbon credit you buy from them. So, for this factory it might pollute a tonne, but is essentially now paying another group to go out and plant trees which will, say, draw a tonne of carbon dioxide from the atmosphere.
As emission levels are predicted to keep rising over time, it is envisioned that the number of companies wanting/needing to buy more credits will increase, which will push the market price up and encourage more groups to undertake environmentally friendly activities that create for them carbon credits to sell. Another model is that companies that use below their quota can sell their excess as 'carbon credits.' The possibilities are endless hence making it an open market.
Managing emissions is one of the fastest-growing segments in financial services in the City of London's financial district with a market now worth about $30 billion, but which could grow to $1 trillion within a decade. Louis Redshaw, a former trader at Enron and now head of environmental markets at Barclays Capital predicts that "Carbon will be the world's biggest commodity market, and it could become the world's biggest market overall." [1]
Creating Real Carbon Credits
The Kyoto Protocol established the Clean Development Mechanism as a Flexible Mechanism by which capped entities could develop real, measurable, permanent emissions reductions voluntarily in sectors outside the cap. Criticisms of carbon credits stem from the fact that establishing that an emission of CO2 equivalent GHG has indeed been reduced involves a complex process. This process has been established in a learning by doing manner as the concept of a carbon project has been refined over the past 10 years.
The first step in determining whether or not a carbon project has legitimately lead to the reduction of real, measurable, permanent emissions is understanding the CDM methodology process. This is the process by which project participants submit, through a Designated Operational Entity (DOE) their concepts for emissions reduction creation. The Clean Development Mechanism Executive Board (CDM EB), along with the CDM Methodology Panel decide which environmental proofs do indeed result in reductions that are additional.
Additionality and Its Importance
It is also important for any carbon credit (offset) to prove a concept called additionality. Additionality is a term used by Kyoto's Clean Development Mechanism to describe the fact that a carbon dioxide reduction project (carbon project) would not have occurred had it not been for concern for the mitigation of climate change. More succinctly, a project that has proven additionality is a beyond business as usual project.
It is generally agreed that voluntary carbon offset projects must also prove additionality in order to ensure the legitimacy of the environmental stewardship claims resulting from the retirement of the carbon credit (offset). According the World Resources Institute/World Business Council for Sustainable Development (WRI/WBCSD) : "GHG emission trading programs operate by capping the emissions of a fixed number of individual facilities or sources. Under these programs, tradable 'offset credits' are issued for project-based GHG reductions that occur at sources not covered by the program. Each offset credit allows facilities whose emissions are capped to emit more, in direct proportion to the GHG reductions represented by the credit. The idea is to achieve a zero net increase in GHG emissions, because each tonne of increased emissions is 'offset' by project-based GHG reductions. The difficulty is that many projects that reduce GHG emissions (relative to historical levels) would happen regardless of the existence of a GHG program and without any concern for climate change mitigation. If a project 'would have happened anyway,' then issuing offset credits for its GHG reductions will actually allow a positive net increase in GHG emissions, undermining the emissions target of the GHG program. Additionality is thus critical to the success and integrity of GHG programs that recognize project-based GHG reductions."
EXAMPLES:
Carbon Credits - Wealth Creator for Eco-friendly Indian Companies
It is estimated that 60-70% of Green House Gases (like hydro fluorocarbons, methane and nitrous oxide) emission is through fuel combustion in industries like cement, steel, textiles and fertilizers. They are released as by-products of certain industrial process, which adversely affect the ozone layer, leading to global warming. Carbon credits seek to reduce these emissions by giving them a monetary value. One credit gives the owner the right to emit one ton of carbon dioxide. Such a credit can be sold in the international market at the prevailing market price. This means that carbon becomes a cost of business and is seen like other inputs such as raw materials or labor.
International treaties have set quotas on the amount of GHG countries can produce, which in turn set quotas for businesses. Businesses that are over their quotas must buy carbon credits for excess emissions, while those below can sell their remaining credits. The ones who are selling are companies that use clean technology and those buying are the world’s polluters. These credits can be exchanged between businesses or bought and sold in international markets at prevailing market price at two exchanges, namely the Chicago Climate Exchange and the European Climate Exchange. The Multi-Commodity Exchange of India (MCX) may soon become the third exchange in the world to trade in carbon credits.
As emission levels increase globally, the number of companies wanting/needing to buy more credits will increase, pushing up the market price and encouraging businesses to undertake eco-friendly activities that create for them carbon credits to sell. Developed countries have to spend nearly $300-500 for every ton reduction in CO2, against $10-$25 by developing countries. India’s GHG emission is below the target and so, it is entitled to sell surplus credits to developed countries. India is considered to claim about 31% of the total world carbon trade, which can give $25bn by 2010. This is what makes trading in carbon credits such a great business opportunity. Foreign companies which cannot fulfill the norms can buy the surplus credit from companies in other countries. Many Indian companies have been re-rated on the stock markets on the basis of the bonanza that will accrue to them when carbon trading kicks off. SRF Ltd and Shell Trading International have entered into sale and purchase Credit Emission Reduction. Suzlon Energy and Shriram EPC have business in wind energy which is eligible for carbon credit benefits. Shree Renuka Sugars is also expected to benefit from carbon credits. Gujarat Flourochemicals was among the early companies to register for Clean Development Mechanism (CDM) project.
India has emerged as the dark horse in this race as more than 200 Indian entities have applied for registering their CDM Project for availing carbon credits. Currently, one carbon credit is worht 13 euros. Indian companies can have higher incomes more from carbon credits than their core business. The carbon credit market was worht $25 billion last year and is growing at tremendous space, and there is a demand to reduce 1 billion ton of carbon emissions in the world, so that threats like global warming could be dealt with.
Indian companies are fast realizing there’s money to be made by becoming eco-friendly. With new core sector projects like power and steel coming up in India, the carbon credit market will rise once again. The 800 million farming community in India has also a unique opportunity where they can sell Carbon Credits to developed nations.