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What is Carbon Credit Trading?

By Charity Delich
Updated: May 16, 2024

Carbon credit trading offers a way for companies to reduce their overall carbon dioxide output in order to comply with pollution laws and regulations. In a typical carbon emissions trading scheme, companies buy or sell carbon credits. One ton of carbon is usually equivalent to one carbon credit. Collectively, the trading companies must adhere to an overall total carbon emissions limit. Carbon credit trading is also referred to as a cap and trade transaction, carbon emission trading, CO2 emissions trading, or simply emissions trading.

Carbon credit emissions trading occurs both nationally and internationally, and the limits and trading rules that apply to each emissions trade vary from country to country. Some countries promote voluntary emissions trading by offering tax credits or other incentives to companies that participate in the schemes. Other countries make carbon credit trading mandatory. For example, a number of countries have signed an international emissions trading agreement, known as the Kyoto Protocol, which makes carbon credit trading mandatory. Under the Kyoto Protocol, each participating country must adhere to certain caps on greenhouse gas emissions.

Other international carbon credit schemes also exist. A European emissions trading scheme, known as the European Union Emission Trading System (EU ETS), is one of the largest global carbon credit trading schemes. Under the EU ETS, companies that emit large amounts of carbon dioxide must oversee and report on their emissions levels. In addition, each year these companies must give the government an amount of emissions allowances equivalent to their total carbon emissions output.

Whether mandatory or voluntary, most carbon credit trading schemes work in a similar manner. Typically, companies are given a carbon emissions cap by a government agency or an international authority. If a company’s carbon output exceeds its total cap, the company can sell the excess to a company that has not reached its carbon credit limit. In essence, companies that emit too much carbon dioxide must pay for polluting the environment while companies that pollute less are financially rewarded. The policy behind this system is to require companies that have the ability to reduce their emissions to do so.

Carbon trading is one of the largest financial markets targeted at reducing greenhouse gas emissions. Other types of pollutants that can be traded on an emissions market include acid rain, methane, nitrous oxide, and hydrofluorocarbons. The goal of these emissions trade markets is ultimately to help reduce emissions growth while helping companies comply with pollution laws.

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Discussion Comments
By chicada — On Feb 25, 2011

@ Amphibious54- one of the biggest debates surrounding carbon markets has to do with the fraud factor. There is no central registry that monitors the transactions of RECs. This can open the door for multiple transactions of the same REC. This has been one of the biggest criticisms of the REC market.

Another major criticism is that the sale of green tags does not necessarily mean that more renewable energy will be produced. Some energy sources that can receive an REC are intermittent, so they do not actually reduce the number of coal and gas fired plants on line.

The REC market has gotten better. Now they are issued with unique identification numbers to make sure it is not double counted when it is issued.

By Georgesplane — On Feb 22, 2011

@ amphibious54- Green tags/RECs are different from cap-and-trade schemes. Green tags are certificates proving that a person has purchased power generated from renewable energy. These certificates help to pay for the higher cost of capitalization associated with renewable energy like wind and solar. A green tag is issued for every Mw of energy produced by a qualifying renewable energy utility.

The market for green tags can be voluntary, or compliance based. In compliance cases, companies and utilities buy green tags to act as carbon offsets to fulfill Renewable Portfolio Standards (RPS). In a voluntary market, consumers who simply want to support renewable energy buy green tags. Sometimes companies will use the purchase of green tags to boost their image with the public.

By Amphibious54 — On Feb 20, 2011

Are there any other carbon credit systems being discussed besides cap and trade? How is the cap-and-trade market monitored? Are green tags and RECs the same as carbon credits? How do you ensure that this theoretical credit has not been sold or traded multiple times? It seems like there is a lot of room for fraud in this system of trading green credits.

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