What are carbon credits and how do they work?
Carbon credits are a key component of national and international emissions trading schemes that have been implemented to mitigate global warming. They provide a way to reduce greenhouse effect emissions on an industrial scale by capping total annual emissions and letting the market assign a monetary value to any shortfall through trading. Credits can be exchanged between businesses or bought and sold in international markets at the prevailing market price. Credits 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.
A 'carbon credit', sometimes referred to as an offset, is a permit to emit a specified amount of greenhouse gases, usually expressed in metric tonnes of carbon dioxide equivalent (CO2e). 'Carbon credits' are named after the most prominent greenhouse gas, carbon dioxide, but can represent other warming gases.
Credits can be allocated by a government as part of a plan that sets a limit on the total amount of CO2 that may be emitted in that jurisdiction, in what generally referred to as a cap-and-trade system. Companies may be awarded a number of permits, and must emit only as much GHG for which they have permits. Carbon credits can be earned through projects that reduce emissions, or by companies that cut their own emissions and thereby free up credits they possess for trading. Carbon markets exist wherein which companies may purchase and sell credits.