What Are Carbon Credits?

What Are Carbon Credits?

Let me explain carbon credits directly to you: they are permits that let the owner emit a specific amount of carbon dioxide or other greenhouse gases (GHGs). Each credit permits one ton of carbon dioxide or the equivalent in other GHGs.

The main purpose of this system is to cut down on GHG emissions into the atmosphere.

Key Takeaways

I want you to grasp these essentials: carbon credits were created to lower greenhouse gas emissions. Companies get a decreasing number of credits over time and can sell extras to others. This setup gives companies a financial reason to reduce emissions. It's based on the cap-and-trade model that cut sulfur pollution in the 1990s. At the Glasgow COP26 summit in November 2021, negotiators agreed to a global carbon credit offset trading market.

How Do Carbon Credits Work?

Here's how it operates: the United Nations assigns credits to countries, and each country handles issuing, monitoring, and annual reporting. Governments permit companies to emit a certain amount of GHGs before they must buy credits.

If emissions go over limits, companies have to purchase credits. If they buy too many, they can sell the excess on a carbon exchange or marketplace. This is known as a cap-and-trade program.

U.S. Carbon Credits

In the U.S., cap-and-trade programs are controversial, but 13 states have adopted them to reduce GHGs, according to the Center for Climate and Energy Solutions. Eleven Northeast states formed the Regional Greenhouse Gas Initiative (RGGI) to tackle this together.

California’s Cap-and-Trade Program

California started its cap-and-trade in 2013, applying to large power plants, industrial facilities, and fuel distributors. The state says it's the fourth largest program globally, after the EU, South Korea, and China.

Important Aspects of Cap-and-Trade

People sometimes call cap-and-trade a market system because it assigns exchange value to emissions. Supporters say it pushes companies to invest in cleaner tech to dodge rising permit costs. Critics claim it creates too many credits since caps are set years ahead, and companies reduce emissions faster than expected, then treat credits as profit tools.

The U.S. Clean Air Act

The U.S. has regulated emissions since the 1990 Clean Air Act, which was the world's first cap-and-trade program, though it uses 'allowances' instead of 'caps.' The Environmental Defense Fund credits it with slashing sulfur dioxide from coal plants, ending the 1980s acid rain issue.

The Inflation Reduction Act

Signed into law on August 16, 2022, the Inflation Reduction Act targets deficit reduction, inflation control, and carbon emission cuts. It focuses heavily on environmental cleanup, rewarding companies that store GHGs underground or reuse them in products. Tax credits rose from $50 to $85 per metric ton for stored carbon and from $35 to $60 for reused carbon in manufacturing or oil recovery.

These boosted credits aim to draw more investment into carbon capture. The old 45Q incentive was criticized for only supporting easy projects.

Who Can Sell Carbon Credits?

Only businesses and governments can sell or buy carbon credits. But carbon offsets are available on the voluntary market, where emission reduction projects sell non-regulatory credits that anyone can buy.

Fast Fact on Carbon Credits and Offsets

Governments sell carbon credits to businesses, which can resell them on regulated markets. Carbon offsets come from voluntary markets, sold by organizations, projects, or individuals to fund green initiatives. Various entities, like landowners in reforestation or carbon removal projects, can sell offsets if they join a registry and use funds for operations.

Why Companies Buy Carbon Credits

Companies buy credits to legally emit more GHGs. They also get offsets for 'net-zero' status. With the climate crisis pressing, there's increasing pressure for net-zero pledges to cut or offset emissions across operations.

Some companies reduce emissions via business changes, but many can't eliminate them entirely. Offsets fund activities like tree planting or conservation instead.

Worldwide Carbon Credit Initiatives

The UN's IPCC proposed carbon credits in the 1997 Kyoto Protocol to cut global emissions, setting binding targets. The Marrakesh Accords detailed the rules. It split countries into industrialized (Annex 1) and developing. Annex 1 traded in their market, selling surplus via Emissions Reduction Purchase Agreements. Developing countries got Certified Emission Reductions (CERs) for sustainable projects, traded separately. The first period ended in 2012; the U.S. left in 2001.

The Paris Climate Agreement

The Kyoto was revised in 2012's Doha Amendment, ratified by 148 nations by June 2022. Over 190 countries signed the 2015 Paris Agreement for emission standards and trading. The U.S. exited in 2017 under Trump, rejoined in 2021 under Biden, and exited again in 2025 under Trump.

Fast Fact on the Paris Agreement

The Paris Agreement aims to cut GHGs and limit temperature rise to under 2 degrees Celsius above preindustrial levels by 2100.

The Glasgow COP26 Climate Change Summit

At the 2021 summit, nearly 200 countries activated Paris Agreement Article 6, letting nations buy offset credits for emission reductions elsewhere. This should boost investments in forest protection and renewable tech. Brazil plans to be a big trader, as its negotiator said it would spur projects for major reductions. Other rules include no tax on bilateral trades, canceling 2% of credits, and 5% of revenues to an adaptation fund for developing countries. Credits from 2013 were carried over, adding 320 million to the market.

Who Gets Carbon Credit Money?

When companies sell government-issued carbon credits on the market, the money goes to the selling company. For offsets, funds go to the sponsoring project or entity, representing one ton of emissions offset by their work.

Are Carbon Credits Good or Bad?

The regulated carbon credit program is a solid way to push businesses to lower emissions. Voluntary offsets are fine for countering emissions but not for reducing them directly, which is good but not perfect.

How Much Is a Carbon Credit Worth?

Prices vary by time, location, regulations, policy, and demand. BloombergNEF projected 2024 averages of $42 per metric ton in California and $76 in Europe.

The Bottom Line

Carbon credits reduce GHG emissions by creating a trading market for permits. Companies get declining credits and can sell extras. This incentivizes emission cuts; those who can't pay more to operate. Supporters say it delivers real reductions. It also drives carbon accounting for measuring impacts by companies, governments, and individuals.