What’s That: Carbon Credits

By Published On: July 10, 2024Categories: Daily Market News & Insights, What Is It Wednesday

As more and more organizations shift focus toward sustainable practices, the need for innovative solutions to reduce greenhouse gas (GHG) emissions has become increasingly urgent. Carbon credits, a relatively recent financial instrument, have emerged as a powerful tool in the global effort to mitigate the impact of carbon dioxide (CO2) and other GHGs. Today’s What’s That Wednesday aims to explain what carbon credits are, their origins, uses, benefits, and the challenges they present.

 

What Are Carbon Credits?

A carbon credit, sometimes referred to as an offset, represents a permit or certificate allowing the holder to emit a specific amount of carbon dioxide or equivalent GHGs. Typically, one carbon credit equals one metric ton of CO2. These credits are part of a market-based approach to controlling pollution by providing economic incentives for achieving reductions in the emissions of pollutants.

There are two primary types of carbon markets:

Compliance Markets: These are regulated by mandatory national, regional, or international carbon reduction regimes. Entities such as governments or companies must comply with legally binding emission reduction targets.

Voluntary Markets: These markets operate outside of the compliance framework, allowing companies, governments, or individuals to purchase carbon credits voluntarily to offset their emissions.

 

The Origins of Carbon Credits

The concept of carbon credits originated from the Kyoto Protocol, an international treaty adopted in 1997 and enforced in 2005. The Kyoto Protocol aimed to reduce GHG emissions and introduced mechanisms like Emissions Trading, the Clean Development Mechanism (CDM), and Joint Implementation (JI). These mechanisms laid the foundation for the carbon credit market.

Emissions Trading (Cap-and-Trade): Countries or companies have a cap on emissions and can trade excess allowances.

Clean Development Mechanism (CDM): This mechanism allows a country with an emission-reduction or emission-limitation commitment under the Kyoto Protocol to implement an emission-reduction project in developing countries.

Joint Implementation (JI): Joint implementation allows a country with an emission reduction commitment to earn emission reduction units from an emission-reduction or emission removal project in another country.

 

 

Uses of Carbon Credits

Carbon credits serve several purposes, including environmental compliance, emissions offsetting, and incentivizing green projects. Governments and regulatory bodies can establish a “cap,” or limit, on the total amount of emissions allowed within a specific sector or region. An example of this mechanism active in the U.S. today is the California Cap-and-Trade program. Organizations bound by emissions caps can use compliance carbon credits to meet their legal requirements. Companies that emit less than their allotted cap can trade or sell their surplus credits to entities exceeding their limit. This creates a financial incentive for companies to reduce emissions and fosters a market that helps subsidize high-cost carbon mitigation projects.

Companies and individuals can also purchase voluntary carbon credits to offset their own carbon footprints. One example of how Mansfield has used carbon credits was in support of our recent Sustainability Summit. The event was focused on networking with other companies from various industries to discuss the future of our collective sustainability efforts. Given the purpose of the gathering was for the overall benefit of reducing emissions and promoting sustainable practices within the fuel industry, Mansfield purchased voluntary carbon credits, investing in removal, conservation, and reduction projects to mitigate the attendee’s travel emissions.

 

Benefits of Carbon Credits

Carbon credits encourage the reduction of GHG emissions, contributing to global efforts to combat climate change. Projects funded by carbon credits often provide additional environmental benefits, such as biodiversity conservation and improved air and water quality. The carbon credit market creates economic opportunities, boosting innovation and investment in green technologies and projects.

For businesses, purchasing carbon credits can be part of a broader strategy to demonstrate their commitment to sustainability and corporate social responsibility (CSR). Demonstrating commitment through investments can not only bolster the public image but also meet the growing consumer and investor demand for sustainable practices. Carbon credits also offer flexibility to entities bound by emissions regulations, allowing them to choose the most cost-effective way to meet their obligations via reduction and/or offsetting initiatives.

 

Challenges of Carbon Credits

The carbon credit market can be highly volatile, with prices fluctuating based on supply and demand dynamics, regulatory changes, and economic conditions. This volatility can create uncertainty for investors and project developers.

Ensuring the integrity of carbon credits is a challenge that requires significant due diligence. Robust verification and certification processes are essential to creating and maintaining a climate-forward system.

 

This article is part of Daily Market News & Insights

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The information contained herein is derived from sources believed to be reliable; however, this information is not guaranteed as to its accuracy or completeness. Furthermore, no responsibility is assumed for use of this material and no express or implied warranties or guarantees are made. This material and any view or comment expressed herein are provided for informational purposes only and should not be construed in any way as an inducement or recommendation to buy or sell products, commodity futures or options contracts.

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