Carbon credits and how it can slow down climate change
In general, a carbon credit is a permit that allows a company that holds it to emit up to a certain amount of carbon dioxide or other greenhouse gases. The purpose is to limit the extent of pollution caused by emission of carbon dioxide or other greenhouse gases. Further, the government may lower the number of permit levels each year thus lowering the total emission caps. Companies are therefore motivated to invest in clean technologies.
In a “cap-and-trade” system, the government issues a limited number of annual permits that allow companies to emit a certain amount of carbon dioxide. The total amount permitted is the "cap" on emission. Companies are taxed or fined if they produce a higher level of emissions than their permits allow.
When this system is applied to the commercial world, companies are encouraged to reduce carbon emission so that they may sell any excessive carbon credits to other companies which have not yet caught up with the carbon reduction standards. Despite the investments made on environmental protection, companies may off-set such investments or even make profits from selling carbon credits. That provides a more measurable incentive to the commercial sector in making contributions to slow down climate change.
UNFCCC and Kyoto Protocol
United Nations Framework Convention on Climate Change (UNFCCCs) and Kyoto Protocol play important roles in emission reduction. The UNFCCC sets out commitments by its parties (which include both developed and developing countries) to reduce climate change. The Kyoto Protocol is a protocol to the UNFCCC that imposes emission reduction targets on developed country parties. In general, emission reduction targets under the Kyoto Protocol can be met through:
- International Emissions Trading which allows developed countries to trade carbon credits;
- Clean Development Mechanism which allows developed countries to carry out projects to reduce emissions in developing countries, generating carbon credits; or
- Joint Implementation which allows developed countries to carry out emission reduction projects in other developed countries.
Primary and secondary carbon markets
Carbon credits have a primary and a secondary market each with a different focus. A primary carbon market involves obtaining carbon credits from the development of emission reduction projects. A secondary market deals with trading of carbon credits as investments.
The secondary market mainly consists of two groups of buyers which are (i) entities which use emission allowance attached to the carbon credits to comply with emission control requirements under international or domestic legislation and (ii) banks and investment firms which deals with carbon credits as part of their ordinary course of business like how they trade other commodities.
Compliance markets and voluntary markets
Generally, there are two types of carbon markets. Compliance markets are created and regulated by mandatory national, regional, or international carbon reduction regimes, and are used by entities which by law have to account for their carbon emissions. Voluntary markets allow companies to trade carbon credits on a voluntary basis.
On 16 July 2021, Mainland China’s carbon trading officially kicked off at the Shanghai Environment & Energy Exchange. Mainland China’s carbon trading market is overseen by the Ministry of Ecology and Environment. China has aimed to strengthen its 2030 climate target, hit peak emissions before 2030 and achieve carbon neutrality before 2060.