August 9, 2012

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“Carbon Trading” refers to a group of market-based approaches currently being used in various countries to regulate and reduce the emission of carbon dioxide and other greenhouse gases.  A market for carbon trading can result in two different ways.  First, a regulatory body—typically a government—may cap the amount of carbon dioxide that a source (such as a power plant) is allowed to produce.  The implementation of a “cap and trade” scheme effectively gives a monetary value to the right to emit carbon dioxide.  Second, companies may voluntarily engage in offsetting their own carbon production through carbon trading, investing in projects worldwide that reduce the overall output of carbon dioxide and other greenhouse gases.

The actual instruments traded on carbon markets are referred to as “carbon credits” and “carbon offsets.”  Although both these terms can be used rather loosely, a carbon credit is generally defined as the right to emit one metric tonne of carbon dioxide or another greenhouse gas with a carbon dioxide equivalency.  These credits are the direct result of cap and trade schemes and the allocation of emissions permits.  When a source reduces its carbon output below the level of its allocated permits, it can then sell those permits as carbon credits to other sources needing to increase their output of carbon.

A carbon offset, in contrast, can basically be understood as any activity that leads to a reduction in carbon dioxide or another greenhouse gas.  Given such a broad definition, offsets can take a number of forms.  The reforestation of a barren area of land, for example, creates a carbon sink, which helps consume carbon dioxide from the environment. Renewable energy projects, such as wind turbines or solar power, are another source of offsets.  Such “clean energy” projects create energy for consumption without the generation of carbon—energy that theoretically takes the place of traditional energy that would yield a carbon byproduct.  Activities like reforestation and clean energy can be partly funded through certification schemes that verify these projects will result in carbon reductions.  These certified reductions, or carbon offsets, are then sold in carbon trading markets to sources needing or desiring to offset their own carbon emissions.  The United Nations’ Clean Development Mechanism, which was established under the Kyoto Protocol, is one body that certifies carbon offset projects in the developing world and brings in investment from countries and companies looking to meet their emission reduction targets.

Carbon trading in most areas of the United States is currently voluntary.  Companies wishing to reduce their carbon footprint can purchase offsets for their carbon dioxide emissions from various internet providers and on foreign carbon markets.  Certain offset providers and markets have been subject to criticism, however, for a lack of accountability and oversight.  Companies should therefore be cautious when considering options to reduce their carbon footprint.