Carbon Credit focuses on reducing greenhouse gases in the environment. A carbon credit is a broad term that refers to any tradable certificate or permit that represents the right to emit a specific amount of carbon dioxide or the equivalent amount of another greenhouse gas. Carbon credits and carbon markets are components of national and international efforts to reduce greenhouse gas (GHGs) concentrations. In this article, we will discuss Carbon Credit which will be helpful for UPSC exam preparation.

Types of Carbon Credit

• Voluntary Emissions Reduction (VER)
• It is a carbon offset that is traded for credits in the over-the-counter or voluntary market.
• Certified Emissions Reduction (CER)
• It is based on emission units (or credits) created through a regulatory framework to offset the emissions of a project.

Carbon Credit Initiatives

• In a 1997 agreement known as the Kyoto Protocol, the United Nations' Intergovernmental Panel on Climate Change (IPCC) developed a carbon credit proposal to reduce global carbon emissions.
• The agreement established legally binding emission reduction targets for the countries that signed on to it.
• Another agreement, known as the Marrakesh Accords, outlined how the system would operate.
• The Kyoto Protocol classified countries' economies as industrialised or developing. The industrialised countries ran their own emissions trading market.
• If a country emits less than its target amount of hydrocarbons, it can sell its excess credits to countries that did not meet their Kyoto targets through an Emission Reduction Purchase Agreement (ERPA).
• Carbon credits known as Certified Emission Reductions (CER) were issued by the separate Clean Development Mechanism for developing countries.
  • These credits could be given to a developing country in exchange for helping to fund sustainable development initiatives. CER trading took place in a separate market.

Paris Climate Agreement

• The Kyoto Protocol was revised in 2012 in an agreement known as the Doha Amendment, which was ratified by 147 member nations as of October 2020, with "deposited their instrument of acceptance."
• More than 190 countries signed on to the 2015 Paris Agreement, which also establishes emission standards and allows for emissions trading.
• The U.S. dropped out in 2017 but subsequently rejoined the agreement in January 2020.

Glasgow COP26 Climate Change Summit

• Negotiators at the November 2021 summit agreed to implement Article 6 of the 2015 Paris Agreement, allowing nations to work toward their climate targets by purchasing offset credits representing emission reductions by other countries.
• The agreement is intended to encourage governments to invest in initiatives and technology that protect forests and build renewable energy infrastructure in order to combat climate change.
• Several other provisions in the agreement include a zero-tax on bilateral trades of offsets between countries and the cancellation of 2% of total credits, with the goal of reducing overall global emissions.
• In addition, 5% of offset revenue will be placed in an adaptation fund for developing countries to aid in the fight against climate change.
• Negotiators also agreed to carry over offsets from 2013 to allow 320 million credits to enter the new market.

Trading Credits

• Carbon credits can be traded on both the public and private markets. Current trading rules permit the international transfer of credits.
• Credit prices are primarily determined by market levels of supply and demand. Credit prices fluctuate due to differences in supply and demand in different countries.
• Although carbon credits are beneficial to society, they are difficult for the average investor to use as investment vehicles.
• The only product that can be used as an investment in credits is certified emissions reduction (CERs).
  • CERs, on the other hand, are sold by special carbon funds set up by large financial institutions. Small investors can gain access to the market through carbon funds.
• There are specialised exchanges for trading credits, such as the European Climate Exchange, the NASDAQ OMX Commodities Europe exchange, and the European Energy Exchange.

Carbon Credit and Developing Countries

• Developing countries such as India and China are expected to be the largest sellers, while Europe will be the largest buyers of carbon credits.
• Global carbon credit trading is estimated to be worth $5 billion, with India contributing approximately $1 billion.
• China is currently the largest seller of carbon credits, accounting for roughly 70% of the market.
• Carbon, like other commodities, is now being traded on India's Multi Commodity Exchange (MCX).
• MCX has become Asia's first exchange to trade carbon credits.

What are Cap and Trade?

• A government regulatory programme designed to limit, or cap, the total level of emissions of certain chemicals, particularly carbon dioxide, as a result of industrial activity is known as cap and trade.
• Cap and trade supporters argue that it is a more appealing alternative to a carbon tax. Both measures are attempts to reduce environmental damage while causing the industry no undue economic hardship.
• Cap-and-trade energy programmes aim to gradually reduce pollution by incentivizing businesses to invest in clean alternatives.
• The government issues a fixed number of permits to businesses that include a cap on allowed carbon dioxide emissions.
• Companies that exceed the cap must pay a tax, whereas companies that reduce their emissions may sell or trade unused credits.
• The total limit (or cap) on pollution credits decreases over time, providing corporations with an incentive to seek out less expensive alternatives.
• Critics argue that the caps may be set too high, giving businesses an excuse to delay investing in cleaner alternatives for too long.

Carbon Emission Trading

• Carbon trading, also known as carbon emissions trading, is a market-based system aimed at reducing greenhouse gases that contribute to global warming, particularly carbon dioxide emitted by the combustion of fossil fuels.
• The goal is to enable market mechanisms to steer industrial and commercial processes toward lower-emissions or less-carbon-intensive approaches than those used when there is no cost to emitting carbon dioxide and other GHGs into the atmosphere.
• Because GHG mitigation projects generate credits, this approach can be used to fund carbon reduction schemes among trading partners worldwide.
• Carbon trading currently accounts for the majority of emission trading, an approach that provides economic incentives for reducing pollutant emissions.
• This approach is most commonly used by countries to meet their Kyoto Protocol obligations, such as reducing carbon emissions to mitigate the effects of climate change.

*For detailed notes on this topic, check this link Carbon Trading

Carbon Markets

• Carbon markets enable the sale and purchase of carbon emissions with the goal of lowering global greenhouse gas emissions.
• Carbon markets can reduce emissions beyond what countries can do on their own.
• For example, A factory in India can emit greenhouse gases in two ways:
  • A country that has not been able to reduce emissions can provide technology or financial support to that factory in India in order to claim the emission reduction as its own.
  • On the other hand, that factory in India can make investments and sell emission reduction credits, which are known as Carbon Credits. As a result, other parties who are struggling to meet their targets can buy these Carbon Credits and claim them as their own.

Carbon Trading Emissions under Kyoto Protocol

• Article 17 of the Kyoto Protocol allows countries with excess capacity, i.e. emissions permitted but not "used," to sell it to countries that are over their targets.
• As a result, a new commodity in the form of emission reductions or removals was created.
• Because carbon dioxide is the primary greenhouse gas, people simply refer to carbon trading.
• Carbon is now tracked and traded in the same way that any other commodity is. This is known as the 'Carbon Market.'
• Under the Kyoto Protocol emissions trading scheme, more than actual emission units can be traded and sold.
• Other units that may be transferred under the scheme, each of which is equivalent to one tonne of CO2, include:
  • A removal unit (RMU) is based on land use, land-use change, and forestry activities such as reforestation.
  • An emission reduction unit (ERU) produced by a joint implementation project.
  • A certified emission reduction (CER) resulting from a clean development mechanism (CDM) project activity. It is an activity in which a country with an emission-reduction target under the Kyoto Protocol is permitted to implement an emission-reduction project in developing countries.
  • The registry system tracks and records transfers and acquisitions of these units.
  • An international transaction log ensures the secure transfer of emission reduction units between countries.

Carbon Trading Emissions under Paris Agreement

• Article 6 of the Paris Agreement establishes three distinct mechanisms for voluntary cooperation, two of which are based on markets and the third on "non-market" approaches.
• The first mechanism would allow a country that has exceeded its Paris climate pledge to sell any excess to a country that has fallen short of its own targets.
  • This overachievement could be in terms of emission reductions, but it could also include other types of targets, such as renewable energy goals or forest expansion goals.
• The second mechanism would establish a new international carbon market governed by a UN body for the trading of emissions reductions generated anywhere in the world by the public or private sectors.
  • It has not yet been decided whether to include REDD projects, which reduce emissions from deforestation and forest degradation, within Article 6.
• The third mechanism of Article 6 for "non-market approaches" is less well defined. It would establish a formal framework for climate cooperation among countries where no trade is involved, such as development aid.

Conclusion

Carbon credits and carbon markets are components of national and international efforts to reduce greenhouse gas concentrations (GHGs). Carbon trading is a type of emissions trading strategy. If an organisation is subject to a cap-and-trade system, it will most likely be given credits to use toward its cap. If the organisation produces fewer tonnes of carbon emissions than it is allotted, the remaining carbon credits can be traded, sold, or held.

FAQs

MCQs

1. What does one carbon credit represent?

A) One ton of sulfur dioxide
B) One ton of methane
C) One ton of carbon dioxide
D) One ton of nitrous oxide

2. What was the primary purpose of the Kyoto Protocol?

A) To encourage deforestation
B) To promote industrialization
C) To limit greenhouse gas emissions
D) To establish free trade zones

3. Which mechanism allows developed countries to invest in emission reduction projects in developing countries?

A) Emission Trading Scheme
B) Clean Development Mechanism (CDM)
C) Cap-and-Trade System
D) Carbon Offset Program

4. Which international agreement led to the creation of carbon credits?

A) Montreal Protocol
B) Paris Agreement
C) Kyoto Protocol
D) UNFCCC

5. Which market is the largest buyer of carbon credits?

A) Europe
B) Africa
C) North America
D) South America

GS Mains Questions and Model Answers

Q1: Discuss the role of carbon credits in global efforts to combat climate change.

Answer: Carbon credits are crucial in global climate change mitigation efforts as they create a market-based system to limit emissions. By placing a cap on emissions and allowing for trading, they incentivize companies to reduce their carbon footprint. The Clean Development Mechanism (CDM) allows developed countries to fund emission reduction projects in developing countries, making carbon credits an effective tool for global cooperation in addressing climate change.

Q2: Analyze the impact of carbon markets on developing countries.

Answer: Carbon markets provide significant economic and environmental benefits to developing countries. Through mechanisms like the CDM, developing nations can attract investment for sustainable development projects, reducing emissions and creating economic opportunities. Additionally, these projects contribute to technological advancements in clean energy and infrastructure, promoting long-term growth while meeting environmental goals.

Q3: How do carbon credits facilitate the implementation of the Paris Agreement?

Answer: Carbon credits play a key role in the implementation of the Paris Agreement by enabling countries to meet their Nationally Determined Contributions (NDCs) through emissions trading. Article 6 of the Paris Agreement facilitates international cooperation by allowing countries to trade carbon credits, promoting cost-effective reductions in global emissions. This system incentivizes investment in green technologies and supports global efforts to limit temperature rise to 1.5°C.

Previous Year Questions on Carbon Credit

1. UPSC CSE Prelims 2022:

Question: The concept of carbon credit originated from which of the following?

A) Earth Summit
B) Kyoto Protocol
C) Montreal Protocol
D) Nagoya Protocol

Answer: (B)

Explanation: The concept of carbon credits originated from the Kyoto Protocol, which introduced market-based mechanisms to reduce greenhouse gas emissions globally.

2. UPSC CSE Mains 2021 (GS Paper 3):

Question: "Carbon credits are a crucial element in the global response to climate change." Analyze with reference to the Clean Development Mechanism (CDM).

Answer: Carbon credits, as part of the CDM under the Kyoto Protocol, allow developed countries to invest in emission-reduction projects in developing countries, earning credits in return. This market-based mechanism provides financial incentives for reducing greenhouse gas emissions and promotes sustainable development. The CDM fosters international cooperation, technology transfer, and investment in clean energy projects, contributing to global climate goals.