Carbon Credits & Carbon Markets


The purpose of carbon credits is to create economic value from defined environmental benefits – in this case, the reduction of greenhouse gas (GHGs) emissions.  The increased concetration of GHGs due to the burning of fossil fuels and other polutants is contributing to the warming of the earth’s surface and lower atmosphere, causing untold damage to the earth's ecosystem.  GHGs include:

  • Carbon Dioxide (CO2)
  • Methane (CH4) 
  • Nitrous Oxide (N2O) 
  • Sulfur Hexafluoride (SF6) 
  • Perfluorocarbons (PFCs) 
  • Hydrofluorocarbons (HFCs)

Carbon CreditsThe emission of these gases has long been a concern.  One of the most effective methodologies created to address this problem is a market-based “cap and trade” system.  Essentially, large emitters of carbon are given a cap on their emission allowance.  They must reduce emissions to a level equal to or below the cap.  If they come in under their emission reduction target they are issued carbon credits.  Those who cannot meet their reduction goals must purchase credits in the carbon market and thus bring their emissions into compliance with the cap.  This system is used on the Chicago Climate Exchange (CCX) and by countries signatory to the Kyoto Protocol on the European Climate Exchange (ECX).  

In brief, the carbon market can be explained as the market resulting from the buying and selling of emission allowances and reduction credits in order to enable countries under Kyoto and companies under CCX to meet their GHG emission targets.    

More technically, carbon credits, called Carbon Financial Instruments (CFIs) on the CCX, are currently traded on the CCX and the ECX.  CFIs represent one metric tonne (2,200 lbs.) of CO2-equivalent emission reduction to the atmosphere.  These CFIs must meet a defined set of scientifically-based rules and a framework which assures that an actual emission reduction did in fact occur.  The rules and framework are spelled out in “protocols”, which define the emission reduction and how this may be measured and quantified.  All such protocols must meet a scientific and business standard and must be approved by a designated body of the CCX.

Credits are issued according to a protocol standard: specific events, often termed “offsets”, which occur under a stringent set of protocols, may also be turned into a CFI.  For instance, this is the case with agricultural methane: methane emissions are captured and destroyed per the protocol’s definition and a CFI is created.  Therefore, CFIs simply represent overall emission reduction.  They are not tied to a single source.  Currently, CFIs are trading most actively in Europe, on the ECX.