Carbon Credits

With global warming due to greenhouse emissions becoming probably the most serious threat for the planet and human-kind today, a series of steps have been taken globally to cut down on emissions. The rationale behind Carbon Credits is to put a cost to greenhouse emissions in terms of real money, and create an incentive for industries and corporations for keeping their emissions low.

The Carbon Credits system, put into place through the Kyoto protocol in the Earth Summit in 1992, defines upper limits on the amount of greenhouse emissions allowed for developing and developed nations. The nations then take their limits, and accordingly define limits for local industries and corporations, called 'operators'. Effectively, each operator is allowed a certain volume of emissions, measured in credits. If any operator can manage to keep their emissions under the limit, they can 'trade' the difference. Similarly, any operator which emits more than its credits, must buy those credits by paying money.

With the above system in place, any operator, say A, whose emissions exceed their
allocated credits by a certain amount might do either of the following:
- Pay an operator B who has some surplus credits to buy credits equal to the amount, or
- Pay money to an operator C which C can use to invest in technology to reduce its emissions by that amount.

The above mechanisms which allow credits to be traded allow operators to find out the most cost effective way of cutting its greenhouse emissions, by choosing to invest in technology that can reduce its emissions, or by buying credits from another operator who has excess credits.

The above mechanism also extends to countries. Developed countries with a very high cost of reducing greenhouse emissions can sponsor a low emission project in a developing country. The developed country effectively gets credits to meet its emission reduction targets, while the developing country can get capital investment or clean technology. This system very effectively puts a price on emissions, and in turn, the emissions show up on their balance sheets as liabilities, in case of operators that exceed their credits, and assets, in case of operators who keep their emissions less than their credits. With emissions directly affecting the profitability of a company and the economy of a country, the managements and governments are driven to invest in technology that cuts emissions and if possible, accumulate extra credits.