Definition of Emission Allowance Credit
An emission allowance credit is known by several names, including emission-reduction credit, emission offset and carbon credit. The fundamental idea behind the credit is the same, regardless of title: A credit is awarded to a business, organization or operator when it reduces its emissions of greenhouse gases below its established limit, or quota, by one metric ton. The resulting trade in carbon credits is considered to be emission offsets: the increase in emissions by some operators can be balanced by the decrease from other operators.
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Function
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Credits are earned by successfully reducing emissions in one-ton quantities. These credits can be kept, sold or traded. For example, if a corporation owns a factory that produces 60 tons of carbon emissions annually, but at the end of one year came in at a measurable 55 tons, then this corporation would be awarded 5 emission allowance credits for reducing its overall total. Then, if a steel mill producing 10 tons of emissions annually expects to exceed its quota by one ton (11 tons total), it can purchase an emissions credit from the previous corporation to allow for this one-ton overage.
Effects
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The goal of the credit system is a reduction of overall emissions on a global scale. Participating countries, and the operators within their borders, honor their carbon-emissions quotas while presenting incentives for remaining below them. In allowing these credits to be bought and sold, operating organizations seek out cost-effective methods for reducing their emissions: the operator can either adopt more environmentally safe practices, invest in "greener" technology, or purchase emissions credits from other operators that have surplus credits.
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Size
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Emission allowance credits, or emission-reduction credits, are awarded only for actual, quantifiable reductions in emissions. To qualify, the emissions themselves must be permanent pollutants that are in surplus and, therefore, quantifiable and enforceable by the prevailing protocol. If these criteria are met, a credit can be awarded for each metric ton of emissions reduced per three-month period. Similarly, when the credit is sold or traded, it can be used to allow an excess of emissions in the measure of one metric ton.
History
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A chief source of greenhouse-gas emissions is the burning of fossil fuels (coal, oil, natural gas). These emissions are predominantly found to be caused by the industrial sectors that rely heavily on the burning of fossil fuels: steel, cement, fertilizer, textile, and some power-generating facilities. In releasing major greenhouse gases during production (hydro-fluorocarbons, carbon dioxide, nitrous and methane), the emissions are believed to damage the earth's atmosphere and affect its climate. As a result, the carbon credit was conceived as a method for increasing awareness about the danger of these major greenhouse gases while providing a way to control their emissions.
Origins
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The mechanism by which the concept of emission-allowance/reduction credits was formalized is the Kyoto Protocol. Internationally adopted by more than 170 countries, the Kyoto Protocol set limits, or quotas, on the amount of greenhouse gas participating countries could emit. Each country, in turn, set emissions caps on the installations of its operators (businesses, factories, producers, and organizations). By virtue of their own national registry systems, countries monitor emissions and validate credits in accordance with the United Nations Framework Convention on Climate Change, an international environmental treaty ratified by the U.N. in 1992 and from which the Kyoto Protocol "update" was created.
Credit Trading
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If an operator does not use all of its allowances, what remains can be sold as credits on the open market, or privately between operators. There are currently five global exchanges through which these credits can be traded. These credits, when sold, allow the purchasing operator to exceed its own emission allowance, or quota. Only those countries that have ratified the Kyoto Protocol can trade over the carbon-credit exchanges. Despite this, the Kyoto Protocol prioritizes the internal abatement of polluting greenhouse gases by the participating countries before they begin buying credits from each other.
Types
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The Kyoto Protocol has some flexibility, allowing credits to be obtained as part of the cap-and-trade system (original assigned quotas) and as the result of a project that offsets emissions.
There are three methods by which this can be accomplished: Joint Implementation---a developed country, or operator within that country, seeking to avoid the costs of domestically reducing polluting gases, can instead set up a project to reduce emissions in another country and receive emissions credits. Clean Development Mechanism---a developed country or operator can sponsor an emissions reduction project in a developing country and receive emissions credits. Emissions Trading---participating countries and operators can trade credits over the international carbon-credit exchanges, allowing those with an emissions allowance shortfall to purchase credits from those with a surplus.
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