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Carbon Credit: Carbon Trading

Wednesday, March 21, 2012


Carbon Credits are part of a tradable permit scheme. They provide a way to reduce greenhouse gas emissions by giving them a monetary value. A credit gives the owner the right to emit one tonne of carbon dioxide. Carbon credits are measured in tonnes of carbon dioxide. 1 credit = 1 tonne of CO2. These credits need to be authentic, scientifically based and comply with a regulatory body for these are traded with confidence.

A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent (tCO2e) equivalent to one tonne of carbon dioxide.

Carbon credits and carbon markets are a component of national and international attempts to mitigate the growth in concentrations of greenhouse gases (GHGs). One carbon credit is equal to one metric tonne of carbon dioxide, or in some markets, carbon dioxide equivalent gases. Carbon trading is an application of an emissions trading approach. Greenhouse gas emissions are capped and then markets are used to allocate the emissions among the group of regulated sources.

Importance of carbon credit:

Carbon credits are an important constituent of national and international emissions trading schemes. They provide means to reduce greenhouse effect emissions on an industrial scale by capping total annual emissions and letting the market assign a monetary value to any shortfall through trading. These credits can be exchanged between businesses and can be bought or sold at prevailing market prices in international markets. Credits can be used between trading partners and around the world to finance carbon reduction schemes. There are many companies that sell carbon credits to commercial and individual customers interested in lowering their carbon footprint on a voluntary basis. These carbon offsetters purchase credits from an investment fund or a carbon development company that has accumulated credits from individual projects. The quality of the credits is partly based on the validation process and partly on the sophistication of the fund or development company that acts as the sponsor to the carbon project, the reflection of which can be seen in the price. Typically, voluntary units have less value than the units sold through the rigorously-validated Clean Development Mechanism.

Burning of fossil fuels is a major source of industrial greenhouse gas emissions, especially for power, cement, steel, textile, fertilizer and many other industries which rely on fossil fuels (coal, electricity derived from coal, natural gas and oil). The major greenhouse gases emitted by these industries are carbon dioxide, methane, nitrous oxide, hydrofluorocarbons (HFCs), etc., all of which increase the atmosphere's ability to trap infrared energy and thus affect the climate.

The concept of carbon credits came into existence as a result of increasing awareness of the need for controlling emissions. The IPCC (Intergovernmental Panel on Climate Change) has observed that:

Policies that provide a real or implicit price of carbon could create incentives for producers and consumers to significantly invest in low-GHG products, technologies and processes. Such policies could include economic instruments, government funding and regulation, while noting that a tradable permit system is one of the policy instruments that has been shown to be environmentally effective in the industrial sector, as long as there are reasonable levels of predictability over the initial allocation mechanism and long-term price.

Trading of carbon credits

Buying carbon credits is not a charitable donation, but a retail action. Trade in carbon credits has the potential to make forestry more profitable and to sustain the environment at the same time. One of the primary solutions for climate change being thought by global warming alarmists is the purchase and sale of carbon credits. For trading purposes, one credit is considered equivalent to one tonne of CO2 emissions. Credits can be exchanged between businesses or bought and sold in international markets at the prevailing market price

Value of carbon credits:

Carbon credits create a market for reducing greenhouse emissions by giving a monetary value to the cost of polluting the air such as carbon emitted by burning of fossil fuels. This means that carbon becomes a cost of business and is seen like other inputs such as raw materials or labour.

Carbon credits are measured in tonnes of carbon dioxide.

 1 credit = 1 tonne of CO2.

Each carbon credit represents one metric ton of C02 either removed from the atmosphere or saved from being emitted. The carbon credit market creates a monetary value for carbon credits and allows the credits to be traded.For each tonne of carbon dioxide that is saved or sequestered carbon credit producers may sell one carbon credit.

Kyoto Protocol:

The Kyoto Protocol is a legally binding agreement under which industrialized countries will reduce their collective emissions of greenhouse gases by 5.2% compared to the year 1990 (but note that, compared to the emissions levels that would be expected by 2010 without the Protocol, this target represents a 29% cut). The goal is to lower overall emissions from six greenhouse gases - carbon dioxide, methane, nitrous oxide, sulfur hexafluoride, HFCs, and PFCs - calculated as an average over the five-year period of 2008-12. National targets range from 8% reductions for the European Union and some others to 7% for the US, 6% for Japan, 0% for Russia, and permitted increases of 8% for Australia and 10% for Iceland.

The mechanism was formalized in the Kyoto Protocol, an international agreement between 180 countries, and the market mechanisms were agreed through the subsequent Marrakesh Accords. The mechanism adopted was similar to the successful US Acid Rain Program to reduce some industrial pollutants.

The carbon trade is an idea that came about in response to the Kyoto Protocol. Signed in Kyoto, Japan, by some 180 countries in December 1997, the Kyoto Protocol calls for 38 industrialized countries to reduce their greenhouse gas (GHG) emissions between the years 2008 to 2012 to levels that are 5.2% lower than those of 1990. The idea behind carbon trading is quite similar to the trading of securities or commodities in a marketplace. Carbon would be given an economic value, allowing people, companies, or nations to trade it. If a nation bought carbon, it would be buying the rights to burn it, and a nation selling carbon would be giving up its rights to burn it. The value of the carbon would be based on the ability of the country owning the carbon to store it or to prevent it from being released into the atmosphere. (The better you are at storing it, the more you can charge for it.)

Carbon credits fully fungible (trade-able) financial instruments, and are measured in tons of carbon dioxide equivalent (tons CO2e). There are four types:

·         EUAs: European Union Allowances are issued freely by the EU for several years at one go, for use within the Emission Trading Scheme (EU ETS). The ETS second phase began Jan 1 2008 and ends Dec 31 2012. All second phase EUA must be used within that period.

·         CERs: Certified Emission Reductions are issued by the UNFCCC for demonstrable reductions of greenhouse gas emissions in Clean Development Mechanism (CDM) Projects under Article 12 of the Kyoto Protocol.

·         ERUs: Emission Reduction Units are credits created under Article 6 of the Kyoto Protocol, Joint Implementation (JI).

·         VERs: Verified Emission Reductions are issued by independent bodies for demonstrable reductions of greenhouse gas emissions in projects that, for whatever reason, fall outside of the CDM. Their standards may be just as strict (such as with the Voluntary Carbon Standard (VCS) Gold Standard), or not as stringent. However the market will generally reflect a poorer price for a VER that has been issued to a low or difficult to verify standard.


·         Underwritten by governments and is governed by global legislation enacted under the UN’s aegis (protection)

·         Two General Categories: Developed Countries & Developing Countries

·         The country that fail target will be penalized.

·         Flexible Mechanisms.

·         Financial exchanges like the new EU Emissions Trading Scheme or from projects which reduce emissions in non-Annex 1 economies under the Clean Development Mechanism (CDM)

Clean Development Mechanism (CDM)

The Clean Development Mechanism (CDM) is one of the "flexibility" mechanisms defined in the Kyoto Protocol (IPCC, 2007). It is defined in Article 12 of the Protocol, and is intended to meet two objectives: to assist parties not included in Annex I in achieving sustainable development and in contributing to the ultimate objective of the United Nations Framework Convention on Climate Change (UNFCCC), which is to prevent dangerous climate change; and to assist parties included in Annex I in achieving compliance with their quantified emission limitation and reduction commitments (greenhouse gas (GHG) emission caps). "Annex I" parties are those countries that are listed in Annex I of the treaty, and are the industrialized countries.

Under the CDM you can cut the deal for carbon credit. Under the UNFCCC, charter any company from the developed world can tie up with a company in the developing country that is a signatory to the Kyoto Protocol. These companies in developing countries must adopt newer technologies, emitting lesser gases, and save energy.

Only a portion of the total earnings of carbon credits of the company can be transferred to the company of the developed countries under CDM. There is a fixed quota on buying of credit by companies in Europe.

Indian Scenario:

India and UNFCCC   

India signed the UNFCCC on 10 June 1992 and ratified it on 1 November 1993. Under the UNFCCC, developing countries such as India do not have binding GHG mitigation commitments in recognition of their small contribution to the greenhouse problem as well as low financial and technical capacities. The Ministry of Environment and Forests is the nodal agency for climate change issues in India. It has constituted Working Groups on the UNFCCC and Kyoto Protocol. Work is currently in progress on India's initial National Communication (NATCOM) to the UNFCCC. India being a developing country has no emission targets to be followed. However, she can enter into CDM projects. As mentioned earlier, industries like Cement, Steel, Power, Textile, Fertilizer etc emit green houses gases as an outcome of burning fossil fuels. Companies investing in Windmill, Bio-gas, Bio-diesel, and Co-generation are the ones that will generate Carbon Credits for selling to developed nations. Polluting industries, which are trying to reduce emissions and in turn earn carbon credits and make money include Steel, Power generation, Cement, Fertilizers, Waste disposal units, Plantation companies, Sugar companies, Chemical plants and Municipal corporations. India comes under the third category of signatories to UNFCCC.

India acceded to the Kyoto Protocol:

India signed and ratified the Protocol in August, 2002 and has emerged as a world leader in reduction of greenhouse gases by adopting Clean Development Mechanisms (CDMs) in the past few years. According to Report on National Action Plan for operating  Clean  Development Mechanism(CDM) by Planning Commission, Govt. of  India, the total  CO2-equivalent  emissions  in 1990 were 10, 01, 352 Gg (Gigagrams), which was approximately 3% of global emissions. If India can capture a 10% share of the global CDM market, annual CER revenues to the country could range from US$ 10 million to 300 million (assuming that CDM is used to meet 10-50% of the global demand for GHG emission  reduction  of  roughly 1 billion tonnes O2, and prices  range from US$ 3.5-5.5 per tonne of CO2). As the deadline for meeting the Kyoto Protocol targets draws nearer, prices can be expected to rise, as countries/companies save carbon credits to meet strict targets in the future. India is well ahead in establishing a full-fledged system in operating CDM, through the Designated National Authority (DNA).

The Delhi Metro Rail Corporation (DMRC) has become the first rail project in the world to earn carbon credits because of using regenerative braking system in its rolling stock. DMRC has earned the carbon credits by using regenerative braking system in its trains that reduces 30% electricity consumption.

Other than Industries and transportation, the major sources of GHG’s emission in India are as follows:

• Paddy fields

• Enteric fermentation from cattle and buffaloes

• Municipal Solid Waste

Of the above three sources the emissions from the  paddy  fields  can  be  reduced through special irrigation strategy and appropriate choice of  cultivars;  whereas  enteric  fermentation emission can also be reduced through proper feed management. In recent days the third source of emission i.e. Municipal Solid Waste Dumping Grounds are emerging as a potential CDM activity despite being provided least attention till date.

Certified Emission Reductions – Source of Generation

Industries like:

·         ƒAgriculture

·         ƒEnergy (renewable & non-renewable sources)

·         ƒManufacturing

·         ƒMetal production

·         ƒMining and mineral production

·         ƒChemicals

·         ƒAfforestation & reforestation

Benefits of Carbon Trading

• Sellers and intermediaries can hedge against price risk

• There is no counterparty risk as the Exchange guarantees the trade

• The price discovery on the Exchange platform ensures a fair price for both the buyer and the seller

• Players are brought to a single platform, thus eliminating the laborious process of identifying either buyers or sellers with enough credibility

By, switching to Clean Development Mechanism Projects, India has a lot to gain from Carbon Credits:

a) It will gain in terms of advanced technological improvements and related foreign investments.

b) It will contribute to the underlying theme of green house gas reduction by adopting alternative sources of energy

c) Indian companies can make profits by selling the CERs to the developed countries to meet their emission targets.

Taxation of Carbon Credits:

Income from sale of CERs should be accounted for under the head ‘Business and Profession’. However, in case of sale of Intangible, it would be taxable under the head ‘Capital Gains’ though most companies in India are recording earnings from carbon credit trading as Income from ‘Other Sources’ currently. Trading in CER is carried out either in spot market or in futures. Service tax could be applicable on account of dealing in CERs on the exchange platform, and in case of contracts resulting in delivery, VAT could be applicable.

Typically, carbon credits in India are sold to overseas buyers; hence, there would be no VAT applicable on these goods. Thus, sale of CERs to overseas buyers should qualify as exports. However, there is no explicit mention made in this regard by the revenue authorities. Further, in light of India undergoing a revolutionary amendment from regulatory perspective, like the proposed Direct Taxes Code, 2010, Goods and Service Tax, IFRS, etc., the position and treatment of carbon credits would have to be commented accordingly.

Source: NPCS Team

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