At a Glance
- Carbon credits are certificates of greenhouse gas emission reductions.
- The Kyoto Protocol established the Clean Development Mechanism, which issues carbon credits to projects in developing countries that lower their greenhouse gas emissions.
- Due to the economic slowdown and the lack of an international climate change agreement, the price of carbon credits are currently very low.
- Today’s carbon credit prices do not provide an incentive for private investors to complete and run their projects. The Pilot Auction Facility for Methane and Climate Change Mitigation (PAF) will provide a price guarantee for future carbon credits, restoring the missing financial incentive.
Carbon credits are certificates which demonstrate that the emissions of a greenhouse gas, measured in tons of carbon dioxide (tCO2), have been avoided or reduced. Credits can be traded and sold, and may be used by industrialized countries or by private companies that have emission reduction targets (for example under the Kyoto Protocol or a cap-and-trade program) to meet part of their emission reduction objectives. Carbon credits can also be canceled by their buyer, and thus not used as an offset, resulting in a net benefit for the climate.
Clean Development Mechanism
One type of carbon credit is the Certified Emission Reduction (CER), which is issued by the Kyoto Protocol’s Clean Development Mechanism (CDM) to projects that reduce emissions of greenhouse gases in developing countries.
The number of carbon credits achieved corresponds to the reduction in carbon emissions below a baseline (i.e., "business as usual”), such as building a renewable energy power plant instead of a coal-fired one. The sale of carbon credits gives project developers an added source of revenue which allows them to undertake the “clean” investment, which is less profitable than the “business as usual.” In other words, the “clean” project faces additional (or incremental) costs and these costs can be covered by the sale of carbon credits. In some cases, revenues from the sale of carbon credits are the only source of finance that allows such a project to operate.
The market for carbon credits is currently largely idle because of the worldwide economic slowdown, compounded by the absence of an international climate change agreement. This has led to a total collapse in carbon prices. After trading in a range of 11 to 12 Euros per ton for several years, CDM credits are now trading for 10 to 15 Euro cents. These very low prices remove the incentive to invest in “clean” projects and put at risk the sustained operation of existing emission reduction projects that are dependent on revenues from the sale of credits. This is where the PAF can play a role in providing a price guarantee for the generation of future carbon credits.