CARBON TRADE

Carbon Transactions – A Primer


GHG emission reduction transactions can be classified as either allowance-based or projectbased

(Capoor and Amborsi, 2006). Both allowance-based and project-based carbon

transactions are measured and traded in standard units representing a quantity of CO2

equivalent (metric tons of CO2 equivalent = MTCO2). The goal of any tradeable permit

program is to allow market forces to efficiently allocate emission mitigation resources so that

the overall emission reduction goal is achieved at the lowest cost. Emission trading programs

allocate benefits to entities that reduce emissions at low cost by allowing them to make

additional emission reductions, thereby gaining emission allowances that they can sell to those

facing high emission reduction costs. Emission trading programs provide a profit incentive to

devise lower cost emission reduction methods and technologies as well as environmentally

sound land use changes that encourage long-term economic efficiency.

Allowance-based carbon transactions (also called emission allowances) are created by a

regulatory or other cap-and-trade body and are initially allocated or auctioned to the user.

Emission allowance transactions are based on the buyer’s direct emissions. Buyers must

reconcile their emissions account at the end of each compliance period through direct and

verified measurements to ensure compliance with their allocated/auctioned emission

allowances.

Project-based carbon transactions (also called emission reduction credits) are created using

methodologies/rules approved by the organization issuing these transactions from a project that

can credibly demonstrate reduction in GHG emissions compared to what would have happened

without the project. Forestry offset projects are one category of projects that can provide

emission reduction credits. Others include projects such as capturing landfill methane,

conservation tillage practices, and alternative energy.

Emission reduction credits should be issued only after their reductions have been verified,

which can then be used to offset direct emissions above an organization’s allocated/auctioned

emission allowances. The purchase or sale of contracts for emission reduction credits typically

carry higher transaction costs and risk than emission allowances. The “quality” of projects for

gaining emission reduction credits is directly related to the credibility of the organization

issuing the credits, the methodologies/rules for establishing baselines and monitoring the

project’s performance, and the requirement for third-party verification. Once emission

reduction credits are issued and used to offset direct emissions, they provide an identical

environmental improvement in reducing GHG emissions as emission allowances.