Carbon credits are a key component of national and international attempts to mitigate the growth in concentrations of greenhouse gases (GHGs). 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. The idea is to allow market mechanisms to drive industrial and commercial processes in the direction of low emissions or less "carbon intensive" approaches than are used when there is no cost to emitting carbon dioxide and other GHGs into the atmosphere. Since GHG mitigation projects generate credits, this approach can be used to finance carbon reduction schemes between trading partners and around the world.
The mechanism was formalized in the Kyoto Protocol*, an international agreement between more than 170 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 Protocol agreed 'caps' or quotas on the maximum amount of Greenhouse gases for developed and developing countries. n turn these countries set quotas on the emissions of installations run by local business and other organizations, generically termed 'operators'. Countries manage this through their own national 'registries', which are required to be validated and monitored for compliance by the UNFCCC**. By permitting allowances to be bought and sold, an operator can seek out the most cost-effective way of reducing its emissions, either by investing in 'cleaner' machinery and practices or by purchasing emissions from another operator who already has excess 'capacity'.
Carbon credits create a market for reducing greenhouse emissions by giving a monetary value to the cost of polluting the air. Emissions become an internal cost of doing business and are visible on the balance sheet alongside raw materials and other liabilities or assets.
* The Kyoto Protocol is a protocol to the United Nations Framework Convention on Climate Change (UNFCCC** or FCCC), an international environmental treaty produced at the United Nations Conference on treaty is intended to achieve stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system.
** The United Nations Framework Convention on Climate Change (UNFCCC or FCCC) is an international environmental treaty produced at the United Nations Conference on Environment and Development (UNCED), informally known as the Earth Summit, held in Rio de Janeiro from 3 to 14 June 1992.