What is Carbon credit?

Dear Bavesh,

I am by no means an expert on carbon trading, but this is my limited understanding:

Each carbon credit allows a business to emit one tonne of Carbon Dioxide. Governments decide how much Carbon Dioxide each (large) business should emit and gives them a free allowance of carbon credits to cover that amount.

If a (energy inefficient) business produces more Carbon Dioxide than its free allowance then it must buy more credits. On the other hand, a (energy efficient) business which produces less Carbon Dioxide than its allowance, can sell the carbon credits it doesn't need. So you get a market in carbon credits which penalises the worst emitters of Carbon Dioxide.

The European Union allocates carbon credits to its member countries under the "European Union Emission Trading Scheme". These are traded on markets such as the European Climate Exchange - so the market determines the price of carbon credits.

If the total amount of carbon credits given out each year remains the same, but more and more Carbon Dioxide keeps being produced, the carbon credits will go up in value because more people will need them. The theory is it will then make financial sense for big emitters to cut their Carbon Dioxide emissions rather than pay for ever more expensive carbon credits.

In this way the "market" will force companies to reduce their emissions.

Hope this helps, best wishes, Ken