CARBON CREDITS: HOW THEY WORK, MARKET AND COMPANIES - ENVIRONMENT - 2025

The carbon credits are certified emissions reductions or uptake of atmospheric carbon that can be traded in the financial market. They are an initiative promoted by the Kyoto Agreement within the framework of the Joint Implementation of Projects and the Clean Development Mechanisms (CDM).

The carbon credits mechanism arises under the premise that an initiative will prosper, if it brings immediate economic benefits. In this way, the aim is to encourage compliance with the greenhouse gas emission reduction quotas of the Kyoto Protocol.

Carbon dioxide emissions per capita, 2017. Our World in Data / CC BY (https://creativecommons.org/licenses/by/4.0)

A certificate is obtained from a verified greenhouse gas emission reduction or carbon fixation project. These certificates are issued by duly registered specialized institutions that assess compliance with emission reduction or carbon fixation

It is not just about reducing CO ₂ emissions, but about any of the gases established as greenhouse gases. To issue the certificate in the reduction of emissions of a gas other than CO ₂, the equivalence relation is established.

CO2 gases, water vapor and methane in the atmosphere

Once these certificates are obtained, they acquire an economic value in the market established by supply and demand. These certificates are transformed into financial bonds that can be exchanged on the markets.

The demand comes mainly from industrialized countries that are obliged to meet emission quotas. If they cannot meet their quotas directly, they purchase carbon credits to certify that they have removed CO ₂ or its equivalent in other gases from circulation.

The offer comes from developing countries that are not obliged under the Kyoto protocol to meet quotas. However, these countries generally have extensive natural areas and with the right programs they can increase carbon fixation.

How carbon credits work?

Global warming and greenhouse gases

The planet's climate is regulated by a mechanism known as the greenhouse effect, compared to greenhouses for agricultural production. In a greenhouse, the glass or plastic roof lets in sunlight and prevents the exit of heat, maintaining a suitable temperature.

In the atmosphere the role of the greenhouse roof is played by certain gases, which is why they are called greenhouse gases.

Greenhouse gases

Water vapor, CO ₂ and methane (CH ₄) are the most important greenhouse gases. To these are added others emitted by industry, agriculture, mining and other human activities.

The Kyoto Protocol includes gases such as sulfur hexafluoride (SF ₆), perfluorinated hydrocarbon (PFC), hydrofluorocarbon (HFC) and nitrous oxide (N ₂ O).

These gases allow long-wave solar radiation (sunlight) to pass through, but absorb and emit part of the short waves (heat) emanating from the Earth. In this way they help regulate the earth's temperature.

Carbon emissions. Source: Global_Carbon_Emission_by_Type_fr.png: Robert A. Rohdederivative work: Ortisa / CC BY-SA (http://creativecommons.org/licenses/by-sa/3.0/)

The equilibrium is broken if an amount of greenhouse gases is added to the atmosphere above the usual. In this sense, humans not only emit additional amounts of greenhouse gases, but reduce carbon sinks by eliminating forests.

The Kyoto Protocol

Faced with the crisis of the progressive increase in global temperature by human action, the states have tried to reach agreements to reduce the emission of greenhouse gases. Among these, the most important to date is the Kyoto Protocol initially signed by 86 countries.

Position of the countries in relation to the Kyoto Protocol. Source: Kyoto_Protocol_participation_map_2009.png: * Kyoto_Protocol_participation_map_2009.png: Users Emturan on en.wikipediaderivative work: Emturan (talk) derivative work: ELEKHHT / CC BY-SA (http://creativecommons.org/licenses/by-sa/3.0/)

This established a goal to reduce greenhouse gas emissions by 5% by 2012. For this, the protocol promoted mechanisms that include the Joint Implementation of Projects, the Clean Development Mechanism and the Transaction of Emissions between Countries.

Joint Implementation of Projects

They are projects between countries included in Annex I of the Kyoto Protocol to reduce emissions or fix carbon.

Clean Development Mechanisms

These mechanisms include forestry projects for carbon capture (absorption of CO ₂), carbon conservation and carbon replacement.

Countries that implement these types of projects can obtain an official document certifying the estimated amount of carbon fixed, stored or replaced.

Transaction of Emissions between Countries

Finally, the last mechanism of the protocol is the emission trading mechanism that allows Annex I countries to acquire carbon credits.

Carbon bonds

In the framework of the Clean Development Mechanisms of the Kyoto Protocol, the idea of ​​carbon credits arose. These are also known as Reduced Emission Certificates (CERs). Each bond is equivalent to one metric ton of atmospheric carbon in the form of CO ₂ removed from circulation or its equivalent in other gases.

Carbon credits acquire an economic value due to the Law of Supply and Demand in the financial markets. The United Nations Framework Convention on Climate Change and the Conference of the Parties specifically define the criteria for certification.

Justification of the carbon credits mechanism

Reducing emissions of carbon or other greenhouse gases has an impact on economic development. It is estimated that reducing CO ₂ emissions by 10% would represent a 5% drop in world GDP.

In this sense, the need for an economic incentive for said reduction through the carbon credit market is proposed.

Benefits of carbon credits. Source: Eduardo Ferreyra / Public domain

Another premise is that greenhouse gases are distributed equally throughout the atmosphere. For this reason, it does not matter where carbon fixation occurs or its emission is reduced since the positive impact is global.

Types of carbon credits

There are three basic types of carbon credits, derived from the mechanisms established by the Kyoto protocol to reduce emissions. Emission Reduction Units (URE, or ERU in English) bonds are derived from the joint action mechanism.

While the Clean Development Mechanism arises two types of bonds that are the Certificates of Reduction of Emissions (CERs in its acronym in English) and the UDA. The latter derive from activities of carbon fixation by land use and forestry

Certification standards

There are different certification standards for carbon credits to enter the market, some of the most recognized are the Clean Development Mechanism (CDM), the Gold Standard (GS) and the Verified Carbon Standard (VCS).

Carbon credit market

The carbon credit market is created by changing the Reduced Emission Certificates in the financial market. By 2016 there were already 55 countries with a carbon emissions market.

The need and the demand

The need arises from the commitment that developed countries have made to comply with greenhouse gas emission reduction quotas. Measures to reduce emissions mean economic investments and restrictions on their industries.

Depending on their circumstances, these countries implement what is within their power without affecting their economic interests. However, this is usually insufficient to cover their quota, so there is a demand for alternatives.

The offer

The Kyoto Protocol does not establish an obligation to meet reduction quotas for developing countries. However, in most cases, these countries have favorable conditions for the development of carbon fixation projects.

It is here where the opportunity arises to combine the improvement of the environment with economic benefits.

Certified projects

Countries develop afforestation or reforestation projects and obtain emission reduction certificates, via the fixation of atmospheric carbon. These certificates are later transformed into bonds that are sold to developed countries that are unable to meet their quotas.

It is hoped that the result of this market is that developed countries meet their quotas, combining their direct actions with the financing of the actions of developing countries through the acquisition of carbon credits.

Variants and behavior of the carbon credit market

Information on transaction prices, volumes and other aspects is very restricted, since the contracts are confidential.

Variants of the carbon credit market

The carbon bond market has two variants, the regulated market and the voluntary market. The regulated market is determined by the obligation on the part of the governments and companies of developed countries to comply with established quotas.

The voluntary market is established at the company level without mediating a regulatory obligation, motivated by financial strategies or social responsibility.

Market behavior

Between 1996 and 2003, at least 288 transactions with emission reduction bonds were carried out. In 2003 the market reached 70 million metric tons in CO ₂ equivalents, with 60% corresponding to national states and 40% to private companies.

Furthermore, 90% of the carbon credits traded in these negotiations in 2003 originated in developing countries. The prices of these bonds vary and in 2018 the World Bank set a minimum price of $ 3 per metric ton of CO ₂ equivalent.

Prices generally range from $ 3 to $ 12 per metric ton and a transaction from a small project represents between 5,000 and 10,000 metric tons.

Companies that buy carbon credits

National states, public-private associations and private companies participate in the commercialization of carbon credits. There are specialized intermediaries like Natsource LLC and Evolution Markets LLC, and market analysts like PCF plus Research and PointCarbon.

Similarly, there are international registry providers that are custodians of the bonds such as Markit based in the United States.

There are national advisory and trading companies for these bonds, such as the South Pole Group in Colombia. As well as interested private clients, such as LATAM Airlines, Natura Cosméticos, Grupo Nutresa, and public entities such as the Municipality of Medellín.

Carbon credits in Mexico

Of the total number of projects under Clean Development Mechanisms in Latin America for 2012, Mexico had 136 registered projects (23%). These projects generated 17% of the CER carbon credits in all of Latin America.

Mexico ranks second in Latin America, after Brazil, in Clean Development Mechanism projects and CER carbon credits. To further incentivize the process, in 2014 a carbon emission tax was approved, which can be offset with CDM projects.

In addition, in October 2019, the Ministry of the Environment and Natural Resources published the definitive regulation for carbon emissions trading. This secretariat had already formed in 2013 the Mexican Carbon Platform (MexiCO ₂)

MexiCO ₂ is made up of the Mexican Stock Exchange, the United Nations Environment Program (UNEP) and other national and international entities.

Carbon credit trading

In 2018 the municipality of Mexico City became the first Latin American local government to enter the carbon market. The Ejido San Nicolás Totolapan forest conservation and maintenance project raised $ 46,908 by selling 3,909 bonds at a price of $ 12 each.

Other areas and companies

An area where more emphasis has been placed is renewable energies where banks have financed projects and commercialized carbon credits. Among them are the Inter-American Development Bank (IDB), Banco Santander Central Hispanoamericano (BSCH), Andean Development Cooperation (CAF) and Banco Bilbao Vizcaya Argentaria (BBVA).

Companies that acquire carbon credits

In Mexico there are various companies that have entered the national carbon credit market, such as Grupo Herdez and Unilever. Others are from the banking sector such as HSBC and Banco BX +, or from the industrial area such as the petrochemical company Mexichem.

Carbon credits in Colombia

Of the total number of projects under Clean Development Mechanisms in Latin America for 2012, Colombia had 39 projects (7%) that generated 6% of the CER carbon credits in all of Latin America.

Public politics

The Colombian government has promoted policies to encourage CDM projects, such as a tax on carbon emission from 2017. This, together with the authorization by the Ministry of the Environment and Sustainable Development of the purchase of carbon credits to avoid the tax.

The country has the Protocol for the Certification of Forest Programs for Climate Change Mitigation under the responsibility of the Colombian Institute of Technical Standards and Certification (ICONTEC). This agency grants the corresponding certifications to Clean Development Mechanisms projects.

Mercantile Exchange

Starting in 2016, the Colombian Mercantile Exchange began managing the carbon bond market in the country, both the regulated and voluntary markets.

Projects

This country is recognized as one of the Latin American countries with the most Clean Development Mechanism projects and has 8 projects with hydroelectric plants. On the other hand, the first Latin American forestry project aimed at generating carbon credits was developed in Antioquia and Arauca.

Oil palm

The National Federation of Oil Palm Growers (Fedepalma) ventured into the generation of carbon credits. For this, it promoted an umbrella project for the reduction of methane emissions by its associates through wastewater management.

The Chocó-Darién

Another major project that is supported by the generation of carbon credits is the REDD + Chocó-Darién forest protection project. With this project, about 13,000 hectares of tropical forest are protected.

Bibliographic references

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4. Lobos, G.,, Vallejos, O., Caroca, C. and Marchant, C. (2005). The Market for Carbon Credits (“Green Bonds”): A Review. Inter-American Journal of Environment and Tourism.
5. López-Toacha, V., Romero-Amado, J., Toache-Berttolini, G. and García-Sánchez, S. (2016). Carbon bonds: financialization of the environment in Mexico. Social Studies (Hermosillo, Son.).
6. Schneider, SH (1989). The Greenhouse Effect: Science and Policy. Science.