Carbon trading is effectively an interaction between buyers and sellers trading the right to emit greenhouse gases. Mandatory government schemes have been created as a result of the Kyoto protocol, and are known as the compliance market. The scope of legislative schemes is largely limited to heavy industry and power generating companies at present, although there are moves to increase the number and type of organisations that will be included in compliance schemes in future.

There are also an increasing number of organisations that wish to take action but are not legally required to do so. Engaging in voluntary schemes provides useful experience in measurement and strategic decision making, preparing an organisation for the time when government schemes expand and participation will become mandatory. These organisations trade through the voluntary market.

The type of scheme and credits that can be bought are determined by the need to meet mandatory compliance or voluntary targets. There are two distinct mechanisms at work to bring about a reduction in carbon emissions under a carbon trading market.

Allowance-based schemes are based on the right to produce a certain quantity of greenhouse gases. One allowance or credit equates to 1 tonne of carbon dioxide equivalent emitted into the atmosphere. This is relatively easy to measure, and technology and expertise are available to validate the quantities produced, although levels are less easy to predict in advance. Tradable rights to emit, called allowances, are distributed to producers of carbon pollution. Companies are free to trade allowances on the carbon market.

Project-based schemes are based on credits certifying that 1 tonne of carbon dioxide equivalent has been removed or saved from emission into the atmosphere. Predicting and subsequently proving something has not happened is more complicated to measure, therefore elaborate control mechanisms have developed to verify these credits. The essential requirement is that the savings are additional to business as usual. For example, if an industry is legally required to reduce greenhouse gases, then any reductions made would be considered ‘business as usual’ and not generate credits. The easiest projects to classify are those that have no other income other than that generated by carbon credits, such as methane capture in landfill sites.

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