Carbon Units: Their Origins and Purpose

Nowadays, many organizations have committed to reducing greenhouse gas (GHG) emissions, a pressing necessity rather than a luxury. Organizations can reduce GHG emissions by implementing new technologies, such as enhancing energy efficiency or switching to alternative energy sources. However, there is another route—acquiring carbon units.

 

Understanding Carbon Units

Carbon units are a modern solution that needs clarification. They are divided into carbon allowances and carbon credits. A carbon allowance is the right to emit one ton of CO2 equivalent, initially issued by an authorized body within an emissions trading system (ETS)—a key mechanism for national carbon regulation. Organizations receive these allowances for free initially but may later purchase them at auction if they need to exceed their emission limits. Unused allowances can be sold on secondary markets through accredited exchanges like the European Energy Exchange (EEX), Intercontinental Exchange (ICE), Nasdaq, and others. These transactions occur within spot trading and derivatives trading frameworks, assisting regulated organizations in managing their GHG emissions. National ETS operate on this principle in 36 countries worldwide.

A carbon credit, similar to a carbon allowance, permits an organization to emit one ton of CO2 equivalent. However, while an allowance represents a right to emit, a credit is a verified emission reduction that can be transferred from one organization to another. Carbon credits are generated through climate projects aimed at either absorbing or preventing GHG emissions. Examples include afforestation, reforestation, revegetation, biochar projects, and carbon capture, utilization, and storage (CCUS). Prevention projects might involve switching from fossil fuels to more eco-friendly alternatives, waste management, and other actions. Carbon credits are issued by authorized international and national bodies, as well as independent organizations like Verra, Gold Standard, and the American Carbon Registry.

 

Demand for Carbon Credits

The demand for carbon credits is high because they are created not only by regulated organizations within ETS. Firstly, under the Paris Agreement, nearly all countries have voluntarily committed to quantitative targets for reducing GHG emissions (Nationally Determined Contributions, NDCs). Secondly, many countries are further implementing carbon regulation through ETS and carbon taxation systems, where offsetting part of emissions with carbon credits is allowed, not just carbon allowances. This opportunity allows for a greater reduction of the carbon footprint of products. This is crucial in light of the introduction of cross-border carbon regulation starting in 2026 for exports of cement, aluminum, electricity, fertilizers, hydrogen, and ferrous metals to the EU, and similar regulations in China and other countries. In such cases, the size of the carbon fee on exports is likely to decrease. Thirdly, most major corporations in the Fortune 500 have voluntarily committed to reducing their emissions under standards like the Science Based Targets initiative (SBTi).

So, what are carbon units today? Are they the future equivalent of Bitcoin? Should you purchase them now if you don't have emission reduction obligations, or is it pointless? We will discuss this in our upcoming articles.