e c o -t r ading for the Future

An introduction to
Carbon Credits
 Carbon Offsetting

Introduction
Many scientists, naturalists and well- environment, the Kyoto Protocol of 1997, In the Compliance Market, companies,
established mainstream ecological since signed by 187 countries, introduced governments, or other entities buy carbon
foundations believe our world is being various measures and an infrastructure has offsets and indeed have to do so in order
threatened by global warming and the evolved which, mainly through the media to comply with post-Kyoto regulations on
effects of CO2 emissions and acceptance of Carbon Credits, rewards organisations the total amount of carbon dioxide they are
of this concept has become more making a valuable contribution to reducing allowed to emit.
widespread in recent years. Even in these carbon emissions and charges those whose
In the Voluntary Market, governments,
safe and relatively temperate shores, carbon footprint is considered excessive.
companies and individuals all choose to
notable changes have occurred. The five The dramatic growth of the Carbon Credit
purchase carbon offsets to mitigate their
months from May to September 2009 were market to date shows just how much
own greenhouse gas emissions be they
the hottest in the UK since records began. potential exists in a market which is only
from transport, power consumption or some
now beginning to be embraced by players
These scientists believe that reductions in other function. They are not legally obliged
as significant as America and China
carbon and greenhouse gas emissions are to do so.
essential if we are to minimise our impact Regulations, mostly subsequent to the Kyoto
It is important to understand the difference
on the environment. Protocol, and, quite separately, a demand
between these two markets.
emanating from a radical change in public
In response to the impact that industrialised
mood have created two distinct markets for
nations are having on the global
carbon offsets.

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How it Works
The Compliance Market is regularly checked and verified by independent the costs associated with Certified Emissions
review boards appointed for each country. Each Reductions (CERs), which are subject to much
We have seen that the opportunity to trade such project goes through rigorous testing and more stringent regulation, pushing up the price.
carbon credits was created by the United analysis to determine the resultant reduction of This means that individuals and companies
Nations Kyoto Protocol, a legally binding carbon emission or the amount of carbon it is can reduce their emissions in a more efficient
document committing countries to achieving in fact to remove from the atmosphere. Once and cost effective way. Despite there being
reductions in the emission of greenhouse gases validated and registered, the credits generated less regulation, VERs are still subject to a
(GHGs). The treaty created a number of such by a project are known as Certified Emissions standard and emissions reductions must be real,
targets that nations needed to meet in order Reductions (CERs). measurable, permanent, additional to what is
to safeguard the environment. Collectively, already being done, and independently verified.
industrial nations agreed to reduce their GHGs
The Voluntary Market The voluntary market may at present be smaller
by an average of 5.2% from 1990 levels, the
major impact of this to be borne by the most In the Voluntary Market, governments, companies than the compliance market. However its growth
developed countries. The government of each and individuals all purchase carbon offsets to is led not by public policy but by the private
Kyoto signatory country is now responsible for mitigate their own greenhouse gas emissions be sector which is evolving its own infrastructure of
ensuring that it and companies operating there they from transport, power consumption or some organisations such as the Carbon Trust to advise
are reducing GHG emissions. other function. companies on achieving carbon neutrality. With
major companies such as Tesco, The Co-op, and
To facilitate this, the Kyoto Protocol established a There are broadly two reasons why these Marks and Spencer aiming for carbon neutrality,
medium, known as a carbon credit. Each carbon organisations and individuals choose to buy it is the opinion of many active in these markets
credit permits emissions of one tonne of CO2. voluntary credits. Firstly they may be doing to is that the wider scope and more competitive
If a company has emissions over its allowance, demonstrate Corporate Social Responsibility and pricing of the voluntary market mean that it has a
then this entails a cost. Conversely, companies to establish their brand as being sympathetic to strong potential to outstrip the mature market size
able to stay under their allowance receive credits major global issues. Secondly they may consider of the compliance regime.
which can be traded on exchanges. that emissions regulations will become more
generally applicable in future and it is only a This is where our clients can come in. They can
Additionally, companies creating projects, say matter of time before they will be involved in a choose to buy carbon credits emanating from
in developing countries, which actively reduce compliance scheme anyway. projects which reduce CO2 emissions. In time
GHG emissions become eligible for these carbon they may wish to sell them on to a company
credits and then can raise funds, by selling them, Additionally they may consider the Voluntary aiming for carbon neutrality.
perhaps to a company exceeding its allowance, market to be attractive financially and see good
on an exchange. reason to hold a portfolio of credits. Though MH-Carbon is active in both types of
market for these reasons it specialises in the
Credits generated for the compliance market Though Voluntary Emissions Reductions (VERs) voluntary market.
must come from a high standard project which are verified by a third party, they do not carry

Location of CDM Projects (%)

Each carbon
credit is equivalent
to one tonne of
22.32% CO2
39.70% India
China

Philipines (1.76%)

Republic of Korea (1.85%)

15.88% Malaysia and Indonesia (5.62%)

Other
Mexico (5.28%)

Brazil (7.60%)

United Nations Framework Convention on Climate Change, 2010

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Projects reducing emissions
These are sample categories of environmental
projects which reduce carbon emissions and may
generate carbon credits:

Renewable energy sources Agriculture Afforestation and reforestation

Sources of renewable energy, such as a wind A number of developing countries have large Afforestation refers to the process of establishing
farm or hydro-electricity plant, generate agricultural sectors but not the financial a forest on land that has never been a forest,
significant reductions in GHG emissions and resources to make them environmentally
sustainable. Projects which reduce animal or has not been one for a considerable period
can gain high levels of carbon credits. This type
waste such as methane, one of the most of time. Reforestation refers to restocking
of projects has the added benefit of providing
dangerous GHGs, and change agricultural existing forests and woodlands which have been
power as well as reducing emissions.
process techniques to methods which are more depleted. This is especially important in regions
environmentally friendly, can achieve significant such as South America where logging and other
reductions in carbon emission. environmental destruction are widespread.
Capture of fugitive emission and waste handling and Projects such as these have the added benefit
disposal of safeguarding the habitat of hundreds of
species of animals which rely on forest and
Developing and installing technology which Mining and Metal production rainforest for survival.
captures emissions and waste and then either
disposes of it in an environmentally friendly way These projects involve changing production
or reuses it, results in a reduction in GHGs. This processes to achieve significant reductions
is the second biggest project type, as factories in carbon emissions and make them more Wastewater Treatment
produce large amounts of waste are able to environmentally-friendly.
Wastewater treatment facilities have significant
reuse it. For example, rice factories produce huge
impact on reducing the environmental effects of
amounts of waste rice husks that can easily be
various industrial processes.
burned for fuel and are carbon-free. Transport
Industries which use innovation and technology
This refers to the process of switching to reduce this environmental impact are suitable
transportation to less carbon intensive means or for significant credits based on CO2 reduction.
Manufacturing and chemical industries introducing new technologies to improve vehicle
These projects involve changing manufacturing fuel efficiency.
processes to make them more environmentally-
friendly. Changes to industrial processes can Methane Capture
make significant reductions in carbon emissions. Many process and industries produce
environmentally harmful methane, from landfill
sites to mines and farms.
Methane capture systems are a cost effective
way of tackling climate change and they use
proven technologies to address global warming.
Methane fired power plants are already in use,
turning the waste into energy. Projects such as
CDM Project Distribution by Type (%) these produce carbon credits.

Af/Re-forestation (0.54%)
4.93%
Capture of
fugitive emission

17.00%
Waste handling
and disposal
Energy demand (0.96%)

Each carbon
4.54%
62.61% Agriculture
Renewable
energy sources Transport (0.11%)
Mining (0.96%)
Metal production (0.29%)
Chemical industries(2.39%)
credit is equivalent
4.82% Manufacturing
to one tonne of
Other (0.85%)
CO2
United Nations Framework Convention on Climate Change, 2010

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How Emission Reduction Projects Are The project must also conform to the sustainable
Main parties involved
Processed development requirements in the host country
and must not have an unacceptable negative
The overall process implemented by the Kyoto A
impact on other elements of the environment as CDM Executive Board (EB)
Protocol to encourage emission reducing projects a by-product. The host country must also have
is known as the Clean Development Mechanism Supervises the CDM, processes
a project board which verifies potential CDM
(CDM) and its various stages are outlined here. projects and this is the point of contact for the registration requests, develops
These stages are applicable to projects which project developer in that country. guidelines, and issues CERs.
will be eligible for the compliance market. The
process for the voluntary market may not involve CDM projects also have to conform to the concept
every stage. of additionality. This means that all reductions in
GHGs must be additional to what would have B
There are a number of other project requirements occurred without the project. Incorrect assessment Designated Operating Entities
for CDM projects, which must be met in order to of additionality is the main reason for project Independent third parties which act
qualify as a credit generating option. submissions to be held up or rejected completely as auditors for the project. They are
The project needs to be undertaken in a country (UNFCC, CDM Guidelines, 2008). certified by the EB, to check and validate
which has signed and ratified the Kyoto Protocol. The project development cycle below outlines the the Project Design Document (PDD,
This provides a good deal of variety but it does usual steps a project will go through in order to a technical document describing the
exclude projects from the United States as, project).
currently, they have not ratified the Protocol. be registered and start receiving credits.

C
CDM project development cycle Buyers
Identification of project and development of project concept code by project developer To raise finance, project developers
may sell to buyers. They are involved by
Development of Project Design Document (PDD) forward-buying CERs at a lower price
but with more risk, or opting to take an
Project description
equity stake in the underlying project.
Select baseline approach and assess additionality These CERs can be sold on later.

Set baseline emission level and crediting period

Calculate net emission reductions

D
Project Developers
Develop a monitoring plan
The company which develops and
Assess environmental impacts operates the CDM project. These can
include:
Invite local stakeholders for comments Private sector companies
Governmental bodies
Host country approval
NGOs
Submission of the PDD Financial institutions.

Make PDD publicly available for 30 days

E
Validation of project Designated National
Authorities (DNA)
Submission of validation reports and PDD by operational entity
Each country involved in the CDM has
Registration with the CDM a DNA. The authority is responsible
for granting approval to local projects,
Project implementation and monitoring by the project developer
which have fulfilled national criteria for
sustainable development and with a
Verification and certification by the operational entity
good chance of succeeding at eventual
Possible review by the CDM Executive Board registration. They are a focal point for
the project developers. The UNFCCC
Issuance of CERs to project developers maintains a list of DNAs.
UNFCCC, 2010

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The market: pricing and trading
Each carbon offset not only helps the position of industrialised countries and whether Risk-diversification
environment but is an asset that can be bought they are buyers of credits. It demonstrates that
and sold. This additionally presents financial most of Western Europe, Australia and the USA A number of buyers are purchasing different types
opportunities for companies, governments and, are net buyers of credits. of credits under all of the trading mechanisms in
importantly, individuals. order to spread risk.
There are a number of reasons behind the
Once a project has been accredited and issued purchase of carbon credits:
credits certified to a recognised standard, its
associated credits can be traded on a suitable Good publicity
exchange.
Market Prospects Some buyers, particularly large companies and
On the compliance side alone, official research governments, are purchasing credits in order
Many, active in carbon markets, feel that, over
and projections from the United Nations
time, prices will rise. to demonstrate to the public and the electorate
Framework Convention for Climate Change
that they are contributing to sustainable
indicate that the trading schemes are operating
development and are concerned about the future
strongly and that demand for credits is exceeding
of the global environment.
supply by approximately 249.6 Mt of CO2 every
year (UNFCC, 2009). The map below shows the

Countries buying carbon credits - 2010/11

UNFCCC, 2009

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How are credit prices established? broker might be attractive to both buyers and
sellers. Buyers get the benefit of convenience,
schemes such as these that will lead to growth in
the voluntary carbon market which could interest
Credits are quoted in Euros (e) or US Dollars quality and range of access to projects, while our clients. BA charge for each tonne of carbon
(US$) for sale on the global market. Factors sellers get the benefit of the broad network of offset on their flights, at approximately 11.70
affecting credit prices include: buyers this exposes them to. per credit. Clear Offset, one of the largest offset
companies, charge 15.49, and Pure Offsetting
Market price charge 10.90. On the EU Emissions Trading
Scheme (EU ETS), spot prices for EUA credits
In the majority of cases, the value of compliance
credits is benchmarked to the European Union
Primary and Secondary Prices are currently e13.58. The prices of voluntary
credits are usually considerably lower than these
Emission Allowance (EUA), the most established Following the global economic contraction,
and many, actively involved in the carbon credit
trading system. It is therefore important to have prices of compliance credits fell dramatically
markets, consider that this shows a clear direction
a strong understanding of the underlying market from a peak of e28.73 in July 2008 to just under
dynamics of the EUA. e10 in early 2009 (World Bank, State and Trends for the voluntary carbon market.
of the Carbon Market, 2009) as buyers concerns
Credit over a lack of finance available to complete
Exchanges and funds
projects reached a peak. Of the current CER trading platforms, the
Price negotiations can often depend on the credit
worthiness of buyers and sellers e.g. projects European Union Emissions Trading Scheme
In mid-June 2009, a recovery began in Credit
operated by developing countries may offer (EU ETS) is by far the largest and it continues to
prices of the 2009 vintage (this describing the
lower prices as credit is more risky. Alternatively, dominate the global carbon market.
year in which the offset took place) despite
projects run in a developing country but operated question marks over short-term supply. In the Year-end 2008 transactions valued at US$92
from the UK often sell for higher prices. secondary market (CER), which is the trading billion represented an 87% year-on-year growth
of already issued CERs, futures contracts for over 2007 with over three billion contracts traded
Terms and conditions of sale December 2009 closed at e12.68 on the (World Bank, State and Trends of the Carbon
If the seller offers delivery guarantees, uses European Climate Exchange on 3rd August 2009 Market, 2009).
established methodology or bears the cost of - a rise of almost 20% from mid-June of that year
(Carbon Positive, August 2009). The options market is used as a tool on the
developing the documentation then premium exchange to hedge against volatility and risk
prices can be negotiated. The voluntary VER OTC market has seen large and has continued to grow briskly. Options
growth as sales volumes have increased year on volumes on the London-based European Climate
Risk year and the market has become more liquid. Exchange (ECX) increased five-fold between
The level of risk can significantly alter the 2007 and 2008, and have continued overall
As well as individuals, companies around the
price. This may include sovereign risk - is the growth since, if at a less startling rate thus
world have entered the market, offsetting their
project located in a politically unstable country? solidifying its place as the global carbon market
own emissions and offering the chance to their
Or Quality risk - is the project developed to leader (World Bank, State and Trends of the
customers to offset theirs too. BP has entered
standards such as the CDM Gold Standard? Carbon Market, 2009).
into an emissions reduction programme,
And delivery risk - are there guarantees if the implementing a trading system across all its To take advantage of this, a number of
project fails to generate the expected volumes of business units. It emphasises high quality credits major finance houses have set up funds to
emissions reductions. with strict verification requirements. purchase carbon credits. There are many major
This programme constitutes a part of BPs overall institutional carbon funds, including the World
Stage of project development
strategic involvement in clean technologies and Bank Prototype Carbon Fund which raised
The more developed a project, in terms of renewables. US$180m from governments and the private
approvals and documentation as well as physical sector in 2002, and Dutch-based Carboncredits.
TransAlta, a large Canadian coal fired utility, has
construction, the less likely it is, in theory, to fail nl, which raised US$250m in the same year
announced its intention to become net carbon
to generate credits. Therefore prices tend to be (UNFCC, 2009).
neutral by 2020 - an initiative which would
set higher.
signify the need to purchase millions of tons of
Access to market emissions reductions each year.

Generally, a wider access to market will result Airlines such as BA also offer their customers
in higher bids, due to the competitive nature of the opportunity to purchase credits to offset the
buyers. For this reason, going through a credit emissions generated by their flights, and it is

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Selling Carbon Credits
fall outside the scope of that system development of intermediaries such as the Bank
are too small to warrant the costs of being of New York which created a registry for VERs in
certified as a Compliance Credit June 2006.

VERs
are specifically developed for the voluntary
market
VERs are developed according to a number of
different standards and must be verified by a
As distinct from the CER and compliance third party. The voluntary market does not have
market, which is geared to comply with the to comply with the Kyoto Protocol but there is,
Kyoto Protocol, there is also a voluntary market,
which is based on trading Voluntary Emission
nevertheless, a standard which voluntary credits
need to attain. The best known and respected
The market is
Reductions (VERs).
This market recognises activities which reduce
of these is the Gold Standard which denotes
best practice methodology and is a high quality
label for carbon credits applicable to both the
growing. In 2008,
GHGs and issues credits in the form of VERs.
These can be sold to companies or individuals
wishing to voluntarily reduce their carbon
voluntary and compliance (Kyoto) markets.
123.4 million metric
Supporters of the Gold Standard are committed
footprint.
VERs can be generated from projects which:
to promoting sustainable development through
carbon offset markets that are characterised by
tones of CO2E were
are either based in a country that has not
ratified the Kyoto Protocol (e.g. USA) or
transparency, sustainability and equality of access
for all market participants. transacted
does not have the infrastructure to support The voluntary market is growing. In 2008, 123.4
the more elaborate requirements of the million metric tonnes of CO2E were transacted
system required for Compliance Credits - a near doubling of the 2007 volume. There
have not yet been registered under that appears to have been a shift in the VER market to
system more structured growth facilitated greatly by the

CERs
Buyers looking to sell their CERs to generate Projects can also generate a secure revenue benefits in terms of job creation, energy security
a surplus need to look at the various options stream through the sale of forward contracts, and poverty reduction as well as any delivery
available and weigh up the merits. Firstly it is where payment is made by the buyer upon guarantees. The buyer may also pay a premium
most important to understand the buyer. agreed delivery of CERs on agreed dates. where all documentation is already completed
This provides higher risk but much lower prices and paid for by the project developer.
The preferences of buyers are not always just and the potential for stronger price growth once
based on level of risk and price. Other facts may the emission reductions are generated and issued The market is growing. In 2008, 123.4 million
also be relevant. (TFSGreen, 2009). metric tonnes of CO2E were transacted.
For those who purchase CERs direct from the Prices generated take into account how early
project developer, there are two main structures. in the development of the project the buyer
Equity stakes, where the buyer receives revenue becomes involved and therefore how much risk
from the proceeds of the project, including CER is being taken on. There are also added benefits
revenues or the CERs themselves, can be agreed. that can be built into the price such as social

Carbon offset credits tradings schemes and exchanges

Volume and value as of end 2009
2008 2009
Volume Value Volume Value
(Mt CO2E) (US$m) (Mt CO2E) (US$m)

EU ETS 3,093 100,526 6,326 118,474

NSW 31 183 34 117

Chicago Climate Exchange 69 309 41 50

Total 3,193 101.018 6,401 118,641

Ecosystem Market Place, New Carbon Finance, 2010

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Hotspots
Reforestation Uruguay Wind farm Turkey Biomass India
Uruguay also has high potential for a Choosing a location for a wind farm is extremely As a major rice producer, there is potential for a
reforestation projects. Close to 8% of the difficult and needs to be undertaken by a biomass project in India. Rice production creates
land area is forest and, due to the countrys power company with the appropriate expertise a by-product of rice husks. These are commonly
appropriate climate, there is the potential for as a huge number of variables can affect the burnt in landfill sites and give off environmentally
much more. suitability of the site. damaging methane. Rice production firms
working with local power companies are creating
It has recently adopted a Forestry Law Plans to install a wind power plant in Izmir, a processing plant enabling the burning of the
benefiting companies in this activity, showing Turkey, connected to the national grid will husks to generate energy so this will offset the
the government is keen to help this sector. This significantly reduce GHGs and help to reduce emissions. It is estimated that one processing
involves low start-up costs coupled with tax Turkeys energy deficit. plant attached to a rice production factory would
benefits. reduce emissions by a total of 322,688 tonnes
The project is planned to generate approximately
A recent study by the Organisation for Economic 797,745 tCO2e emission reductions over 7 of CO2. This is an average of 46,098 credits
Co-operation and Development found that years and it was funded by the project developer every year. The price of credits associated with a
funding carbon reduction projects in Uruguay forward by selling VERs. project such as this is likely to rise. .
has the potential to absorb 23% of its total GHG
emissions by 2030.

Reforestation Costa Rica Hydro electricity Honduras Agricultural Management - Uruguay

Costa Rica is now considered a politically With an annual GDP per capita of only In Uruguay, 50.2% of countrys GHG emissions
stable country and was one of the first to sell US$3,000, Honduras is one of the poorest come from the agricultural sector, in particular,
carbon credits. A massive 30% of the country countries in the Western Hemisphere. It is a net methane from livestock. Uruguay emits
is designated as nature reserves and the importer of electricity with the contribution of approximately 1.6 tonnes of CO2 per capita,
government has announced its intention to fossil-fuelled power plants towards total electricity every year, and the potential to reduce this is yet
become one of the worlds first carbon neutral production growing from 37% to 60% between to be explored. The country has only 3 registered
countries by 2021. This makes it an ideal place 2000 and 2003. Meanwhile, in the same period, credit generating projects and none of these is
for a reforestation project. the contribution of hydroelectricity decreased in agriculture, despite this making the largest
from 63% to 40%. contribution to Uruguays GHG emissions. This
Project developers buy rainforest land from creates huge potential for carbon credit buyers.
private owners in the country and then contract A project developer working with a major Past studies have shown that, as well as reducing
third parties to measure CO2 levels absorbed by renewable energy supplier in Honduras, has GHG emissions, crop yields are increased as
replanting and avoiding deforestation. created a hydro-electricity plant in the region. climate temperatures reduce and this is an added
One company in particular is selling units worth agricultural benefit.
200 VERs per year for US$12,000. These As well as creating jobs and increasing economic
VERs can then be sold through a management development in the region, it is projected to The most popular way of managing the methane
company which takes a 5% fee. This essentially produce 35,660 tCO2e in reductions every year is by installing anaerobic digestion systems
means buyers are forward purchasing VERs for over a contract spanning 15 years at large livestock farms. By working with a
US$16 each. When the market develops, these The low start-up costs involved in this project Uruguayan company with expertise in this
are projected to sell for more. enhance the prospect of a growth in value of the specialised field, project developers and buyers
associated carbon credits. of associated carbon credits can prosper.

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Concerns
Carbon trading is extremely new and many The other issue is over-supply. If countries are will not reach a satisfactory outcome, and the
companies, suppliers and buyers are still coming very successful in cutting their emissions, the emission will be decreased by 1.7 billion tons in
to terms with its possibilities. number of credits will increase, and prices will 2020 (-20%).
fall. However, this is unlikely to happen as long
The main concern is that compliance carbon as emission caps are tightened regularly. These concerns are generally considered to be
credits are essentially a legal construct, whose minimal. As long as the environment remains a
existence is dependent on government intent. If The Kyoto Protocol is set to apply in its current priority, companies, countries and governments
governments no longer support the capping of phase from 2008 to 2012. Until 2012, the will all continue to be on the lookout for ways to
emissions, the market will in effect cease. market is expected to stay relatively stable. A reduce their carbon output and buyers of carbon
concern is that we cannot know how the carbon credits will have the potential to benefit.
Rulings on allocations also have a strong market place will change post-2012 following
impact. If the European Commission allocates the Protocol review and the move into its second
emission allowances which are too high, then the commitment period. All the signs are that the
scheme would in effect be pointless. However, caps will be further tightened. The EU ETS is
it is commonly felt that its plan is to gradually calling for further sectors to be included in the
decrease the allocations, boosting demand for agreement and has outlined a number of post-
carbon credits and tightening their supply, so this 2012 scenarios. Under one such scenario, the
risk is perceived to be minimal. international climate negotiations at UN level

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Prices of carbon credits are indicative only and are based on current exchange rates. Carbon Credit prices can go down as well as up. It may be difficult to
obtain true market process for VERs as many are transacted "over the counter" and as such values may vary from reseller to reseller. Currently VER's are illiquid
in comparison to the compliance EUA credit market. There may be a big difference between the buying and selling price of carbon credits. Trading in carbon
credits involves risk. You may get back less than your total outlay and in extreme cases make no recovery. However you may also benefit from any possible increase
in the value of the carbon credits.
Any growth shown or suggested is a projection only and cannot be guaranteed.
MH Carbon deals in the physical delivery of carbon credits only operating mainly in the Voluntary credit market. MH-Carbon use carbon credits from recognised
and independently verified projects to ensure the emission reductions are effective.
Whist efforts have been made to ensure that the data and other information in this report are accurate, no warranty as such can be given and, additionally,
information applicable to the carbon credit markets is subject to change.
The purpose of this report is solely to provide introductory information and some background to the specific topic. It is not intended for use directly or indirectly
in market forecasting or for making decisions.
MH-Carbon and/or its directors, agents or employees accept no responsibility or liability for any losses or damages incurred as a result of use of this report.
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