How to Measure & Price Carbon Credits

There have been a number of proposals to help stem climate change, which primarily is caused by the anthropogenic production of greenhouse gases. One of the most popular, already adopted by the European Union, is a cap-and-trade system. In it, the amount of gases that companies are allowed to emit is capped; companies that wish to continue to emit greenhouse gases must purchase credits -- called "carbon credits" -- that license them to produce a certain amount of pollution. One of the tricky parts of this system is measuring the amount of carbon companies are expelling, setting a properly sized cap and deciding the proper price for these credits.

Instructions

Measuring Carbon

• 1

  A government seeking to establish a cap-and-trade system should identify all major carbon-producing industries. It then should decide whether to place the cap upstream (where carbon-producing materials, such as oil, are produced) or downstream (where these materials are burned, such as in power plants).

• 2

  Take samples of carbon output. A government should attempt to estimate how much carbon is emitted each year by which industries by taking samples from different economic sectors. This should establish a baseline level of carbon emissions to formulate a proper cap.

• 3

  Allot credits based on the estimated total amount of carbon. Once the total amount of carbon is tabulated, a government can decide how many credits to issue. For example, if a country emits 100 million tons of carbon annually, a government might issue 1 million credits, each of which licenses the bearer to expel 100 tons of carbon per year.

Pricing Carbon

• 4

  Hold an auction. Some governments choose to issue a certain number of free credits to critical industries. To correctly price the credits, however, a government can hold an auction allowing companies to bid on the remaining credits.

• 5

  Open an exchange. In Europe, carbon credits are traded on a Bourse, like a stock exchange, with buyers and sellers trading credits at fluctuating prices. This system helps set a transparent market price for the commodity, giving companies an idea of how much they will have to spend for the next year's supply of carbon emissions.

• 6

  Regulate when necessary. If the price of carbon goes too high -- in which case industry is stifled or companies are losing money -- or too low -- in which case companies lack an incentive to cut carbon emissions -- a government may step in and place an artificial floor or ceiling on the price.