Explainer: What are Carbon Credits, who has them, how and where to trade them?

As Kenya hosts the inaugural Climate Change summit, there has been much talk about Carbon Credits and their sale. What are they, who has them, how and where are they traded and how do they contribute to reducing the effects of Climate Change?

First, some context. It has been agreed that greenhouse gases such as carbon dioxide warm up the atmosphere and limit the earth’s ability to cool itself and this leads to the damaging effects on climate that we have witnessed.

Ice caps melting, floods, drought, and other effects. This is why at the Paris Climate Summit in 2015, 190 nations signed up to the Paris Agreement and committed to reducing their greenhouse gas emissions and limiting the global temperature increase to below 2 degrees Celsius.

This historic agreement was actually preceded by the Kyoto Protocol of 1997, where it was also decided that a carbon credit proposal was mooted to reduce carbon emissions. Later in Marrakesh, Morocco, they spelled out how the system would work. So what are carbon credits?

In very simple terms, carbon credits are buying permission to pollute. If you are a company whose business and production processes are necessarily polluting because of the nature of your business, then you find a place or another country or another company that is doing work to clean the environment.

So let’s say, you cannot avoid polluting where you are, so you pay someone else who is doing work to reverse the effects of your own actions that are damaging the environment. So, you are emitting carbon dioxide into the environment which we have agreed is warming up the earth and causing the negative effects we have all experienced.

But, to offset your actions, you are paying someone who is working on removing or absorbing that carbon dioxide from the air. That person could be doing that through planting trees, which if you remember our science classes in primary school, absorb carbon dioxide from the air for their own photosynthesis. Or they could be investing in renewable energy like we are doing here in Kenya.

Each permit or carbon credit is equivalent to 1 tonne of carbon dioxide that is emitted into the environment. Each company, depending on their size and nature of business and determined emissions into the atmosphere is assigned a certain number of permits.

They can trade these and also, if they do not emit as much carbon dioxide as initially estimated, they can sell those permits to others.

The World Bank estimates that each ton of carbon dioxide should cost between 40 dollars and 80 dollars, based on the Paris climate agreement. But most of the time the price is far lower than this. And we shall talk about why the trading system and the pricing are considered problematic by many countries including Kenya, in a moment.

But first, how does the trade of carbon credits actually work?

Well, first it is important to note that carbon credits are an intangible commodity. The carbon credits trade system is not as regulated as other markets and they are traded in what is known as a voluntary market.

Secondly, companies don't deal with each other directly. There are companies in between, brokers if you like. One way of understanding this is how we deal with maize in this country. The farmer has the commodity, which is maize and there is a buyer at the other end of that chain.

Now, we have brokers who get the commodity from the one who owns it, incur their transportation, storage costs, etc., and then get that commodity to the buyer at the other end. Now the cost the broker bought the maize at, from the farmer is not the same cost he will sell it to the one at the market.

Similarly, the carbon credit trade system is aligned. It is the companies trading in them that get to decide what the price of the carbon credits will be, in an unregulated voluntary market system. And this is sometimes problematic. Many are raising issue with this. This is because market forces are still skewed to those on the other side of the world. They are the ones recognised, certified, according to their standards. Not ours.

In fact, one rallying call from President William Ruto on this has been to find a better way to decide the price. He says, we in this part of the world who are engaging in climate-friendly practices, from growing trees to using renewable energy are the ones with something to sell and yet, not the ones deciding the price. So his argument has been that we should have a say in the cost of the carbon credits.

In fact, Kenya has a lot to offer in this trade. Though we are one of the smallest polluters in the world, contributing to less than 1% of the world’s emissions, we have also done quite some work in offsetting the effects of others.

That is why in June this year, a group of 16 companies from Saudi Arabia bought more than 2.2 million tonnes of carbon credits in a Kenyan auction that was what was billed as the world’s largest sale of its kind.

The trade though is not perfect, there are questions about who is setting the pricing and the standards. That those in the other part of the world who are causing the pollution are the ones setting these standards, while the ones who are offsetting the actions and the owners of the carbon credits are not getting their fair share.

The bottom-line of this carbon credit approach is that there is a recognition that most human beings are motivated when there is money involved. Lessons learned from years of trying to tackle this is that forcing people to do things and make commitments to reduce the effects of climate change is not as easy.

Attempts to compel governments to commit to things has proven difficult because all countries are sovereign, you cannot impose everything on them, they have their own domestic policies and priorities and so it was thought that if you do two things, one is involve the private sector and two, inject some money into it, then you might move the needle a little on the commitments made to tackling climate change and in particular, reducing greenhouse gas emissions.

Then it was decided to put in place market mechanisms. This would incentivize people and companies to save the environment while making money at the same time. Now, this concept is itself problematic to some climate activists even as others argue that it is a measurable approach.

Challenges raised are that. One, it is voluntary and therefore not binding. Two, the fact that one continues to pollute simply because they can offset their actions elsewhere remains a problem.

Activists say that the agreement should go beyond paying someone else to solve the problems you are causing but that you should also be bound to change your own processes and make them green and beneficial to the environment and thirdly is who regulates the carbon credit trade. Who decides the terms of the sale or the trade, the price of the carbon credits?

That is why there is a proposed legislation that seeks to regulate this trade. It is known as the Carbon Credit Trading and Benefit Sharing Bill, 2023.

It intends to establish a regulatory framework for the trading of carbon credits and benefit sharing of the same, establish a carbon trading and benefit authority and register and regulate carbon trading businesses and also set up a tribunal that would mediate disputes in the market. Hopes to introduce clarity on some issues and put Kenya on the world map as a market leader in the carbon space and establish the growth of carbon projects in the country.