There are two distinct types of emission assets. These are “permits to pollute” which form the trading credits of a cap and trade system (e.g. EUAs) and “carbon offsets” or carbon credits (eg CER’s & ERU’s), which actually represent an actual current or future reduction in CO2e in the atmosphere.
As the Kyoto scheme is a “Cap and Trade” Scheme, there is a ceiling to the amount of CO2 that participating companies can emit. Above this amount they must purchase more permits or offsets through the market and below which, they are able to sell their emission allowances back into the market.
A complete set of forward, spot and derivative instruments are available for these companies to achieve their emission objectives. At the end of each year, participating firms must surrender emission permits/offsets to their respective government for cancellation equal to their pollutants. Failure to do so results in a fine of €100 per ton, in addition to having to purchase the equivalent shortfall for retirement the following year.
Carbon Credits can also be created through The Voluntary Carbon Markets. The accreditation systems within these markets are generally less rigorous, yet the carbon credits produced still represent a reduction in the atmosphere of 1 ton of CO2e (Carbon Dioxide or Green House Gas Equivalent). As the name suggests, these emission reductions are generally for voluntary use, and thus have no compliance value within the EU ETS (European Union Emissions Trading Scheme).
Companies outside of the EU ETS or Kyoto Protocol can use these credits to demonstrate Corporate and Social Responsibility (CSR), and of course individuals are able to retire these in order to reduce their own carbon footprint.
The Voluntary Carbon Market has, however, often pioneered new methodologies (processes to reduce CO2e). If these methodologies are successful, they can be developed into full scale CDM (Clean Development Mechanism) and JI (Joint Implementation) Methodologies. In addition, developing compliance markets often utilize Voluntary Credits before a specific standard/methodology is developed or officially adopted.
Pricing of these credits, however, remains erratic and the market is especially opaque.