Carbon allowance
A unit granting permission to emit a specified amount under an emissions trading scheme.
Example
Participants surrender allowances to cover regulated emissions.
The catch
An allowance and a project-based carbon credit have different origins.
In more depth
Carbon allowance, explained.
A carbon allowance gets its value from scarcity. A government fixes the total number of allowances, which sets the cap, then hands some out free and auctions the rest. Each one usually covers a tonne of CO₂e. Companies that emit less than their holdings can sell the surplus, and those that emit more must buy, so the market finds the cheapest cuts first.
The climate result comes from the cap, so a single firm's cut inside a capped system may only free an allowance for someone else to use. Economists call this the waterbed effect. In the EU Emissions Trading System, a declining cap and a reserve that absorbs surplus allowances soften it.