Carbon Trading: What It Is, How It Works, and Market Examples
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Summary:
Carbon trade, an integral part of climate change mitigation, involves the buying and selling of emission credits. Governments authorize this practice to regulate carbon emissions, aiming to gradually curb their impact on climate change. This article delves into the origins, mechanisms, regional markets, and recent global agreements surrounding carbon trading, offering an in-depth understanding for professionals in the finance industry.
Understanding carbon trade
Carbon trade, synonymous with carbon emissions trading, is a government-authorized process enabling entities to buy and sell credits, allowing a specified amount of carbon emissions. The underlying objective is to systematically reduce overall carbon emissions and address climate change concerns.
The evolution from cap and trade
Adopted from cap and trade regulations successful in sulfur pollution reduction during the 1990s, carbon trading introduces market-based incentives to control emissions. Unlike traditional mandates, it rewards companies cutting emissions and imposes financial consequences on those failing to do so.
The concept originated from the Kyoto Protocol, a UN treaty implemented in 2005 with the goal of reducing carbon dioxide emissions to 5% below 1990 levels by 2012. Although achieving mixed results, the core idea involved incentivizing nations to reduce emissions and trade permits.
Incentivizing emission reductions
Essentially, nations are incentivized to reduce emissions, allowing them to sell surplus permits. Wealthier nations often support the efforts of higher-polluting nations by purchasing their credits. Over time, this creates a compelling dynamic, encouraging wealthier nations to actively reduce emissions.
Externalities and fossil fuel usage
Fossil fuel usage entails externalities—additional costs not included in the fuel price. Carbon trading internalizes these costs, holding companies accountable for the environmental impact of their emissions.
Regional carbon trading markets
Although lacking a global marketplace, various regions have established their own carbon trading markets. Examples include California’s cap-and-trade program, the Western Climate Initiative, and China’s national emissions-trading program—the world’s largest carbon market.
Carbon trading agreement post glasgow COP26
The rules for a global carbon market were solidified at the Glasgow COP26 conference in November 2021. The framework, Article 6, encompasses a centralized system for public and private sectors and a bilateral system for countries to trade carbon offset credits. The agreement allocates funds to aid developing countries in addressing climate change.
Frequently asked questions
What does carbon trading mean?
Carbon trading, or carbon emissions trading, utilizes a marketplace to buy and sell credits permitting the emission of a certain amount of carbon dioxide. This practice has led to the adoption of carbon accounting to measure environmental impact.
Can carbon be sold?
Carbon emissions rights can be sold on various marketplaces, ranging from international to local levels. California’s cap-and-trade system is an example of a regional exchange.
Where can you trade carbon emissions?
Regional exchanges, including Xpansiv CBL in New York, AirCarbon Exchange in Singapore, and the Shanghai Environment and Energy Exchange, facilitate carbon trading.
What is the current price of carbon?
Carbon prices vary globally based on jurisdiction and market supply and demand. As of early 2022, the benchmark EUA Futures price ranged between €80 and €100 euros.
Is carbon trading effective in reducing global carbon emissions?
Carbon trading is designed to systematically reduce carbon emissions by incentivizing nations and companies to cut back on their emissions. However, its effectiveness remains a matter of debate, with ongoing discussions about its role in addressing the larger issue of global warming.
How do carbon trading agreements impact developing countries?
Carbon trading agreements, such as those outlined in Article 6 of the Glasgow COP26 framework, allocate funds to aid developing countries in tackling climate change. These agreements aim to create a balanced approach, ensuring that developing nations receive support to address environmental challenges.
Are there concerns about oversaturation in the carbon market?
Yes, under the new carbon trading agreement, there are concerns that participants can use previous credits created between 2013 and 2020, potentially saturating the market and putting downward pressure on prices. This raises questions about market dynamics and the long-term impact on carbon credit values.
Key takeaways
- Carbon trade originated from cap and trade regulations.
- It incentivizes nations to reduce emissions and trade permits.
- Regional markets exist, with China having the world’s largest carbon market.
- The Glasgow COP26 conference established global rules for carbon trading.
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