What is Carbon Market?

“By the time we see that climate change is really bad, your ability to fix it is extremely limited… The carbon gets up there, but the heating effect is delayed. And then the effect of that heat on the species and ecosystem is delayed. That means that even when you turn virtuous, things are going to get worse for quite a while.” – Bill Gates

The sole purpose of carbon markets is to decrease the amount of greenhouse gas emissions that contribute to global warming, particularly carbon dioxide emitted by burning fossil fuels cost-effectively by setting limits on emissions and enabling the trading of emission units, which are instruments representing emission reductions. This trading helps to reduce the emissions at a lower cost to be paid to do so by higher-cost emitters, thus lowering the economic cost of reducing emissions.

The carbon market is also known as carbon trading, emissions trading, and carbon emissions trading, and in simple words, the carbon market is an environmental policy device that places an economic cost on carbon emissions.

How does it operate?

Carbon markets are similar to the “cap-and-trade” systems used by the E.U. and California, what happens in this trade is that the government puts a cap on the number of greenhouse gases that can be emitted by various industries or any other sector of the economy. A fixed amount of allowance is given to businesses according to the metric tons of CO2 they can emit. Those who emit less than their allotment can sell the extra to other businesses or companies, motivating other industries to reduce emissions produced by them faster. This means that if a company reduces its carbon emissions significantly, it can trade the excess permits on the carbon market for cash. If it’s not able to limit its emissions it may have to buy extra permits.

This scheme of international carbon market or carbon trading was set up under the U.N.’s 1997 Kyoto protocol on climate change. Under that agreement, developed countries aimed to reduce their greenhouse gas emissions, but developing countries did not. So, if a developing country curbs its emissions for example by building a solar panel plant or planting trees, they could sell a “credit” to a developed country, which could count that emission reduction in its target.

Benefits of a carbon market

The carbon trading schemes have been successful in managing environmental problems like global warming in the past, with the help of trading in sulfur dioxide permits helping to limit acid rain in the US. One of the major attractions for governments concerned with stemming CO2 is that the cap-and-trade scheme is so much easier to implement as compared to the expensive direct regulations, and unpopular carbon taxes.

If regional carbon trading schemes can be joined up globally, with a high price at carbon, it could be a better and speedy method to help the world decarbonise.

Disadvantages of a carbon market

One main drawback which is observed is that creating a market in something called carbon dioxide which has absolutely no intrinsic value is very difficult. You need to promote scarcity – and you have to strictly limit the right to emit so that it can be traded. In the world’s biggest carbon trading scheme, the EU ETS, political interference has created gluts of permits.

Another disadvantage is that the offset permits, gained from paying for pollution reductions in poorer countries, are allowed to be traded as well. Because of this, the importance and effectiveness have become questionable of these permits in reducing carbon emissions.