Carbon emission trading

Carbon emission trading is a type of emissions trading scheme designed for carbon dioxide and other greenhouse gases. A form of carbon pricing, its purpose is to limit climate change by creating a market with limited allowances for emissions. Carbon emissions trading is a common method that countries use to attempt to meet their pledges under the Paris Agreement, with schemes operational in China, the European Union, and other countries.
Emissions trading sets a quantitative total limit on the emissions produced by all participating emitters, which correspondingly determines the prices of emissions. Under emission trading, a polluter having more emissions than their quota has to purchase the right to emit more from emitters with fewer emissions. This can reduce the competitiveness of fossil fuels, which are the main driver of climate change. Instead, carbon emissions trading may accelerate investments into renewable energy, such as wind power and solar power.
However, such schemes are usually not harmonized with defined carbon budgets that are required to maintain global warming below the critical thresholds of 1.5 °C or "well below" 2 °C, with oversupply leading to low prices of allowances with almost no effect on fossil fuel combustion. Emission trade allowances currently cover a wide price range from €7 per tonne of CO₂ in China's national carbon trading scheme to €63 per tonne of CO₂ in the EU-ETS.
Other greenhouse gases can also be traded but are quoted as standard multiples of carbon dioxide with respect to their global warming potential.
An international coalition to create a global carbon market, including a global, gradually declining, cap on emissions began to form in COP30. It can speed up emissions reduction seven-fold in all participating countries, while delivering $200 billion per year for clean-energy and social programs.

Purpose

The economic problem with climate change is that the emitters of greenhouse gases do not face the external costs of their actions, which include the present and future welfare of people, the natural environment, and the social cost of carbon. This can be addressed with the dynamic price model of emissions trading.
An emissions trading scheme for greenhouse gas emissions works by establishing property rights for the atmosphere. The atmosphere is a global public good, and GHG emissions are an international externality. In the cap-and-trade variant of emissions trading, a cap on access to a resource is defined and then allocated among users in the form of permits. Compliance is established by comparing actual emissions with permits surrendered. The setting of the cap affects the environmental integrity of carbon trading, and can result in both positive and negative environmental effects.
Emissions trading programmes such as the European Union Emissions Trading System complement the country-to-country trading stipulated in the Kyoto Protocol by allowing private trading of permits, coordinating with national emissions targets provided under the Kyoto Protocol. Under such programmes, a national or international authority allocates permits to individual companies based on established criteria, with a view to meeting targets at the lowest overall economic cost.

History

Carbon emission trading began in Rio de Janeiro in 1992, when 160 countries agreed the UN Framework Convention on Climate Change. The necessary detail was left to be settled by the UN Conference of Parties.
In 1997, the Kyoto Protocol was the first major agreement to reduce greenhouse gases. 38 developed countries committed themselves to targets and timetables. The resulting inflexible limitations on GHG growth could entail substantial costs if countries have to solely rely on their own domestic measures.
Carbon emissions trading increased rapidly in 2021 with the start of the Chinese national carbon trading scheme. The increasing costs of permits on the EU ETS have had the effect of increasing costs of coal power.
A 2019 study by the American Council for an Energy Efficient Economy finds that efforts to put a price on greenhouse gas emissions are growing in North America. In 2021, shipowners said they were against being included in the EU ETS.

Global Carbon Market Statistics

The global carbon market has experienced significant growth in recent years. In 2023, the value of the global carbon market reached a record high of 881 billion euros, representing a 2% increase from the previous year. The European Union Emissions Trading System remains the largest carbon market based on value, accounting for approximately 87% of the global market size in 2023.
In terms of trading volume, approximately 12.5 billion metric tons of carbon dioxide were traded in global carbon markets in 2022, which represented a decline of over 20% from the previous year but still an 18.2% increase compared to 2019 levels. Europe dominated the carbon trading volume, accounting for roughly 74% of the traded volume of CO₂ worldwide in 2022.

Economic aspects and tools

Economists generally agree that to regulate emissions efficiently, all polluters need to face the full marginal social costs of their actions. Regulation of emissions applied only to one economic sector or region drastically reduces the efficiency of efforts to reduce global emissions. There is, however, no scientific consensus over how to share the costs and benefits of reducing future climate change, or the costs and benefits of adapting to any future climate change.

Carbon offsets and credits

Carbon leakage

A domestic carbon emissions trading scheme is constrained in its regulatory jurisdiction. GHG emissions may thus leak to another region or sector with less regulation. Generally, leakages reduce the effectiveness of domestic emission abatement efforts. Notwithstanding, leakages may also be negative in nature, increasing the effectiveness of domestic abatement efforts. For example, a carbon tax applied only to developed countries might lead to a positive leakage to developing countries. However, a negative leakage might also occur due to technological developments driven by domestic regulation of GHGs, helping to reduce emissions even in less regulated regions.
The current state of carbon emissions trading shows that roughly 22% of global greenhouse emissions are covered by 64 carbon taxes and emission trading systems as of 2021. Energy intensive industries that are covered by such instruments may view the regulatory disparity between jurisdictions as a loss of competitiveness. They may therefore make strategic production decisions that involve carbon leakage. To mitigate carbon leakage and its effects on the environment, policymakers need to harmonize international climate policies and provide incentives to prevent companies from relocating production to regions with more lenient environmental regulations.
Free emission permits, given to sectors vulnerable to international competition, are one way of addressing carbon leakage by acting as a subsidy for the sector in question. The Garnaut Climate Change Review considered the free allocation of permits unjustified in any circumstances, arguing that governments could deal with market failure or claims for compensation more transparently with the revenue from full auctioning of permits.

Border Adjustment

Another economically efficient solution to carbon leakage is border adjustment, where tariffs are set on imported goods from less regulated countries. A problem with border adjustments is that they might be used as a disguise for trade protectionism. Some types of border adjustment may also not prevent emissions leakage.
The EU Carbon Border Adjustment Mechanism takes in effect for 6 sectors in 2026.

Relevance to climate justice

Carbon trading can be helpful to achieve climate justice. It can transfer money from rich countries, which tend to have higher emissions, to countries with lower incomes and lower emissions for improved climate action.
Cap-and-trade systems have also been linked to causing environmental justice as low-income communities receive less benefits from reduced emissions and are often located near the emitters. Companies under emission trading systems will often emit more pollutants not covered by the system and disproportionately affect low-income communities.

Potential global carbon market

The Paris Agreement provided a legal base for the creation of a global carbon market, which has a potentially significant role in stopping climate change. In the beginning of 2024, the idea made some progress with the Bonn meeting where new tools and supervisory bodies were created.
The rules of the European Union Emissions Trading System include the possibility of connecting it with other trading systems. This has already happened with the Switzerland emissions trading system. China expressed a support for a global carbon market, saying it is better than the EU Carbon Border Adjustment Mechanism.
In 2023 the global value of carbon markets was $948.75 billion. It is expected to reach 2.68 trillion dollars by 2028 and 22 trillion by 2050.
Merging the ETC of China and the EU can be something that sends "a powerful signal to the rest of the world and catalyzes international buy-in" while strongly increasing the efficiency of the system and allowing both countries to attain higher results with less spending.
A global carbon market can speed up emissions reduction seven-fold in all participating countries, while delivering $200 billion per year for clean-energy and social programs. An international coalition for creating it began to form in COP 30. The plan is to create a global emissions cap beginning with a level close to current emissions rate, and then reducing it until reaching net-zero by 2050. For any activity which causes emissions, people would buy allowances. As the cap decreases, the cost of the allowances will increase, creating an incentive for decarbonization. There will be a border adjustment mechanism governed by all participants. Poorer countries can not pay or pay less and part of the revenue will be spent on helping them address the climate crisis.