Home Explainers Explained: Carbon Trading - How Carbon is Sold in Markets ?

Explained: Carbon Trading – How Carbon is Sold in Markets ?

Carbon trading is a concept of incentivising low carbon emission by countries/firms, essentially by putting up a price, post the maximum allowed limits.

How Carbon is Sold in Markets ?
A representational image. Photo Credit: bigstockphoto.com

Carbon emission and its harmful effects on the environment has always been a subject of debate. However, not much has done so far in this regard, besides rounds of meetings and promises of co-operation by world leaders to tackle it together. One reason why it never happened in substantial amounts because until recently curbing emissions had an indispensable outcome which is the slowdown in manufacturing. Almost the world over, the production relies heavily on some form of emissions sometimes direct as in case of fossil fuels or indirect, for example, electricity. One primary reason why we’re still struggling with this is due to the unavailability of ‘efficient’ technologies to harvest renewable resources such as solar, wind, geothermal and biomass energy.

The impact of climate change can be broadly categorised into the localised effect and the effect on earth as a whole, for long, economically weaker countries considered climate change as some form of bullying from the more developed nations, so because despite minimal contribution to the global climate change they have to bear the brunt for more than what they have contributed.

To tackle this, the economists come up with a concept, called Carbon trading or precisely the rightful, right to pollute. Those countries which are either contributing fewer emissions or have lowered emissions by upgrading their technologies to greener alternatives earns carbon credits which then can be traded with entities that require more emissions for their produce. By this method, those country having a lesser share in global climate change gets monetary compensation.

The concept of externalities in emissions.

Whenever an entity consumes non-renewable resources such as fossil fuels, it generates emission. Still, the economic impact of the emissions is nowhere accounted in the process, neither in the fuel prices nor in machinery or technology. For instance, water pollution by a leather or chemical industry impacts nearby farmers dependent on the water body for irrigation or fisheries, inflicting upon them, economic as well as health losses. These externalities, often negative in the case with pollution, forms the underlying principle of carbon trading.

Origin of carbon trading

The idea of trading emissions finds its roots in, US sulphur dioxide (SO2) cap and trade programme started, started in 1990, to reduce acid rain events. Environment policy experts viewed it as a successful model for achieving a significant reduction in emissions.

United Nations Framework Convention on Climate Change (UNFCCC) adopted a similar ‘cap and trade’ mechanism called Carbon trading, in the Kyoto protocol, held in 1997. However, the USA never ratified this C&T model to date.

How carbon is sold in markets ?

In carbon trading, 1 CER (certified emission reduction) is equivalent to 1 tonne of emissions. The amount of emission per unit of CER are fixed however the prices to purchase them keeps fluctuating as they are regulated under the free market principles of demand and supply.

In the cap and trade model, governments (or any central authority) independently sets annual emission reduction targets. Once the target is identified, proportional numbers of CERs are allocated to different sectors of economies or individual companies. The polluters can spend CER per tonnes of emission, post the allocated CER are depleted they must either arrest emissions or can buy more carbon credits. Also, the investment made by companies towards greener technology is accounted and earns them additional CER(s) which can be either utilised or sold in the open market or to the government.

As per the Kyoto Protocol, only developed nations that fall in Annexure A or B, have legally binding targets while other developing countries such as India and China enjoy discretion in determining targets.

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Ashutosh Mishra
He is the Founding editor at Indian Spectator. His core interests are politics, economics and technology. 

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