Carbon Emissions Trading: How Does It Work?

Carbon Emissions : Trading | Cap & Trade | Carbon Offsets | Trading Market | Further Reading

Carbon emissions are traded on the commodity market in two main ways: cap and trade, and baseline and credit (also known as carbon offsets). Carbon emissions contracts are usually traded under the commodity code of RJ on the New York Mercantile Exchange (NYMEX).

Carbon Emissions Trading

The primary special feature of carbon emissions trading is that if handled and regulated properly, this mechanism allows industry globally to gradually and collectively lower the pollution rate down to a more acceptable level. The end result of this is intended to be a mitigation of the global warming effect. On a more mercenary level, it also helps to bolster the societal image of companies that are perhaps perceived as major polluters. Carbon emissions are currently traded on a number of commodity exchanges. The European Climate Exchange (ECX) is a major platform for the trade of carbon offset credits, as is Climate Exchange (CLE-LN). There are also the Australian Securities Exchange (ASX) (where they are traded as Certified Emission Reductions, or CERs). the Montreal Climate Exchange (MCEX), the Multi Commodity Exchange (MCX), BM&F Bovespa (BOVESPA), the Insurance Futures Exchange (IFEX), the European Energy Exchange (EEX) and the Tianjin Climate Exchange (TCX): these all trade in carbon emissions, as do several others. The carbon credit market is getting bigger every year.

Cap and Trade

As mentioned above, there are two distinct types of carbon emissions trading. The first of these is known as cap and trade. Cap and trade is a policy whereby a government sets a standardised price for carbon dioxide emissions and companies subsequently have to pay for the amount of carbon dioxide that they produce. This in effect means that the more wasteful a company is in terms of its carbon dioxide output, the more they stand to lose financially. The government also sets a cap on the total amount of carbon dioxide that a company is allowed to emit. Any company that is producing carbon dioxide above the cap must purchase carbon credits from another company, or pay a fine.

Carbon Offsets

Carbon offsets are different, in that they deal not with companies that break a cap on emissions; rather they reward companies whose emissions are under an agreed ceiling. If a company is operating below the cap set by their government, then they receive credits which are subsequently purchased by companies operating above the cap. This in theory should offset the balance of carbon emissions, hence the name.

Carbon Trading Market

Currently, carbon emissions trading is technically allowed in any of the 37 countries that fall under the jurisdiction of the Kyoto Protocol. The largest emissions trading scheme is currently in operation in the European Union, under the name of the European Union Emission Trading Scheme (EU ETS). Currently 25 of the 27 countries in the EU are enrolled in the scheme. The United States of America also began to engage in carbon cap and trade emissions trading in 2009. Australia and New Zealand are currently in the process of embarking upon their own schemes to implement a carbon credit market. One of the primary factors influencing prices in the carbon trading market is be the cap that is imposed on carbon emission levels by the regulating jurisdiction. As the cap is lowered, as it is periodically, there will be more companies operating above the set limit of carbon emissions. This will mean that there will in theory be more companies in need of carbon offset credits, which could result in a higher price for each credit. A change in the level of carbon emissions generally across the board will also affect prices, as it is hope that cleaner ways of manufacturing products will be found, eliminating the need for any kind of carbon reduction scheme at all.


Further Reading

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