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Emissions trading (or carbon trading) is an approach used to manage – reduce and offset – the emissions of pollutants. There are two markets which are quite different.
The regulatory market is based on an approach, called 'cap and trade', which incentivises the reduction of emissions.
The voluntary market allows people and organisations to offset their emissions by paying for legitimate reduction projects through the purchase of carbon credits
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Carbon trading
Carbon trading markets can be separated into two major types:
- the compliance (or regulatory) market
- the voluntary market
The regulated market
The largest regulated carbon market, as prescribed by the Kyoto Protocol, set up so far is the European Union Emission Trading Scheme (EU ETS) which was launched in 2005 which allows EU members to trade amongst themselves.
Emissions trading (often known as 'cap and trade') is an administrative approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants.
In such a plan, a central authority (usually a government agency) sets a limit or cap on the amount of a pollutant that can be emitted. Companies or other groups that emit are required to hold an equivalent number of credits or allowances which represent the right to emit a specific amount. The total amount of credits cannot exceed the cap, limiting total emissions to that level. Companies that need to increase their emissions must buy credits from those who pollute less. The transfer of allowances is referred to as a trade. In effect, the buyer is being fined for polluting, while the seller is being rewarded for having reduced emissions. Thus, in theory, those that can easily reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest possible cost to society.
The Voluntary market
The voluntary carbon market is quite a different scheme. It does not rely on legally mandated emissions reductions to generate the demand for emission credits or allowances, i.e., a cap is set on emissions and trading takes place to assist entities to meet their targets. The participants in the voluntary market are a wide range of businesses and non-profit organizations who are seeking ways of voluntarily offsetting their carbon dioxide emissions. The voluntary market is more fragmented and confusing than the regulated market and many different types of carbon trading transactions take place. However, it can provide very innovative and flexible ways for entities to address their emissions and create carbon neutral products. It is growing rapidly and starting to mature to the point where accounting, verification and certification standards are being developed that provide a good measure of the quality and value of the emission credits being created and traded.
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