What is Carbon Trading?

If you hear the terms “carbon trading” or “emissions trading,” and your first reaction is “Huh?” you’re not alone. While carbon trading is a growing trend globally, especially in the business sector, many individuals still have no idea what it is or why they should care about it.

The Purpose of Emissions Trading

The idea behind carbon or emissions trading is that large polluters will be limited in the amount of greenhouse gases (such as carbon dioxide) they can emit into the environment.

What Carbon Trading Involves

The government issues permits to polluting companies within set limits. Each permit allows the company to emit one metric tonne of CO2. When a company uses its allowed permits, it essentially is forced to either stop its emissions of pollutants, or pay more for new permits (which they must buy from other companies or carbon traders who have invested in the permits, as there are a set total number of permits issued overall).

The system is designed to do two things to heavy-polluting companies:

1. The businesses are essentially penalised financially if they exceed their allowed emissions levels, and

2. The businesses are given an added incentive to willingly cut their CO2 and other emissions, because they can sell any unused permits they have, making “going green” a more profitable option.

Carbon Trading as an Alternative to Taxation

There are multiple models of emissions control measures available to governments. Carbon trading is one method, through a “Cap & Trade” system. The emissions trading scheme is an alternative to simply taxing heavy polluters. Both systems have their benefits and their critics. One up-side of carbon trading is that it doesn’t immediately carry the negative connotation of taxation, because it offers the ability to not only avoid paying more but to actually earn a profit.

Cap & Trade Explained

A Cap & Trade system is really exactly what it sounds like. Governments put a cap (or total limit) on the amount of emissions they will allow throughout the country. Permits are sold or distributed to polluting companies or individuals. These permit holders can then freely trade their permits, where some will decrease emissions and others will trade for additional permits if they’ve reached they’re allowed emissions levels. During the trading process, the government doesn’t introduce more permits (in an ideal scenario). So as permits are used, existing permits become more valuable to buyers, resulting in market price increases in a stock market-like trading environment.

Last updated 22 September 2008