What is the carbon market? Definition and meaning

The carbon market, also known as carbon trading, emissions trading or carbon emissions trading, is a market created from trading carbon emission allowances which are aimed at encouraging companies and nations to limit their emissions of CO2 (carbon dioxide).

Carbon emissions trading is an environmental policy device that places an economic cost on carbon emissions. Governments set a price for CO2 emissions, and businesses have to pay for the amount of carbon they emit. This effectively creates an economic incentive not to pollute.

In the European Union carbon market, for example, where companies have to operate within a CO2 cap, those emitting too much can purchase unused allowances from corporations that emitted below their limit.

Carbon MarketSince 2005, the European Union carbon market has grown considerably. (Source: European Commission)

The European Commission says it aims to have 21% lower carbon emissions in 2020 than in 2005, and 43% lower by 2030.

According to an IETA (International Emissions Trading Association) survey, 88% of respondents saw carbon markets as an effective policy instrument.

Dirk Forrister, CEO and President of IETA, said:

“This year’s survey (2015) is a sign that, after a few years of crisis and reform, market participants see a stronger EU ETS (emissions trading system) in the future, and that sentiment is increasingly positive around the world. Recent years have seen a burst of activity in new market development, which is reflected in the survey.”

“The message for Paris is that markets matter – and the challenge for policymakers is to bring together all these bottom-up efforts and find a way to make the links between domestic actions and international contributions.”

Natural and man-made carbon emissions

CO2 emissions occur when carbon dioxide is released into the atmosphere, either through human activities such as burning fossil fuels or naturally.

Emissions tradingXYZ Inc. was able to adhere to regulations by buying some of John Doe’s leftover allowance.

Our planet has natural processes that remove carbon from the atmosphere, so that naturally-emitted CO2 levels remain stable. Animal and plant respiration are examples of natural carbon emissions.

The Earth does not have the capacity to remove human-related carbon emissions. Since the Industrial Revolution, which began in the 18th century, CO2 concentrations in the atmosphere have increased considerably.

CO2 is a greenhouse gas – a gas that contributes to the greenhouse effect by absorbing infrared radiation. Carbon dioxide traps heat as it travels upwards away from Earth towards space.

If we fail to stop CO2 levels from rising, global warming will accelerate, resulting in potentially life-threatening consequences.

Carbon offsetting

Carbon offsetting is the process by which companies and households can compensate for the release of greenhouse gas (GHG) emissions by funding certified GHG reduction projects that either destroy the emissions, sequestrate CO2, or prevent emissions elsewhere.

One carbon offset (carbon credit), is a financial unit of measurement that represents the removal of one tCO2e (tonne of carbon dioxide equivalent) from the atmosphere.

Carbon credits come from greenhouse gas emission reduction projects that deliver statistically measurable reductions in emissions by either replacing the use of fossil fuels with renewable energy, reducing fossil fuel usage through energy efficiency, or capturing and storing released carbon in plants.

According to The Gold Standard, a Swiss-based organization established by the World Wildlife Fund and other international NGOs to try and secure sustainable growth:

“Carbon offsetting provides the opportunity to offset unavoidable emissions, reducing a company’s impact on the environment. It offers companies’ access to compelling social-economic community marketing opportunities whilst helping to finance projects that would not otherwise be viable. The atmosphere does not care where GHGs are emitted or where they are prevented. All that matters in the fight against climate change is reducing the total amount of emissions.”

The United Nations Framework Convention on Climate Change says the following about emissions trading:

“Emissions trading, as set out in Article 17 of the Kyoto Protocol, allows countries that have emission units to spare – emissions permitted them but not “used” – to sell this excess capacity to countries that are over their targets.”

“Thus, a new commodity was created in the form of emission reductions or removals. Since carbon dioxide is the principal greenhouse gas, people speak simply of trading in carbon. Carbon is now tracked and traded like any other commodity. This is known as the “carbon market.”

Video – The Emission Trading Scheme