Human activities, particularly the
burning of fossil fuels such as coal, oil, and natural gas, along with various
industrial processes, release significant amounts of greenhouse gases into the
atmosphere. These gases, including carbon dioxide (CO₂), methane (CH₄), and
nitrous oxide (N₂O), trap heat from the sun through a natural process known as
the greenhouse effect. While the greenhouse effect is essential for maintaining
temperatures that support life on Earth, the rapid increase in greenhouse gas concentrations
due to human activities has intensified this effect, leading to global warming.
The continuous accumulation of greenhouse gases poses a profound threat to environmental stability, human health, and economic security. It exacerbates natural disasters, threatens food and water resources, and intensifies social and geopolitical tensions as communities struggle to adapt. Recognizing these risks, the global community has prioritized efforts to reduce emissions, transition to renewable energy sources, and implement policies aimed at mitigating climate change impacts.
Carbon trading is the trading of credits
that permit a company or other entity to emit a certain amount of carbon
dioxide or other greenhouse gases into the atmosphere. It is a market-based approach to controlling pollution by
providing economic incentives for reducing the emissions of greenhouse gases.
It is one of the strategies designed to combat climate change by putting a
price on carbon emissions, encouraging companies or other entities to lower
their carbon footprint. Buying credits enables
the entity to pollute more than its nation's government allows. And those that
emit less will have leftover permits to sell. In a carbon trading
system, a governing body (like a government or international organization) sets
a cap on the total amount of greenhouse gases that can be emitted by certain
sectors or the entire economy. Emission allowances (also called carbon credits)
are then distributed or auctioned to companies. Each allowance typically
permits the holder to emit one metric ton of carbon dioxide or its equivalent
in other greenhouse gases.
Purpose and Benefits
·
Carbon trading internalizes the external
costs of emissions by assigning a price to carbon pollution, encouraging
emitters to reduce emissions cost-effectively.
·
It creates financial incentives for
investment in renewable energy and energy efficiency.
·
It supports countries and companies in
meeting their climate targets under international agreements like the Paris
Agreement.
·
International carbon markets under
Article 6 of the Paris Agreement facilitate cooperation and trading of emission
reductions between countries, enhancing ambition and sustainable development
Mechanism of Carbon Trading
Carbon markets are systems designed
to incentivize the reduction of greenhouse gas emissions by assigning a price
to carbon. They operate through the trading of carbon credits, which represent the right to emit a specific amount of
greenhouse gases. The whole mechanism of carbon trading is explained below:
Setting
a cap: A central authority (such as a government or an
international body) sets an overall limit, or cap, on the total amount of
greenhouse gases that can be emitted by all participating entities (such as
industries, power plants, or even entire countries) over a certain period. The
cap is typically reduced over time to progressively lower total emissions.
Allocation
of allowances: Emission allowances (or permits) are
then either allocated for free or auctioned to the participating entities. Each
allowance typically gives the right to emit one metric ton of carbon dioxide
(CO₂) or its equivalent in other greenhouse gases (CO₂e).
Monitoring
and reporting emissions: Companies are required to measure
and report their actual greenhouse gas emissions accurately and regularly,
according to strict monitoring and verification standards. Independent
third-party audits are often required to ensure credibility.
Trading:
Companies that emit less than their allowed limit can sell their unused
allowances to others who exceed their limits. This creates a market price for
carbon, where supply and demand determine the cost of emitting greenhouse
gases.
Compliance
and penalties: At the end of each compliance period
(typically one year), companies must surrender enough allowances to cover their
actual emissions. If a company cannot cover its emissions with its allowances,
it faces heavy fines or penalties.
Types of
Carbon Markets
There
are two main types of carbon markets: compliance and voluntary.
Compliance
markets: Compliance
carbon markets are legally mandated systems established by governments or
regulatory bodies with the primary goal of achieving predetermined emission
reduction targets. These markets commonly operate through cap-and-trade
systems. In such systems, a limit (cap) is set on the total allowable
emissions within a specific jurisdiction or sector. Allowances, which are
permits to emit a certain amount of greenhouse gases, are then distributed or
auctioned to regulated entities. This creates a market dynamic where entities
that manage to reduce their emissions below their allocated cap can sell their
excess allowances (often referred to as carbon credits) to those entities that
exceed their emission limits. This trading mechanism generates a financial
incentive for companies to reduce their emissions and invest in
cleaner technologies, as doing so can help them avoid the cost of purchasing
additional allowances. Furthermore, the structured nature of these markets,
often featuring tightening emission limits over time, encourages long-term
investment in low-carbon innovation to ensure continued compliance and
potential for profit through the sale of surplus credits.
Voluntary
carbon markets: Voluntary
carbon markets provide a platform for organizations, institutions, and
individuals to voluntarily offset their greenhouse gas emissions. In
these markets, participants achieve this by purchasing carbon credits that are
generated by projects specifically designed to reduce or remove emissions from
the atmosphere. To maintain credibility and ensure environmental integrity, the
carbon credits traded in these markets typically undergo rigorous verification
by independent third-party organizations, such as Verra and the Gold Standard
Foundation. These organizations establish comprehensive standards that emission
reduction or removal projects must meet to be certified and subsequently issue
carbon credits. This process offers a mechanism for entities to take
responsibility for their unavoidable emissions and actively support a diverse
range of climate action projects that go beyond their own operational
boundaries.
India adopted
regulations in 2024 for its planned compliance carbon market under the Carbon
Credit Trading Scheme (CCTS), marking a significant step toward structured
carbon trading in the country
In summary, carbon
trading is a key tool in global climate policy, enabling cost-effective
emission reductions through market mechanisms that incentivize cleaner energy
and innovation while supporting international climate commitments.
