Carbon Trading

Carbon trading is a market-based mechanism designed to reduce global greenhouse gas (GHG) emissions by assigning a monetary value to carbon emissions. It allows countries, companies, or organisations to buy and sell permits or credits that represent the right to emit a specific amount of carbon dioxide (CO₂) or its equivalent in other greenhouse gases. The system seeks to create economic incentives for reducing emissions cost-effectively, aligning environmental protection with market efficiency.
It is a cornerstone of climate change mitigation policy, emerging from the framework of the Kyoto Protocol (1997) and later reinforced under the Paris Agreement (2015).

Concept and Mechanism

The principle behind carbon trading is rooted in the idea that pollution has a cost and that market forces can be used to limit it efficiently.
The system functions under the “cap-and-trade” model:

1. Cap: A government or international authority sets a limit (cap) on the total amount of greenhouse gases that can be emitted by covered entities (such as industries or countries).
   • This cap is gradually reduced over time to achieve emission reduction targets.
2. Allocation of Allowances: Within this cap, emission permits or allowances are distributed — either freely or through auction — to participating entities.
   • Each allowance typically represents one tonne of CO₂ equivalent (1 tCO₂e).
3. Trade: Entities that emit less than their allocated limit can sell their surplus allowances to others that exceed their limits.
   • This creates a carbon market where emission rights are traded, encouraging companies to innovate and cut emissions at the lowest cost.
4. Compliance and Monitoring: At the end of each compliance period, companies must surrender enough allowances to cover their emissions. Independent audits and monitoring systems ensure transparency and accountability.

Types of Carbon Trading

There are two main categories of carbon trading systems:

1. Compliance (Regulated) Markets

Established under international or national regulations, these markets operate through legally binding caps.
Key examples include:

• European Union Emissions Trading System (EU ETS): Launched in 2005, it is the world’s largest and most successful carbon market, covering over 11,000 power stations and industrial plants.
• Regional Greenhouse Gas Initiative (RGGI, USA): A cooperative effort among several U.S. states to cap CO₂ emissions from the power sector.
• China’s National Carbon Market: Initiated in 2021, it is the largest single-country carbon trading system, initially covering the power sector.

2. Voluntary Carbon Markets (VCMs)

Operate outside mandatory regulations, allowing businesses, organisations, or individuals to voluntarily offset their emissions by purchasing carbon credits generated from environmental projects.
Examples of voluntary carbon credit projects:

• Afforestation and reforestation.
• Renewable energy installations (solar, wind, hydro).
• Methane capture from landfills or agriculture.
• Energy efficiency initiatives.

These credits are verified under standards like Verra’s Verified Carbon Standard (VCS), Gold Standard, or Climate Action Reserve.

Carbon Credits and Offsets

A carbon credit represents a reduction or removal of one tonne of CO₂ equivalent from the atmosphere. It may be earned through activities that:

• Reduce emissions (e.g., switching to renewable energy).
• Avoid emissions (e.g., preventing deforestation).
• Remove carbon (e.g., planting trees or carbon capture and storage).

Carbon offsets allow entities to compensate for their own emissions by financing emission-reduction projects elsewhere, often in developing countries.
For example, a company in Europe might offset its emissions by funding a wind power project in India.

International Framework

1. Kyoto Protocol (1997)

The Kyoto Protocol, under the UNFCCC (United Nations Framework Convention on Climate Change), formally introduced market-based mechanisms to reduce global emissions:

• Clean Development Mechanism (CDM): Allowed industrialised countries to invest in emission-reduction projects in developing countries and earn Certified Emission Reductions (CERs).
• Joint Implementation (JI): Enabled developed countries to earn Emission Reduction Units (ERUs) by investing in projects within other developed countries.
• International Emissions Trading (IET): Permitted the trading of assigned emission units between countries with emission caps.

2. Paris Agreement (2015)

The Paris Agreement replaced the Kyoto Protocol’s structure with a more flexible, bottom-up system of Nationally Determined Contributions (NDCs).Article 6 of the agreement introduced new market mechanisms:

• Article 6.2: Enables countries to trade emission reductions (Internationally Transferred Mitigation Outcomes, ITMOs).
• Article 6.4: Establishes a global carbon market supervised by the UN to encourage sustainable development and environmental integrity.

Carbon Pricing and Market Value

The price of carbon varies widely across markets depending on policy stringency and demand.

• In the EU ETS, prices often range between €80–€100 per tonne of CO₂.
• In voluntary markets, prices are generally lower, from US$5 to US$50 per tonne, depending on project quality and verification standards.

A higher carbon price incentivises industries to invest in cleaner technologies and reduce emissions, while a low price may fail to drive meaningful change.

Benefits of Carbon Trading

1. Cost-Effective Emission Reduction: Companies that can reduce emissions cheaply can sell excess allowances, lowering overall abatement costs.
2. Encouragement of Innovation: Creates incentives for cleaner technologies and renewable energy investments.
3. Global Cooperation: Promotes collaboration between developed and developing countries through project-based mechanisms like CDM.
4. Revenue Generation: Governments can auction emission permits, using proceeds for climate adaptation, research, or green infrastructure.
5. Flexibility: Provides industries with multiple pathways to compliance — through reduction, trading, or offsetting.

Criticisms and Challenges

While carbon trading has achieved significant results, it faces several limitations and criticisms:

1. Market Manipulation and Over-Allocation: Early schemes, such as the EU ETS, initially issued too many allowances, reducing incentive for emission cuts.
2. Verification and Integrity Issues: Some carbon offset projects have been criticised for exaggerated or unverifiable emission reductions.
3. Inequity Between Nations: Developing countries often bear the burden of hosting offset projects while developed nations continue high emissions.
4. Price Volatility: Fluctuations in carbon prices can create uncertainty for investors and industries.
5. Greenwashing Concerns: Some corporations use carbon credits to claim carbon neutrality without reducing actual emissions.

Carbon Trading in India

India actively participates in both compliance and voluntary carbon markets, primarily under the Clean Development Mechanism (CDM).

• India is one of the largest suppliers of Certified Emission Reductions (CERs) globally, with projects in renewable energy, waste management, and forestry.
• The Perform, Achieve and Trade (PAT) Scheme, launched by the Bureau of Energy Efficiency (BEE) under the National Mission for Enhanced Energy Efficiency (NMEEE), is a domestic carbon trading mechanism.
  • It sets specific energy-efficiency targets for industries.
  • Surplus savings are converted into Energy Saving Certificates (ESCerts), which can be traded.

Additionally, the Indian Carbon Market (ICM) is under development to align with the Paris Agreement goals and promote domestic trading in emission reductions.

Future Prospects

With the global push for net-zero emissions by mid-century, carbon trading is expected to expand and evolve.Emerging trends include:

• Integration of digital verification tools (blockchain and satellite monitoring).
• Inclusion of nature-based solutions, such as blue carbon (mangrove and wetland conservation).
• Linking of regional carbon markets to enhance liquidity and uniformity.
• Development of carbon border adjustment mechanisms (CBAMs) to prevent “carbon leakage” — the shifting of emissions to countries with lax regulations.