Carbon Trading

Carbon trading describes an economic market trading scheme that will encourage a reduction in emissions of the climate-changing gases caused by anthropogenic activities such as the burning of fossil fuels for energy generation. Unlike a carbon tax, which is a rigid market-based instrument that simply increases the cost of emitting carbon dioxide (CO2), carbon trading allows a more flexible approach.

The most common form of carbon trading occurs within a cap-and-trade environment. A government sets an overall cap on the level of emissions and issues emitters with allowances that can be bought and sold amongst members of the scheme. The scheme works by allowing a company that produces too many emissions to purchase allowances from an emitter that has produced less than their entitlement, thus ensuring the overall emission targets set by a government are met.

Trading in gases that pollute the atmosphere was first trialed in the United States under provisions in the Clean Air Act in 1990 (United States). Known as the Acid Rain Program, the U.S. government imposed a cap on sulphur dioxide (SO2) emissions from power plants, distributed allowances and the permission of the owners to meet targets by installing new technologies, burning fuels with a lower sulphur dioxide content, engaging in projects that reduced SO2 emissions from other parts of the economy, or through the trading of allowances between other participants in the scheme. Between the late 1980s and 2000, sulphur dioxide emissions from U.S. industry had been reduced by 5 million tons per year.

The success of the Acid Rain Program provided the United States with a strong argument that trading schemes could successfully reduce carbon emissions and should therefore be employed as a mechanism to reduce CO2 emissions under the terms of the Kyoto Protocol. Although the United States pulled out of the Kyoto Protocol in 2001, Articles 6 and 17 provide mechanisms that enable member nations to trade greenhouse gases. The Kyoto Protocol allows all greenhouse gases to be traded either directly through the transfer of allowances or through the Clean Development Mechanism. This mechanism primarily allows polluters in the developed world to earn credits for investing either in technologies that lower emissions in developing nations, or through investment in carbon sinks.