Reducing greenhouse gas
emissions, like carbon dioxide, is a crucial component in the
fight against climate change. One way governments are trying to reduce their
emissions is through carbon trading, a market-based system that aims to provide the economic
incentives for countries and businesses to reduce their
environmental footprint. Almost every activity from travel to farming
and even watching this video leads to the emission of gases such as carbon dioxide,
contributing to the greenhouse effect responsible for
climate change. Unlike voluntary offsets, where consumers
can choose to pay a company to balance out their carbon footprint, such as funding reforestation
projects which absorb CO2, carbon trading is a legally binding scheme that caps total
emissions and allows organizations to trade their allocation, hence
the term “cap and trade." All “cap-and-trade" systems have emissions
limits calculated by governments and policymakers, which are compatible with their target of
limiting environmental damage. Carbon allowances, or units, totalling up to
this maximum are then allocated to companies and can be traded
on a market. Each year, organizations with a large carbon
footprint are allocated an allowance proportionate to their historical emissions, which can then
be bought and sold on a secondary market. If, for example, a company knows they have
gone over their allowance, then they will need to buy more carbon
units from their carbon market. But if they implemented measures to reduce
their emissions, they can sell any excess units on
the market. A credit, which can start from $12 or run
as high as $125, allows for the emission of pollutants equivalent to
one ton of carbon dioxide. The price of carbon is determined
by supply and demand. Supply of units is capped at a level deemed
acceptable and their cost will rise and fall depending on whether firms
find alternatives to polluting. By assigning a price to damaging activity,
the system provides a financial incentive for firms to reduce emissions, whilst lowering
the overall cost of these reductions as the cheapest improvements
are made first. Although carbon trading seems great in theory,
it hasn’t been easy to put into practice. The first international carbon
market was set up under the UN’s 1997 Kyoto Protocol
on Climate Change. However, following widespread reports of corruption
and abuse of the system, the market collapsed. A report in 2015 found that an estimated 80%
of sustainable projects under the trading scheme were questionable, enabling emissions
to increase by roughly 600 million metric tons. Since then, there hasn’t been a
consensus on the best way to implement a cap-and-trade
scheme globally. However, there are a number of emission
trading markets around the world at both national
and regional levels. The oldest active carbon market is the European
Union’s Emission Trading System, which launched in 2005, while other schemes are
operating in Canada, Japan, New Zealand, South Korea, Switzerland and the United States.
At the start of 2021, China launched the world’s largest carbon market for
its thermal power industry. The sector accounts for 40% of China’s emissions,
equivalent to double the emissions covered by the EU’s
carbon market. As governments tightened environmental standards,
the total value of global carbon markets grew 34% in 2019,
reaching €194 billion. It’s the third consecutive year of record
growth and values these emissions nearly five times their
worth in 2017. And the number of cap-and-trade markets is
likely to increase as many countries, cities and companies worldwide try to meet their
ambitious pledge of net-zero carbon emissions by 2050 — a target set
by the United Nations. Cap-and-trade systems have been successful
in tackling environmental problems in the past, including one covering sulphur dioxide
emissions, which helped reduce acid rain in the U.S. Compared to direct regulations or
taxes, carbon trading doesn’t require as much government intervention in the economy,
leaving businesses to find their solutions. And as long as the cost of emitting greenhouse
gases is high enough to encourage these alternatives, many environmentalists believe it could be
a relatively straightforward and efficient method to drive
decarbonization. However, an oversupply of carbon allowances
during the 2008 financial crisis saw the price of polluting fall in the EU’s trading
system, reducing the incentive for businesses to
change their behaviour. In response, the EU created the ‘market
stability reserve,’ or MSR, a decade later, which gives the European Commission the ability
to tighten or loosen the supply of carbon units. As a result, their price tripled
from 8 euros per tonne of CO2 to around 25 euros per
tonne of CO2 over a year. In turn, the energy sector moved output away
from coal power stations to cleaner, natural gas powered-electricity production
that produces less CO2. In 2019, emissions fell by 8.7%,
the largest decline since 2009. The EU’s carbon market has also caught the
eye of hedge funds and traders. Whereas OPEC controls a third of the global
oil supply, the EU regulates all carbon allowances within its emission
trading system. And with the EU’s long-term aim of gradually
increasing the price of carbon units, these are seen as a popular
long-term investment. While the COVID-19 pandemic led to a glut
of carbon allowances as activity across the economy fell, prices are now back
up above pre-COVID levels. However, there are concerns that heavy emitters
may find loopholes in carbon trading systems. Unlike the earlier Kyoto Protocol agreement,
the 2015 Paris Climate Agreement commits all signatories, not just the most developed economies,
to impose carbon emission targets. If implemented successfully, analysts believe
that international emissions trading could cut global emissions by
around 60% to 80% by 2035. Critics of carbon trading worry that countries
facing economic difficulties might be tempted to cheat, either by making their
overall emissions cap too generous, or using accounting tricks
to overstate reductions. For example, a nation might reduce its carbon
emissions by building a wind farm to replace a coal-fired
power station. This would free up a portion of its carbon
allowance, which could be sold to another country but might still count as a reduction
in the first country’s emissions, even though overall output
hasn’t changed. There are also fears that major polluters
might relocate across borders to avoid signing up for a cap-and-trade scheme, or
finding a more lenient jurisdiction. Another criticism of carbon markets is that
developed countries, which have done most of the polluting to date, are able to invest
in low-carbon technology and have reoriented their economies to less carbon-intensive
activities, unlike poorer nations. Climate campaigners also argue that too much
focus on merely redistributing pollution obscures the fundamental need for all countries to
transition away from fossil fuels in the near future to avoid severe and irreversible
damage to the environment. The increasing popularity of cap-and-trade
schemes, and the rising price of carbon allowances are forcing companies to consider
their effect on the climate and has led to a
reduction in emissions. Although imperfect, the EU’s carbon trading
scheme is a model for other economies to emulate. With the creation of the biggest carbon market
in China and the US’s return to the Paris Climate Agreement, the global carbon market’s
size and importance look set to grow. Hi guys, thanks for
watching our video. So do you think carbon trading is an
effective way to tackle climate change or is there
a better way? Comment below the video to let us
know and we’ll see you next time.
