Carbon Market: How It Works and Global Trends

With governments and corporations looking to reduce greenhouse gas emissions, carbon markets are rapidly becoming a leading weapon against climate change. Carbon markets put a cost on carbon emissions, which persuades companies to reduce their footprint and enables emission credits to be bought and sold. Europe is ahead of the game when it comes to carbon trading, with a well-developed system that feeds into global policy.

What is a Carbon Market?
A carbon market is a mechanism by which companies, governments, and institutions are able to sell and purchase carbon credits. The objective is to provide financial incentives for reducing emissions. The two mechanisms by which carbon markets operate are:

Compliance Markets: They are governed by states, with emissions limits that have the force of law placed upon industry. Industries with emissions below their allowance level can sell any excess allowances to industries above allowance level. European Union Emissions Trading Scheme (EU ETS) is largest and most mature compliance market.
Voluntary Markets: Companies and individuals purchase carbon credits to cover their emissions, usually investing in activities such as reforestation, renewable energy, or methane capture. Unlike compliance markets, these are not under regulatory programs.

How Carbon Markets Work in Europe

Europe has led in carbon trading since the EU ETS was first introduced in 2005. The scheme covers large industries like power, manufacturing, and air transport, and requires firms to hold allowances per ton of carbon emitted.

EU ETS Major Features:
Cap-and-Trade System: There is a limit on total emissions, which falls over time to encourage companies to switch to cleaner business practices.
Allowance Trading: Firms that cut emissions below their cap can sell excess credits, while firms with excess emissions have to purchase additional allowances or incur penalties.
Carbon Pricing: Prices of allowances are determined by supply and demand, and the price increases as controls are strengthened.
Expansion Plans: The EU is also expanding the system to shipping and other high-emitting sectors, confirming its 2050 carbon-neutrality goal.

Carbon Markets in Other Nations

While Europe is the global leader in carbon trading, other countries have established their own markets:

United States: No national system, but regional schemes. California has a cap-and-trade scheme, and the Regional Greenhouse Gas Initiative (RGGI) in the Northeast.
China: Opened the world's largest carbon market in 2021, for power generation. It will be expanded to other sectors in the future.
Canada: Employs a mix of federal and provincial carbon pricing instruments, such as cap-and-trade and carbon tax.
Australia: Has tried various carbon pricing mechanisms to spur emission reductions.

Carbon Market Challenges

Carbon markets, however, have a number of challenges despite their advantages:

Price Volatility: The price of carbon credits varies with the economy, regulation, and demand and supply.
Regulatory Differences: Rules vary from country to country in controlling markets, which makes it hard to consolidate globally.
Effectiveness Concerns: Carbon markets are criticized on the grounds that these enable companies to carry on polluting by merely purchasing credits rather than cutting emissions directly.

Future of Carbon Markets:-

Regulatory agencies and governments are attempting to make carbon trading plans more robust by enhancing transparency, uniforming rules, and interconnecting various markets across the world. The EU is consistently streamlining its ETS, while other parts of the world are trying to reinforce their own schemes.

With tighter climate policy and higher carbon prices, companies are increasingly accounting for the emissions cost in their long-term planning. Carbon markets will increasingly determine firm and government decisions to transition to a low-carbon economy.

Source: Content based on available information regarding carbon markets.