Carbon trading, also known as emissions trading, is a market-based system designed to reduce greenhouse gas emissions cost-effectively.
The core principle is “cap and trade”:
Cap: A government or regulatory body sets a maximum limit (a “cap”) on the total amount of greenhouse gases that a group of companies or industries can emit. This cap is lowered over time to reduce total emissions.
Allowances: Companies receive or buy a limited number of permits (called “allowances” or “credits”), each representing the right to emit one ton of CO₂ or equivalent.
Trade: Companies that can reduce their emissions cheaply can sell their extra allowances to companies that find it more expensive to cut their own pollution. This creates a financial incentive for everyone to reduce emissions.
In short, it puts a price on carbon pollution and allows the market to find the least expensive ways to cut emissions overall.
Advantages of Carbon Trading
Cost-Effective Reduction: It ensures that emissions are cut where it costs the least to do so. This is more efficient than a one-size-fits-all regulation, saving the economy money overall.
Drives Innovation: The financial incentive to sell extra credits encourages companies to invest in and develop new, cleaner technologies and energy-efficient processes.
Guarantees Environmental Outcome: The system is built around a firm “cap” on total emissions. Regardless of trading, the total emissions from the capped sector cannot exceed this limit, providing certainty in meeting reduction targets.
Rewards Green Companies: Companies that pollute less are financially rewarded by being able to sell their unused allowances. This provides a direct revenue stream for sustainable practices.
Market-Based Flexibility: Instead of being told how to reduce emissions, companies have the flexibility to choose the most cost-effective method for their specific situation (e.g., upgrading technology, switching fuels, or buying credits).