What Is the Carbon Trade?

The carbon trade came about in response to the Kyoto Protocol. Adopted in Kyoto, Japan, in December 1997, the Kyoto Protocol called for 38 industrialized economies to reduce their greenhouse gas emissions between the years 2008 to 2012 to levels 5.2% lower than those of 1990. Carbon is an element stored in fossil fuels such as coal and oil. When these fuels are burned, carbon dioxide is released and acts as a greenhouse gas.

The idea behind carbon trading is quite similar to the trading of securities or commodities in a marketplace. Carbon is given an economic value, allowing people, companies, or nations to trade it. If a nation buys carbon, it is buying the right to burn it, and a nation selling carbon gives up its rights to burn it. The value of the carbon is based on the ability of the country to store it or to prevent it from being released into the atmosphere. (The better you are at storing it, the more you can charge for it.)

Carbon Trading Basics

The carbon trading market facilitates the buying and selling of the rights to emit greenhouse gases. The industrialized nations, for which reducing emissions is a daunting task, buy the emission rights from another nation whose industries do not produce as much of these gases. The market for carbon is possible because the goal of the Kyoto Protocol was to reduce emissions as a collective.

On the one hand, carbon trading seems like a win-win situation: greenhouse gas emissions may be reduced while some countries reap economic benefits. On the other hand, critics of the idea feel some countries exploit the trading system and the consequences are negative. While carbon trading may have its merits, the debate over this type of market is inevitable, since it involves finding a compromise between profit, equality, and ecological concerns.

Global Carbon Trade Framework Agreed at COP26 Climate Change Summit

After successful negotiations at the 2021 Glasgow COP26 Climate Summit, global carbon trading now has a more structured framework for countries to follow. The agreed-upon rules set clear guidelines of how the carbon market will work for bilateral deals between countries and in a United Nations-supervised marketplace.

In a nutshell, the basics of the agreement revolve around carbon credit offsets. For example, nations that reduce their emissions more than they had pledged receive credits that can then be sold to countries where it's costly to cut greenhouse gasses. The agreement aims to incentivize nations to make greater investments in climate mitigation initiatives and technologies, such as producing more renewable energy, to generate credits that they can trade.

Carbon credit trading has surged in recent years as climate change continues to make headlines. The value of global carbon markets grew by 20% in 2020, marking its fourth year of consecutive growth, according to a McKinsey report. Some estimates place the value of a unified global carbon market at $100 billion. Corporations are also making more references to carbon as investors place increased importance on environmental management. UBS analysis of earnings call transcripts reveals that mentions of "carbon" and associated terms over the past three years have tripled to about 1,600 per quarter.