Carbon Trade

What Is Carbon Trade?

Carbon trade is the buying and selling of credits that permit a company or other entity to emit a certain amount of carbon dioxide. The carbon credits and the carbon trade are authorized by governments with the goal of gradually reducing overall carbon emissions and mitigating their contribution to climate change. Carbon trading is also referred to as carbon emissions trading.

  • Carbon trade agreements allow for the sale of credits to emit carbon dioxide between nations as part of an international agreement aimed at gradually reducing total emissions.
  • The carbon trade originated with the Kyoto Protocol, a United Nations treaty that set the goal of reducing global carbon emissions and mitigating climate change starting in 2005.
  • Various countries and territories have started carbon trading programs—for example, in July 2021, China started a national emissions-trading program.
  • Cap and trade, a variation on carbon trade, allows for the sale of emission credits between companies.
  • These measures are aimed at reducing the effects of global warming but their effectiveness remains a matter of debate.
  • Rules for a global carbon market were established at the Glasgow COP26 climate change conference in November 2021, enacting an agreement first laid out at the 2015 Paris Climate Agreement.

In July 2021, China started a long-awaited national emissions-trading program. The program will initially involve 2,225 companies in the power sector and is designed to help the country reach its goal of achieving carbon neutrality by 2060. It will be the world's largest carbon market. That made the European Union Emissions Trading System the world's second-largest carbon trade market. The EU's trading market is still considered the benchmark for carbon trading.

Understanding Carbon Trade

The carbon trade originated with the Kyoto Protocol, a United Nations treaty that set the goal of reducing global carbon emissions and mitigating climate change starting in 2005. At the time, the measure devised was intended to reduce overall carbon dioxide emissions to roughly 5% below 1990 levels by 2012. The Kyoto Protocol achieved mixed results and an extension to its terms has not yet been ratified.

The essential tenet of the Kyoto Protocol was that industrialized nations needed to lessen the amount of their CO2 emissions.


The notion is to incentivize each nation to cut back on its carbon emissions in order to have leftover permits to sell. The bigger, wealthier nations effectively subsidize the efforts of poorer, higher-polluting nations by buying their credits. But over time, those wealthier nations reduce their emissions so that they don't need to buy as many on the market.

When countries use fossil fuels and produce carbon dioxide, they do not pay for the implications of burning those fossil fuels directly. There are some costs that they incur, like the price of the fuel itself, but there are other costs not included in the price of the fuel. These are known as externalities. In the case of fossil fuel usage, these externalities are often negative externalities, meaning that the consumption of the product has negative effects on third parties.

Advantages and Disadvantages of the Carbon Trade

Proponents of the carbon trade argue that it is a cost-effective partial solution to the problem of climate change and that it incentivizes the adoption of innovative technologies.

However, carbon emissions trading has been widely and increasingly criticized. It is sometimes seen as a distraction and a half-measure to solve the large and pressing issue of global warming.

Despite this criticism, carbon trading remains a central concept in many proposals to mitigate or reduce climate change and global warming.

The Cap-and-Trade System

This is how carbon trade works: Each nation is awarded a certain number of permits to emit carbon dioxide up to a certain level. If it does not use up all of its permits, it can sell the unused permits to another nation that wants to emit more carbon dioxide than its permits allow. Every year, a slightly smaller number of new permits is awarded to each nation.

A cap-and-trade system is a variation on carbon trade. In this case, the trade, while authorized and regulated by the government, is conducted between companies. Each company is given a maximum carbon pollution allowance. Unused allowances can be sold to other companies.

The goal is to ensure that companies in the aggregate do not exceed a baseline level of pollution. The baseline is reduced annually. 

The state of California operates its own cap-and-trade program. A group of U.S. states and Canadian provinces got together to create the Western Climate Initiative.

Cap-and-trade energy programs are intended to gradually reduce pollution by giving companies an incentive to invest in clean alternatives.


Carbon Trading Agreement Post Glasgow COP26

After much deliberation, rules for a global carbon market were established at the Glasgow COP26 climate change conference in November 2021, enacting a globally unified approach first laid out at the 2015 Paris Climate Agreement. The agreed-upon framework, known as Article 6, will comprise a centralized system and a separate bilateral system. The centralized system is for the public and private sectors, while the bilateral system is designed for countries to trade carbon offset credits, helping them meet their emission targets.

Under the new agreement, those who create carbon credits will deposit 5% of proceeds generated into a fund to help developing countries tackle climate change. Also, 2% of credits will be canceled to ensure an overall reduction in emissions. The new rules allow participants to use previous credits created between 2013 and 2020, prompting fears that they could potentially saturate the market and put downward pressure on prices.

Proponents of the framework say that it creates financial incentives for countries and companies to create emission-reducing technology and initiatives, such as mechanical carbon capture systems and forest planting—all of which will help reduce carbon levels in the atmosphere.

What Does Carbon Trading Mean?

Carbon trading, also known as carbon emissions trading, is the use of a marketplace to buy and sell credits that allow companies or other parties to emit a certain amount of carbon dioxide. 

Can Carbon Be Sold?

While the philosophical question has been subject to debate, the fact is that carbon is sold on various marketplaces—some international, some at the country level, and some on the state or local level, like California's cap-and-trade system.

What Is the Current Price of Carbon?

There is no fixed price of carbon worldwide—prices fluctuate by jurisdiction and by market supply and demand—but the benchmark EUA Futures price is €69.1 0 or $78.16 as of Nov. 18, 2021.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Bloomberg. "China's Giant Carbon Market to Start Trading This Week." Accessed Nov. 19, 2021.

  2. European Commission. "EU Emissions Trading System (EU ETS)." Accessed Nov. 19, 2021.

  3. United Nations. "The Kyoto Protocol." Accessed Nov. 19, 2021.

  4. California Air Resources Board. "Cap-and-Trade Program." Accessed Nov. 19, 2021.

  5. Western Climate Initiative. "Program Design and Implementation." Accessed Nov. 19, 2021.

  6. Financial Times. "COP26 Global Carbon Market Rules Pave Way for Emissions Credits Boom." Accessed Nov. 19, 2021.

  7. Ember. "Daily Carbon Prices." Accessed Nov. 19, 2021.