What Is Carbon Trade?

Carbon trade is the buying and selling of permits to emit carbon dioxide, with the goal of gradually reducing carbon emissions and mitigating its contribution to climate change.

Carbon trading is generally conducted between nations. The European Union Emissions Trading System is the world's largest carbon trade market.

Carbon trading is also referred to as carbon emissions trading.

Understanding Carbon Trade

The carbon trade originated with the Kyoto Protocol, a United Nations treaty which set an objective 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.

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.

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.

The Cap and Trade System

A cap and trade system is a variation on carbon trade but the trade, while authorized and regulated by government, is conducted between companies. Each company is given a maximum 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. Five U.S. states and four Canadian provinces got together to create the Western Climate Initiative.

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, often these externalities are negative externalities, meaning that the consumption of the good has negative effects on third parties.

Carbon Trade Pros and Cons

Carbon emissions trading has been widely and increasingly criticized. It's seen as a dangerous distraction, and a half-measure to solve the large and pressing issue of global warming. There have also been reports of corruption. 

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