Writer:
Hazrin Izwan Che Haron @ Shafiee
Research Portfolio Officer (Industry & Tourism Thrust)
The importance of reducing greenhouse gas emissions in the fight against climate change is widely recognized. Carbon trading is one way that governments are attempting to incentivize organizations to reduce their carbon footprint by providing economic incentives through a market-based system. The basics of carbon trading: Carbon trading is a legally binding scheme that caps total emissions and allows organizations to trade their allocation. Emissions limits are calculated by governments and policymakers, and carbon allowances are allocated to companies, which can be traded on a market.
Organizations with a large carbon footprint are allocated an allowance proportionate to their historical emissions, which can then be bought and sold on a secondary market. If a company goes over its allowance, it will need to buy more carbon units from the market. Conversely, if they implement measures to reduce their emissions, they can sell any excess units on the market.
A credit, which can start from $12 or run as high as $125, allows for the emission of pollutants equivalent to one ton of carbon dioxide. The price of carbon is determined by supply and demand. Supply of units is capped at a level deemed acceptable, and their cost will rise and fall depending on whether firms find alternatives to polluting. By assigning a price to damaging activity, the system provides a financial incentive for firms to reduce emissions while lowering the overall cost of these reductions as the cheapest improvements are made first. Carbon trading can be a relatively straightforward and efficient method to drive decarbonization.
The first international carbon market collapsed following widespread reports of corruption and abuse of the system. A report in 2015 found that an estimated 80% of sustainable projects under the trading scheme were questionable, enabling emissions to increase by roughly 600 million metric tons. There hasn’t been a consensus on the best way to implement a cap-and-trade scheme globally.
There are a number of emission trading markets around the world at both national and regional levels. The oldest active carbon market is the European Union’s Emission Trading System, which launched in 2005, while other schemes are operating in Canada, Japan, New Zealand, South Korea, Switzerland, and the United States. Cap-and-trade systems have been successful in tackling environmental problems in the past, including one covering sulfur dioxide emissions, which helped reduce acid rain in the U.S. Compared to direct regulations or taxes, carbon trading doesn’t require as much government intervention in the economy, leaving businesses to find their solutions.
An oversupply of carbon allowances during the 2008 financial crisis saw the price of polluting fall in the EU’s trading system, reducing the incentive for businesses to change their behaviour. There are concerns that heavy emitters may find loopholes in carbon trading systems.
While there are challenges with implementing a successful carbon trading system, many countries, cities, and companies worldwide are trying to meet their ambitious pledge of net-zero carbon emissions by 2050. Cap-and-trade systems have been successful in tackling environmental problems in the past, and if implemented successfully, analysts believe that international emissions trading could cut global emissions by around 60% to 80% by 2035.
