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Carbon Emissions Trading

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Carbon Emissions Trading

The Boeing 737 MAX was designed to reduce CO2 emissions.

Photo: Boeing 737 MAX / Boeing Corporation
the earth

Carbon trading is a market created by governments' response to global warming.

Credit: NASA

What Is Carbon Emissions Trading?

Carbon emissions trading is when companies buy or sell their government-granted allotments of carbon dioxide output. Usually, the companies are utilities and other industries that burn coal and other fossil fuels that emit too much carbon dioxide into the air. Governments issue limited credits to these companies to get them to reduce their CO2 output, and slow down global warming. Companies that don't produce more can buy credits from companies that are under their limit.

How did this come about? The International Energy Agency recommended that no more than a third of the world's reserves of fossil fuels should be burned by 2050. If more is burned, the CO2 will heat up the atmosphere by 2 degrees Celsius. Scientists agree that, once that happens, it will create flooding, drought, and super-storms that will be devastating. (Source: WSJ, The Coming Carbon Asset Bubble, October 30, 2013)

Cap and Trade Makes Carbon Trading Possible

Carbon emissions trading really took off when the EU instituted a cap and trade program in 2005. This set a cap on the total the amount of CO2 that heavy industries and utilities could emit. The cap must be low enough to actually reduce the greenhouse gases that cause global warming. However, if the cap is too low, then it will make the cost of doing business too high, and slow economic growth. If the cap is too high, then it won't impact global warming.

Carbon Trading News

CO2 emissions from commercial airlines are one of the fastest growing contributors to global warming. In 2011, the EU decided to tax flights for their carbon footprints. In response to protests from the U.S. and China, it agreed to abide by a plan developed by the U.N.'s International Civil Aviation Organization (ICAO). However, the EU is growing impatient, and threatens to resume the tax scheme. This could cause a trade war. (Source: VOA, Airlines Urge UN Deal, September 23, 2013)

The Carbon Trading Market

The market for carbon trading was $176 billion in 2011, and could exceed $1 trillion by 2020. Most of this is a result of the EU's Emission Trading Scheme (ETS) that caps emissions for any company doing business in the EU, but many other countries are creating their own markets. As part of the United Nations Framework Convention on Climate Change (UNFCCC), all countries agreed to the Durban Platform in 2011. This says they will negotiate the details of a comprehensive global cap and trade program by 2015, which be implemented in 2020. (Sources: Ernst & Young, The Future of Global Carbon Markets; Global Finance, What a Gas!, July 2008)

How Trading Works

The cap allows each company to emit a certain amount of CO2. The EU issues about two billion of these European Allowances (EUAs) each year. To comply with the EU mandate, companies may either:

  1. Take measures to emit only what they are allowed.
  2. Reduce their emissions below the allowed amount and sell or bank the surplus EUAs.
  3. Continue emitting above their allowance, and buy EUAs in the marketplace to cover it.

Carbon Emission Reductions Credits

Certified Emission Reductions (CERs) credits are also traded. These were created by the Kyoto Protocol, and are credits issued to projects in developing countries that reduce emissions. There are also greenhouse gas emission credits which can be used to fulfill nation-specific caps in the USA, UK, Canada, New Zealand and Japan.

Is Carbon Emissions a New Form of Currency?

This ability to buy and sell EUAs, CERs and other units on a freely traded market has created a new form of "currency". Traders include not only the emitters themselves, but also banks, hedge funds and other investors, who provide liquidity and increase market efficiency. A unit of carbon trading equals the reduction of one metric ton of carbon dioxide orits equivalent in other greenhouse gases. (Source: Cantor CO2 web site)

The idea that a tradeable market is now based on something that is not much more than a concept takes this to a new level. Even if the value of a mortgage-backed security is far removed from its underlying asset, you can still trace it back to something tangible, a loan made by a bank to a person who owns a house.The recent global credit crisis is a result of the creation of new types of derivatives, CDOs, mortgage-backed securities whose value expanded far beyond that of the hard assets that upon which they were based. Creation of new forms of currency is bound to continue.

The value of EUAs, CERs and the like can only be traced back to a colorless, odorless gas, and a measurement of how much of that gas could have been emitted. What is one unit of carbon really worth? Like gold, and unlike a house, it doesn't really have a useful value other than what the market says it has. Thus, in some ways, these EUAs and such are new forms of currency. Article updated October 31, 2013

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