What is carbon trading? | CNBC International - YouTube

Reducing greenhouse gas emissions, like carbon dioxide,

is a crucial component in the fight against climate change.

One way governments are trying to reduce their emissions is through carbon trading, a market-based

system that aims to provide the economic incentives for countries and businesses

to reduce their environmental footprint.

Almost every activity from travel to farming and even watching this video leads to the

emission of gases such as carbon dioxide, contributing to the greenhouse effect

responsible for climate change.

Unlike voluntary offsets, where consumers can choose to pay a company to balance out

their carbon footprint, such as funding reforestation projects which absorb CO2, carbon trading

is a legally binding scheme that caps total emissions and allows organizations to trade

their allocation, hence the term “cap and trade."

All “cap-and-trade" systems have emissions limits calculated by governments and policymakers,

which are compatible with their target of limiting environmental damage.

Carbon allowances, or units, totalling up to this maximum are then allocated to companies

and can be traded on a market.

Each year, 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, for example, a company knows they have gone over their allowance, then they will

need to buy more carbon units from their carbon market.

But if they implemented 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, whilst lowering the overall cost of these reductions as the

cheapest improvements are made first.

Although carbon trading seems great in theory, it hasn’t been easy to put into practice.

The first international carbon market was set up under the

UN’s 1997 Kyoto Protocol on Climate Change.

However, following widespread reports of corruption and abuse of the system, the market collapsed.

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.

Since then, there hasn’t been a consensus on the best way to implement

a cap-and-trade scheme globally.

However, 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. At the start of 2021, China launched the world’s

largest carbon market for its thermal power industry.

The sector accounts for 40% of China’s emissions, equivalent to double the emissions covered

by the EU’s carbon market.

As governments tightened environmental standards, the total value of global carbon markets grew

34% in 2019, reaching €194 billion.

It’s the third consecutive year of record growth and values these emissions nearly five

times their worth in 2017.

And the number of cap-and-trade markets is likely to increase as many countries, cities

and companies worldwide try to meet their ambitious pledge of net-zero carbon emissions

by 2050 — a target set by the United Nations.

Cap-and-trade systems have been successful in tackling environmental problems in the

past, including one covering sulphur 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.

And as long as the cost of emitting greenhouse gases is high enough to encourage these alternatives,

many environmentalists believe it could be a relatively straightforward and efficient

method to drive decarbonization.

However, 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.

In response, the EU created the ‘market stability reserve,’ or MSR, a decade later,

which gives the European Commission the ability to tighten or loosen the supply of carbon units.

As a result, their price tripled from 8 euros per tonne of CO2

to around 25 euros per tonne of CO2 over a year.

In turn, the energy sector moved output away from coal power stations to cleaner, natural

gas powered-electricity production that produces less CO2.

In 2019, emissions fell by 8.7%, the largest decline since 2009.

The EU’s carbon market has also caught the eye of hedge funds and traders.

Whereas OPEC controls a third of the global oil supply, the EU regulates all carbon allowances

within its emission trading system.

And with the EU’s long-term aim of gradually increasing the price of carbon units, these

are seen as a popular long-term investment.

While the COVID-19 pandemic led to a glut of carbon allowances as activity across the

economy fell, prices are now back up above pre-COVID levels.

However, there are concerns that heavy emitters may find loopholes in carbon trading systems.

Unlike the earlier Kyoto Protocol agreement, the 2015 Paris Climate Agreement commits all

signatories, not just the most developed economies, to impose carbon emission targets.

If implemented successfully, analysts believe that international emissions trading could

cut global emissions by around 60% to 80% by 2035.

Critics of carbon trading worry that countries facing economic difficulties might be tempted

to cheat, either by making their overall emissions cap too generous,

or using accounting tricks to overstate reductions.

For example, a nation might reduce its carbon emissions by building a wind farm to replace

a coal-fired power station.

This would free up a portion of its carbon allowance, which could be sold to another

country but might still count as a reduction in the first country’s emissions, even though

overall output hasn’t changed.

There are also fears that major polluters might relocate across borders to avoid signing

up for a cap-and-trade scheme, or finding a more lenient jurisdiction.

Another criticism of carbon markets is that developed countries, which have done most

of the polluting to date, are able to invest in low-carbon technology and have reoriented

their economies to less carbon-intensive activities, unlike poorer nations.

Climate campaigners also argue that too much focus on merely redistributing pollution obscures

the fundamental need for all countries to transition away from fossil fuels in the near

future to avoid severe and irreversible damage to the environment.

The increasing popularity of cap-and-trade schemes, and the rising price of carbon allowances

are forcing companies to consider their effect on the climate

and has led to a reduction in emissions.

Although imperfect, the EU’s carbon trading scheme is a model for other economies to emulate.

With the creation of the biggest carbon market in China and the US’s return to the Paris

Climate Agreement, the global carbon market’s size and importance look set to grow.

Hi guys, thanks for watching our video.

So do you think carbon trading is an effective way to tackle climate change

or is there a better way?

Comment below the video to let us know and we’ll see you next time.