What is Carbon Trading?

Emissions trading (or cap and trade) is an administrative approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants.

In such a plan, a central authority (usually a government agency) sets a limit or cap on the amount of a pollutant that can be emitted. Companies or other groups that emit the pollutant are given credits or allowances which represent the right to emit a specific amount. The total amount of credits cannot exceed the cap, limiting total emissions to that level. Companies that pollute beyond their allowances must buy credits from those who pollute less than their allowances or face heavy penalties. This transfer is referred to as a trade. In effect, the buyer is being fined for polluting, while the seller is being rewarded for having reduced emissions. Thus companies that can easily reduce emissions will do so and those for which it is harder will buy credits which reduces greenhouse gasses at the lowest possible cost to society.

There are currently several trading systems in place with the largest being the European Union's. The carbon market makes up the bulk of these and is growing in popularity. Many businesses have welcomed emissions trading as the best way to mitigate climate change. Enforcement of the caps is a problem, but unlike traditional regulation, emissions trading markets can be easier to enforce because the government overseeing the market does not need to regulate specific practices of each pollution source. However, monitoring (or estimating) and verifying of actual emissions is still required, which can be costly. Critics doubt whether these trading schemes can work as there may be too many credits given by the government, such as in the first phase of the European Union's scheme. Once a large surplus was discovered the price for credits bottomed out and effectively collapsed, with no noticeable reduction of emissions.