Carbon emission trading

From CEOpedia | Management online
Carbon emission trading
See also

Carbon emissions trading aims to reduce emissions of greenhouse gases (GHG). These include carbon dioxide in particular. However, gases such as methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride are also greenhouse gases. Especially since 1990s, global carbon emissions have increased by over 20%. Sectors that emit the most carbon are energy, electricity and transport; industry and industrial processes as well as agriculture (Villoria-Sáes et al 2016, pp. 49-58).

The top 5 carbon emitters are China, USA, India, Russia and Japan (2016). If the European Union is included in this list as a region, it would be in third place (Jiang et al 2022, 357-366).

In response to climate change, 38 developed countries have signed the Kyoto Protocol in 1997, which is known as the international climate protection agreement. The aim was to achieve an average reduction in greenhouse gas emissions of 5% in the years 2008-2012 compared with 1990. In order to comply with the Kyoto Protocol, countries set individual targets to reduce greenhouse gas emissions by 2020. EU countries, for example, were to limit their emissions by up to 30%. In support of these targets, the following three mechanisms can be introduced, which are included in the agreement:

  • Joint Implementation (article 6),
  • Clean Development Mechanism (article 12), and
  • Emissions Trading Schemes (ETS) (article 17) (Villoria-Sáes et al 2016, pp. 49-58).

Emissions trading

Emissions trading allows countries that have fallen below their allowed emissions level in a specified period of time to sell them to other countries that have in turn missed and exceeded their emissions target. To ensure that emissions are also reduced and not just shifted to other countries, the possible emission volumes are capped each year. In this way, a new trading market, also known as the carbon market, has emerged in recent years. From this global perspective, individual countries must establish emissions trading at the national level (UNFCCC 2022).

EU Emissions Trading Scheme

The EU Emissions Trading Scheme (EU ETS) is Europe’s central climate protection instrument and could potentially be used internationally in the future. It was adopted in 2003 and came into force in 2005 to implement the international climate protection agreement of Kyoto. The EU ETS is the first established carbon market in the world and remains the largest. Originally, the EU Emissions Trading Scheme only covered factories from the energy-intensive industry and electricity sectors. In 2012, intra-European air traffic was added. Since 2021, the emissions trading scheme has also applied to the power sector, industry, and the heat and transport sectors. Now the trading scheme covers over 11,000 factories that generate about 40% of greenhouse gas emissions in Europe (European Union 2015).

Cap and trade

Europe’s carbon market works according to the cap and trade principle. There is a capped total number of certificates that can be traded. European countries distribute these to their factories and power plants. This gives them permission to emit carbon. There is one certificate for one ton. If they don't have these allowances, the factories and power plants are not allowed to emit carbon and would have to pay fines for non-compliance. However, the market contains fewer allowances with each passing year than tons of carbon emitted to date. This is intended to motivate companies to limit their carbon emissions each year and invest in new technologies. The carbon emissions trading compensates for this shortage by allowing companies that have a surplus of allowances to sell them to other companies that emit more carbon (European Union 2015).

The EU ETS is a quantity-based control instrument that sets an annually decreasing carbon emission limit for obligated companies. The allowance price is determined partly through auctions and partly on secondary markets. For example, between 2012 and 2017, the price of an allowance was €10 per ton of carbon. By 2019, the price had risen to €25 per ton. However, according to scientists, even this price is too low to achieve the desired control effect. The idea, in fact, is that as the price of allowances rises, the amount of carbon emitted can be reduced to a minimum. Therefore, a European carbon price floor is being discussed, which would set a minimum price for the certificates (Hintermayer 2020).

Emissions trading outside of Europe

Seventeen different national or subnational emissions trading schemes are in operation worldwide, covering about 8% of annual global greenhouse gas emissions (as of August 2015). As China is the world's largest carbon emitter, the implementation of an emissions trading scheme is seen as a critical step towards effective greenhouse gas mitigation with global impact. China has seven emissions trading schemes underway, which together form the second largest carbon market in the world. Chinas national ETS was launched in 2021, but only regulates carbon emissions from the power sector. This covers about 2,000 power entities, which are responsible for 40% of China's total greenhouse gas emissions (Ren, Lo 2017, pp. 414-425).


Author: Alexandra Schewior