Carbon Trading: Balancing Ambition with Reality

Imagine a market where companies and individuals can buy and sell the right to emit greenhouse gases. This is the essence of carbon trading, a controversial tool used to combat climate change. Inspired by the success of cap-and-trade regulations in reducing sulphur pollution, carbon trading aims to gradually shrink the overall carbon footprint. However, concerns about its effectiveness, accessibility, and potential for greenwashing persist. In this article, we delve into the complex world of carbon trading, exploring the challenges faced by investors and consumers, and examining the potential solutions that could unlock its true potential for a sustainable future.

The Current State:

The global carbon market size has seen significant growth in recent years, reaching an estimated value of €865 billion in 2022. Revenue from carbon taxes and emissions trading systems (ETS) also reached a record high of $95 billion in 2023.

The European Union Emissions Trading System (EU ETS) dominated the scene in 2022, representing 87% of the global market size. In terms of volume, the carbon market witnessed a staggering 12.5 billion metric tons of CO2 traded in the same year. Furthermore, coverage of these systems is expanding rapidly, with 23% of global greenhouse gas emissions now covered by 73 instruments in 2023. While China is a significant player, its operational emissions trading market in 2022 was still relatively small, valued around €1.2 billion.

Two main approaches:

Cap-and-trade: This is a government regulatory program designed to limit, or cap, the total level of emissions of certain chemicals, particularly carbon dioxide, as a result of industrial activity. The government sets the limit, or “cap” on emissions permitted across a given industry. It issues a limited number of annual permits that allow companies to emit a certain amount of carbon dioxide and related pollutants that drive global warming. Companies that surpass the cap are taxed, while companies that cut their emissions may sell or trade unused credits. The European Union Emissions Trading System (EU ETS) is indeed one of the largest examples of a cap-and-trade system.
Offset markets: Carbon markets exist under both mandatory (compliance) schemes and voluntary programs. Compliance markets are created and regulated by mandatory national, regional, or international carbon reduction regimes. Voluntary markets function outside of compliance markets and enable companies and individuals to purchase carbon offsets on a voluntary basis with no intended use for compliance purposes⁴. Offset markets allow companies that must reduce emissions under a regulation to pay other firms to do the mitigation instead. Examples of offset markets include forest conservation or renewable energy projects.