Carbon emission trading

Carbon emission trading (also called carbon market, emission trading scheme (ETS) or cap and trade) is a type of emissions trading scheme designed for carbon dioxide (CO₂) and other greenhouse gases (GHGs). A form of carbon pricing, its purpose is to limit climate change by creating a market with limited allowances for emissions. Carbon emissions trading is a common method that countries use to attempt to meet their pledges under the Paris Agreement, with schemes operational in China, the European Union, and other countries.

Emissions trading sets a quantitative total limit on the emissions produced by all participating emitters, which correspondingly determines the prices of emissions. Under emission trading, a polluter having more emissions than their quota has to purchase the right to emit more from emitters with fewer emissions. This can reduce the competitiveness of fossil fuels, which are the main driver of climate change. Instead, carbon emissions trading may accelerate investments into renewable energy, such as wind power and solar power.

However, such schemes are usually not harmonized with defined carbon budgets that are required to maintain global warming below the critical thresholds of 1.5 °C or "well below" 2 °C, with oversupply leading to low prices of allowances with almost no effect on fossil fuel combustion. Emission trade allowances currently cover a wide price range from €7 per tonne of CO₂ in China's national carbon trading scheme to €63 per tonne of CO₂ in the EU-ETS (as of September 2021).

Other greenhouse gases can also be traded but are quoted as standard multiples of carbon dioxide with respect to their global warming potential.

The economic problem with climate change is that the emitters of greenhouse gases (GHGs) do not face the external costs of their actions, which include the present and future welfare of people, the natural environment, and the social cost of carbon. This can be addressed with the dynamic price model of emissions trading.

An emissions trading scheme for greenhouse gas emissions (GHGs) works by establishing property rights for the atmosphere. The atmosphere is a global public good, and GHG emissions are an international externality. In the cap-and-trade variant of emissions trading, a cap on access to a resource is defined and then allocated among users in the form of permits. Compliance is established by comparing actual emissions with permits surrendered. The setting of the cap affects the environmental integrity of carbon trading, and can result in both positive and negative environmental effects.

Emissions trading programmes such as the European Union Emissions Trading System (EU-ETS) complement the country-to-country trading stipulated in the Kyoto Protocol by allowing private trading of permits, coordinating with national emissions targets provided under the Kyoto Protocol. Under such programmes, a national or international authority allocates permits to individual companies based on established criteria, with a view to meeting targets at the lowest overall economic cost.

"Economy-wide pricing of carbon is the centre piece of any policy designed to reduce emissions at the lowest possible costs".