Carbon Emission Trading

How does it work?

The goal of carbon emission trading (also known as cap and trade) is to minimize the cost and meet a specific emission target i.e. how many pollutants are released to the atmosphere. The government sets the cap which is the overall emission limit for the economy. A permit to release a specific amount of pollutants such as a ton of CO2 is than sold to companies in a form of so called carbon credit. These credits entitle the companies to emit specific quantity of pollutants. If a company needs to increase its emission allowance it has to buy additional credits from another company which didn’t used all the permits it originally purchased from government. Therefore a company polluting more will pay more and the company that pollutes less will receive payment for its environmental friendliness.

EU system now/future

European Union Emission Trading System (EU ETS) is nowadays largest emission system in the world. It is focused on large emitters, usually power plants. Allowances are distributed in phases by European commission to EU member states' governments. Producers get the allowances for free from the governments on their production base in previous years. If they reduce they CO2 production, the producers can sell the allowances to subjects on the market (other pollutants, governments, traders). There is national registry and the European Commission supervising the ownership of each allowance and monitor the change of ownership during whole phase.

Governments negotiated higher quantities of allowances for their industries in the phase one (2005-2007). The result was that producers were not motivated to save anything. The price of allowance started at €30 per tonne CO2 but declined to €0.10 in September 2007. Now we are in second trading period which lasts from 2008 to 2012. The allocation of second phase cut at average of nearly 7% below the 2005 emission levels, so producers are firstly really motivated to cut emissions. But economic downturn came, the demand of electricity decreased so the result was again the surplus of allowances.

3rd phase is about to start in 2013. The major differences from previous periods are the transition to only one overall cap for whole EU and tighter reduction in accordance with EU goal of 20% savings in 2020 in compare with year 1990. It means the annual reduction of about 36 million tones. The price of CO2t is expected to be between 20 and 30€/ton in 2020. There will be allowances auction system instead of free allocation and specific projects will be financed from profits in order to “fight and adapt to climate change”.

Why there is more regulation needed?

  • The idea is aimed at the wrong objective – carbon trading does not address the real object which is global warming. Emissions quotas are usually very generous and there are no strict bindings for great pollutants to decrease their emissions. Instead we are postponing the necessary change by making these emissions a bit more expensive for strongly polluting companies.
  • Carbon emission trading systems are ineffective and costly to run – the main goal is to limit the amount of emission released in the atmosphere. It is obvious that we can achieve these goals using current tools so why there is the need to introduce an entire new market based system that would be less transparent than emission taxes and other regulatory approaches. Moreover huge bureaucracies are created to set limits, overview carbon credits trading, register and monitor amount of emission.
  • Carbon emission trading does not address the responsibility of ordinary people – if we are supposed to cut our emissions (before it’s too late) than obviously every interested party should be involved in such an initiative. However carbon emission trading sets the emission limits on industries only. There are no incentives for ordinary people to buy more eco-friendly car or effective house heating system etc. History shows us that there have been significant improvements in this area by using emission standard target which enforced car makers to make more fuel efficient and less fuel consuming cars.
  • Carbon emission trading is on the first view a really appealing idea but … – Most people find themselves amazed by the idea of carbon trading. The companies will have to lower their emission or pay hard money for not doing so and these few “green” companies will be rewarded for their behavior. However do we really want to place the responsibility of the Earth climate in the market? These days carbon emission trading is far from being properly regulated. Most of us probably realize the potential importance and gravity of market failure in this case. Some argue that it is because carbon emission trading does not affect the economy to such extent while we may raise a question if we should prioritize economy to the climate.
  • Using carbon emission trading we will not cut the emissions enough – Scientists agree that we have to make radical cuts of greenhouse gasses by the year 2020 or we risk irreversible damage to climate and a possibility of accelerated global warming. Carbon emission trading hasn’t so far been successful in cutting the emission in acceptable rate. Recent data shows that only about 1-2% cut is made every year in EU carbon emission trading area while suggested rate is 2.5-5%. And there are countries that are unable to meet even that quota.

What to do?

It is probably quite clear that this issue has a direct impact on every person in the world. Scientists are saying that we have to reduce our carbon emission by 20-40% 1990 levels by the year of 2020. There a lot of talks about climate change – most notably Bali conference or United Nations Climate Change Conference – but as usual with the politicians very little is actually being done. We have to look at the carbon emission trading as a system that is designed to meet usually not very tight emission limits for the lowest costs. In this way it provides a wrong form of incentive for the corporations that must necessarily do the most serious cuts in the amount of pollutants they are producing. Therefore carbon trading works for them as a system for postponing these serious cuts far to the future. When we look at the carbon trading system as a form of a modest regulation which is not effectively addressing our needs there are obvious reasons to regulate this area more heavily. It is a question if we can achieve acceptable results by more regulating the carbon trading or implement some entire new idea.

Suggested changes

• Lower emission allowances over time
• Emissions with respect to sensitivity of area (some areas are more effected by CO2 than others)
• Let non-profit oraganizations participate: “green” organizations can buy up allowances and retire them
• Offer opportunity for coporations to prematurely retire allowances and receive tx reductions
• Set expensive punishments for non compliance
• Include carbon-offset trading in the system
o Incentives for EMs to participate: carbon-ranching, UN-REDD
• Increase regulations for enegery efficiency and using renewable sources


Different systems exist in different countries, bot with regard to carbon emission trading and relating trading systems, such as offset-trading. Benefits could be greatly enhanced if emission trading was standardized and integrated within regions. Especially EMs would gain incentices to actively particilate in carbon emission trading, if an offset trading system was integrated within a cross-regional carbon emission trading system.

Questions for discussion

Is the climate change, especially global warming of the planet Earth caused by the humankind or is it natural cyclic process that man cannot rule?

How much are CO2 responsible for it and how about other GHGs?

Why is the energetic sector only one involved in EU ETS? Why not transport, building industry or all businesses?

Does it make sense at all if only EU countries will reduce their CO2 emission by 10 or 20%? How about developing countries such as China, India and others?


[1] Wikipedia. [online]
[2] New York Times [online]
[3] The World Bank Carbon Finance Web Site [online]
[4] European comission [online]

Unless otherwise stated, the content of this page is licensed under Creative Commons Attribution-ShareAlike 3.0 License