Carbon emission trading

Carbon emissions trading is a form of emissions trading that specifically targets carbon dioxide (calculated in tonnes of carbon dioxide equivalent or tCO2e) and it currently constitutes the bulk of emissions trading.

This form of permit trading is a common method countries utilize in order to meet their obligations specified by the Kyoto Protocol; namely the reduction of carbon emissions in an attempt to reduce (mitigate) future climate change.

Under Carbon trading, a country having more emissions of carbon is able to purchase the right to emit more and the country having less emission sells the right to emit carbon to other countries. The countries emitting more carbon thereby satisfy their carbon emission requirements, and the trading market results in the most cost-effective carbon reduction methods being exploited first. For any given expenditure on carbon reduction, the market mechanism will result in the greatest reduction.

A carbon market (or greenhouse gas emission allowance trading system) is a public policy tool for reducing greenhouse gas emissions (mainly carbon dioxide) in the environment. atmosphere, responsible for global warming. This policy consists in charging issuers the cost of the nuisance to the climate of their emissions, according to the polluter-pays principle. This additional cost to emitters should encourage them to reduce their emissions, for example by reducing their energy consumption or by using renewable energies rather than fossil fuels.

The carbon market and the carbon tax have the same goal: to reduce emissions. The difference: by creating a tax, the authorities set a price for carbon; by establishing a market, the authorities set a cap on carbon emissions. A carbon market, a public tool that puts a limit on the emissions of facilities covered by the market, can not be assimilated to a financial market or a conventional market.

Principles and functioning
In a carbon market a public entity (for example, the United Nations, the European Union or states, etc.) sets emission ceilings for greenhouse gas emitters lower than their current emission level and distributes emission allowances corresponding to this ceiling.

At the end of a certain period, issuers must prove that they have fulfilled their obligations by returning to that public authority a volume of allowances equivalent to their volume of emissions over the period. Those who have emitted more greenhouse gases than the authorized level must buy the quotas they lack, except to be inflicted a large fine usually non-discharge. Conversely, those who have issued less than their allocated amount of allowances may sell the allowances they do not need on the market or, when the market allows them to keep them for use in the next period.

The unit of account and exchange, the quota, represents 1 tonne of carbon (or equivalent greenhouse gas), which can be traded on an organized market (a carbon exchange) or over the counter (over-the- counter). The Counter), directly between a buyer and a seller.

The price of the quota depends primarily on the quantity of allowances issued by the public entity, ie the level of the fixed ceiling: the less it distributes quotas in relation to emissions, the more carbon emitters must reduce their emissions. or buy quotas. The price thus reflects the degree of ambition of climate policy. In this context, the price is established by exchanges between market players at the equilibrium level between supply and demand for allowances. Other factors influence the price of quotas:

growth: with a constant mode of production (capital, labor, raw materials), the rise in production increases carbon emissions and therefore the demand for quotas,
the weather: periods of cold increase fossil energy consumption and therefore the demand for quotas,
technological innovations: they make it possible to modify the factors of production and, potentially, to produce the same goods by emitting less carbon (decrease of the carbon intensity of the production),
the relative price of the energies which influence in the short term the arbitrations between mode of production of electricity

Emissions trading works by setting a quantitative limit on the emissions produced by emitters. The economic basis for emissions trading is linked to the concept of property rights (Goldemberg et al.., 1996, p. 29).

Costs and valuation
The economic problem with climate change is that the emitters of greenhouse gases (GHGs) do not face the full cost implications of their actions (IMF, 2008, p. 6). There are costs that emitters do face, e.g., the costs of the fuel being used, but there are other costs that are not necessarily included in the price of a good or service. These other costs are called external costs (Halsnæs et al.., 2007). They are “external” because they are costs that the emitter does not carry. External costs may affect the welfare of others. In the case of climate change, GHG emissions affect the welfare of people now and in the future, as well as affecting the natural environment (Toth et al., 2001). These external costs can be estimated and converted into a common (monetary) unit. The argument for doing this is that these external costs can then be added to the private costs that the emitter faces. In doing this, the emitter faces the full (social) costs of their actions (IMF, 2008, p. 9), and will therefore take these costs into account in their decisions and actions.

Ethics and fairness
The manner in which climate change is addressed involves ethical and other issues related to fairness. To actually calculate social cost requires value judgements about the value of future climate impacts (Smith et al.., 2001). There is no consensus among economists over how to value the fairness (economists use the term equity to mean fairness) of a particular climate policy, e.g., how to share the burden of costs for mitigating future climate change (Toth et al., 2001). Nor do economists have any professional expertise in making ethical decisions, e.g., over the value assigned to the welfare of future generations (Arrow et al.., 1996, p. 130). Typically all the impacts of policy, both the costs and benefits, are added together (aggregation), with different impacts on different individuals assigned particular “weightings,” i.e., relative levels of importance. These valuations are chosen by the economist doing the study. Valuations can be difficult since not all goods have a market price.

There are methods to infer prices for “non-market” goods and services. However, these valuations can be controversial, e.g., valuations of human health impacts, or impacts on ecosystems (Smith et al.., 2001). There is also controversy over how potentially positive benefits from climate change in particular regions, e.g., tourism, offset negative impacts in other regions, e.g., reduced food production (Smith et al.., 2001). The main advantage of economic analysis in this area is that it allows a comprehensive and consistent treatment of climate change impacts. It also allows the benefits of climate change policy decisions to be compared against other possible environmental policies.

Coase model
Coase (1960) (referred to by Toth et al.., 2001; and Helm, 2005, p. 4) argued that social costs could be accounted for by negotiating property rights according to a particular objective. Coase’s model assumes perfectly operating markets and equal bargaining power among those arguing for property rights. For climate change, the property rights are for emissions (permits or quotas). However, it should be noted that other factors affect the climate than just emissions, e.g., the ocean, forests, etc. (Goldemberg et al.., 1996, pp. 28–29). In Coase’s model, efficiency, i.e., achieving a given reduction in emissions at lowest cost, is promoted by the market system. This can also be looked at from the perspective of having the greatest flexibility to reduce emissions. Flexibility is desirable because the marginal costs, that is to say, the incremental costs of reducing emissions, varies among countries. Emissions trading allows emission reductions to be first made in locations where the marginal costs of abatement are lowest (Bashmakov et al.., 2001). Over time, efficiency can also be promoted by allowing “banking” of permits (Goldemberg et al.., 1996, p. 30). This allows polluters to reduce emissions at a time when it is most efficient to do so.

One of the advantages of Coase’s model is that it suggests that fairness (equity) can be addressed in the distribution of property rights, and that regardless of how these property rights are assigned, the market will produce the most efficient outcome (Goldemberg et al.., 1996, p. 29). In reality, according to the held view, markets are not perfect, and it is therefore possible that a trade off will occur between equity and efficiency (Halsnæs et al.., 2007).

Taxes versus caps
A large number of papers in the economics literature suggest that carbon taxes should be preferred to carbon trading (Carbon Trust, 2009). Counter-arguments to this are usually based on the possible preference that politicians may have for emissions trading compared with taxes (Bashmakov et al.., 2001). One of these is that emission permits can be freely distributed to polluting industries, rather than the revenues going to the government. In comparison, industries may successfully lobby to exempt themselves from a carbon tax. It is therefore argued that with emissions trading, polluters have an incentive to cut emissions, but if they are exempted from a carbon tax, they have no incentive to cut emissions (Smith, 2008, pp. 56–57). On the other hand, freely distributing emission permits could potentially lead to corrupt behaviour (World Bank, 2010, p. 268).

A pure carbon tax fixes the price of carbon, but allows the amount of carbon emissions to vary; and a pure carbon cap places a limit on carbon emissions, letting the market price of tradable carbon allowances vary. Proponents argue that a carbon tax is more easy and simple to enforce on a broad-base scale than cap-and-trade programs. The simplicity and immediacy of a carbon tax has been proven effective in British Columbia, Canada – enacted and implemented in five months. Taxing can provide the right incentives for polluters, inventors, and engineers to develop cleaner technologies, in addition to creating revenue for the government.

Supporters of carbon cap-and-trade systems believe it sets legal limits for emissions reductions, unlike with carbon taxes. With a tax, there can be estimates of reduction in carbon emissions, which may not be sufficient to change the course of climate change. A declining cap gives allowance for firm reduction targets and a system for measuring when targets are met. It also allows for flexibility, unlike rigid taxes. Providing emission permits under emissions trading is preferred in situations where more accurate target level of emissions certainty is needed.

In an emissions trading system, permits may be traded by emitters who are liable to hold a sufficient number of permits in system. Some analysts argue that allowing others to participate in trading, e.g., private brokerage firms, can allow for better management of risk in the system, e.g., to variations in permit prices (Bashmakov et al.., 2001). It may also improve the efficiency of system. According to Bashmakov et al.. (2001), regulation of these other entities may be necessary, as is done in other financial markets, e.g., to prevent abuses of the system, such as insider trading.

Incentives and allocation
Emissions trading gives polluters an incentive to reduce their emissions. However, there are possible perverse incentives that can exist in emissions trading. Allocating permits on the basis of past emissions (“grandfathering”) can result in firms having an incentive to maintain emissions. For example, a firm that reduced its emissions would receive fewer permits in the future (IMF, 2008, pp. 25–26). This problem can also be criticized on ethical grounds, since the polluter is being paid to reduce emissions (Goldemberg et al.., 1996, p. 38). On the other hand, a permit system where permits are auctioned rather than given away, provides the government with revenues. These revenues might be used to improve the efficiency of overall climate policy, e.g., by funding reductions in distortionary taxes (Fisher et al.., 1996, p. 417).

In Coase’s model of social costs, either choice (grandfathering or auctioning) leads to efficiency. In reality, grandfathering subsidizes polluters, meaning that polluting industries may be kept in business longer than would otherwise occur. Grandfathering may also reduce the rate of technological improvement towards less polluting technologies (Fisher et al.., 1996, p. 417).

The economist William Nordhaus argues that allocations cost the economy as they cause the under utilisation an efficient form of taxation. Nordhaus points out that normal income, goods or service taxes distort efficient investment and consumption, so by using pollution taxes to generate revenue an emissions scheme can increase the efficiency of the economy.

Form of allocation

The economist Ross Garnaut states that permits allocated to existing emitters by ‘grandfathering’ are not ‘free’. As the permits are scarce they have value and the benefit of that value is acquired in full by the emitter. The cost is imposed elsewhere in the economy, typically on consumers who cannot pass on the costs.

“It is important that we stop thinking in terms of payments to Australian firms in order to compensate them for the effects of the domestic emissions trading scheme. There is no basis for compensation arising from the loss of profits or asset values as a result of this new policy. The rationale for payments to trade-exposed, emissions-intensive industries is different and sound. It is to avoid the economic and environmental costs of having firms in these industries contracting more than, and failing to expand as much as, they would in a world in which all countries were applying carbon constraints involving similar costs to ours.”

The units which may be transferred under Article 17 emissions trading, each equal to one metric tonne of emissions (in CO2-equivalent terms), may be in the form of:

An assigned amount unit (AAU) issued by an Annex I Party on the basis of its assigned amount pursuant to Articles 3.7 and 3.8 of the Protocol.
A removal unit (RMU) issued by an Annex I Party on the basis of land use, land-use change, and forestry (LULUCF) activities under Articles 3.3 and 3.4 of the Kyoto Protocol.
An emission reduction unit (ERU) generated by a joint implementation project under Article 6 of the Kyoto Protocol.
A certified emission reduction (CER) generated from a clean development mechanism project activity under Article 12 of the Kyoto Protocol.
Transfers and acquisitions of these units are to be tracked and recorded through the registry systems under the Kyoto Protocol.

Market trend
Carbon emissions trading has been steadily increasing in recent years. According to the World Bank’s Carbon Finance Unit, 374 million metric tonnes of carbon dioxide equivalent (tCO2e) were exchanged through projects in 2005, a 240% increase relative to 2004 (110 mtCO2e) which was itself a 41% increase relative to 2003 (78 mtCO2e).

The increasing costs of permits have had the effect of increasing costs of carbon emitting fuels and activities. Based on a survey of 12 European countries, it was concluded that an increase in carbon and fuel prices of approximately ten percent would result in a short-run increase in electrical power prices of roughly eight percent. This would suggest that a lowering cap on carbon emissions will likely lead to an increase in the costs of alternative power sources. Whereas a sudden lowering of a carbon emission cap may prove detrimental to economies, a gradual lowering of the cap may risk future environmental damage via global warming.

In 2010 Chicago Climate Exchange (CCX) ceased its trading of carbon emissions. 450 members of the CCX had achieved reductions of 700million tonnes of emissions over the life of the cap and trade program. The seven year CCX cap and trade program claimed to have successfully provided cost-effectiveness and market-based flexibility for emissions trading.

Business reaction
Economist Craig Mellow wrote in May 78 2008: “The combination of global warming and growing environmental consciousness is creating a potentially huge market in the trading of pollution-emission credits.”

With the creation of a market for mandatory trading of carbon dioxide emissions within the Kyoto Protocol, the London financial marketplace has established itself as the center of the carbon finance market, and is expected to have grown into a market valued at $60 billion in 2007.[not in citation given] The voluntary offset market, by comparison, is projected to grow to about $4bn by 2010.

Twenty three multinational corporations came together in the G8 Climate Change Roundtable, a business group formed at the January 2005 World Economic Forum. The group included Ford, Toyota, British Airways, BP and Unilever. On 9 June 2005, the Group published a statement stating that there was a need to act on climate change and stressing the importance of market-based solutions. It called on governments to establish “clear, transparent, and consistent price signals” through “creation of a long-term policy framework” that would include all major producers of greenhouse gases. By December 2007, this had grown to encompass 150 global businesses.

Business in the UK have come out strongly in support of emissions trading as a key tool to mitigate climate change, supported by Green NGOs.

Voluntary surrender of units
There are examples of individuals and organisations purchasing tradable emission permits and ‘retiring’ (cancelling) them so they cannot be used by emitters to authorise their emissions. This makes the emissions ‘cap’ lower and therefore further reduces emissions. In 1992, the National Healthy Air License Exchange was established to pool donations for buying and retiring sulfur allowances under the USA sulfur allowance trading program.

The British organization “Climakind” accepts donations and uses them to buy and cancel European Allowances, the carbon credits traded in the European Union Emission Trading System. It is argued that this removes the credits from the carbon market so they cannot be used to allow the emission of carbon and that this reduces the ‘cap’ on emissions by reducing the number of credits available to emitters.

The British organisation Sandbag promotes cancelling carbon credits in order to lower emissions trading caps. As of August 2010, Sandbag states that it has cancelled carbon credits equivalent to 2145 tonnes of CO2.

European example
The 1st January 2005, “the European Union has created the largest environmental market quota in the world” (or EU ETS European Union Emission Trading Scheme, EU ETS)

Approximately 11,000 power plants and industrial sites with high CO2 emissionsare concerned by the European carbon market, which requires them to have sufficient quotas to cover their emissions (allowable exchangeable quotas). Quotas are distributed free of charge to certain industrialists and states seek to preserve “essential industries” some of which “threaten to relocate their production if the cost of carbon becomes too high”.

To reduce European emissions (by 40% between 1990 and 2030), the emissions included in the European carbon market will have to be reduced by 43% compared to 2005 (and not 1990). However, the carbon market is badly dysfunctional (with a quota price falling to less than 10 euros, which does not encourage manufacturers to reduce their emissions).

Despite a 900 million quota gel (backloading) adopted in January 2014, and long-term reform projects with for example the creation of a stability reserve (validated in May 2015), the carbon market does not keep its promises: about 2 billion allowances would be surplus, which should be removed to launch the market.

In the face of this failure and before the European Council decided, MEPs voted in February 2017 on a new project to reform the EU’s greenhouse gas emission allowance trading (ETS) system, a reform that is valid until in 2030; but only 800 million CO2 allowancesin this context, they could be canceled (whereas more than 2 billion would have to be canceled according to the latest assessment to rebalance the market). The British Conservative MP Ian Duncan, project rapporteur would further reduce the quotas allocated each year but members have not adopted this measure. In the plenary session, MEPs also mostly refused to implement any border adjustment mechanism in order to “protect industries competing with their non-carbon constrained competitors”.

In February 2017, the Euro-parliamentarians proposed to the European Commission and the Council of Europe to create 3 funds (to be financed by the auctioning of allowances) to 1) modernize the energy systems of some Member States; 2) boost investment in renewables, carbon capture and storage (CCS) and low carbon technologies; 3) enable a “just transition”, through the training and reallocation of the workforce affected by the energy transition (financed by 2% of the emission allowance auction revenues).

In August 2018, a report by the think tank Carbon Tracker revealed that the price of carbon on the EU’s emissions trading scheme (EU ETS) jumped by 310% in one year; it attributes this increase to the market anticipation of the commissioning of the market stability reserve (MSR) from January 2019, the centerpiece of the EU-ETS reform adopted in 2017. The price per tonne of CO2 expected to reach 25 euros by the end of 2018 and 40 euros by 2023, which should force Germany, Italy, Spain and the Netherlands to use more gas and less coal, as was observed in United Kingdom where a CO 2 floor pricehas been put in place.

Critics of carbon trading, such as Carbon Trade Watch, argue that it places disproportionate emphasis on individual lifestyles and carbon footprints, distracting attention from the wider, systemic changes and collective political action that needs to be taken to tackle climate change.[full citation needed] Groups such as the Corner House have argued that the market will choose the easiest means to save a given quantity of carbon in the short term, which may be different from the pathway required to obtain sustained and sizable reductions over a longer period, and so a market-led approach is likely to reinforce technological lock-in. For instance, small cuts may often be achieved cheaply through investment in making a technology more efficient, where larger cuts would require scrapping the technology and using a different one. They also argue that emissions trading is undermining alternative approaches to pollution control with which it does not combine well, and so the overall effect it is having is to actually stall significant change to less polluting technologies. In September 2010, campaigning group FERN released “Trading Carbon: How it works and why it is controversial” [full citation needed]which compiles many of the arguments against carbon trading.

The Financial Times published an article about cap-and-trade systems which argued that “Carbon markets create a muddle” and “…leave much room for unverifiable manipulation”. Lohmann (2009) pointed out that emissions trading schemes create new uncertainties and risks,[vague] which can be commodified by means of derivatives, thereby creating a new speculative market.

In China some companies started artificial production of greenhouse gases with sole purpose of their recycling and gaining carbon credits. Similar practices happened in India. Earned credit were then sold to companies in US and Europe.

Recent proposals for alternative schemes to avoid the problems of cap-and-trade schemes include Cap and Share, which was being actively considered by the Irish Parliament in May 2008, and the Sky Trust schemes. These schemes state that cap-and-trade or cap-and-tax schemes inherently impact the poor and those in rural areas, who have less choice in energy consumption options.

Carbon trading has been criticised as a form of colonialism, in which rich countries maintain their levels of consumption while getting credit for carbon savings in inefficient industrial projects. Nations that have fewer financial resources may find that they cannot afford the permits necessary for developing an industrial infrastructure, thus inhibiting these countries economic development.

The Kyoto Protocol’s Clean Development Mechanism has been criticised for not promoting enough sustainable development.

Another criticism is the claimed possibility of non-existent emission reductions being recorded under the Kyoto Protocol due to the surplus of allowances that some countries possess. For example, Russia had a surplus of allowances due to its economic collapse following the end of the Soviet Union. Other countries could have bought these allowances from Russia, but this would not have reduced emissions. Rather, it would have been simply be a redistribution of emissions allowances. In practice, Kyoto Parties have as yet chosen not to buy these surplus allowances.

Structuring issues
Corporate and governmental Carbon emission trading schemes (a trading system devised by economists to reduce CO2 emissions, the goal being to reduce global warming) have been modified in ways that have been attributed to permitting money laundering to take place. The principal point here is that financial system innovations (outside banking) open up the possibility for unregulated (non-banking) transactions to take place in relativity unsupervised markets.

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