Carbon Credit Trading

A carbon market is a market system that aims to establish a price for emissions in order to limit global climate change.

It does this by turning units of greenhouse emissions into tradable assets that can be bought or sold by countries in order to meet national emission limits.

These units are otherwise known as carbon credits. One carbon credit is equal to one metric tonne of carbon dioxide equivalent.

The use of carbon credits as a means to offset emissions has been criticised by some, who argue that it can lead to a 'permit to pollute'. Others argue that these markets are necessary in order to avoid the most catastrophic effects of climate change.

The carbon market is still in its early stages of development. The most well-known and established market is the European Union Emissions Trading Scheme, which launched in 2005.

In the first year of the scheme, around 11,000 power plants and factories were required to surrender allowances for each tonne of CO2 they emitted . These allowances were allocated to them for free, based on their past emissions.

The total number of allowances was capped at a level that would ensure emission reductions in line with the Kyoto Protocol target for the EU of an 8% reduction from 1990 levels by 2012.

Allowances could be traded if a company needed to emit more than its allocation. The price of allowances fluctuated according to supply and demand.

In the early years of the scheme, there were concerns that the allocations had been too generous, leading to a large surplus of credits and a low carbon price. As a result, the European Commission made adjustments to the scheme, including postponing the sale of some allowances and withdrawing others from the market altogether.

In 2012, the EU emissions trading scheme was extended to include aviation.

Further Global Carbon Markets:

The Japanese carbon market is the second largest in the world, after the EU. It launched in 2010 and covers around 1,200 companies . Japanese offsets can be used for compliance with the country's domestic Emissions Trading Scheme as well as the Kyoto Protocol's Clean Development Mechanism.

Japanese businesses have been active in international carbon markets, both as buyers and sellers of credits. In 2012, Japanese firms were the second largest group of buyers of credits from the Clean Development Mechanism, behind only India .

The American carbon market is much smaller than Europe's and Japan's. However, there are a number of regional initiatives underway, including the Regional Greenhouse Gas Initiative (RGGI) – a market-based program to reduce greenhouse gas emissions from the power sector in nine Northeastern states.

The RGGI cap-and-trade program requires power plants in participating states to purchase allowances at auction or from other entities that hold them, in order to emit CO2. The total number of allowances is reduced over time, so the price of allowances increases as the cap declines.

Revenues generated from allowance auctions are invested in energy efficiency, renewable energy and direct bill assistance programs.