As concern about global climate change and carbon emissions mitigation is becoming ever more important, governments and corporations across the world have introduced innovative strategies to reduce steadily rising carbon emissions. Some of these strategies such as carbon taxes, energy efficiency strategies, command and control policies and market-based pollution trading mechanisms have been around for some time. However, they were previously used for other pollution control purposes, besides that of carbon emissions mitigation, with varying degrees of success. Nonetheless, since their success in the US to reduce domestic sulfur dioxide deposits in the 1990s, market-based instruments have again risen to the forefront in the fight against climate change.
To put it simply, carbon markets are a means to control and reduce carbon dioxide emissions by having a regulatory authority set a quantitative limit (known as a “cap”) on absolute or relative carbon emissions by major emitters such as industrial factories and power plants. For each ton of carbon emitted over the cap, the emitter would need to buy allowances to be able to legally exceed the limit.
If an emitter is able to emit less than the regulated amount, then it would be able to sell the difference to other emitters via carbon allowances. Carbon trading thereby incorporates financial incentives for corporations to lower their carbon emissions. Under a cost-benefit analysis, if a carbon emitter can lower its emissions at a lower cost than what it would require to purchase carbon allowances, it will do so. If not, then it will purchase allowances on the open market which would serve to rectify the externalities.
Due to the amenability of financial inducements in the carbon market for the business sector, the global carbon market has been growing exponentially since its development across the world in the early 2000s. Beginning in 2006, the market has grown robustly to reach a record total of $176 billion by the end of 2011 (Fig 1). Secondary trading allowed this robust increase during 2010 and was able to blunt the impact of the tertiary effects of the global economic crisis, as well as reduce carbon prices.
Globally, the growth in the carbon emission markets expanded in 2011-2012 as European power producers voluntarily purchased more permits before they are obligated to begin repayment for auctions beginning in 2013. Yet, the bulk of carbon trading activity is still in the EU since it accounts for approximately 97 percent of the global trade in certified emissions reductions (CERs). But this unequal distribution is due to change as more countries have begun to implement carbon trading in an aggressive attempt to stem carbon emissions.
Despite international economic turmoil, the global carbon market is performing quite well. The robustness of the carbon market is illustrated through the fact that even though there has been an overall reduction in the number of CERs traded in 2011, a record number of carbon emissions related products were traded (global transaction volumes reached a new high of 10.3 billion tons of carbon dioxide equivalent) in late 2011, despite a fall in prices of EU Allowance Units (EUAS) below $10. Due to the increased liquidity and depth of the CER market, as well as the increased liquidity in the Emission Reduction Unit (ERU) secondary market, trading volumes expanded in 2011. This increase – the second time in three years – came despite the Eurozone crisis.
Europe is still the dominant player in the global carbon market. It is expected that this trend will continue through 2020 given that the US and Japan have still not made any progress on national carbon legislation. The World Bank estimated that by 2025, the global carbon trading market would equal approximately $1 trillion, of course, driven mostly by Europe, but with significant growth outside of the EU. Boosted by immense economic potential and amid fears over being left behind, countries outside of the EU are moving ahead with establishing carbon-trading programs.
Some countries, such as Ireland, have even noted a positive impact on its negative debt situation by the introduction of a carbon tax. And, while a carbon tax is somewhat conceptually opposed to the notion of a carbon market, it is still parallel to the development of carbon management strategies globally. And, as discussed below with Australia, a carbon tax can transition to a carbon market at a later date.
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