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Global Ideas

How does carbon trading work?

Carbon trading or emissions trading is a complex, market-based mechanism to achieve climate protection at the lowest possible cost. Here's how it works.

Smoke spews out of a pipe

Companies can buy permits if they exceed emission limits

Emissions trading was agreed upon by world leaders in 1997 in Kyoto, Japan as one the main elements of the United Nations Kyoto Protocol, a legally binding global agreement to reduce greenhouse gas emissions.

The aim is to bring down carbon emissions with as little economic cost as possible. The idea behind it is that since it's irrelevant on a global scale where air is polluted, emissions can be saved in places where it's the cheapest to do so. That mostly means that pollution is emitted in industrialized nations whereas emissions are saved in developing countries.

Governments set the limits, or caps, on how much carbon dioxide companies can emit. If firms go above these, they must buy permits to do so. If they go under the limit, they can sell permits they don't need.

Environmental groups such as Greenpeace criticize that way too many permits are handed out, making them too cheap. Environmental experts say that firms will only switch to environmentally-friendly production when the market price for a carbon permits rises higher than the investment needed to save the same amount of greenhouse gas emissions.

Technology transfer

In addition to emission cutting, the Clean Development Mechanism (CDM) anchored in the Kyoto Protocol is meant to facilitate technology transfer to developing nations and thus contribute to a sustainable, climate-friendly development.

Companies can carry out emissions reduction in a developing country and write off the saved carbon amounts against their own emissions account.

But the avoiding of emissions must be "additional." That means the measure must be made possible through carbon trading and should not involve say, setting up a wind power plant that would be profitable anyway.

The system is assessed by independent reviewers to ensure that it adheres to the standards and is eligible for a certified emission reduction (CER). CER projects must be registered with the UN and must fulfill stringent conditions for the certification to be used in carbon trading.

Gold Standard CER, another certification scheme, also focuses on sustainability. It's meant for renewable energy and energy-efficiency projects. Environment damages have to be at a minimum and the projects must have a beneficial effect on the local population, jobs and health.

Europe's carbon scheme a model

Air pollution is dealt with differently across the word. Europe's Emissions Trading Scheme (ETS), which came into force on January 1, 2005, is one of the largest and most ambitious carbon trading mechanisms.

The system is known as cap and trade. The amount of total emissions is limited but emission permits can be traded freely. Companies that exceed their individual limit are able to buy unused permits from firms that have taken steps to cut their emissions.

Some 12,000 industries and plants are included in the ETS. They include sectors ranging from power generation to iron and steel to glass and cement. Aviation will be included in the ETS starting in 2012.

The idea behind Europe's trading scheme has been hailed as a positive step in the effort to tackle human-induced climate change. And it's inspired another giant in the developing world - India said at the beginning of this year that it plans to start energy-efficient certification based on the EU model.

Author: Oliver Samson (sp)
Editor: Mark Mattox

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