Emissions Trading Systems – How they work

The overriding purpose of emissions trading is to put a price on carbon dioxide. The concept where entities that emit greenhouse gases should pay for the damage caused to the environment follows from the polluter-pays principle, which is enshrined in international environmental law. Emissions trading represents an attempt to achieve this in the most economically efficient way and to lower overall emissions of greenhouse gases. Furthermore, emissions trading may also create incentives for inefficient entities to invest in green technology.

The platform used for emissions trading resembles other systems for trading such as the stock market. The main difference is that the objects traded are emission allowances or their derivatives as opposed to stocks and shares. One emission allowance corresponds to one unit of emissions, for example one tonne of carbon dioxide. Currently, emissions trading systems are administered by government organisations and are underpinned by laws and regulations. Companies that are subject to the systems are allocated emissions allowances by auctioning or based on other standards. Political and economic interests dictate how the allocation of emission allowances is conducted. Companies must then cover their emissions with emission allowances by surrendering emission allowances back to the government as they emit greenhouse gases. If a company has an excess number of emission allowances to spare, these may be sold on the platform to other companies. Thus, a company may profit financially by emitting less than the amount covered by the emission allowances in their possession. Conversely, if a company emits more than what is covered for by the emission allowances in their possession, additional allowances may be purchased to make up for the gap. Overall costs of these companies’ increase, creating incentives for them to invest in green technology.

Emissions trading is not the only way to put a price on carbon. Alternatives such as carbon taxes are often pitched against emissions trading. Both methods have their strong and weak points. However, the overall trend in the world seems to be tilting towards emissions trading. China has just recently launched its own emissions trading system which is destined to become the largest in the world. In the future, it may be possible to link different emissions trading systems with each other, thus creating a global price for carbon dioxide and other greenhouse gases.

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