What is carbon trading and how does it work
Today, more than 40 countries and 25 subnational governments have implemented a price on carbon. China has been running eight pilots and is creating a national trading system which is set to become the largest in the world.
More than one thousand businesses and investors have called for comprehensive price on carbon. Internal carbon pricing has equally been gaining momentum; over companies already account for the climate risks their business is exposed to. This helps companies plan ahead and weigh the financial risks of future investments. Our steel producer might be operating in several countries and needs to budget the cost of doing business as more regulators implement carbon prices.
This trend was reinforced by the recommendations of the Task Force on Climate-related Financial Disclosures — a G20 initiative currently chaired by Michael R. With a number of milestones coming up, the end of the Kyoto protocol in will be the most significant moment.
After this point the Paris Agreement will govern international carbon pricing schemes. The details of the mechanism are still being negotiated; the main difference being that both developed and developing nations have set reduction targets. The Kyoto Protocol allowed for emission offsets in developing countries, whereas Paris creates an opportunity to extend the reach and deepen the integration of carbon markets.
Linking various trading schemes into an international carbon market will stabilize prices and offer more cost-effective emission reduction options. Permit prices need to be substantial to make it financially attractive for the steel producer to invest in cleaner technologies.
Carbon markets have seen relatively low prices for a number of years. In earlier schemes, difficulty in assessing emission baselines and the free allocation of carbon permits led to an oversupply in the market. This can be remedied by tightening caps in line with current climate targets and auctioning all available permits. International aviation and shipping have traditionally not been included in trading schemes. However in , the International Civil Aviation moved to create a market based mechanism to reduce greenhouse gas emissions which is to become operational in Increasing the regional and sectoral reach of international trading systems will go a long way to remedy carbon leakage and drive up prices.
Broader criticisms of carbon trading include concerns that it has proven ineffective - some offset schemes even counterproductive - and it disproportionately affects lower income classes. The views expressed in this article are those of the author alone and not the World Economic Forum.
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