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In 1992, dignitaries from nearly all countries in the world convened to deliberate on environmental issues. This unprecedented convention was called the Earth Summit and it sowed the seeds of international cooperation towards protecting the environment. A product of these efforts is the Kyoto Protocol adopted in 1997, which is a set of guidelines for combating climate change that all the participating countries have pledged to adopt. It undoubtedly happens to be the foremost global action against climate change. Its positive reception is well testified by the fact that it has been renewed three times since it was first adopted. Each time that it was renewed, it came back rejuvenated with dynamic propositions to combat climate change – of which Carbon Trading is a fitting exemplar.

What is Carbon Trading?

Carbon (Or Emissions) Trading is a market-based approach to control pollution. This approach was incubated in a series of micro-economic computer simulations between 1967-70 for the National Air Pollution Control Administration of the United States of America. These studies used mathematical models to compare the cost and effectiveness of various control strategies which included the model on which Carbon Trading would be developed. This model was first used by C. Boyden Gray to control levels of sulfur dioxide to prevent acid rain before being applied to control Carbon or Greenhouse Gases.

This approach was officially recognised in Article 17 of the Kyoto Protocol.

How does it work?

By creating tradable pollution permits, it attempts to add profit motive as an incentive for good performance, unlike traditional regulation methods such as Carbon Tax that are based solely on the threat of penalties.

Carbon Trading is usually done either under cap-and-trade schemes or credits that compensate for emissions.

Cap-and-trade is the most popular form of Carbon Trading. Cap-and-trade involves a governing body which sets a cap (Maximum limit) on allowable emissions. It then distributes or auctions off allowances which are created by dividing the total cap into smaller parts. Firms who do not have enough allowances to cover their emissions will have to either make reductions or purchase another firm’s spare allowances. Members with surplus allowances are allowed to sell them or bank them for future use.

A successful scheme relies on a strict but feasible cap that cuts emissions over time. If the cap is set too high, there will be excess emissions and thus the scheme will turn futile. Whereas, if the cap is set too low the allowances will become scarce and overpriced. However, problems as such can be easily countered by issuing more allowances to stabilise the price and using various other functions of supply and demand to maintain the optimum market atmosphere.

Another popular form of Carbon Trading is in the form of credits or carbon offsets. These are often used along with cap-and-trade schemes. Firms who are unable to contain their emissions below specified limits may compensate by funding already approved emission reduction projects.

An example of how this system works can be witnessed in the form of an electricity generation plant. Generally, they use coal to generate electricity as it is cheaper than natural gas, which mainly consists of methane, and is also used in generating electricity. Operators remain indifferent towards the fact that natural gas releases considerably less greenhouse gas as opposed to coal. Under a cap-and-trade scheme, it will need more allowances when operating with coal than gas, as coal produces more emissions. This will make the operation with coal equally or more expensive in relation to gas and also with higher pollutants. Thus, the operators/owners of the plant will find it more feasible to switch their fuel to gas which will in turn help in achieving the overall objective of reducing greenhouse gases in the atmosphere.

Supporters argue that this should be preferred to other forms of pricing such as carbon taxes, which do not guarantee an exact level of reduction. However, critics often cite that trading is often plagued by weak caps, free handouts of allowances to the biggest polluters and purchase of credits which do not guarantee it will translate into a reduction of emissions.

Current Carbon Trading systems

The European Union’s Emission Trading System (ETS) is the world’s largest scheme for trading emission allowances. It was introduced in 2005, and it currently covers about 50% of the emissions in Europe. The current cap is designed to fall by 1.74% annually to achieve the target of reducing emissions to 21% in 2020 as compared to their level in 2005. The trade in permits in ETS currently is estimated to have a value of €150bn. In simple terms, this scheme has been effective in regulating and putting a limit on half of the emissions in Europe which were earlier unregulated. The companies are also now no longer free to pollute.

ETS also allows its members to earn credits or carbon offsets by funding emission reduction projects in poorer countries that do not have emissions targets.

However, there are a few problems with the ETS such as the exclusion of transport, home and public-sector industries and as with all other cap-and-trade schemes, influential industries can be exempted by flooding them with free allowances.

What about India?

India already has existing market-based approaches hence it could simply focus on broadening and deepening the scope of its already existing approaches which include the Perform Achieve and Trade (PAT) Mechanism and the Renewable Energy Certificate (REC) scheme.

Using PAT, mandatory energy consumption targets are placed on companies in energy-intensive industries. Those with the greatest inefficiencies have the highest reduction targets. Companies that outperform their targets are awarded certificates that can be traded to weaker performers or banked for future use. The REC scheme awards renewable power producers with credits, which can be sold to entities that have a renewable purchase obligation.

Instead of focusing on a more formal and centralised system like the ETS, India could simply focus on developing these capabilities by improving existing registry systems for the PAT and REC schemes to adequately track reductions in emissions. The improved system will be able to promote transparency, environmental integrity, reduce risk of double counting as well as help India to be prepared for engaging in international trade.

By this way, India will be able to start slowly and avoid the initial confusion surrounding the trading system as well as reduce any chances of developing same problems similar to the ETS due to the gradual introduction of the scheme.

In conclusion, Carbon Trading coupled with already existed national policy measures could greatly facilitate the country achieving its goal of reducing emissions by 33% – 35% of 2005 levels by 2030.


By Hussain Lokhandwala

Grade 12 student, The Riverside School, Ahmedabad 

This piece was written under our Writing Mentorship Program – June 2019.

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