I received a great response to my last post on carbon trading from Kristy, who said:

“As I was reading [your post], I was aware that I didn’t really know what carbon-trading was. I had an idea it was some way of rich nations giving money to poor nations to buy their right to pollute the environment, but I hope it’s a whole lot more than that.” - Kristy

Great point, Kristy. But is it true? Is carbon trading really nothing more than a way for developed countries to ease their collective conscience while continuing to emit more and more greenhouse gases into the atmosphere? Rather than preach to you about the values of carbon trading (because admittedly, I do believe it to be good thing), I will try to explain the basics of carbon trading and let you decide for yourself.

This post is the first in a four-part series on carbon trading. Part 1 covers the idea behind cap-and-trade. Part 2 will describe how the Kyoto Protocol works as a carbon trading system. Part 3 will describe voluntary carbon markets and carbon offsetting. Finally, Part 4 will talk about the business of carbon trading and emerging carbon markets.

As this is a complicated and often confusing subject, I am looking forward to hearing comments and questions from the Celsias community. Please don’t hesitate to ask; there are no bad questions.

Cap-and-trade

Carbon trading comes in two forms: mandated and voluntary. In a mandated carbon trading scheme, often called cap-and-trade, countries or firms are forced to reduce their GHG emissions to a certain level. In a voluntary carbon market, countries, firms, or individuals offset their emissions without legal necessity.

The idea of cap-and-trade is based on the fact that greenhouse gas emissions are a global problem, not a local one. Scientifically, it does not matter whether our greenhouse gas emissions comes from New York or Jakarta. The effect on global climate is the same. Therefore, cap-and-trade’s main goal is be to reduce overall emissions with little regard for their origin.

There are three basic ways to reduce our GHG emissions. First, we can reduce our use of carbon-emitting technologies and devices. For example, buying energy efficient products reduces the need for utilities to burn fossil fuels to create your electricity, and therefore reduces total world carbon emissions. Second, we can improve the technologies we use by reducing the emissions they create. Third, we can develop projects that actively reduce atmospheric GHG. These projects are varied, from planting trees (PDF) to recovering methane from landfills, but they all serve the ultimate purpose of capturing greenhouse gases rather than letting them be released into the atmosphere.

Cap-and-trade schemes (PDF) are an attempt to incorporate all three of these methods in the most economically efficient way. Under a cap-and-trade system, an overall cap is set on total emissions. The goal of the system is to reduce emissions below that level. Each participant in the cap-and-trade scheme either buys or is given so-called “allowances.” These are amounts (generally expressed in metric tonnes CO2 equivalent) of greenhouse gases that they are allowed to emit. The total number of allowances adds up to the cap.

Here is how carbon trading works at its most basic level: Imagine a world with only two greenhouse gas emitters, Power Plant A and Power Plant B (these could also be countries or industrial companies, but imagine power plants for now). Plant A can easily reduce its own emissions to below the level of its allowances through energy efficiency retrofits or other personal measures. Plant A therefore has excess allowances. For Plant B, on the other hand, it would be prohibitively expensive to reduce its personal emissions below its allowed level. So instead, Plant B buys the extra allowances from Plant A. The total level of emissions remains below the cap, and each participant reaps the benefits of trading. The Kyoto Protocol, which I will discuss in more detail in Part II of this series of posts, introduces another element. Under Kyoto, Plant B has the option of financing a carbon reduction project (such as reforestation) in a developing country instead of, or in addition, buying extra allowances from Plant A.

Did Plant B buy its way out of reducing its own emissions? Undoubtedly, yes. However, the ultimate goal of reducing total emissions below a set level was achieved. Ultimately, every country will need to improve its own practices, but some can change more quickly and easily than others. This is the theory behind cap-and-trade. It’s up to you to decide whether it is right or wrong.