Carbon emission trading

Carbon emission trading (also called carbon market, emission trading scheme (ETS) or cap and trade) is a type of emissions trading scheme designed for carbon dioxide (CO₂) and other greenhouse gases (GHGs). A form of carbon pricing, its purpose is to limit climate change by creating a market with limited allowances for emissions. Carbon emissions trading is a common method that countries use to attempt to meet their pledges under the Paris Agreement, with schemes operational in China, the European Union, and other countries.^[1]

Emissions trading sets a quantitative total limit on the emissions produced by all participating emitters, which correspondingly determines the prices of emissions. Under emission trading, a polluter having more emissions than their quota has to purchase the right to emit more from emitters with fewer emissions. Compared to a fixed carbon tax, a theoretical advantage of this market-based approach is that the most cost-effective carbon reduction methods would be utilised first by emitters. This can reduce the competitiveness of fossil fuels, which are the main driver of climate change. Instead, carbon emissions trading may accelerate investments into renewable energy, such as wind power and solar power.^[2]: 12

However, such schemes are usually not harmonized with defined carbon budgets that are required to maintain global warming below the critical thresholds of 1.5 °C or "well below" 2 °C, with oversupply leading to low prices of allowances with almost no effect on fossil fuel combustion.^[3] Emission trade allowances currently cover a wide price range from €7 per tonne of CO₂ in China's national carbon trading scheme^[4] to €63 per tonne of CO₂ in the EU-ETS (as of September 2021).^[5] Latest models of the social cost of carbon calculate a damage of more than $3000 per ton CO₂, while policy recommendations range from about $50 to $200.^{[6][failed verification]} At the same time, existing schemes generally only cover a limited scope of emissions, especially carbon emissions from industry and large power generation, excluding emissions of other potent GHGs such as methane (CH₄) or nitrous oxide (N₂O) from agriculture as well as emissions from transport and private consumption.

Other greenhouse gases can also be traded but are quoted as standard multiples of carbon dioxide with respect to their global warming potential.