Carbon Markets Gain Momentum, Despite Challenges

Product Number: 
VST103

The global carbon market has expanded quickly over the past two years, buoyed by new and continued interest among national and regional governments in curbing carbon emissions. Worldwide, carbon trading reached a total value of $59.2 billion in 2007, up 80 percent over 2006, according to initial estimates from the market research group Point Carbon.1 Earlier estimates indicated that the volume of carbon permits and credits traded in 2006 was more than double the amount traded in the previous year.2 (See Table 1.)

Carbon markets are designed to combat climate change by putting a price on carbon dioxide (CO2) and other greenhouse gases. Companies and other entities can trade the right to emit these gases through permits, credits, or allowances. The overall amount of emissions in a state or country is often limited by legislation. If a company emits more than allowed by law, it can buy permits from another company that has reduced its emissions to below its allocation.

In the past, large emitters (such as factories or power plants) had little financial incentive to limit carbon dioxide emissions because there were no costs directly associated with greenhouse gas emissions. Carbon markets are helping to internalize the true environmental costs of emitting CO2 and other gases that contribute to climate change.

Mandatory carbon markets are underpinned by national or regional legislation. The European Union, for example, established the European Union Emissions Trading Scheme (EU-ETS) as part of its strategy to meet its Kyoto Protocol-mandated emissions targets.3 With the EU-ETS, the European Union expects to meet its Kyoto targets for $4.3 billion–5.4 billion annually, an amount equivalent to less than 0.1 percent of the region’s gross domestic product.4 Without the EU-ETS, compliance costs would be about twice as high.5

The EU-ETS is the world’s largest carbon trading platform. (See Figure 1.) Its test trading period began in 2005 and finished in 2007. During this time about 11,500 large emitters—such as power plants, heat generators, and energyintensive factories—were included in the trading scheme. In 2006, the EU-ETS more than tripled the volume traded during the previous year, from 321 million tons of carbon dioxide equivalent to 1.1 billion tons.6 (Carbon credits are measured in terms of CO2 equivalent to account for the varying potential of carbon dioxide and other greenhouse gases to contribute to climate change.) The value of the traded carbon also tripled over the same time period, from $8.4 billion in 2005 to $24.9 billion in 2006 (in 2007 dollars).7

The EU-ETS entered its second trading phase in 2008. This phase, which lasts until 2012, corresponds to the Kyoto Protocol’s first emissions reductions commitment period. New emissions sources, such as aviation, will be added, as will other types of greenhouse gases beyond carbon dioxide.8 More stringent emissions caps during this period mean that there are fewer permits to be traded, and this is—so far—keeping prices higher than at the end of the first trading period. During 2007 there was an oversupply of permits, as too many had been initially allocated, and the price per permit crashed to nearly zero.9 (See Figure 2.)

Other carbon credits can also be traded on the EU-ETS: those created through the Kyoto Protocol’s “flexibility mechanisms.” These are known as the Clean Development Mechanism (CDM) and Joint Implementation (JI). The CDM— which allows industrial countries to meet their Kyoto targets in part by investing in clean development projects in developing countries—produced 475 million tons of certified emissions reductions in 2006 alone.10 These credits were valued at more than $5 billion.11 JI, which has projects primarily in Eastern Europe, has been slower to start, with 16 million tons of credits traded in 2006, at a value of $144 million.12

Some observers are concerned that several important sources of greenhouse gases are not adequately addressed by the existing mechanisms. One area that has been especially controversial is known as Reducing Emissions from Deforestation in Developing Countries. With deforestation accounting for 20 percent of global emissions, including 70 percent of Brazil’s emissions and 80 percent of Indonesia’s, forest protection is an essential part of the efforts needed to combat climate change.13 At climate negotiations in Bali in December 2007, the World Bank announced the creation of a Forest Carbon Partnership Facility.14 This financial instrument is intended to compensate countries for costs they incur to keep existing forests intact.15

Forestry is often mentioned in conjunction with yet another type of carbon market: the voluntary market. This market is used by businesses, organizations, and individuals who voluntarily purchase carbon credits (often referred to as carbon offsets in this context) to mitigate their greenhouse gas emissions. The credits are usually exchanged over the counter—not through a formal market—or through an established trading mechanism such as the Chicago Climate Exchange (CCX). Ecosystem Marketplace, a U.S.-based organization that tracks environmental markets, estimated that in 2006 at least 23.7 million tons of CO2 equivalent were exchanged on the voluntary market, including about 10.3 million tons exchanged through CCX.16 The Chicago Climate Exchange reports that its trading volume doubled to 22.9 million tons during 2007.17

While carbon markets continue to grow, several key questions remain. One very important issue is whether and how the United States will establish a national carbon cap and will institute mandatory carbon trading. As the world’s largest CO2 emitter and the only industrial nation that has not ratified the Kyoto Protocol, the U.S. government’s inaction threatens to mute the concerted efforts of the 176 other countries, and the European Union, that have ratified the protocol.18

In the meantime, several state and regional initiatives in the United States and Canada are gaining momentum. The Regional Greenhouse Gas Initiative (RGGI), which is set to begin in 2009, is a commitment by at least 10 northeastern states to cap regional CO2 emissions at 1990 levels by 2014 and to reduce them by 10 percent below that level by 2018.19 In 2006, California passed legislation requiring a 25-percent reduction in CO2 emissions by 2020.20 Carbon trading to meet this goal is likely to begin in 2012, and most reductions are expected to come from major emitters in-state.21 And the Western Climate Initiative, modeled after RGGI, has set a goal of bringing regional emissions to 15 percent below 2005 levels by 2020 by establishing a market mechanism.22 Currently, California, six other western states, and two Canadian provinces have signed on, with six other western states in the United States, one Mexican state, and three provinces joining as observers.23

Notes: 

1.Point Carbon, “Global Carbon Market Grows 80% in 2007,” press release (Oslo: 18 January 2008). Dollar amount converted from euros using exchange rate for 18 January 2008.

2.World Bank, State and Trends of the Carbon Market 2007 (Washington, DC: May 2007), p. 3.

3. European Communities, “EU Action Against Climate Change,” brochure, September 2005, p. 8.

4. Ibid. Euros converted to dollars on 18 January 2008.

5. Ibid.

6.World Bank, op. cit. note 2.

7. Ibid.

8. European Communities, op. cit. note 3, p. 9; European Commission, “Climate Change: Commission Proposes Bringing Air Transport into EU Emissions Trading Scheme,” press release (Brussels: 20 December 2006).

9. Alex Dewar et al., Cap and Trade Policy in the United States (draft) (Washington, DC: Natural Resources Defense Council, August 2007), p. 12.

10.World Bank, op. cit. note 2.

11. Ibid.

12. Ibid.

13.World Bank, “Forest Carbon Partnership Facility Launched at Bali Climate Meeting,” press release (Bali, Indonesia: 11 December 2007).

14. Ibid.

15. Ibid.

16. Katherine Hamilton et al., State of the Voluntary Carbon Markets 2007: Picking Up Steam (San Francisco: Ecosystem Marketplace, July 2007), p. 5.

17. Point Carbon, “Carbon Market North America,” 16 January 2008, at www.pointcarbon.com, p. 4.

18. This does not include emissions from gas flaring, cement making, or land use change. U.S. carbon dioxide emissions are a Worldwatch calculation from BP, Statistical Review of World Energy (London: 2007); U.N. Framework Convention on Climate Change, “Status of Ratification,” at unfccc.int, viewed 18 January 2008.

19. Regional Greenhouse Gas Initiative, “About RGGI,” at www.rggi.org, viewed 20 July 2007; Point Carbon, op. cit. note 17.

20. Office of the Governor, “Gov. Schwarzenegger Signs Landmark Legislation to Reduce Greenhouse Gas Emissions,” press release (27 September 2006); Felicity Barringer, “Officials Reach California Deal to Cut Emissions,” New York Times, 31 August 2006; Point Carbon, “Carbon Market North America,” 1 August 2007, at www.pointcarbon.com.

21. Office of the Governor, op. cit. note 20.

22.Western Climate Initiative, at www.westernclimate initiative.org, viewed 28 January 2008.

23. Ibid.