How do carbon markets work?

In theory putting a price on carbon emissions should incentivise businesses to stop polluting. So why have carbon markets failed to achieve their goal of reducing global emissions?

The Economist explains Carbon Markets – how they work, why they are not working well at present, and how they could work better to help combat climate change.

The origin of Carbon Markets can be traced back to the US Government’s 1990 law that forced polluters to pay for their emissions that were causing acid rain.

The ‘Cap and Trade’ mechanism introduced in the law proved successful in helping to curb acid emissions. This gave rise to the idea of using the same device to help reduce emissions of greenhouse gases. In 1997 the Kyoto Protocol formalised this and Carbon Markets started to be established around the world.

Unfortunately due to low carbon prices, lax enforcement in some countries and weak penalties Carbon Markets have not fulfilled their promise and are having minimal impact on reducing carbon emissions.

‘Carbon Leakage’ where polluting companies relocate their activities to countries with lower carbon prices and weaker enforcement, is also a major weakness of the system.

Carbon Markets can become a much effective tool to help combat climate change if…

  1. The number of permits should be reduced so the carbon price increases substantially to at least $50 – $100 per tonne.
  2. A minimum carbon price should be set that rises over time.
  3. There should be much stricter enforcement and much bigger penalties.
  4. To stop carbon leakage there should be a border tax on imports of products from countries with low carbon prices.

The EU is currently showing some progress by reducing permits and increasing the carbon price to 60 euros per tonne.

However for Carbon Markets to be effective globally China must be really get more serious about them.

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