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India has been in the forefront of an intense battle to protect the environment by reducing its carbon foot print. To this end, it has invested heavily in low-carbon intensive technologies, successfully switched to renewable energy and stepped up its efforts to protect forests. In the process it earned hundreds of millions of carbon credits or emission reduction certificates that are also called CERs. Under the prevailing Kyoto Protocol climate agreement, carbon credits are used in market-based system of Carbon Trading. Carbon trading allows countries and companies to sell their carbon credits for money. In December the UN Climate Change Conference or COP 25 was held in Madrid. COP 25 was to have finalised rules for a new global carbon market under the Paris Agreement. For India, one the goals and focus at the Madrid conference was to win the right to sell its hard-earned carbon credits .But the talks that concluded in Madrid on 15th December ended without agreeing on the rules for future carbon trading

Carbon Trade:

  • Carbon trading is an exchange of credits between nations designed to reduce emissions of carbon dioxide.
  • Carbon trading is also referred to as carbon emissions trading. Carbon emissions trading accounts for most emissions trading.

Why We Have the Carbon Trade?

  • When countries use fossil fuels and produce carbon dioxide, they do not pay for the implications of burning those fossil fuels directly. There are some costs that they incur, like the price of the fuel itself, but there are other costs not included in the price of the fuel. These are known as externalities. In the case of fossil fuel usage, often these externalities are negative externalities, meaning that the consumption of the good has negative effects on third parties.
  • These externalities include health costs, (like the contribution that burning fossil fuels makes to heart disease, cancer, stroke, and lung diseases) and environmental costs, (like environmental degradation, pollution, climate change, and global warming). Interestingly, research has found that, often, the burdens of climate change most directly affect countries with the lowest greenhouse emissions.
  • So, if a country is going to burn fossil fuels, and produce these negative externalities, the thinking is that they should pay for them.
  • The carbon trade originated with the 1997 Kyoto Protocol, with the objective of reducing carbon emissions and mitigating climate change and future global warming. At the time, the measure devised was intended to reduce overall carbon dioxide emissions to roughly 5% below 1990 levels by between 2008 and 2012.

How It Works?

  • Basically, each country has a cap on the amount of carbon they are allowed to release. Carbon emissions trading then allows countries that have higher carbon emissions to purchase the right to release more carbon dioxide into the atmosphere from countries that have lower carbon emissions.
  • The carbon trade also refers to the ability of individual companies to trade polluting rights through a regulatory system known as cap and trade. Companies that pollute less can sell their unused pollution rights to companies that pollute more.
  • The goal is to ensure that companies in the aggregate do not exceed a baseline level of pollution and to provide a financial incentive for companies to pollute less.

Kyoto Protocol:

The Kyoto Protocol is an international agreement linked to the United Nations Framework Convention on Climate Change (UNFCCC), which commits its Parties by setting internationally binding emission reduction targets.

  • The Kyoto Protocol was adopted in Kyoto, Japan, in December 1997 and entered into force in February 2005.
  • The first commitment period under the Kyoto Protocol was from 2008-2012. The Doha Amendment to the Kyoto Protocol was adopted in Qatar in December 2012. The amendment includes new commitments for parties to the Kyoto Protocol who agreed to take on commitments in a second commitment period from January 2013 to December 2020 and a revised list of greenhouse gases to be reported on by Parties in the second commitment period.
  • Recognizing that developed countries are principally responsible for the current high levels of Greenhouse Gas (GHGs) in the atmosphere, the Kyoto Protocol places commitments on developed nations to undertake mitigation targets and to provide financial resources and transfer of technology to the developing nations.
  • Developing countries like India have no mandatory mitigation obligations or targets under the Kyoto Protocol

Paris Agreement:

The Paris Agreement of 2016 is a historic international accord that brings almost 200 countries together in setting a common target to reduce global greenhouse emissions in an effort to fight climate change.

  • The pact seeks to keep global temperature rise to below 2 degrees Celsius from pre-industrial levels, and to try and limit the temperature increase even further to 1.5 degrees Celsius.
  • To this end, each country has pledged to implement targeted action plans that will limit their greenhouse gas emissions.
  • The Agreement asks rich and developed countries to provide financial and technological support to the developing world in its quest to fight and adapt to climate change.

Benefits of emissions trading:

  • Emissions trading achieves the environmental objective – reduced emissions – at the lowest cost.
  • Emissions trading incentivizes innovation and identifies lowest-cost solutions to make businesses more sustainable.
  • Cap and trade has proven to be an effective policy choice.
  • Emissions trading is better able to respond to economic fluctuations than other policy tools.
  • Cap and trade is designed to deliver an environmental outcome – the cap must be met, or there are sanctions such as fines. Allowing trading within that cap is the most effective way of minimising the cost – which is good for business and good for households.
  • Determining physical actions that companies must take, with no flexibility, is not guaranteed to achieve the necessary reductions. Nor is establishing a regulated price, since the price required to drive reductions may take policy-makers several years to determine.
  • By allowing the open market to set the price of carbon allows for better flexibility and avoids price shocks or undue burdens. For example, as seen in Europe, prices will fall during a recession as industrial output, and thus emissions, fall. A centrally-administered tax does not have the same flexibility.
  • The combination of an absolute cap on the level of emissions permitted and the carbon price signal from trading helps firms identify low-cost methods of reducing emissions on site, such as investing in energy efficiency – which can lead to a further reduction in overheads. This helps make business more sustainable for the future. Imposing technology on business does not allow for creativity and can actually lead to higher costs as companies look merely to comply with regulations.
  • Cap and trade has proven its effectiveness in the US through the acid rain program, where it quickly and effectively reduced pollution levels at a far lower cost than expected. The EU Emissions Trading System has shown that cap and trade can be extended to carbon, and in doing so creates a price on carbon that drives emissions reductions. Reductions in pollution that industry feared would be excessively costly were achieved at a fraction of the original estimates.
  • Emissions trading can provide a global response to a global challenge. Cap and trade provides a way of establishing rigour around emissions monitoring, reporting and verification – essential for any climate policy to preserve integrity.


  • Creating a market in something with no intrinsic value such as carbon dioxide is very difficult. You need to promote scarcity – and you have to strictly limit the right to emit so that it can be traded.
  • In the world’s biggest carbon trading scheme, the EU ETS, political interference has created gluts of permits.
  • These have often been given away for free, which has led to a collapse in the price and no effective reductions in emissions. Another problem is that offset permits, gained from paying for pollution reductions in poorer countries, are allowed to be traded as well.
  • The importance of these permits in reducing carbon emissions is questionable and the effectiveness of the overall cap and trade scheme is also reduced.