Carbon Trading

Carbon trading (also known as cap and trade) is an administrative approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants. Sometimes called emissions trading, is a market-based tool to limit GHG (Greenhouse Gas Emissions). It is the most visible result of early regulatory efforts to mitigate climate change, and grew out of the Kyoto Protocol, which was adopted in 1997. The protocol requires that by 2012, developed countries will achieve greenhouse gas emission reductions of at least 5% against baseline levels of 1990.

In carbon trading, a limit or cap is set by a central authority (usually a governmental body) on the amount of a pollutant that can be emitted. Companies or other groups are issued emission permits and are required to hold an equivalent number of allowances (or credits) which represent the right to emit a specific amount. The total amount of allowances and credits cannot exceed the cap, limiting total emissions to that level. Member firms that do not have enough allowances to cover their emissions must either make reductions or buy another firm's spare credits. Members with extra allowances can sell them or bank them for future use. The transfer of allowances is referred to as a trade. In effect, the buyer is paying a charge for polluting, while the seller is being rewarded for having reduced emissions by more than was needed. These cap and trade schemes can either be mandatory or voluntary.

In 2005 the European Union created the world's first proper carbon market, the EU Emissions Trading Scheme (ETS), which compels highly polluting industries to buy permits to emit CO2.

A successful cap-and-trade scheme relies on a strict but feasible cap that decreases emissions over time. If the cap is set too high, an excess of emissions will enter the atmosphere and the scheme will have no effect on the environment. It can also drive down the value of allowances, causing losses in firms that have reduced their emissions and banked credits. If the cap is set too low, allowances are scarce and overpriced.

Some cap and trade schemes have safety valves to keep the value of allowances within a certain range. If the price of allowances gets too high, the scheme's governing body will release additional credits to stabilize the price. The price of allowances is usually a function of supply and demand.

Carbon emissions trading has been steadily increasing in recent years. According to the World Bank's Carbon Finance Unit, 374 million metric tonnes of carbon dioxide equivalent (tCO2e) were exchanged through projects in 2005, a 240% increase relative to 2004 (110 mtCO2e) which was itself a 41% increase relative to 2003 (78 mtCO2e).

Certain emissions trading schemes have been criticised for the practice of grandfathering, where polluters are given free allowances by governments, instead of being made to pay for them. Critics instead advocate for auctioning the credits.

India is the fourth largest emitter of greenhouse gases in the world in absolute terms. But its per capita emission of 1.2 tons per person per year is much lower than the West’s figure of 20 tons, or than the global average of 8 tons. If India has to realize its ambitions of economic growth and take large sections of its population out of the low income trap, it must grow. That means greenhouse gas emission reductions will continue to be one of the country’s greatest challenges.

India certainly being the preferred location for carbon credit buyers or project investors because of its strategic position in the world today.

The companies all over the world rightnow are just adapting to changes brought by Kyoto Protocol and as and when this industry gets mature, we will see how this will impact the world globally bringing in changes across all sectors. This impact is inevitable as "Carbon" becomes the biggest commodity to be traded ever, in the world!