THE story of the carbon market is a fascinating journey that reflects humanity’s evolving understanding of climate change and the creative economic mechanisms devised to address it.
The concept of trading emissions, which underpins the carbon market, emerged from the intersection of environmental science and economics in the late 20th century.
At its core, the carbon market is a system where carbon emission reductions are commoditised and traded, offering a flexible tool to achieve climate goals.
This market-based approach is designed to incentivise companies and countries to reduce their greenhouse gas emissions by putting a price on carbon, thereby internalising the environmental costs of carbon pollution that were once considered externalities.
The roots of the carbon market can be traced back to the 1960s and 1970s, when environmental regulation began to shift from prescriptive rules towards more flexible, incentive-based mechanisms.
Economists such as Ronald Coase, and later Thomas Crocker and John Dales, theorised that trading pollution rights could be more efficient than traditional command-and-control regulation.
Their ideas gained practical traction in the United States during the 1990s, most notably with the introduction of the sulphur dioxide (SO₂) trading system to combat acid rain.
This programme, implemented under the 1990 Clean Air Act Amendments, proved that market-based environmental regulation could deliver real-world benefits cost-effectively.
The SO₂ trading system’s apparent success laid the groundwork for the application of similar principles to carbon emissions, which were becoming an increasing concern due to mounting evidence about global warming.
The 1992 United Nations Framework Convention on Climate Change (UNFCCC) marked a pivotal moment in international climate policy.
The Convention established the principle of “common but differentiated responsibilities”, recognising both the global nature of climate change and the varying capacities of countries to address it.
However, it was the 1997 Kyoto Protocol that truly set the stage for the modern carbon market.
Under Kyoto, industrialised countries agreed to legally binding emission reduction targets for the first commitment period (2008-2012).
To help achieve these targets cost-effectively, the Protocol introduced three innovative market-based mechanisms: International Emissions Trading (IET), the Clean Development Mechanism (CDM) and Joint Implementation (JI).
International Emissions Trading allowed countries with excess emission allowances (Assigned Amount Units, or AAUs) to sell these to countries exceeding their targets.
The Clean Development Mechanism enabled industrialised countries to invest in emission-reduction projects in developing countries and earn Certified Emission Reductions (CERs), which could be used to meet their own targets.
Joint Implementation functioned similarly, but between developed countries.
These mechanisms gave birth to the first formal international carbon markets, fostering a global trade in emission reductions.
The flexibility and efficiency offered by carbon trading attracted considerable interest and investment, ushering in a new era of climate policy.
Parallel to international efforts, regional and national carbon markets began to emerge, most prominently in Europe.
The European Union Emissions Trading System (EU ETS), launched in 2005, became the world’s largest carbon trading scheme and remains a cornerstone of EU climate policy.
The EU ETS operates on a cap-and-trade principle: a cap is set on the total amount of greenhouse gases that can be emitted by all participating installations, and allowances can be traded.
This system not only encouraged emissions reductions in power generation and heavy industry but also set a benchmark for other jurisdictions considering similar approaches.
The success and challenges of the EU ETS have provided valuable lessons for the design and implementation of emissions trading systems worldwide.
Other regions followed suit, with varying degrees of ambition and effectiveness. New Zealand, for example, established its own Emissions Trading Scheme (NZ ETS) in 2008, covering all sectors of the economy, including forestry.
In North America, the Regional Greenhouse Gas Initiative (RGGI) was launched in 2009 as the first mandatory market-based programme in the United States to reduce greenhouse gas emissions.
California introduced its own cap-and-trade system in 2013, which has since linked with Québec’s system in Canada.
China, as the world’s largest emitter, launched pilot projects in several provinces and cities before rolling out its national carbon market in 2021, initially covering the power sector but with plans for expansion.
These diverse systems reflect the adaptability of carbon markets to different political, economic, and environmental contexts.
Carbon markets have faced significant challenges and criticisms. One major challenge has been the volatility and, at times, persistently low prices of carbon allowances, which can undermine incentives to invest in clean technologies.
This has been particularly acute in the EU ETS, where an initial oversupply of allowances and the economic downturn after 2008 led to low prices and limited impact on emissions.
Reforms, such as the Market Stability Reserve, have since been implemented to address these issues and strengthen the market signal.
Another criticism concerns the environmental integrity of some offset projects, particularly under the CDM, where doubts have been raised about the additionality and permanence of emission reductions.
In some cases, projects that would have happened anyway were credited with reductions, weakening the overall impact of the market.
Moreover, the carbon market’s complexity and susceptibility to fraud have sparked debates about its effectiveness and fairness.
For instance, the phenomenon of “carbon leakage”, where industries relocate to jurisdictions with laxer climate policies, remains a concern.
Additionally, the proliferation of voluntary carbon markets, where companies and individuals purchase offsets to compensate for their emissions, has created a parallel system with varying standards and oversight.
Ensuring the credibility and transparency of these markets is an ongoing challenge.
The Paris Agreement, adopted in 2015, marked another turning point in the history of carbon markets.
Unlike the Kyoto Protocol’s top-down approach, Paris established a more flexible, bottom-up framework where countries set their own Nationally Determined Contributions (NDCs).
The Agreement’s Article 6 specifically provides for voluntary cooperation between countries, including the use of internationally transferred mitigation outcomes (ITMOs), essentially laying the groundwork for a new era of global carbon trading.
Negotiations around Article 6 have been complex, reflecting the lessons learned from previous mechanisms and the need to ensure robust accounting and environmental integrity.
As of the early 2020s, the rules for the Paris-era carbon market are still being finalised, but the direction is clear: market-based approaches remain central to global climate strategy.
In recent years, the carbon market has seen renewed momentum, driven by surging climate ambition, advances in data and technology, and growing recognition from the private sector.
Many corporations are setting net zero commitments and using carbon markets both to meet internal targets and to finance emission reductions beyond their own operations.
The rise of “carbon removal” credits, such as those generated by direct air capture or enhanced soil carbon sequestration, signals an evolution in the market’s function from merely reducing emissions to actively removing greenhouse gases from the atmosphere.
Blockchain technology is also being explored to enhance transparency and traceability in carbon trading, potentially addressing some longstanding concerns.
The carbon market’s future will be shaped by its ability to adapt and innovate in response to evolving climate science, policy, and societal expectations. Ensuring environmental integrity, equity, and transparency will be critical to maintaining trust and effectiveness.
As climate impacts intensify and the window for action narrows, the carbon market stands as both a testament to past ingenuity and a vital tool for the challenges ahead.
It embodies the hope that global cooperation and market forces can work together to drive the transformation necessary for a sustainable future.
DISCLAIMER:
The views expressed here are those of the writer and do not necessarily represent the views of Sarawak Tribune. The writer can be reached at khanwaseem@upm.edu.my.
