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Functioning of a Carbon Market
Context:
COP29, currently underway in Baku, Azerbaijan, has bolstered the concept of carbon markets for reducing emissions by endorsing standards that could pave the way for establishing an international carbon market as early as next year.
What is a Carbon Market?
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- A carbon market facilitates the buying and selling of the right to emit carbon dioxide into the atmosphere.
- Governments issue carbon credits, with each credit allowing the holder to emit one metric ton (1,000 kilograms) of carbon dioxide.
- By capping the total number of credits, governments can regulate the amount of carbon emissions.
- Entities without carbon credits cannot legally emit carbon.
- First implemented in the U.S. in the 1990s to manage sulfur dioxide emissions under the cap-and-trade model, carbon markets enable unused credits to be sold to those in need, with prices determined by supply and demand.
- Additionally, carbon offsets, such as funding tree-planting initiatives to absorb carbon, can also be traded, allowing polluters to compensate for their emissions indirectly.
Benefits of Carbon Markets
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- Carbon emissions and climate change exemplify an economic externality, where the true costs of pollution are not accounted for in market prices due to undefined property rights.
- For instance, while a firm pays for raw materials like iron, it incurs no direct cost for polluting the atmosphere.
- This lack of financial accountability encourages unchecked emissions.
- Carbon emissions and climate change exemplify an economic externality, where the true costs of pollution are not accounted for in market prices due to undefined property rights.
- Carbon markets address this issue by assigning a cost to pollution, incentivising businesses to reduce emissions.
- Technological advancements and standardised accounting frameworks now enable corporations to monitor and report emissions more accurately, though challenges remain, especially for smaller businesses in developing nations.
- Large corporations like ExxonMobil and General Motors support carbon markets as a more flexible and efficient alternative to government-imposed emission limits, allowing firms to trade credits and allocate them according to market needs.
Challenges and Concerns
- Despite its potential, a carbon market’s effectiveness depends on robust governance.
- Governments may undermine its purpose by oversupplying credits, reducing their price, and failing to curb emissions.
- Corruption or leniency could allow firms to emit more than permitted.
- The success of carbon offsets also hinges on businesses’ genuine commitment to reducing emissions, as some use offsets more for public image than environmental impact.
- Critics question how governments can determine the optimal supply of credits, warning that excessive restrictions may hinder economic growth, while lax limits may fail to achieve meaningful reductions.
- Balancing environmental goals with economic considerations remains a key challenge.
Way Forward
- The effectiveness of carbon markets relies on transparent governance, strict enforcement, and incentivised participation, ensuring accountability and optimal credit supply to meet environmental goals.
- Collaboration among governments, corporations, and international bodies is crucial to balance economic growth with climate commitments.
