Carbon markets are mechanisms that enable the trading of greenhouse gas (GHG) emission credits, allowing governments and non-state entities to buy or sell allowances or credits that represent a reduction, avoidance, or removal of emissions. The primary objective of these markets is to provide cost-effective solutions for achieving climate targets and implementing climate policies.
There are two main types of carbon markets:
- Compliance Markets: Established by regulatory frameworks, these markets require participants to adhere to legally binding emission reduction targets. Entities that emit beyond their allowances must purchase additional credits, while those that emit less can sell their surplus allowances. Examples include the European Union Emissions Trading System (EU ETS) and regional schemes like the California Cap-and-Trade Program.
- Voluntary Markets: In these markets, participation is not mandated by law but driven by organizations or individuals aiming to offset their emissions voluntarily. Participants purchase carbon credits to compensate for their carbon footprint, often to meet corporate social responsibility goals or to appeal to environmentally conscious consumers.
Carbon markets operate under mechanisms such as:
- Cap-and-Trade Systems: A cap is set on the total amount of GHG emissions allowed, and entities receive or purchase emission allowances. Those needing to increase their emission capacity must buy allowances from others willing to sell.
- Baseline-and-Credit Systems: Projects that reduce emissions below a predetermined baseline can generate credits, which can then be sold to entities seeking to offset their emissions.
Internationally, Article 6 of the Paris Agreement facilitates cooperation among countries through carbon markets, aiming to enhance the ambition of climate actions and promote sustainable development. By enabling the transfer of emission reductions between countries, Article 6 seeks to lower the global cost of achieving emission reduction targets and to encourage investment in low-carbon technologies.
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