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Carbon Cap and Trade: A Complete Guide

As global temperatures continue to rise innovations in pollution policy begin to emerge. An interesting market-based system or Carbon Cap and Trade system has emerged in various countries around the world over the past three decades. These programs aim to set a “cap” or limit on the total number of emissions and allocate allowance credits that companies can trade amongst themselves. This allows the policymaker to set climate targets and companies to have agency to trade and emit at a level that makes sense for them. This blog will explore the different types of carbon markets and their impacts on global emissions.


How Carbon Cap and Trade Works

Carbon Cap and Trade Supply and Demand Graph Chart
Source: Forevergreen

The cap is set by policymakers and governments based on net-zero or emissions reduction targets. The Air Resource Board in California, set their cap to deliver an overall 15% reduction in greenhouse gas emissions and set a statewide limit on sources responsible for 85 percent of California’s GHG emissions. [1]. There are two ways permits can be allocated once the cap has been set, either for free or through an auction. Theoretically, the advantage of auctioning allowances—rather than giving them away for free—is that resulting revenues can be used to reduce other taxes that act as a drag on income or investment. This can be the most efficient option as it minimizes net cost to the economy. 


There are two types of carbon markets. First is the Regulatory or Compliance Market. These are established by governments or multilateral regimes, one of the largest regulatory carbon markets is the EU Emissions Trading System (ETS). The other market is the Voluntary Carbon Market (VCM). The VCM allows companies, non-profit organizations, governments, and individuals to buy and sell carbon offset credits. 


Benefits of Carbon Cap and Trade

The benefits of carbon trading have been seen across the world. China has so far managed only a 5% reduction since 2020 [2], Since 2005, the EU ETS has helped bring down emissions from power and industry plants by 37% [3] In California reductions were most prominent in the electricity imports sector, which declined by 12.4% or approximately 2,434,000 metric tons of CO2e. [4] 


Outside of the raw number of emissions reduced there are many benefits related to technological innovation. Since companies are held financially accountable for their environmental impacts, many are forced to develop new technologies to avoid emissions and purchase additional allowance credits. For example in 2017 when China announced is carbon markets, global solar energy capacity doubled year over year and today solar panels are almost twice as efficient as they were five years ago. [5] 


Criticisms and Challenges

There are some challenges that the cap and trade model need to overcome in order to reach the ambitious climate targets set by regulators. First and foremost is the lack of data. Many times companies lack historical data sets of their emissions and regulators are left to estimate total emissions. At the same time companies can cheat the system and fudge numbers. This may be temporary as the SEC released mandatory emissions disclosures in March of 2024. It can also be challenging to target specific industries or companies in this model. In California it was actually found that Oil & Gas companies emitted 3.5% more than before the program. [6] As the market matures and more data becomes available regulators can adjust their models to ensure a higher quality marketplace. 


The Future of Carbon Cap and Trade

The expected growth of carbon markets over the next decade is massive. As more an more industries are subject to its regulation, there is an expected domino effect. As on industry is forced to comply, it will push its peers and competitors to face the same rules. Additonally with the new boarder regulations such as Carbon Boarder Adjustment Mechanism (CBAM) many countries will opt for manufacturers to pay domestic fees as opposed to international tariffs. Additionally the VCM has been projected to grow from around $2 billion in 2022 to about $100 billion in 2030 and around $250 billion by 2050 by Morgan Stanley [7]. Deloitte also projects promising growth with consumer purchases of carbon offsets becoming more pervasive and grow into a nearly US$100 billion market in developed economies by 2030. [8] As the markets grow and consumers become more aware of their own carbon footprint these tools and marketplaces will be more and more valuable.


Conclusion

We hope that you learned something about carbon cap and trade and carbon markets. It is a new and exciting industry that can be a powerful tool in reducing carbon footprints and mitigating global temperature rise. We encourage you to check out our Carbon Footprint Calculator to learn more about your personal carbon footprint and reach out to us if you are interested in purchasing or learning more about carbon offset credits. Thanks for reading and have a great day!


  1. https://ww2.arb.ca.gov/sites/default/files/cap-and-trade/guidance/cap_trade_overview.pdf

  2. https://www.theguardian.com/environment/2024/feb/22/growth-in-co2-emissions-leaves-china-likely-to-miss-climate-targets#:~:text=And%20on%20the%20target%20of,2025%20to%20meet%20the%20target.

  3. https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/what-eu-ets_en#:~:text=A%20'cap%20and%20trade'%20system,-The%20EU%20ETS&text=Since%202005%2C%20the%20EU%20ETS,and%20industry%20plants%20by%2037%25.

  4. https://blogs.edf.org/climate411/2023/11/15/a-decade-in-californias-cap-and-trade-has-slashed-climate-pollution-and-generated-investments-where-does-it-go-from-here/#:~:text=Cap%2Dand%2Dtrade%20is%20reducing%20emissions&text=Sources%20covered%20by%20cap%20and,tons%20of%20CO2e.

  5. https://www.weforum.org/agenda/2017/10/how-carbon-pricing-accelerates-innovation/

  6. https://www.investopedia.com/terms/c/cap-and-trade.asp

  7. https://www.morganstanley.com/ideas/carbon-offset-market-growth

  8. https://www2.deloitte.com/uk/en/blog/emea-centre-for-regulatory-strategy/2023/navigating-challenges-within-the-voluntary-carbon-market.html

  9. https://www2.deloitte.com/us/en/insights/industry/financial-services/financial-services-industry-predictions/2023/financial-firms-carbon-offset-market.html


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