What is Carbon Trading?

Mary McMahon
Mary McMahon

Carbon trading is a practice which is designed to reduce overall emissions of carbon dioxide, along with other greenhouse gases, by providing a regulatory and economic incentive. In fact, the term “carbon trading” is a bit misleading, as a number of greenhouse emissions can be regulated under what are known as cap and trade systems. For this reason, some people prefer the term “emission trading,” to emphasize the fact that far more than just carbon is being traded.

When a company exceeds its emissions cap, it can buy credits from a company that has excess credits.
When a company exceeds its emissions cap, it can buy credits from a company that has excess credits.

This practice is part of a system which is colloquially referred to as a “cap and trade.” Under a cap and trade system, a government sets a national goal for total greenhouse gas emissions over a set period of time, such as a quarter or a year, and then allocates “credits” to companies which allow them to emit a certain amount of greenhouse gases. If a company is unable to use all of its credits, it can sell or trade those credits with a company which is afraid of exceeding its allowance.

Carbon trading provides a very obvious incentive for companies to improve their efficiency and reduce their greenhouse gas emissions, by turning such reductions into a physical cash benefit. In addition, it is a disincentive for being inefficient, as companies are effectively penalized for failing to meet emissions goals. In this way, regulation is accomplished largely through economic means, rather than through draconian government measures, encouraging people to engage in carbon trading because it's potentially profitable.

As a general rule, carbon trading is paired with an overall attempt to reduce carbon emissions in a country over an extended period of time, which means that each year, the number of available credits will be reduced. By encouraging companies to become more efficient ahead of time, a government can often more easily meet emissions reduction goals, as companies will not be expected to change practices overnight, and the carbon trading system creates far more flexibility than setting blanket baseline levels.

In some countries, carbon exchanges have opened up, operating much like stock exchanges. These organizations facilitate the exchange of carbon credits, ensuring that they flow smoothly through the market, and they provide standard set prices for credits, based on market demand and general economic health. In some cases, individual citizens can also participate in carbon trading, purchasing credits to offset their own greenhouse gas emissions, and some advocates have suggested that carbon trading should be formally expanded to all citizens, encouraging global and individual involvement in reduction of greenhouse gas emissions.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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Discussion Comments


I agree that individuals should participate in carbon trading. National governments keep setting new targets for reducing emission. I read just today in the news that the United Kingdom government is trying to reduce their emissions by 60% to 80% until 2050.

The major industries are already participating in carbon trading and the government can only go so far by implementing this policy just for industries. At some point, they need to have households participate too. I think that only with personal carbon trading can we reach the emission reductions we are aiming for.


Oh yea, I had heard about carbon trading. It's also a part of the Kyoto Protocol. Countries are expected to cut down on emissions because cutting down is actually cheaper than buying extra credits to be able to cover their emissions.

I think it's a great idea. If industries care about anything, it's profit. Any other method of reducing emissions wouldn't have worked.


1. How and to whom does a company receive a credits cap and from whom does it come?

2. Who sets the cost of the credits?

3. If a company chooses to sell or trade unused credits, how do they go about doing this and how does this company set a price for the credit?

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