Carbon markets enable climate change mitigation to be accomplished as efficiently as possible. This is why the German Federal Government considers market-based instruments to be an important approach in the fight against climate change.
Carbon markets develop when market-based climate instruments take effect and carbon certificates are traded. Two different instruments that lead to the creation of carbon markets can be distinguished: emissions trading systems and crediting systems.
An emissions trading system (cap and trade system) sets an upper limit, or cap, on the volume of greenhouse gas emissions to be regulated within the system. Within the area regulated by the system, only a limited number of allowances (pollution rights) are issued. Allowances are freely tradable units that are allocated to the participants of the emissions trading system. Each participant must present an allowance certificate for each tonne of CO2eq (carbon dioxide equivalent) that they emit. The certificates can be freely traded. This allows participants to buy additional certificates or, if they have successfully implemented sufficient mitigation measures, to sell surplus allowances. Through the trading of allowances, a uniform carbon price develops. This price acts as an important signal. The exact price largely depends on how ambitious the cap in the emissions trading system is and how expensive the mitigation measures are to implement.
A crediting mechanism (baseline and credit system) enables emissions savings to be remunerated. Such a mechanism allows tradeable certificates to be issued for actual emission reductions achieved by a participant. These certificates are only issued when the participant is able to prove that actual emissions have fallen below a previously determined reference value (baseline). A crediting mechanism can either be rooted in individual climate action projects and programmes or be designed for entire sectors and parts of the economy. Participation in a crediting mechanism is voluntary. Demand for the certificates must therefore be created though alternative means. This can, for example, include making the certificates in the crediting mechanism eligible for use within an emissions trading system.
The Paris Agreement marks a milestone in the further development of international, market-based climate change mitigation mechanisms. At the same time, a number of countries have introduced their own climate change mitigation instruments like emissions trading systems or greenhouse gas taxes in recent years. The world's first trading system for greenhouse gas emissions rights, the European Emissions Trading Scheme, has since been joined by numerous others. National emissions trading systems have also been launched in countries such as New Zealand, Switzerland, Kazakhstan, South Korea, Mexico, Montenegro, the United Kingdom and Indonesia. Germany and Austria use national emissions trading systems to regulate fossil fuel pricing in the buildings and traffic sectors. In addition, there are a number of sub-national trading systems in operation, for example in California or Quebec. China’s national emissions trading system, introduced in 2021, is the largest in the world in terms of emissions covered.
In addition to their prevalence, the level of ambition of price-based instruments for climate change mitigation such as emissions trading systems is also an important factor in their success. The percentage of recorded greenhouse gas emissions and the price for emissions certificates in emissions trading systems varies widely and determines the extent to which these are able to play a meaningful role in reaching climate targets.
A price for greenhouse gas emissions
Many countries already use carbon taxes to set a price for greenhouse gas emissions. They have been introduced in a number of EU countries, Switzerland, Ukraine, Japan, South Africa, Singapore, Chile, Mexico, Argentina and Colombia. Since January 2019, all provinces and territories in Canada have been obliged to introduce a greenhouse gas pricing instrument that meets a minimum national standard. The introduction of a carbon tax is currently being discussed in multiple African countries, including Morocco, Côte d’Ivoire, Senegal and Botswana. In recent years, this has enabled an increasing share of global greenhouse gas emissions to be covered by carbon pricing. The World Bank provides an overview of the status of the implementation of price-based climate instruments on its website .
The new international climate agreement, which was adopted in Paris at the end of 2015 and has been in effect since 2020, has created a basis for the international exchange of mitigation efforts. Article 6 of the Paris Agreement provides for the establishment of a new international market mechanism as well as possibilities to use bilateral mechanisms. These future mechanisms can build on the experience already gained using the Joint Implementation (JI) mechanism and Clean Development Mechanism (CDM) established under the Kyoto Protocol.