• COP29, the ongoing climate conference in Baku, Azerbaijan, has approved standards for setting up international carbon markets.
• These standards aim to curb carbon emissions effectively by implementing market-based solutions.

WHAT IS A CARBON MARKET?

1. Definition
   • A carbon market allows the buying and selling of the right to emit carbon into the atmosphere.
2. Mechanism
   • Governments issue carbon credits that allow holders to emit a specific amount of carbon dioxide.
   • 1 Carbon Credit = 1,000 kilograms of carbon dioxide.
   • By capping the total number of credits, governments control carbon emissions.
3. Trading Process
   • Holders of carbon credits who do not use them can sell their credits to others.
   • The price of carbon credits is determined by market forces (supply and demand).
4. Carbon Offsets
   • Firms can purchase carbon offsets sold by environmental entities that promise carbon-reducing activities (e.g., tree planting).
5. Historical Context
   • First Use: The cap-and-trade model was introduced in the 1990s in the U.S. to control sulphur dioxide emissions.

WHAT IS GOOD ABOUT CARBON MARKETS?

1. Solving the Externality Problem
   • Externalities occur when economic costs (e.g., pollution) are not reflected in market prices.
   • Carbon markets impose costs on pollution, creating financial incentives to reduce emissions.
2. Improved Monitoring and Reporting
   • Technological advancements and standardized accounting have improved the ability to track and report carbon emissions.
   • Examples include real-time data tracking in the energy sector.
3. Corporate Preference
   • Large corporations advocate for market-based systems to trade carbon credits freely.
   • This system is believed to allocate carbon credits efficiently compared to government-imposed limits.
4. Key Arguments by Corporations
   • Voluntary reporting (e.g., Carbon Disclosure Project) is preferred over government intervention.
   • They argue that government-imposed carbon budgets may:
     • Lead to output restrictions.
     • Increase costs.
     • Struggle to accommodate complex supply chains.

5. Example of Supporters
   • Large firms like ExxonMobil and General Motors advocate for carbon markets.

WHAT CAN GO WRONG?

1. Oversupply of Carbon Credits
   • Governments unwilling to reduce emissions may flood the market with carbon credits.
   • This leads to a drop in prices and no real reduction in emissions.
2. Cheating and Corruption
   • Strict caps can fail if governments allow firms to illegally emit carbon.
3. Issues with Carbon Offsets
   • Success depends on firm owners’ incentives to care about emissions.
   • Critics argue firms may purchase offsets for virtue signalling without ensuring real impact.
4. Government Mismanagement
   • Determining the optimal supply of carbon credits is challenging.
   • Politicians, with no personal economic cost, may:
     • Over-restrict carbon credits, slowing economic growth.

5. Market Manipulation
   • Mismanagement of supply and demand can undermine the effectiveness of carbon markets.