Trading Carbon
How it works and why it is controversial

by Jutta Kill, Saskia Ozinga, Steven Pavett and Richard Wainwright

first published 17 August 2010

Carbon trading -- the process of buying and selling quotas that allow the quota holder to emit the equivalent of one tonne of carbon dioxide -- is the policy instrument of choice among governments to tackle climate change.

But the subject is full of jargon, abstract concepts, mathematical formulae and technical detail. It's not surprising that many people find it hard to assess its merits or otherwise, understand its implications and join in debates.

This 118-page guide attempts to unravel some of the complexity, explaining key concepts and terms in plain English (translation into French and other languages in the pipeline), illustrated with case studies. (A synopsis, Designed to Fail, summarises the key points.)

Three basic components underpin the trade in carbon quotas: cap and trade, carbon offsets and trading transactions.

The guide explains how the concept of carbon trading came about and the theory behind cap and trade (sometimes referred to as emissions trading) and carbon offsets, presenting both arguments for and against the practices.

It describes the financial aspects of carbon trading and how the carbon market has changed over the past few years as new interest groups and complex financial arrangements have become involved. As a result, carbon quota prices have become more volatile, speculation in the carbon market has increased, and the market is increasingly delinked from its original objective of providing an effective cost-management tool to reduce carbon dioxide emissions.