Carbon credits trading concept.

Carbon Credits: Are We Trading Our Way to a Greener Future, or Just Trading Air?

Beau Callahan in Climate & Environment September 2025 • 4 min read.

"Explore the promise and pitfalls of carbon pricing and emission trading systems—can they truly combat climate change, or do they risk becoming tools for speculation?"

In the global fight against climate change, emission trading systems (ETS) have emerged as critical tools. These systems, which put a price on carbon emissions, are designed to incentivize companies to reduce their greenhouse gas output by creating a market where emission permits can be bought and sold. The core idea is simple: set a cap on total emissions and let businesses find the most cost-effective ways to stay within those limits.

Secondary markets play a vital role within these emission trading systems. They allow companies to adjust their emission allowances as needed, providing flexibility to respond to changing market conditions and unexpected events. For example, a company that reduces its emissions faster than expected can sell its excess permits, while another facing unforeseen challenges can buy additional allowances to remain compliant.

However, the rise of secondary markets also raises concerns. Some worry that these markets could encourage speculation, leading to permit misallocation and undermining the environmental goals of the trading system. This article explores the complexities of carbon pricing and resale within emission trading systems, examining whether these systems truly pave the way to a greener future or merely shuffle environmental responsibilities.

How Do Emission Trading Systems Work?

Emission trading systems operate on a cap-and-trade principle. A regulatory body sets a limit (cap) on the total amount of certain greenhouse gases that can be emitted by covered entities, such as power plants and industrial facilities. Allowances, or permits, are then issued, each representing the right to emit a specific quantity of greenhouse gases, such as one ton of carbon dioxide.

These allowances are initially allocated through auctions or, in some cases, are given away for free. Companies that can reduce their emissions cheaply can sell their excess allowances to those facing higher abatement costs. This trading creates a financial incentive for emission reductions and ensures that the overall emission cap is met at the lowest possible cost.

Setting the Cap: Regulators determine the total allowable emissions within a specific sector or region.
Allowance Allocation: Emission allowances are distributed to participating entities, often through auctions or a combination of auctions and free allocation.
Trading: Companies can buy and sell allowances based on their individual emission reduction costs and needs.
Compliance: At the end of each compliance period, companies must surrender enough allowances to cover their actual emissions.
Monitoring and Enforcement: Robust monitoring and enforcement mechanisms ensure the accuracy of emission reporting and compliance with the system.

The effectiveness of an ETS hinges on several factors, including the stringency of the emission cap, the design of the allowance allocation mechanism, and the presence of a well-functioning secondary market. A cap that is too high may not drive significant emission reductions, while a poorly designed allocation mechanism can lead to market inefficiencies and windfall profits for some participants.

Are Carbon Markets Truly Effective?

While emission trading systems offer a market-based approach to reducing greenhouse gas emissions, their effectiveness depends on careful design and implementation. Issues such as speculation, market manipulation, and the potential for permit misallocation can undermine the environmental integrity of these systems. Policymakers must address these challenges by ensuring that carbon markets are transparent, liquid, and free from manipulation. Continuous evaluation and adaptation are essential to maximizing the contribution of carbon markets to a sustainable future.

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This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2407.07386,

Title: Carbon Pricing And Resale In Emission Trading Systems

Subject: econ.th

Authors: Peyman Khezr

Published: 10-07-2024

Everything You Need To Know

What is the main purpose of Emission Trading Systems (ETS) and how do they aim to achieve it?

The primary goal of Emission Trading Systems (ETS) is to reduce greenhouse gas emissions. ETS achieves this by setting a 'cap' on the total amount of emissions allowed within a specific sector or region. This cap is enforced through the distribution of emission allowances, each permitting the emission of a specific quantity of greenhouse gases. Companies that emit less than their allowance can sell their surplus permits, creating a financial incentive for emission reductions. This cap-and-trade mechanism ensures overall emission targets are met cost-effectively.

How do secondary markets function within an Emission Trading System, and what role do they play?

Secondary markets within Emission Trading Systems (ETS) allow companies to buy and sell emission allowances. They provide flexibility, enabling companies to adjust their emission permits based on changing conditions. Companies that reduce emissions below their allowance level can sell excess permits, while those exceeding their allowances can purchase more. This trading mechanism helps companies manage costs and respond to market changes or unforeseen events, such as technological advancements or operational challenges, while still meeting the overall emission cap.

What are the potential risks or pitfalls associated with Emission Trading Systems, particularly concerning secondary markets?

One key concern with Emission Trading Systems (ETS) is the potential for speculation in secondary markets. Speculation can lead to permit misallocation, where allowances are not used for actual emission reductions but are instead held for profit. This can undermine the environmental goals of the ETS by driving up the cost of allowances, making it more expensive for companies to comply with emission reduction targets. Furthermore, manipulation of the market and inefficiencies in the system can also occur if the market isn't transparent and well-regulated.

Explain the core steps involved in the operation of an Emission Trading System.

Emission Trading Systems (ETS) function through a series of key steps. First, regulators determine the total allowable emissions, setting the 'cap'. Next, emission allowances are allocated to participating entities, often through auctions or free allocation. Companies then trade these allowances based on their emission reduction costs. At the end of each compliance period, companies must surrender enough allowances to cover their actual emissions. Finally, robust monitoring and enforcement mechanisms ensure the accuracy of emission reporting and compliance with the system. These steps ensure the ETS meets its emission reduction targets effectively.

What factors determine the effectiveness of an Emission Trading System (ETS), and what challenges must policymakers address to ensure its success?

The effectiveness of an Emission Trading System (ETS) hinges on several critical factors. These include the stringency of the emission cap – a cap that is not strict enough may not drive significant reductions. The design of the allowance allocation mechanism is also crucial; a poorly designed system can create market inefficiencies and unfair outcomes. Furthermore, the presence of a well-functioning secondary market is essential to enable trading. To ensure success, policymakers must address challenges such as speculation, market manipulation, and the potential for permit misallocation. They need to ensure that carbon markets are transparent, liquid, and free from manipulation, continuously evaluating and adapting the system to maximize its contribution to a sustainable future.