The future is carbon trading

From time to time it is worth revisiting the rationale behind various initiatives, in part to better understand them but also to bring clarity to the benefits of implementation. Carbon emissions trading is one such practice.

Trading in goods and services has been at the foundation of human development for thousands of years. It introduces opportunity, cost efficiency and flexibility into society that in turn fosters economic growth. These benefits are well understood and have been proven many times over, but the idea that trade can successfully solve an environmental issue is again being challenged, to the extent that implementation of new trading systems is not welcomed by all parts of society.

Carbon trading involves the transfer of some form of carbon emission instrument between two parties in exchange for financial consideration. It has its roots in the mid-1990s, but its economic underpinnings go back into the 1970s and a related large-scale implementation in the United States to tackle sulphur emissions started operating in 1990. Emissions trading is also built on the back of commodity futures trading, which emerged in agricultural areas such as the mid-West of the United States to help balance supply and demand peaks and troughs, which in turn helped farmers manage their income over time.

To best understand carbon emissions trading, it helps to look forward to where we are headed, rather than back to where we started.

The Paris Agreement establishes the need for society to effectively reach zero greenhouse gas emissions in the second half of the century, with the Shell Sky scenario indicating a timeline to 2070 to give a high level of certainty (≥ 85%) that the 2°C goal of the Agreement will not be breached. As surface temperature warming is a function of cumulative emissions over time, temperature will not stabilize until the net addition of carbon dioxide to the atmosphere is zero.

The Sky scenario follows the guidance of Article 4 of the Paris Agreement due to ongoing societal use of oil, coal and gas for the delivery of energy services where non-emitting alternatives remain nascent or in some cases, non-existent. In Sky, society achieves net-zero emissions by balancing remaining emissions with the removal of carbon dioxide from the atmosphere at another location or even at another time.

Sky also illustrates the potential time spread for countries reaching net-zero carbon dioxide emissions. Some achieve that goal as early as the 2040s, but there is a long tail of emitting countries extending to the end of the century. Given the need for a global outcome around 2070, but faced with the reality of countries, sectors and industries only able to reduce emissions at different rates and some potentially not able to reduce to zero, the mechanism that emerges to achieve a balance and fairly distribute the cost of emission reductions across society and over time is carbon trading.

In Sky, emitters in 2070 would purchase carbon removal units from industries able to capture and geologically store carbon dioxide, or even use carbon dioxide to make certain products. This trade in carbon units underpins the journey to net-zero emissions while allowing economies to grow and prosper, making use of the energy services that are needed. But this requires the development of a large-scale industry to generate carbon removal units.

Today, the reduction journey is beginning but carbon emissions trading is just as important. For some emitters, even initial reductions may not be possible, particularly if they are part of an expanding sector. But for others, reductions may come more easily, for example by closing a coal fired power station which has been replaced by large scale implementation of renewables. The power generator can effectively share the reductions made with the sector that is growing, thereby achieving an overall reduction between them but without impinging on the growth prospects for the expanding sector. Trade in carbon units between these entities is the critical facilitator. A vibrant carbon trading market now will also give confidence to developers looking towards the supply of removal units in the future.

As the global economy heads towards large scale carbon emission reductions, implementation will be challenging for some and progress may be limited as a result. But as has been the case in all aspects of economic growth over many centuries, trade should be fully utilised to solve these issues and move forward.