Carbon Trading

Introduction

• Carbon trading is a market-based mechanism designed to reduce greenhouse gas (GHG) emissions by assigning a monetary value to carbon emissions. It allows countries, companies, or organizations to buy and sell carbon credits, thereby providing economic incentives for reducing emissions and promoting climate-friendly practices.
• Carbon trading plays a crucial role in climate change mitigation, sustainable development, and transition towards a low-carbon economy.

Definition

• Carbon trading is a system in which entities that reduce greenhouse gas emissions below a prescribed level can earn carbon credits, which can be sold to other entities that exceed their emission limits.
• One carbon credit = reduction or removal of 1 tonne of CO₂ equivalent (t CO₂e).

Objectives of Carbon Trading

• To reduce global greenhouse gas emissions cost-effectively
• To encourage adoption of clean and green technologies
• To provide financial incentives for emission reduction
• To support sustainable development and climate-smart practices
• To help countries meet international climate commitments

Principle of Carbon Trading

“Polluter pays, reducer earns.”

• Entities emitting less than their allowed limit earn credits
• Entities exceeding limits must purchase credits
• Market forces determine the price of carbon

Carbon Credit

Meaning: A carbon credit is a tradable certificate representing the reduction, avoidance, or removal of 1 tonne of CO₂ equivalent from the atmosphere.

Sources of Carbon Credits

• Renewable energy projects
• Afforestation and reforestation
• Agroforestry and conservation agriculture
• Methane capture (biogas, landfill gas)
• Improved fertilizer and nutrient management

Types of Carbon Trading Mechanisms 

1. Compliance Carbon Market

• Mandatory system enforced by national or international climate laws
• Targets large industries, power plants, and countries with high greenhouse gas emissions
• Emission limits are legally binding, and non-compliance attracts penalties
• Ensures accountability, transparency, and measurable emission reduction
• Requires strict Monitoring, Reporting, and Verification (MRV) mechanisms

Examples

• Kyoto Protocol mechanisms (CDM, JI)
• EU Emission Trading System (EU-ETS) – world’s largest carbon market

2. Voluntary Carbon Market

• Optional participation, not legally binding
• Used by companies, institutions, and individuals to offset their carbon footprint
• Supports corporate sustainability, net-zero targets, and ESG commitments
• Encourages innovation in low-carbon technologies and nature-based solutions
• Important platform for agriculture, forestry, and soil carbon projects

Examples

• Corporate voluntary carbon offsets
• Agriculture- and forestry-based carbon sequestration projects

Major Carbon Trading Mechanisms 

i) Cap and Trade System

• Government fixes a maximum limit (cap) on total greenhouse gas emissions.
• Emission allowances (permits) are allocated free or auctioned to industries.
• Each allowance permits emission of a fixed amount (e.g., 1 tonne CO₂e).
• Trading allowed:
  • Low emitters sell surplus allowances
  • High emitters buy allowances or reduce emissions

Key Features

• ✔ Guarantees overall emission reduction (cap is fixed)
• ✔ Market-driven and cost-effective
• ✔ Encourages cleaner technologies and efficiency
• ✔ Widely used in developed economies

Example: EU Emission Trading System (EU-ETS)

ii) Baseline and Credit System

• A baseline emission level is defined for an activity or project.
• Emissions below the baseline generate carbon credits.
• Credits can be sold to governments or companies to offset emissions.

Key Features

• ✔ Flexible and project-based
• ✔ Widely used in developing countries
• ✔ Highly suitable for agriculture, forestry, agroforestry, and soil carbon projects
• ✔ Encourages adoption of low-emission practices

Examples: CDM projects. Voluntary agriculture-based carbon projects

International Frameworks Supporting Carbon Trading

i) Kyoto Protocol (1997)

• First international agreement with legally binding emission targets for developed countries.
• Laid the foundation for global carbon markets.
• Introduced market-based mechanisms to reduce emissions at lower cost.

ii) Clean Development Mechanism (CDM)

• Part of the Kyoto Protocol.
• Allows developing countries to earn Certified Emission Reductions (CERs) by: Renewable energy projects, Energy efficiency, Afforestation and methane reduction
• CERs are sold to developed countries to meet emission targets.
• Encouraged technology transfer and sustainable development.

iii) Paris Agreement (2015)

• Applies to all countries (developed + developing).
• Focuses on voluntary and cooperative approaches to emission reduction.
• Introduced Article 6, which enables: International carbon trading, Voluntary carbon markets, Agriculture and nature-based solutions

Carbon Trading in Agriculture

Agriculture contributes to both GHG emissions and mitigation. Carbon trading provides farmers with income opportunities through climate-friendly practices.

Agricultural Practices Eligible for Carbon Credits

• Conservation tillage / zero tillage
• Agroforestry and tree-based farming
• Organic farming and natural farming
• Improved nutrient and residue management
• Carbon sequestration in soils

Benefits of Carbon Trading

i) Environmental Benefits

• Reduction in greenhouse gas emissions: Carbon trading creates a financial incentive to cut CO₂ and other GHG emissions.
• Promotion of renewable energy: Encourages adoption of solar, wind, biogas, and other clean energy sources.
• Climate change mitigation: Offsets emissions from industries and agriculture, contributing to global climate targets.
• Improved ecosystem health: Supports afforestation, reforestation, and sustainable land management practices.

ii) Economic Benefits

• Additional income generation: Sale of carbon credits provides extra revenue to industries, farmers, and project developers.
• Cost-effective emission reduction: Allows emission cuts where they are cheapest, reducing overall mitigation cost.
• Investment in green technologies: Attracts private and public investment in clean and low-carbon innovations.
• Market-based flexibility: Companies can choose between reducing emissions or purchasing credits.

iii) Agricultural Benefits

• Rewards sustainable farming: Practices like conservation tillage, agroforestry, and organic farming earn carbon credits.
• Enhanced soil health: Carbon sequestration increases soil organic carbon, improving fertility and water-holding capacity.
• Improved farm productivity: Healthier soils lead to stable yields and resilience against climate stress.
• Diversified farmer income: Carbon trading provides an additional income stream beyond crop production.