Will Carbon Trading Work?

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The European Union Emissions Trading Scheme (EU ETS) is the world's first, and largest, multinational carbon trading program. The first phase of the program was started in 2005 and lasted for three years, through 2007. Phase I was a learning phase and, understandably, there were a number of kinks in the system. EU governments did not have accurate emissions data, and no one had ever tried to set up a such a broadly multinational emissions trading program before. The EU decided not to allow carbon credits to be banked for use in Phase II, and as the program neared its termination date, it became clear that there were more allowances than needed. Since, without banking, the allowances would have no value under Phase II, prices fell to zero.

Nevertheless, there were successes. According to a study by Ellerman and Buchner, Phase I reduced emissions by between 50 and 100 million tons per year below what they otherwise would have been, amounting to a 2.5% to 5% reduction per year. The first phase also provided the experience necessary to establish Phase II, which has been running successfully since the beginning of the year. Phase II has succeeded in placing a price on carbon, and this price is providing a clear signal for both companies and nations to reduce current emissions, as well as to invest in the technologies that promise to reduce emissions even more in the future. Companies are already finding new and innovative ways to reduce emissions -- in some cases in ways that nobody could have anticipated before the program started. The market is finding the cheapest way to reduce emissions, and innovative mechanisms such as the Clean Development Mechanism are supporting projects to reduce emissions in developing countries as well.