Understanding the Carbon Market

Here is the dilemma. Emissions in Year 2 are capped at 90 tons, 10 tons less than Year 1, but production is to increase by 10%. Company A decides to get a new widget making machine that produces 30% less emissions, reducing its total emissions by 15 tons in Year 2, even though it produces 1 more widget than Year 1.

Therefore, company A emits only 3.2 tons of CO2 (35/11) per widget, which is a total of 35 tons. Company B does nothing in Year 2, and using the old equipment it produces 11 widgets at 5 tons of CO2 per widget (50/10), which is a total of 55 tons of carbon.

In Year 2 the economy reaches its target in producing only 90 tons of CO2. However, Company B exceeded its emissions cap by 10 tons, and Company A was 10 tons below its cap. Company A by reducing emissions by 10 tons creates 10 Carbon credits. Whereas Company B is facing a fine of €10 a ton from the Government for what it exceeded in its cap.

Alternatively Company B can make a deal with Company A to buy its credits for less than the fine. A deal is struck at €9 a ton, saving Company B from paying the maximum cost imposed by the Government. The table below shows that the buying and selling of credits between the two companies results in Company A having a lower cost base and therefore is more competitive. This is the concept of carbon trading in promoting and driving efficiencies within business.

Year 2 Emissions Caped at 100 tons per annum for economy

Year 2 Emissions Caped at 100 tons per annum for economy