Emissions trading

Emissions trading is a market-based system that encourages the trading of units to achieve environmental improvements via reduced greenhouse gas emissions. These units can take the form of permits for the release of emissions (pollution), or credits for reductions in emissions (environmental improvement).

Under an emissions trading scheme, the government usually sets a target of total acceptable emissions and this is then divided into tradeable units - usually credits or permits. This provides a guarantee on the achievement of a total environmental outcome but allows for individual parties to decide who undertakes what emissions reduction activities, and for the trading of units between these parties.

The price of permits or credits will be determined by their supply and demand in the market. Emissions trading schemes are arguably a low-cost way for governments to achieve emissions reductions. Parties who can reduce emissions at low cost have an incentive to engage in this activity and sell excess certificates or permits to those parties who can only achieve abatement at high cost and who will be more inclined to purchase these certificates or permits from others.

Emissions trading schemes create an economic incentive for parties to participate in environmental improvements.