In our past articles, we have focused on several policies recently released by both the EU and Canada applicable to businesses to reduce their carbon footprint. This time, we take a look at one of the pioneer decarbonization programs established to help mitigate carbon emissions – the Compliance Market or Emissions Trading Systems. As mentioned in one of our earlier posts, emissions trading systems operate according to mandatory international and regional regulations to help reduce carbon emissions. Countries establish limits or a “cap” on carbon emissions and businesses receive allocated allowances for these emissions. If a business exceeds its allotted cap, they must pay the carbon price for additional carbon credits. However, if a business is able to successfully keeps its emissions below the designated cap, it has the option to trade or sell its allowances to other companies through an exchange. To date, there are over 60 carbon tax and emissions trading programs implemented at regional, national, and subnational levels, with significant pricing enhancements in the EU and Canada (IMF, 2021).

In this comprehensive review, we will explore various emission trading schemes and their respective carbon prices around the world and discuss their future prospects. Several compliance markets exist but our focus will be on the well-established compliance markets and their associated carbon prices.

EU Emissions Trading System (EU ETS)

Inaugurated: 2005

Cap: 1,529 MtCO₂e (2022, stationary installations), 28.4 MtCO2e (2022, aviation)

Current price (as of January 30th 2024): €63.01/tCO₂e

Established in 2005, the EU ETS is the world’s first international emissions trading system. Since its inception, it has effectively reduced emissions by 37.3% within the electricity, heat generation and industry sectors, bringing them below 2005 levels (European Commission, 2023). The EU ETS has raised a total of €152 billion in revenue from auctioning allowances and have distributed this budget to member states for climate and energy action initiatives as well as social measures in support of green transition.

The EU ETS has an aggressive commitment to reduce emissions by 55% by the end of 2030 and thus launched the Fit for 55 Reform package which is set to take place in 2024 onwards. The announcement of this reform package, which includes accelerated emission allowance reductions and a phased elimination of free allowances in certain sectors, has springboard carbon prices to €100 sometime in February 2023. Evaluating its current carbon pricing, it has significantly declined by 27% YTD with contributing factors such as weak industrial output, decline in power emissions, a transition from carbon-intensive power generation and the cost improvement of solar and wind power (S&P Global, 2023). Carbon pricing is expected to continue at the same price point as oversupply and lower power emissions take place.

Figure 2. Historical Emissions Cap Reductions (European Commission, 2023).

However, outlook for overall EU ETS looks very aggressive as it also plans to expand coverage to maritime transport under the existing system starting January 2024 which contributes around 3-4% of EU’s total CO₂ emissions. Currently, the cap in the EU ETS drops to 2.2% per year from 2021-2023 but moving forward, cap will increase to 4.3% per year between 2024-2027 and 4.4% per year after 2028 (EUR-Lex, 2023). Figure 2 illustrates the historical emissions cap reductions since its establishment. Another emissions trading system (ETS 2) is also expected to commence in 2027 covering buildings, road transport, and small-emitting industries. The Social Climate Fund will be established in conjunction with ETS 2 to address potential social impacts arising from carbon pricing in emerging sectors.

UK Emissions Trading Scheme (UK ETS)

Inaugurated: 2021

Cap: 147.2 MtCO₂e (2023)

Current price (as of January 30th 2024): £33.05/tCO₂e

The UK ETS was initially part of the EU ETS but has decided to set up its own emissions trading system in January 2021. The UK, Scottish, and Welsh Governments, along with the Northern Ireland Department of Agriculture, Environment, and Rural Affairs, collectively participate in the UK ETS and established the scheme to elevate the climate ambition of the UK’s carbon pricing policy while safeguarding the competitiveness within the region (Gov.UK, 2024). Currently, the UK ETS covers a quarter of UK’s domestic emissions by energy intensive industries such as power generation sector, offshore oil and gas, and aviation.

The UK ETS mirrors the structure the EU ETS and is divided into phases: phase 1 spans from 2021-2025 and phase 2 covers the period from 2026-2030. The cap for Phase 1 was initially set at 5% below the UK’s expected baseline allocation of the EU ETS cap for Phase IV of the EU ETS (2021-2030) or approximately 156 million allowances. Phase 1 also entrusted operators to generate plans to reduce carbon emissions and pursue carbon abatement initiatives while phase 2 will involve a more comprehensive evaluation of carbon abatement based on energy and carbon data (Gov.UK, 2023).

Carbon prices started out at a price of £47.96 and hit an all-time high of £97.75 per metric ton in August 2022 resulting to a revenue of £4.3 billion (Statista, 2023). In 2023, prices have drastically dropped to £30 price point right after Prime Minister Sunak’s speech on the deferral of petrol and diesel car phaseout leading to less urgency by businesses to seek cleaner alternatives. Compounding the issue, the closure of significant carbon-intensive enterprises like CF Industries' fertilizer factory in Cheshire and Mitsubishi Chemical's Cassel Works chemical plant in Billingham has led to reduced demand for carbon allowances (Clarke, 2023). Falling carbon prices may lead to lower investments in clean energy while domestic companies could face substantial tax obligations for exporting to the rest of Europe due to the implementation of the Carbon Border Adjustment Mechanism (CBAM). The CBAM intends to avoid carbon leakage through imposing a climate tax on certain goods exported to the EU. With the UK’s carbon prices lower than EU, UK-based products can appear more carbon-intensive vs. products under stricter regulations in the EU.

In December 2023, a review was conducted to assess the implementation of the UK Emission Trading System (ETS), examining its initial outcomes and long-term implications. So far, there is a proposal to extend the UK ETS beyond 2030, ensuring its continuation until at least 2050. The plan involves aligning the ETS cap to the relevant net-zero trajectory (Gov.UK, 2023).

California Cap-and-Trade Program

Inaugurated: 2012

Cap: 294.1 MtCO₂e (2023)

Current price (as of January 30th 2024): $28.66/tCO₂e

The California Cap-and-Trade ranks as the world’s second largest carbon market right after the EU with $44.5 billion in carbon allowances traded in 2022. The program covers 85% of GHG emissions in the state that covers more than 450 companies and is being managed by the California Air Resources Board (CARB) (CarbonCredits.com, 2023). The cap-and-trade program (C&T) covers fossil fuel combustion and industrial emissions in power, real estate, and transport. To date, the program has seen reductions in the electricity imports sector by 12.4% while other sectors participating in the program have collectively reduced their carbon emissions by 3.6%. In 2014, California Cap-and-Trade Program linked with the Cap-and-Trade-System of Québec as part of the Western Climate Initiative (WCI). The linkage allowed both C&T systems to synchronize their GHG emission allowances and enable the exchange of allowances between systems and sectors. This also permitted entities to utilize allowances from either system to meet their regulatory requirements. In joint auctions, the minimum auction price will be determined by the greater of the annual reserve prices in California or Quebec, following currency conversion, which can be transacted through either Canadian or American dollars. (Government du Québec, 2018).

Analyzing the carbon price in California, the price point at $28.66 coming from the highest recorded price point at $37.49/tCO₂E in July. Historically, price has risen by 30% in 2023 as a result of the state’s robust climate goals and the significant reduction in carbon allowances. The California Air Resources Board is considering revising its emissions reduction targets for 2030 to either 40%, 48%, or 55%. While the current greenhouse gas (GHG) reduction target stands at 40% below 1990 levels, a minimum of 48% reduction is necessary to safeguard California communities from the impacts of climate change (Environmental Defense Fund, 2023). With CARB’s aggressive plans to increase emissions reduction targets, expect carbon prices to go up as emissions cap will most likely decrease significantly in the coming years.

The success of California’s carbon market has paved the way for the launch of C&T systems in other states such as Washington and Oregon including New York which is also in the process of developing its own program. At present, Washington is actively working to connect its carbon markets with those of California and Quebec, aiming to enhance climate progress. With the proliferation of carbon markets and state and federal policies like the Inflation Reduction Act, enterprises can aggressively explore cleaner technologies together with the support of the government.

South Korean Emissions Trading Scheme (K-ETS)

Inaugurated: 2015

Cap: 589,3 MtCO₂e (2023)

Current price (as of January 30th 2024): $6.70/tCO₂e

The South Korean Emissions Trading Scheme is East Asia’s first nationwide compliance market. 74% of South Korea’s national GHG emissions is covered by the K-ETS incorporating power, industrial, real estate, waste, transport, and domestic aviation sectors (International Carbon Action Partnership, n.d.). K-ETS has generated $845.2 million in revenues since its implementation which has been utilized for mitigation equipment, low-carbon innovation, and technology development for small to medium enterprises. Emissions targets have been initially set to at least 35% below 2018 levels by 2030 but revised Nationally Determined Contributions (NDCs) by South Korea has increased targets to 40% below 2018 levels.

South Korea’s carbon price has been dipping by up to 50% due to an oversupply of allowances, coupled with a perception that the system has made minimal progress in incentivizing polluters to cut emissions. Current arrangements have also put pressure on prices because they have led some permit holders to sell surplus permits before the end of the annual compliance periods, typically until the end of August, thus resulting in an excess of allowances by mid-year (BNN Bloomberg, 2023). In 2025, South Korea is eyeing to introduce a futures market to mitigate price fluctuations and enable participants to manage trading risks more effectively. It also plans to extend the participation among financial firms in the scheme.

China National Emissions Trading Scheme (ETS)

Inaugurated: 2021

Cap: None

Current price (as of January 30th 2024): $9.80/tCO₂e

Launched just in 2021, The China National ETS is already the largest carbon market in the world if we consider emissions regulated as the system covers companies that emit at least thrice as much as those covered by the EU ETS. The Chinese government acknowledges the ETS as one of its “core policy tools” for achieving its national climate ambitions. To date, the ETS only covers the power sector but it accounts for 40% of total GHG emissions.

There are no specific emissions target set under the ETS as the primary function of the carbon market is to raise companies’ efficiency and lower their emissions intensity which is why China’s overall carbon emissions and economy is still growing. But since China’s power companies have encountered paying for their CO₂ emissions, it should serve as a precedent for companies to factor the costs in business operations and therefore, pursue ways to lower their emissions intensity.

China's carbon price has remained relatively stable at $9.80 due to the characteristics of the national carbon market, which tends to be low and seasonal. This is because many companies engage in buying or selling allowances toward the end of each compliance period to meet their market obligations, leading to slow market activity throughout the year. China is planning to expand its ETS beyond power generation to sectors that are eligible under EU’s CBAM which are cement, aluminum, iron and steel. China will likely experience significant impacts from the implementation of CBAM, primarily due to the anticipated effects on its cost competitiveness resulting from increased prices for commodities. The expansion of the ETS to additional sectors could lead to heightened demand for carbon allowances, thus driving prices upward over time. However, this expansion also presents an opportunity for other sectors to prioritize the adoption of decarbonizing technologies, especially considering the global constraints on carbon emissions. By the end of the decade, it is expected that the ETS will cover 70% of its total emissions (Time, 2023).

New Zealand Emissions Trading Scheme (NZ ETS)

Inaugurated: 2008

Cap: 32.2 MtCO₂e (2023)

Current price (as of January 30th 2024): NZ$71.45/mtCO₂e

Launched in 2008, the NZ ETS was established as a result of its Climate Change Response Act 2002 that focuses on meeting international obligations to limit the global average temperature to 1.5°C above pre-industrial levels and cements the implementation, operation, and administration of a GHG emissions trading scheme to reduce emissions. Under the 2015 Paris Agreement, New Zealand has committed to reduce its net emissions (including forestry) by 50% of 2005 gross emissions (minus forestry) by 2030. Currently, NZ ETS covers over 50% of national GHG emissions.

The NZ ETS stands out as the only carbon market that covers the forestry sector that addresses both emissions and removals. Since New Zealand is already 80% renewable-powered, most of its emissions come from transport and industry (Environmental Defense Fund, 2023). The forestry sector plays a key role in reducing those emissions. Revenues from carbon pricing are streamlined into afforestation projects and at the same time the increase in prices lead to a decline in deforestation. So far, acceleration in afforestation has benefitted from NZ ETS which partakes in achieving climate goals. However, afforestation has minimal contribution to emissions reductions especially when other sectors continue to develop. Hence, there is also a need for other heavy-emitting sectors to invest in decarbonizing their operations to fully meet climate targets.

New Zealand’s carbon price has been steadily growing after the government’s decision to pause reviews on the current emissions trading scheme. In 2022, after the previous labor government implemented weaker price settings for the ETS and launched several ETS reviews, carbon prices fell from a record high of NZ$88.50/MtCO₂e (S&P Global, 2023). The NZ ETS comprises two distinct types of units: (1) New Zealand Units (NZUs), which symbolize one metric tonne of carbon dioxide and are utilized as allowances for emissions, and (2) carbon credits, financial instruments representing a unit of CO2 equivalent, awarded for projects aimed at storing, avoiding, or reducing greenhouse gas emissions. The previous government is leaning towards developing more assertive measures for individuals and businesses to transition away from fossil fuel and rely less on carbon credits generated through forest planting to compensate emissions. Several proposals have been put forward, including the straightforward reduction of carbon allowances allocated to participants to match their emissions, as well as reducing incentives for tree planting by imposing restrictions on the volume of carbon credits that forestry activities can generate (Westpac IQ, 2023). Following the recent change in government last October 2023, we have yet to find out the future of NZ ETS.

Are compliance markets an effective solution in curbing carbon emissions?

The effectiveness of compliance markets in curbing carbon emissions is a subject of scrutiny. While they incentivize companies to explore cleaner alternatives as emission caps shrink, free allowances provided by the government somewhat mitigates their emissions reduction efforts. What seems to be a significant concern is the EU's CBAM among countries, where carbon leakage may incur high levies, actually prompting nations to tighten compliance market regulations and businesses to decarbonize operations.

Overall, compliance markets should be integrated into a comprehensive mitigation strategy.

Compliance markets should serve as a push for companies to seek cleaner alternatives in their operations to lessen emissions costs and their overall carbon footprint
Revenues from compliance markets should be allocated for public investments in clean technology infrastructures and mitigation from climate change effects
Compliance markets should be complimentary to carbon removal solutions. Investing in carbon removal methods can help drastically reduce emissions. Carbon Capture and Storage Technologies are only able to address ongoing emissions and not those historically present in the air. If compliance markets can have an effect on businesses to significantly cut their emissions, carbon removal technologies can concentrate on eliminating accumulated GHG emissions in the atmosphere.

The assessment of these global compliance markets and their carbon pricing reveal a complex landscape where regulations, targets, and market mechanisms intersect to address persistent challenges of climate change. The compliance market may be a robust pathway for countries to mitigate carbon footprints among their various sectors but the effectiveness of this program depends on stringent government monitoring, strong collaboration with involved parties, and continuous support for green developments from both the government and the public. Compliance markets will continue to evolve, and carbon pricing strategies will play a key role as countries endeavor to meet their emissions targets and address the climate crisis. As stakeholders, we must remain vigilant, adaptable, and collaborative in navigating this dynamic environment to foster a sustainable future for generations to come.

*Emissions cap data sourced from the International Carbon Action Partnership, with carbon prices retrieved from CarbonCredits.com