What are carbon quotas?

Definition of carbon allowances

Carbon allowances are limits imposed on companies regarding the amount of greenhouse gases (GHG) they can emit. This system operates on the “cap-and-trade” principle, where a cap on total emissions is set (cap), and companies can buy or sell allowances (trade). Carbon allowances differ from carbon credits. Allowances are allocated or purchased in the market, whereas credits are earned by funding projects that reduce GHG emissions elsewhere.

How do carbon allowances work?

Carbon allowances work by capping GHG emissions. Each company is given a limited number of allowances that represent a maximum amount of emissions they are allowed to release. If they emit less than their allowances, they can sell the surplus on the carbon market. Conversely, if they exceed the cap, they must purchase additional allowances to cover their emissions. Companies that fail to comply with their quotas face financial penalties, which incentivizes them to reduce emissions and invest in low-carbon technologies.

Objectives of carbon allowances

The main objective of carbon allowances is to reduce CO2 and other GHG emissions to combat climate change. By limiting the emissions allowed for companies, this system encourages them to adopt more environmentally friendly strategies.

It also promotes investment in low-carbon technologies, such as renewable energy and energy efficiency. Carbon allowances directly contribute to the goals set by the Paris Agreement, which aims to limit global warming to 1.5°C. They also play a key role in achieving long-term carbon neutrality by gradually reducing global emissions.

Sectors impacted by carbon allowances

Carbon allowances primarily apply to heavy industries such as steel, cement, and chemical production, which are among the largest emitters of GHGs. The energy sector, including power plants and heat production using fossil fuels, is also subject to allowances to limit CO2 emissions.

Additionally, the aviation sector has been included in several carbon allowance systems, as well as the maritime sector. These changes aim to involve all high-emission sectors in global efforts to reduce emissions, in line with international climate goals.

Advantages of carbon allowances

Carbon allowances provide flexibility to companies, allowing them to adjust their emissions based on actual needs. Companies that emit less than expected can sell their surplus allowances, creating a dynamic carbon market. This system incentivizes businesses to innovate by investing in new technologies to reduce their costs related to allowances. Additionally, by gradually lowering the cap on allowed emissions, carbon allowances effectively contribute to the reduction of global GHG emissions.

Limitations of carbon allowances

Carbon allowances have several limitations. They can lead to carbon leakage, where industries relocate production to countries with less stringent environmental regulations, which does not reduce global emissions. Additionally, managing this system can be complex for companies, especially due to the need to monitor and comply with quotas. Finally, price volatility in the carbon market can make long-term planning difficult for companies, increasing financial uncertainty.

Carbon allowances around the world

The European Union Emissions Trading System (EU ETS) is the largest carbon market in the world. It operates on a cap-and-trade system to progressively limit CO2 emissions in Europe. Other similar systems exist in regions such as California, Canada, and South Korea, each tailored to local conditions while aiming to reduce GHG emissions.

How can companies benefit from carbon allowances?

Companies can reduce their emissions by adopting green technologies and improving energy efficiency, allowing them to sell unused surplus allowances on the carbon market. This can represent a potential revenue source while complying with environmental regulations.

Additionally, investing in sustainable solutions, such as renewable energy and carbon capture, helps organizations improve their carbon footprint. These strategies also enhance their long-term competitiveness by meeting the expectations of consumers and investors while ensuring sustainability in the face of future climate regulations.