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Carbon market 101: Understanding the concept of "carbon market"

By Karen Adaare
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The United Nations defines “climate change” as the long-term shifts in temperatures and weather patterns. Although primarily driven by human activities, particularly the release of greenhouse gases like carbon dioxide and methane into the atmosphere, the shifts can be natural due to the changes in the sun’s activity or large volcanic eruptions.

These gases trap heat from the sun, resulting in global warming and a host of related challenges, such as more frequent and severe extreme weather events, rising sea levels, altered precipitation patterns, and disruptions to ecosystems.

Addressing climate change is of critical importance due to its far-reaching consequences. It poses a substantial threat to our environment, economy, and overall well-being. Also, climate change can lead to resource scarcity, displacement of communities, and even social unrest as people compete for dwindling resources.

In addressing the issue of climate change among countries, in 1997, the Kyoto Protocol was adopted and in line with the recently signed Paris Agreement 2015, a new way of reducing emissions was introduced to reach the emissions goals. To tackle climate change, the carbon market was established as a means for businesses to measure and achieve their environmental goals.

The carbon market, often referred to as a trading system, functions as a medium through which companies engage in the buying and selling of excess carbon credits and carbon offsets. These carbon credits and offsets are essentially like eco-friendly certificates that businesses accumulate when they successfully reduce their greenhouse gas emissions below certain limits.

This helps companies that have surplus credit to earn financial gains by selling their credits to companies that are above their limit. This way, the carbon market facilitates a balance in the overall reduction of greenhouse gases.

In understanding how the carbon markets work, companies first need to comprehend the concepts of carbon credits and carbon offsets. Carbon credits are generated by companies that have reduced their greenhouse gas emissions below the baseline. Once their emissions fall below the threshold, they are able to sell the excess credits to other companies. The primary goal of carbon credits is to create a financial incentive for companies to decrease their carbon footprint and invest in cleaner, more sustainable business practices.

In contrast, carbon offsets involve both individuals and companies investing in environmental projects around the world in order to balance out their own carbon footprint. For instance, if an individual embarks on a flight that is measured to emit a certain amount of carbon dioxide, the individual has the opportunity to pay the equivalent through an organization that manages projects such as reforestation to mitigate the impact of air travel. Carbon offset is a way to compensate for your emissions by funding an equivalent carbon dioxide reduction elsewhere.



In a cap-and-trade system, a government establishes a limit on greenhouse gas emissions and distributes emission permits accordingly. Emitters are required to possess permits for each ton of emissions they release. These permits can be bought and sold in a market that determines the price of emissions. Companies that can reduce their emissions at a lower cost may sell extra permits to those facing higher costs. This system aims to reduce pollution in our atmosphere. The emission limit for greenhouse gases that contribute to global warming serves as a strict ceiling on pollution, and it becomes more stringent over time.

There are two main types of limits: an "absolute" limit ensures that emissions do not exceed a specific level, while a "relative" limit restricts emissions relative to national or sector-specific output levels.

The trading aspect functions as a marketplace for companies to trade emission permits, allowing them to emit only a set amount, with prices determined by supply and demand. This trading mechanism provides a strong incentive for companies to reduce emissions cost-effectively, thus saving money.

The overall emission limit is divided into individual permits, each granting a company the right to emit one ton of emissions. This market, the "trade" component of cap and trade, offers companies flexibility. It increases the pool of capital available for emissions reduction, encourages faster pollution reduction, and fosters innovation.

The cap-and-trade is therefore designed to limit collective emissions from a group of emitters by setting a maximum cap. It is recognized as a market-based policy to reduce overall pollutant emissions and encourage investments in clean energy and energy efficiency. The government allocates emissions permits, which are restricted by the cap. Since permits are tradable, valuable, and limited - they serve as a price signal when companies buy and sell them.


Alternatively, emitters may sell their permits to other emitters who are willing to pay for the right to emit. When a market sets an emissions price, some emitters may choose to emit less than their permit allows. In this scenario, emitters can trade their extra permits by selling them in a secondary market. The permit market is a distinctive feature of cap-and-trade, allowing emissions reduction efforts to align with market dynamics. In a cap-and-trade program, no single company has a maximum emissions limit. Instead, the cap regulates total emissions, allowing emitters to trade permits based on supply and demand.

Emitters participating in the cap-and-trade program must ensure that their emissions match the amount permitted by their permits. In the case of carbon cap and trade, the objective is to limit emissions sufficiently to prevent dangerous global warming, as indicated.


There are two distinct carbon emissions – the mandated regulatory market and the optional voluntary market.

  1. Regulatory Carbon Market: In the regulatory carbon market, governments set a system to combat climate change. Here, each company operating under a cap-and-trade program is allocated a specific number of carbon credits every year. These credits represent a company's allowable emissions, and they must adhere to this limit. Companies are obliged to reduce their emissions to stay within their allotted credits. If a company successfully reduces its emissions below the credit limit, it ends up with surplus credits. This surplus can sometimes be sold or traded to other companies that may struggle to meet their emissions targets.

The compliance market ensures consistency and credibility in carbon credits. It is regulated by government authorities or international agreements, like the Kyoto Protocol, ensuring that greenhouse gas emissions are reduced and monitored as required by law. There are three key mechanisms under the Kyoto Protocol that have played vital roles in this market: the Clean Development Mechanism (CDM), Joint Implementation (JI), and the EU Trading System (ETS).

  1. Voluntary Carbon Market: On the other hand, the voluntary carbon market operates independently of government mandates. It is, as the name suggests, voluntary. Companies and individuals participating in this market are environmentally conscious and take it upon themselves to offset their carbon emissions. This offsetting is not driven by a legal requirement but by a genuine desire to minimize their environmental impact.

The voluntary carbon market is open to a wide range of participants, including individuals, corporations, and various organizations. It caters to those who want to reduce or eliminate their carbon footprint for reasons beyond legal compliance. Consumers in this market have the option to purchase carbon offsets to compensate for emissions related to specific activities, such as long-distance travel, or to regularly counterbalance their ongoing carbon footprint.

The voluntary market is gaining prominence, particularly in projects related to agriculture and forestry. Private sector entities, in particular, have embraced this market, often driven by corporate social responsibility (CSR) objectives and the desire to enhance their public relations by demonstrating environmental stewardship. However, there are numerous other motivations that fuel participation in this market, such as ethical considerations and a commitment to sustainability.

In summary, these two carbon markets play distinct but equally significant roles in the global effort to combat climate change. The regulatory market is driven by government regulations, ensuring that companies adhere to legally mandated emissions reduction targets. In contrast, the voluntary market represents the collective efforts of environmentally conscious individuals and organizations that voluntarily choose to offset their carbon emissions, contributing to a more sustainable and environmentally responsible future. Both markets, each in its own way, play a crucial part in addressing the urgent issue of climate change.


In developing nations, the Clean Development Mechanism (CDM) stands out as a prominent regulatory market mechanism of particular interest. It involves industrialized countries initiating emission reduction projects within developing nations. These projects encompass various activities, ranging from afforestation to energy efficiency and renewable energy initiatives. As a result of these endeavors, carbon credits, known as Certified Emission Reductions (CER), are generated. These credits are attributed to the industrialized countries, which can then employ them to offset a portion of their domestic greenhouse gas emissions, thereby advancing their emission reduction targets.

Furthermore, these projects play a pivotal role in promoting sustainable development within the host country. They introduce new and supplementary initiatives that not only contribute to curbing global warming but also facilitate the transfer of cutting-edge technology to the host nation. Additionally, they attract investments, create new employment opportunities, and help reduce adverse environmental impacts.

Ghana actively participates in the Voluntary Market System through a range of programs, including Reduced Emissions from Deforestation and Degradation (REDD+), Reforestation, Regenerative Agriculture, Nature-Based Solutions, Carbon and Methane Capture, and Energy Efficiency Improvements. Ghana's commendable efforts in this arena have yielded significant results, according to the World Bank, the country earned $4.8 million by reducing almost 1 million tons of carbon emissions resulting from deforestation and forest degradation. Furthermore, it is projected that by the end of 2024, these efforts may yield up to $45 million in revenue.

The World Bank has been a key partner in these endeavors, and Ghana's Carbon Market Office (CMO) serves as the secretariat responsible for providing administrative and technical support to the public. Its primary role is to facilitate the implementation of Ghana's international carbon market and non-market approaches framework, which includes Bilateral Agreements. Notably, Ghana has an Agreement with Singapore, pending finalization, and an Agreement with Sweden awaiting ratification by Parliament. On the other hand, the Agreement with Switzerland has already been ratified by the Ghanaian Parliament.



The carbon market, in essence, represents a dynamic and essential approach to addressing the urgent issue of climate change, offering a solution that combines environmental protection, economic growth, and international collaboration. These markets underscore the importance of both individual and collective efforts in achieving a more sustainable and environmentally responsible future.

About the Author

KAREN ADAARE is an Associate at SUSTINERI ATTORNEYS PRUC ( Karen specializes in Natural Resources including Mining, Oil & Gas, and Energy, Sustainability practice covering ESG, Climate Change, and Renewables, as well as Dispute Resolution. She welcomes views on this article via