Carbon Trading Definition, Principle and Examples Explained

Carbon trading is the sale and purchase of rights to emit carbon dioxide into the atmosphere. This article discusses carbon trading definition, working principle, and examples, as outlined below;


-Carbon Trading Definition: 4 Ways to Define Carbon Trading

-How Carbon Trading Works

-Examples of Carbon Trading




Carbon Trading Definition: 4 Ways to Define Carbon Trading

Carbon trading is a socioeconomic policy that enforces fiscal costs for carbon emission, in the form of credits and permits per unit of emitted carbon [2].

The carbon tax is a common tool used in carbon trading, which imposes the social cost of greenhouse emissions and their consequences, on major emitters of carbon dioxide. In the carbon trading definition below, some of the objectives of carbon trading are mentioned;

Carbon trading is a scheme which assigns financial costs to carbon emissions; in a bid to address issues affecting sustainability, such as climate change, global warming and pollution; by reducing the rate at which carbon dioxide is emitted into the atmosphere [1].

By helping in the efforts toward sustainable development; carbon trading can also be said to be an important ingredient for establishing a circular economy. Below is another carbon trading definition, which highlights the economic relevance of the concept;

Carbon trading is the practice of selling the rights to emit carbon, per unit of emissions; in order to buffer the economic effects of such occurrences by covering the cost of environmental remediation, energy transition, decarbonization and healthcare.

While some of the links highlighted above might not be obvious, the ideal end-use of funds derived from carbon trading is for economic recovery from the effects (mainly environmental impacts) of carbon emission.

This recovery may take the form of renewable energy adoption, investment in sustainable agriculture, recycling, and advanced sustainable technologies like electric cars.

Lastly, the carbon trading definition below portrays it as a component of decarbonization strategy;

Carbon trading is is the sale of carbon emission permits or credits, as part of decarbonization strategy, to support the operation of other policies as well as carbon removal technologies.


How Carbon Trading Works

Carbon trading works like any policy-based trade system, based on four steps that include; estimation, allocation, enforcement and exchange. Each of these steps is discusses below;

1). Estimation (as part of the Working Principle of Carbon Trading)

The first step in carbon trading is estimation of the economic implications of carbon emissions.

To arrive at a precise estimate, this stage usually involves careful numeric comparisons of emissions in units of tonnes, kilograms or pounds; against fiscal values.

When performed correctly, the outcome is a set of values that can easily be referenced, and can be used to develop standards for the cost of carbon emission in a given region and time.

2). Allocation

Allocation involves the assignment of carbon credits to all projects or schemes where carbon dioxide is produced in significant quantity.

In allocation, the estimated carbon costs are used to determine the taxes or cost of credits to be imposed on major emitters.

3). Enforcement (as part of the Working Principle of Carbon Trading)

After allocating or assigning costs to carbon emissions, the existing policies regarding payment for carbon emissions, must be enforced.

Enforcement is handled primarily by environmental agencies, which could be local, regional, or industry-based.

These agencies have the task of identifying firms and projects whose carbon emissions are significant and should be paid for.

Firms which are subject to carbon taxation are often granted occasional waivers in the form of free carbon credits, as a form of balancing-incentive that encourages these firms to continue their businesses (which are usually beneficial to the society) while still reducing and paying for, their carbon emissions.

How Carbon Trading Works: Policy Enforcement (Credit: Casey Deshong 2009)
How Carbon Trading Works: Policy Enforcement (Credit: Casey Deshong 2009)


4). Exchange

As part of trading activities, participants or business which are under the carbon trading scheme, can exchange (buy and sell) carbon credits among themselves.

Credit selling is more likely to occur when a business has successfully lowered its carbon emissions to the point that it has excess carbon credits which are unused and susceptible to expiry.

Other factors can lead to the possession of excess carbon credits, although emission reduction is the more-desired and ideal cause.

Carbon credit exchange between participants can occur at subsidized cost compared to the price of credits from environmental agencies.


Examples of Carbon Trading

Examples of carbon trading are the allocation of carbon permits and taxes to manufacturing industries like paper mills and chemical factories; material-processing outlets like oil and gas, steel, aluminum and paper production facilities; electricity generation and distribution entities like smart grid, microgrid and power plant operators; and commercial entities like hedge funds.



Carbon trading is a market system and commercial practice which specializes in the sale of carbon credits or emission rights.


Examples of carbon trading are;

1. Manufacturing industry carbon permit allocation for paper mills and chemical factories

2. Sale of carbon emission rights to material-processing outlets like oil and gas refineries, biorefineries, steel, cement, aluminum, paper, and waste-to-energy facilities

3. Enforcement of carbon tax policies in the power sector

4. Commercial carbon permit allocation to hedge funds

5. Exchange of unused carbon credits among major emitters


Carbon trading works by;

1. Estimation

2. Allocation

3. Enforcement

4. Exchange



1). Chen, L.; Wang, D.; Shi, R. (2022). “Can China’s Carbon Emissions Trading System Achieve the Synergistic Effect of Carbon Reduction and Pollution Control?” International Journal of Environmental Research and Public Health 19(15):8932. Available at: (Accessed 4 November 2022).

2). Li, L.; Dong, J.; Song, Y. (2020). “Impact and Acting Path of Carbon Emission Trading on Carbon Emission Intensity of Construction Land: Evidence from Pilot Areas in China.Sustainability 12(19):7843. Available at: (Accessed 4 November 2022).

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