How Carbon Trading Works

Voluntary Carbon Trading

Dr. Richard Sandor (center), chairman and CEO of the CCX, speaks with U.S. Secretary of Energy Spencer Abraham (left) and Chicago Mayor Richard Daley after the CCX’s first allowance auction in 2003.
Dr. Richard Sandor (center), chairman and CEO of the CCX, speaks with U.S. Secretary of Energy Spencer Abraham (left) and Chicago Mayor Richard Daley after the CCX’s first allowance auction in 2003.
Scott Olson/AFP/Getty Images

The Clinton administration helped develop the Kyoto Protocol. But when it came time to ratify the treaty in 2001, the United States chose not to. The government believed that Kyoto was fatally flawed and could cause economic havoc [source: Washington Post]. Not all Americans agreed, however. In 2005, 132 of the nation's mayors pledged to meet Kyoto-like emissions targets. Many cited the economic consequences of dwindling water supplies and rising oceans.

Some cities and companies took action even earlier. In 2003, Dr. Richard Sandor founded the Chicago Climate Exchange (CCX), a voluntary carbon market. Members of the CCX willingly join the pooled commodity but commit to legally binding reductions. Since the CCX is voluntary, all sorts of organizations have joined: companies, universities and even cities. Michigan State, Ford, DuPont and the cities of Chicago and Portland, Ore., are among its members.

Like other cap-and-trade programs, the CCX sets a limit on total allowable emissions and issues allowances that equal the cap. Member firms then trade the allowances -- carbon financial instruments (CFIs) -- amongst themselves. Each CFI equals 100 metric tons of CO2 equivalent. Members that meet their targets can sell or bank their allowances. Firms can also generate CFIs, specifically exchange offsets, by funding approved GHG reduction projects outside of the pool. In 2006, CCX traded a total of 10.2 million tons of CO2 [Climate Exchange, Plc]. Because CCX is owned by an independent, publicly traded company, it's free from the federal regulations that can bog down mandatory carbon trading schemes.

Like Kyoto or the ETS, the CCX has two phases of implementation. In the first phase, which ran from 2003 to 2006, members committed to reducing emissions by only 1 percent per year below their baselines. In the second phase, which will run from 2007 to 2010, members will reduce emissions 6 percent below their baselines.

Although the CCX's high cap has drawn criticism, the pooled commodity's true benefit may end up being the market-based practice it provides its members. Cities across the country have already created municipal carbon schemes. Some states are fashioning mandatory carbon markets for utilities. The United States is very likely headed toward some form of national carbon legislation. When such a time comes, members of the CCX will have the valuable advantage of experience.

Carbon trading and other market-based schemes add a needed dose of economic practicality to the emotionally charged issue of global warming. They help change the way we think about emissions, energy efficiency and the environment.

To learn more about carbon trading, carbon offsets and global warming, check out the links below.

Related HowStuffWorks Links

More Great Links


  • "Cap and Trade." Environmental Protection Agency.
  • Chicago Climate Exchange.
  • "Cleaning Up." The Economist. May 31, 2007. story_id=9217992
  • Emission Trading Scheme (EU ETS)." Europa.
  • "Energy/carbon taxes." U.S. Environmental Protection Agency. c484aff385a753cd85256c2c0057ce35/0483a144da8fa43485256 4f7004f3e68!OpenDocument
  • "Joint Implementation (JI)." UNFCCC. 1674.php
  • "Kyoto Protocol." United Nations Framework Convention on Climate Change.
  • "Lightly carbonated." The Economist. August 2, 2007.
  • O'Halloran, Julian. "Carbon trade scheme 'is failing.'" BBC News. June 5, 2007.
  • "Q&A: The Carbon Trade." BBC News. April 20, 2006.
  • "Q&A: The Kyoto Protocol." BBC News. February 16, 2005.
  • Sanders, Eli "Rebuffing Bush, 132 Mayors Embrace Kyoto Rules." The New York Times. May 14, 2005. ex=1273723200&en=c02e1cce1ca43706&ei=5088
  • "The Senate Proposals." The Washington Post. GR2007071401459.html.
  • Tietenberg, Tom. "European Union Emissions Trading Scheme (EU ETS). The Encyclopedia of Earth. January 30, 2007. Scheme_(EU_ETS)
  • Vedantam, Shankar. "Kyoto Treaty Takes Effect Today." The Washington Post. February 16, 2005.