EMISSIONS TRADING MARKET ANALYSIS

Emissions Trading MarketSize and Trends

The emissions trading market size was estimated to be valued at US$ 317.6 Mn in 2023 and is expected to reach US$ 1,034.5 Mn by 2030, exhibiting a compound annual growth rate (CAGR) of 18.4% from 2023 to 2030.

Emissions Trading Market Drivers:

• Environmental concerns and climate change mitigation: The primary driver behind emissions trading is the global concern about climate change and its adverse impacts. Governments and international bodies recognize the need to reduce greenhouse gas emissions to limit global warming and its consequences. Emissions trading provide a market-based approach to incentivize emission reductions and promote the transition to cleaner and more sustainable practices. According to the International Renewable Energy Agency (IRENA), the total renewable energy generation capacity globally reached 2,537 GW by the end of 2020, a 10% increase from the previous year. Increasing environmental concerns have led to the adoption of sustainable manufacturing practices. According to a survey by the United Nations Industrial Development Organization (UNIDO), 68% of companies worldwide have implemented at least one green initiative in their manufacturing processes.
• Regulatory compliance and international commitments: Many countries have set emission reduction targets and commitments under international agreements like the Paris Agreement. Emissions trading enable countries and industries to meet their regulatory obligations more cost-effectively by trading emission allowances and credits, thus providing flexibility in achieving emission reduction goals. For instance, the European Union's Green Deal aims to make Europe the first climate-neutral continent by 2050. This has led to increased investments in renewable energy, energy efficiency, and other low-carbon technologies.
• Economic efficiency and cost-effectiveness: Emissions trading allows companies to find the most cost-effective ways to reduce emissions. It creates a market for emission allowances, where those able to reduce emissions at lower costs can sell their surplus allowances to those facing higher costs, encouraging emission reductions where they are most economically viable.
• Stimulating clean technologies and innovation: Emissions trading incentivizes businesses to invest in cleaner technologies and practices. Companies that reduce emissions below their allocated allowances can sell the excess allowances, thereby creating financial incentives to invest in low-carbon technologies and innovative solutions to decrease emissions.

Emissions Trading Market Opportunities:

• Expansion of emissions trading schemes: As more countries and regions commit to reduce greenhouse gas emissions, there are opportunities to expand existing emissions trading schemes and implement new ones. Governments can explore the potential of emissions trading in different sectors, such as transportation, industry, and agriculture, to achieve broader emission reduction targets. According to the report provided by the World Bank's State and Trends of Carbon Pricing till 2020, there were 61 carbon pricing initiatives implemented or scheduled for implementation worldwide. These initiatives cover 12 gigatons of carbon dioxide equivalent (GtCO2e), or about 22% of global greenhouse gas emissions
• Linking emissions trading systems: Linking emissions trading systems between different countries or regions offers opportunities to create a larger and more liquid market for emission allowances and credits. This linkage can enhance cost-effectiveness, encourage international cooperation, and increase the overall impact of emission reduction efforts.
• Inclusion of new greenhouse gases: Current emissions trading systems primarily focus on carbon dioxide (CO2) emissions. Opportunities exist to expand these systems to include other greenhouse gases like methane (CH4), nitrous oxide (N2O), and hydrofluorocarbons (HFCs). Integrating a broader range of greenhouse gases into emissions trading can address a more comprehensive set of climate change challenges. The inclusion of new Green House Gases in emissions trading schemes can create new markets for emissions reductions. For instance, the California Cap-and-Trade Program, one of the largest emissions trading schemes in the world, includes multiple GHGs, including CO2, CH4, and N2O. According to the California Air Resources Board, the program covered approximately 360 businesses representing roughly 85% of California's GHG emissions in 2020.
• Market-based solutions for net-zero goals: Countries and companies that are aiming for net-zero emissions have opportunities to use emissions trading as a market-based solution to offset residual emissions. Investing in carbon offset projects and nature-based solutions can help achieve net-zero goals more efficiently. 

Emissions Trading Market Trends:

• Linking of regional carbon markets: Linking of regional carbon markets are having a significant impact on the emissions trading market. By connecting established cap-and-trade systems, it allows emission allowances to be traded across different geographic regions. This opens up larger markets with higher liquidity, thus enabling more opportunities for trading. For instance, when the carbon markets of California and Quebec were linked in 2013, it created a new market covering over 500 Mn people. This linkage boosted trading volumes as the number of available allowances and participants increased substantially. In 2022, discussions are underway about linking the European Union (EU) Emissions Trading System with markets in the U.K., Switzerland and potentially others taking a leap ahead. A larger transnational market will likely to lead more stable carbon prices over time as supply and demand are balanced across a wider area. The expansion of regional carbon market linkages poses both opportunities and challenges for market participants. On the one hand, it gives companies and traders access to a much bigger pool of offset credits and allowances to draw from. For firms operating in multiple areas, they can seek out lower carbon prices in other linked regions. However, it also increases complexities and compliance risks. Emissions or allowances that are traded between jurisdictions may be subject to the rules of both markets. If one region changes its overall emission cap or regulations, it could disrupt the balance across the entire linked market network. Data inconsistencies between uncoupled trading registries also need to be resolved. Overall, market connectivity on a broader scale should increase market liquidity and decrease price volatility but greater oversight will be important as these carbon markets evolve. For example, according to the International Carbon Action Partnership (ICAP), a total of 5.4 billion tons of carbon dioxide equivalent (CO2e) emissions were priced at an average price of US$58/tCO2e in 2021 across the carbon pricing initiatives they monitor. This represented an increase from 2.8 billion tons priced at US$24/tCO2e in 2016, demonstrating the growth of carbon pricing worldwide.
• Integration of carbon markets: The emissions trading market is witnessing a significant influence from the growing integration with complementary climate policies across many jurisdictions. Countries and regions that have emissions trading systems are increasingly linking their carbon markets together and adopting additional climate policies that indirectly impact the supply and demand fundamentals in trading. The European Union Emissions Trading System (EU ETS), the largest carbon market, has witnessed more linkage through inclusion of additional sectors like aviation. It is also coordinating pricing and supply between member states through the adoption of more ambitious near-term emissions reduction targets under the EU's Fit for 55 packages. These new 2030 goals under Fit for 55, which include proposals to reduce EU greenhouse gas emissions by 55% from 1990 levels, are expected to lead to lower free allocations of emissions permits to industries. This would potentially decrease the surplus of allowances, thus supporting higher permit prices going forward, according to the EU Commission. Similar integration is occurring in China as well. Seven regional pilot carbon markets established since 2013 are in the process of being consolidated into a unified national carbon market by 2025 based on guidance under China's 14th Five-Year Plan. There are also plans to expand the scope of this national emissions trading system to include more sectors like aviation, cement, and liquefied petroleum gas. At the same time, China continues to strengthen other policies like operational emission standards and renewable portfolio standards that motivate reductions covered entities which can monetize under the carbon market. According to the International Carbon Action Partnership (ICAP), these measures taken together by China mean the demand for allowance units in the national ETS which is expected to substantially rise in the near future.
• Speculation driving price volatility: Speculation has been playing a significant role in driving price volatility in the emissions trading market. With the introduction of stricter climate regulations and commitments made at Conference of the Parties conferences to reduce carbon emissions, long-term demand for carbon allowances and offsets is expected to grow steadily. However, in the short-term, price movement has largely been dictated by speculative activity as traders attempt to profit from price fluctuations. When market sentiment is positive about the policy support for low carbon transition, speculators tend to push prices upwards in anticipation of higher future demand. This was witnessed in the EU ETS in 2021 when the adoption of a stricter 2030 emissions target by the European Commission led to a spike in allowance prices. However, events like the uncertainty caused by the war in Ukraine have raised concerns about economic growth and energy security, thus causing speculators to sell off their holdings and drive prices down temporarily. In May 2022, the price of EU allowances fell by over 30% from its January high. The entry of financial market players into the carbon market has increased trading volumes substantially but also introduced more short-term volatility that is driven by risk appetite rather than fundamental supply-demand. According to an International Energy Agency report, the share of allowances held by compliance entities in the EU ETS, fell from 85% in 2008 to 58% in 2020, as financial market players acquired a larger position. While higher liquidity is beneficial, unpredictable swings in prices due to speculators jumping in and out of the market make it difficult for corporate emitters to hedge their compliance costs over the long run. It also raises concerns about the market accurately signaling the relative cost of higher carbon versus lower carbon investments. To reduce undue influence of speculation, regulators are exploring options like restricting market access for non-compliance players and imposing position limits on the number of allowances financial entities can hold at a time. For example, in 2021, the China national carbon market piloted a plan to temporarily restrict trading, if the price moved over 10% in a single day. However, a balance, needs to be maintained, since complete removal of financial players may compromise liquidity, that is needed in carbon asset class. Overall, as penetration of carbon pricing increases globally, stabilizing price signals will become more important for the emissions trading market to efficiently support decarbonization.