Carbon Dioxide Emissions Futures – What Is It and How Does It Work?

Some say that communism was failed due to the system’s inability to manage a high number of products and services. Theoretically, it’s doable to manage the economy of a narrow selection of products, but, once there are more products in the market, communism was doomed to failure.

And so, the big rival, capitalism, has been more productive in that sense. In fact, this ideology of the free market enables the trading of infinite products without the intervention of the establishment. This leads to a global free market where anyone can trade almost any product on the planet including… carbon global emission products.

But, what are carbon emission futures, how does it work, and how can anyone trade these environmental financial products?

What is carbon emissions trading?

Carbon emissions trading is a form of financial contract that allows companies to trade government permits of carbon dioxide output. The permit essentially enables countries to control carbon emissions in an attempt to mitigate future climate change and reduce pollution.

Trading of carbon emission was first introduced in 1997 in Kyoto Japan to meet the conclusions of the Kyoto Protocol. But it was only in 2000 when the European Union issued a carbon trade emission limitation and trading program that has made these contracts a standard form to reduce carbon dioxide output. Nowadays, European carbon futures is effectively the benchmark of this market.

Carbon emissions trading – How does it work?

So imagine a scenario that every company gets a cap on the amount of carbon dioxide it can release. But for some reason, company A does not have any use in some of the capacity it has received, and therefore, it can sell the remaining amount to company B. This is the basic principle of any emission futures contract – it has a valid market among factories, large industrial companies, and governments.

With the rise of global warming and environmental concerns, this futures contract could be an important tool to navigate carbon emissions until a new ‘less-polluting solution for burning fuels will arise in the future.

How to trade carbon emission futures?

Essentially, there’s only one way to trade carbon emissions as a physical product, which is via futures contracts. And, like any other futures contract, if you want to buy carbon emission futures then you need to find a brokerage firm that connects you to a futures exchange like the Chicago Mercantile Exchange or the Intercontinental Exchange. Presently, the most traded and ‘liquid’ carbon emission futures contract is the Global Emissions Offset (GEO) Futures, which started trading early this year.

But, if you plan on trading the GEO contract, do not expect high liquidity in this market as this is a new market and currently, there’s a volume of only a few contracts each trading day.

Another carbon emission futures contract that is available in the market and is a bit more liquid is the European Union Allowances (EUA) futures in the ICE exchange.