Our environment is precious and is being damaged by the industrialization of the past decades. International laws and agreements have been set up to limit the damage to our environment and give it a chance to rebuild itself. The most important of these treaties is the Kyoto protocol. In this protocol the signatories agree to reduce the output of hazardous pollutants into the atmosphere. Each country was hereby limited to an amount of pollutants it is allowed to discharge. A country itself would then allocate allowances to different sectors in the industries and the underlying companies operating in these industries. To control the output of pollutants and enforce penalties on companies who overdraw the limits, countries create agencies who control the output of emissions.
Each company is allowed to discharge a specific amount of pollutants into the atmosphere. This limit is called the cap. However not every company will use all of its cap space and they can chose to sell their remaining cap space. Other companies who are in need of extra cap space can then buy this from them. Emissions can be traded similar to other commodities. They can be traded directly between two parties or on a specialized climate-exchange. A difference with the physical commodities market is the more abstract nature of this commodity, where there is some type of delivery of currency or products. The trading of emissions requires both national as international agencies, who monitor the trading of emissions rights between different parties and register the actual output of emissions per company. These agencies manage the overall objectives of the Kyoto protocol and can take measures against companies who overdraw the limits. They can oppose fines or decrease the limit the next year to make up for their overdrawing of the limit of the current year.
The price of emission trading can be influenced by many different factors. First and foremost is the economic growth of companies an important factor for the price. When a company grows it is likely the output of pollutants will increase with it, what will cause the price to rise due to the demand for more allowances. Another factor is the weather and fuel prices. In case of cold weather and for example high natural gas prices companies may switch to coals as fuel input, which creates more emissions compared to natural gas. This causes an increase in demand. The growing usage of less polluting energy types results in a decline in demand for allowances and thus affect the price.