As in any market, prices in carbon markets are broadly determined by the balance of demand for and supply of abatement (which emerges as demand and supply for permits or carbon credits).

In compliance markets, the demand for abatement is determined by the stringency of the abatement target within a country. In an emissions trading scheme, this is the cap on overall emissions.

In compliance markets, the demand for abatement comes through entities that have carbon abatement obligations or a cap on their emissions. Those entities may seek to reduce emissions by investing in their own abatement activities, or they may seek to buy carbon permits on the market. They will buy permits if the price of permits is lower than their own cost of abatement. Other entities may seek to supply abatement by investing in technologies that allow them to reduce emissions more than required, allowing them to sell the excess abatement.

In voluntary markets, the demand for abatement is determined by a broader set of factors, including individual or corporate choices to offset emissions, along with the expectation of future regulation.

The supply of abatement comes from a variety of activities within the economy. Entities with carbon liabilities may choose to reduce them through their own investments and activities that reduce their emissions. Some may reduce emissions by more than necessary in order to supply additional abatement to the market:

In general:

• Most compliance markets also include the use of offsets (abatement produced by actions of entities that do not necessarily have an obligation or cap. Offsets can come from a variety of activities, including forestry or other forms of carbon farming.

• A price on carbon is needed to induce a supply of abatement, as abatement is costly and requires actions that might not otherwise be profitable.

• The Clean Development Mechanism (CDM) under the Kyoto Protocol is an important source of offsets in a number of carbon markets.