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Technical Note
April 2020

Simulating Carbon Markets

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KEY MESSAGES SUMMARY

An emissions trading system (ETS) is a mar-
• Carbon market simulations are programs,
ket-based policy that mandates emissions
models, virtual environments, and/or games that
reductions (through setting a cap) and provides
allow stakeholders to participate in a fictitious
covered entities with the flexibility to select the
process of designing or participating in an
emissions trading system (ETS). specific means to achieve the goal. By putting a
price on carbon through an ETS, companies are
• Simulations can increase carbon pricing
incentivized to pursue the most cost-effective
literacy and build support for the policy among
solutions and the overall environmental goal is
stakeholders, helping to pave the way for an ETS
roll-out. Later, once a government has decided achieved.
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to implement an ETS, simulations can help test Worldwide, interest in carbon pricing and ETSs
design options, engage stakeholders and deepen
as key options for ambitious climate action
knowledge on carbon markets.
is increasing and important lessons can be
• However, simulations only provide a simplified learned from their implementation in different
model of a carbon market. Care should be taken contexts. In countries newly considering an
with the results of any simulation exercise as ETS, however, simulations can be a useful tool
they may not accurately predict how an ETS
to assist both policymakers and businesses to
would play out in real life.
prepare for emissions trading.
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 WHAT IS A CARBON MARKET administrators or climate negotiators, while others
SIMULATION? target multiple ETS stakeholders.
Carbon market simulations are programs, models, • Training Objective – Some tools are intended to
virtual environments, and/or games that allow stake- provide training in the principles of carbon portfo-
holders to participate in a simulated process of lio management. Others are intended to simulate
designing or participating in an ETS. They are a the challenges associated with the task of nego-
low-cost and low-risk option of building capacity for tiating an effective ETS policy that considers the
both policymakers and regulated companies. The expe- interests of diverse stakeholders.
riential learning processes these tools enable serves to
increase ETS literacy, helps build support for ETS as • Platform – Simulation tools may or may not be
a policy option, and illustrates how policy outcomes computer-assisted.
are a function of design. Importantly, ETS simulations In terms of substance, ETS simulations have either
can provide an opportunity for different stakeholders focused on policy design or trading dynamics in a car-
to build relationships, mutual understanding and trust, bon market:
all of which are key prerequisites for working together
on policy design and implementation. Finally, these • Policy design: Based on fictitious country infor-
tools provide stakeholders with a safe and risk-free mation, participants are given various stakeholder
opportunity to try out new ideas, make mistakes, and roles to simulate parts of the ETS design process,
to learn lessons which can serve to speed the adoption such as deciding on the cap.
of effective ETSs.
• Trading: Key elements of an ETS are simulated
and companies are given fictitious information and
Simulations synthesize years of learning into economic resources in order to comply with the
one interactive experience that teaches the virtual ETS regulations. All interactions and trades
principles of emissions trading, demystifies how take place in a virtual marketplace.
to develop and implement a carbon portfolio
management strategy, and demonstrates
that results are driven by design. Highly ETS simulation programs have been
recommended for advocates, industry developed by:
practitioners, and policymakers. • Environmental Defense Fund – CarbonSim
- Dan Dudek, Vice President, • International Carbon Action Partnership
Asia, Environmental Defense Fund - Carbono
• Motu Economic and Public Policy Research
in New Zealand – Emissions trading
WHAT SORT OF SIMULATION TOOLS ARE
AVAILABLE?
There are a number of simulation tools that are avail- ETS simulations have taken place in over 20 countries
able for use by ETS advocates. These differ based on and several states and provinces across six continents.
their users, objectives and the extent to which they are
technology-supported or not:

• Users – Some simulation tools are primarily focused

on a particular user – e.g., regulated industries, ETS

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WHY USE CARBON MARKET capacity for policymakers, companies and the
SIMULATIONS? financial sector:

• By participating in a carbon market simulation,

Before the EU started with its ETS, there was government officials can understand how an ETS
little familiarity with the real-life functioning of a functions and the steps involved in the design
carbon market. Simulation exercises turned out
process. Simulations can also give policymakers
to be a most useful capacity building tool that
some exposure to typical stakeholder concerns
allowed key players in the administration and
or interests, as well as highlighting trade-offs
in the industry to get used to emissions trading.
Simulations allowed for the testing of different involved in the design process.
ETS design options and for developing trading
strategies by companies. The interactive nature The Santiago carbon market exercises were
of the tool helped stakeholder engagement and excellent. Participants holding a range of views
policy design. were able to collaborate and participate in an
- Jos Delbeke, Professor, European experiential learning process that demonstrated
University Institute and former Director how emissions markets work and can be
General, DG-Clima, European Commission designed to serve the interests of diverse
stakeholders.
- Juan Pedro Searle Solar, Head of
Depending on their design and participants, Climate Change Unit in the Ministry of
simulations can serve several objectives, including: Energy of Chile
1. Learning and capacity building: At the start of
an ETS development process, key stakeholders – • Companies can gain an initial understand-
including government officials, regulated entities ing how an ETS would affect them, as well as
and civil society stakeholders – may have limited how to comply with future regulation. They
practical experience with markets. Significant work can start to learn how to factor a carbon price
may be required to explain how carbon markets into their business strategy. Simulations may
work, as well as how they can be designed to meet encourage companies to begin thinking about
the needs of business and society. Simulations can when to invest in emissions reductions, as
be one tool to help build knowledge and expertise well as a broader awareness of the
on emissions trading. need to develop mitiga-
tion and trading strat-
Simulations can help: egies. Simulations
• Learning and capacity building can also flag the
• Design testing importance of
• Engagement and outreach involving other
• Building trust and mutual understanding departments,
such as planning,
procurement and
While any stakeholder can take part in ETS sim-
legal, in developing
ulations, past exercises have focused on building
smart carbon man-
agement decisions.

www.carbonpricingleadership.org | 3
 • If the ETS will be open to other actors in the in its design. If conducted at an early stage, they
financial sector, like traders and investment may also help inform policymakers’ decisions on
banks, their involvement in simulations can appropriate design features.
help familiarize them with the system, as well
as potential financial products and they role they Simulations can be run by governments to meet these
can play in the carbon market. objectives but can also be organized by the private sec-
tor either to advocate for an ETS or in anticipation of
2. Engagement and outreach: Carbon markets can one. What kind of simulation tool is used will depend
initially come across as a complex economic instru- on the audience, objectives and resources of the gov-
ment and there may also be some misconceptions ernment and/or companies. Simulations can run over
about an ETS. Giving stakeholders a hands-on the course of a day or last several weeks or months.
experience with emissions trading can help build When designing or choosing a simulation, it is import-
support for a carbon market both within the gov- ant to be clear which of the above objectives should be
ernment and amongst the private sector. An online prioritized as this has implications for the set-up and
simulation tool can also make the “ETS experience” selection of participants.
more easily accessible.

3. Building trust and mutual understanding: ETS

WHAT ARE THE LIMITATIONS OF
design and implementation require coordination
SIMULATIONS?
and collaboration across government departments There are limitations of simulations (see table 1 for a
and different stakeholder groups. Simulations can comparison of simulated vs. real-life carbon trading).
be a powerful tool for bringing together represen- Some relate to their design -- others as to how simula-
tatives from different institutions to interact in a tions can or should be used.
safe and relaxed setting. Going through a fictitious
policy design process may help with clarifying the “It’s important for those of us working on carbon
arguments underlying certain positions and with markets to have sense of how they work on
building a common understanding of key policy trading desks.”
options, their benefits and draw backs. The per- - Jackson Ewing, Senior Fellow, Nicholas
sonal relationships and trust created through this Institute for Environmental Policy
experience may be beneficial in the next steps of Solutions at Duke University
the process.

4. Design testing: ETSs can be designed in different

ways to fit different jurisdictional contexts and Though powerful, ETS simulations have limits
socio-economic circumstances. Simulations can as they:
help test out the effects of different design deci- • Are imperfect, simplified models of real
sions, including allocation and offset decisions, to life
• Cannot accurately reflect the impact of
better address key policy priorities, amplify co-ben-
non-ETS drivers
efits and minimize the risk of any undesired out-
• Should not be used simultaneously to
comes. By testing these options at an early stage, train participants and predict how an ETS
stakeholders can understand some of the potential will play out in real life.
impacts of the program and the trade-offs involved

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 Table 1: Differences between simulation and real world ETS participants
Participating in Carbon Trading Simulations vs a Real World ETS

Simulation Real World

Prior training Likely little Extensive

Extensive – internal auditors and external

Oversight Only within the confines of the game
inspectors

Avoid noncompliance
Motivation To learn and win
Meet corporate climate targets

Extensive and consequential:

Negligible:
• High performers may get to keep their
• High performers may win
jobs, secure a bonus.
accolades from peers and possibly
• Weak performers may receive/be
Consequences a modest prize
responsible for: criticism by boss,
• Poor performers get to learn from
company fines, job loss(es), company
their experiences
shutdown, jail

Non-carbon drivers Weak influence, if any Extensive and consequential

Simulations provide a simplified model of an actual In reality, a carbon portfolio manager’s job will be far
ETS. As such, care should be taken with the results of more complex than a simulation participant.
a simulation exercise as this may not accurately predict
For all these reasons, as compared to their real-world
how an ETS would play out in real life. Without incur-
counterparts, simulation participants may tend to
ring great expense, it will be challenging to use the sim-
take outsized risks and/or
ulation to accurately replicate real-world conditions.
engage in what may be
Simulations cut down the number of factors partic- considered, in real life,
ipants face compared to a real world ETS. This not fiscally imprudent
only includes a simplified ETS design, but in real life, behavior. As such,
other factors - including those associated with electric- researchers should
ity dispatch restrictions (and prices), labor costs and be extremely cau-
alternative fuel availability - will likely play a bigger tious when using
role than in the simulation. Participants are also free simulation results
of internal oversight or significant consequences in to derive policy
case they make poor design or compliance choices. implications.

www.carbonpricingleadership.org | 5
 HOW CAN SIMULATION TOOLS BE MORE also help them understand the differences between
EFFECTIVE? an ETS and other climate policies like a carbon tax or
command and control regulations. This sort of expe-
This carbon market simulation tool provides rience may also serve to dispel pre-conceived notions
the private sector with a practical way to about an ETS and convey the idea that an ETS can
understand the component parts and dynamics be a cost-efficient way to reduce emissions. A clear
of a carbon market. It underscores the understanding of emissions trading can also help build
importance of ETS design and why it is critical support for the policy.
to participate in the development phase of a
carbon market. Use repeatedly or over a longer period. Multiple
simulations or simulations that run for longer periods
- Carolina Rodriguez Gonzalez, encourage participants to get comfortable with emis-
Environmental Coordinator, LafargeHolcim sions trading. They can try out different strategies in a
continual learning process.
There are several opportunities to enhance the impact
of carbon market simulations. Integrate simulations in a broader engagement pro-
cess. Policymakers may want to deliberately integrate
simulations as an element of their stakeholder outreach
Tips on using simulations:
and discussions. As simulation participants understand
• Run simulations early in the policy and engage more with the ETS, holding simulations in
process tandem with stakeholder discussions can improve the
• Use repeatedly or over a longer period quality and level of the latter.
• Integrate them in the broader engage-
ment process Encourage broad participation. In a simulation, dif-
• Encourage broad participation ferent stakeholders – e.g., regulated industries, politi-
• Encourage cross-organizational cians, and NGOs -- can find themselves as teammates.
participation And simulations can be structured to allow participants
• Involve independent experts to assume roles other than those that they hold in real
• Consider and heed lessons learned from life -- e.g., regulators can assume the role of compa-
evious simulations nies. This serves to lessen barriers that might normally
• Add information to make the simulation divide stakeholders, build understanding for opposing
more alistic viewpoints, and, in turn, contribute to richer and more
• Run simulations in controlled settings meaningful discussions.
• Collaborate with trade associations
An ETS simulation can change people’s
Run simulations early in the policy process. At attitude from “ETS is a burden for business” to
“Business can make a profit from this system if
the very early stages of an ETS development process,
they make a right decision, mitigate first and sell
policymakers and stakeholders alike can benefit sig-
later”.
nificantly from participating in simulations. Doing
so will increase ETS literacy, engage a broader set of - Sumon Sumetchoengprachya, Director,
stakeholders in policy conversations, and provide par- Carbon Business Office, Thailand
ticipants with an opportunity to gain first-hand knowl- Greenhouse Gas Management
edge about the mechanics of carbon markets. It can Organization

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Encourage cross-organizational participation. For Depending on the design of the ETS and objectives
regulated companies, given an ETS will affect many of the simulation, such additional information could
departments – from legal to procurement, production include:
and trading – efforts should be made to include repre-
• The impact of the co-benefits of emissions trading;
sentatives from all relevant departments. By involving
all relevant parties at an early stage, this ensures com- • Other climate, energy or fiscal policies;
panies are better prepared for the realities of emissions
trading. • A comparison with a carbon tax;

Involve independent experts. Involving external • International markets like aviation or linking to
experts, such as representatives from universities or other regions;
research institutes, in the design and running of a
• Risk-hedging instruments like future trades; and
simulation lets policymakers and businesses leverage
existing expertise, particularly when it involves tech- • Broader participation than just regulated compa-
nical topics. Given their independence from the policy nies to allow for more liquidity and speculation in
development process, it can help build trust in and the market.
legitimize the simulation exercise.
Run simulations in controlled settings. If conducted
Consider and heed lessons learned from existing in a controlled fashion, simulations can yield results
ETSs and previous simulations. Where relevant, that will also be useful for policymakers. Knowing how
incorporating best practices and lessons learned from participants react when faced with different market
ETSs that are already in operation can help create a designs and circumstances can help policymakers pro-
more effective simulation experience. Equally, before mote or guard against certain behavior. While some
developing new tools, consider using or building upon efforts have been made in this area1, 2 a greater invest-
the exercises and tools that have been run and devel- ment could yield more useful results.
oped previously. These have already generated signif-
Collaborate with professional trade associations.
icant lessons that organizers of future exercises can
Industrial emitters which are (or could be) subject to
build on.
an ETS may be more inclined to participate in simu-
Add information to make simulations more realistic. lations if they are invited to do so by their respective
Adding design features or inputting data that reflects trade associations.
the latest information and/or local environment can
help make simulations more realistic and accessible.

1. University of Virginia – PEAR Project Team. “Investigation of the Effects of Emission Market Design on the Market-Based Compliance Mechanism of
the California Cap on Greenhouse Gas Emissions”. February 12, 2013.

2. See MexiCO2 and EDF. “Ejercicio de Simulación del Mercado de Carbono en México Reporte de resultados de la tercera simulación”.

www.carbonpricingleadership.org | 7
 MORE INFORMATION
Context: The Carbon Pricing Leadership Coalition (CPLC) is a voluntary partnership of governments, businesses, and civil society
organizations working together to identify and address the key challenges to the successful use of carbon pricing to combat
climate change. This Briefing Note was prepared in collaboration with the International Carbon Action Partnership (ICAP). It was
authored by Josh Margolis Environmental Defense Fund (EDF), and Constanze Haug (ICAP). The Authors are grateful to Marissa
Santikarn, Marcos Castro, Tom Erb and Angela Churie Kallhauge for their input and guidance.
References: This Briefing Note is a synthesis of ideas and literature derived from the key references listed here.
Disclaimer: The findings, interpretations, and conclusions expressed in this Briefing Note do not necessarily reflect the views of
the organizations the authors represent. The CPLC does not guarantee the accuracy of the data included in this work.
Copyright: This Briefing Note is available under the Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO). HYPERLINK
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