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Published on June 19th, 2008 | by Stephanie Evans


The Cap and Trade Market for Emissions

In a world where an ever-increasing concern for the health of our world can no longer be ignored, emission reductions have been targeted as one of the most viable solutions to alleviate the strain on the environment.

Harmful byproducts of industry such as greenhouse gases are affecting individuals, communities, and the entire planet.  One of the most prominent methods used to tackle this issue is the cap and trade market for emissions, also known as an emissions trading scheme (ETS).

Releasing GHGs into the Air

What is Cap and Trade?

Cap and trade is a method of regulation aimed at reducing emissions while working within an economic framework.  This system involves an agency responsible for setting limits on the total emissions allowable by a specific industry.

Individual companies are then permitted emission allowances that indicate the level of pollutants the company is allowed to produce in that given year.  These allowances, broken up into credits, can be traded, bought, and sold in the marketplace.  Therefore, any company whose emissions fall below their allowance will sell their shares to those who do not meet regulation requirements.

The hope is that the most cost-effective improvements will be made as overall emissions are significantly reduced.  For example:

  • Company A may decide that changing its production process is too costly.
  • Company B, which has invested in new machinery, filters, or other technologies, sells its credits to Company A so that overall emissions decrease while allowing a degree of flexibility on how this goal is achieved.

Development of the Emissions Trading Scheme

One of the first and most successful instances of an ETS was brought about by the Clean Air Act in the early 1990s in the United States.  Previously increasing levels of sulfur dioxide (SO2), best known for contributing to acid rain, were brought well below the mandated levels at a cost much lower than anticipated.

This achievement led to what could be the most important instance of cap and trade policy in environmental history, the Kyoto Protocol.  This protocol was formed as an international response to global climate change and focuses on the reduction of the six major greenhouse gases.  The protocol has widespread support in the international community, although the United States—one of the largest emitters of carbon dioxide (CO2)—has not ratified the treaty and thus is not bound by any of its stipulations.

The Kyoto Protocol aims for a 5.2% reduction in emissions in developed countries from their 1990 baseline by 2012.  Under this plan, developed nations, also known as Annex I nations, are to reduce their pollutants while developing nations remain free of restrictions.  The reasoning behind this policy is that developed nations have had time to grow industries and expand their economy unimpeded by environmental concerns.

Incentives and Programs

Additionally, developing nations on average contribute a substantially smaller percentage to global emissions than Annex I nations.  Yet incentives for developing nations to reduce emissions and move towards sustainable development are high.  Like any cap and trade system, countries are allowed to buy and sell credits, in this case called Certified Emissions Reductions (CERs), which are also often referred to more generally as carbon credits.

Beyond this, countries can also offset their emissions using either the Clean Development Mechanism (CDM) or Joint Implementation (JI).  CDM allows Annex I nations to create projects to help non-Annex I nations reduce their emissions.  It involves the same idea with a twist: the development may occur in another Annex I nation.

Currently there are a number of cap and trade markets around the world, both in response to the Kyoto Protocol and independent of it.  The only mandatory carbon trading program is in the European Union, and it is known as the European Union Emission Trading Scheme (EU ETS).

Other notable programs include:

  • The Chicago Climate Exchange (CCX), which is both voluntary and legally binding.
  • The Western Climate Initiative (WCI), in which some U.S. states, Canadian provinces, and Indian nations participate; the Initiative requires signatories to reduce emissions regardless of the standards set by national governments.
  • The Regional Greenhouse Gas Initiative (RGGI), which is an effort by nine eastern U.S. states to decrease greenhouse gases initially by focusing on CO2 output from power plants.

Fresh, Clean Air for Future Generations to Enjoy

The Future of the Emissions Trading Scheme

At this point, the success or failure of recent cap and trade schemes is debatable.  While the obvious success of the Kyoto Protocol lies in its ratification by so many countries, the efficacy of the policy itself is questionable.  Developing countries will continue to emit harmful gases unimpeded, and with Annex I nations taking advantage of the CDM, it is unclear whether developed nations will begin to reduce their emissions at any point in the near future.

With the focus of ETS on maintaining economies as well as reducing emissions, it is likely that other cap and trade projects will face similar problems as the EU ETS and set caps much too high.

At some point, individual households and smaller companies will need to take part in emission reduction, not only voluntarily, but with set emissions limits.  ETS has a very limited application for smaller groups.

Additionally, ETS has a potentially devastating effect on consumers, for it is usually the consumer who must eventually pay for emission reducing technologies.  When power plants, often the first targeted in reduction schemes, find their expenditures increasing because of environmental measures, the cost of individual units of electricity will increase.  In recognition of this phenomenon, many groups are trying to push governmental measures that will provide subsidies for low-income families.

If cap and trade plans are enacted and work, everyone will benefit.  But right now, it seems unlikely that the high hopes many envision for ETS will actually come to pass.

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