Emissions trading

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Emissions trading (or cap and trade) is an administrative approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants [1]. In such a plan, a central authority (usually a government agency) sets a limit or cap on the amount of a pollutant that can be emitted. Companies or other groups that emit the pollutant are given credits or allowances which represent the right to emit a specific amount. The total amount of credits cannot exceed the cap, limiting total emissions to that level. Companies that pollute beyond their allowances must buy credits from those who pollute less than their allowances. This transfer is referred to as a trade. In effect, the buyer is being fined for polluting, while the seller is being rewarded for having reduced emissions. The more firms that need to buy credits, the higher the price of credits becomes -- which makes reducing emissions cost-effective in comparison.

The overall goal of an emissions trading plan is to reduce pollution. In some cases, the cap may be lowered over time. In other systems a portion of all traded credits must be retired, causing a net reduction in emissions each time a trade occurs. In many cap and trade systems, organizations which do not pollute may also buy credits. Environmental groups that purchase and retire pollution credits reduce emissions and raise the price of the remaining credits as per the law of demand. Corporations can also retire pollution credits by donating them to a nonprofit and then be eligible for a tax deduction.

Because emissions trading uses free markets to determine how to deal with the problem of pollution, it is often touted as an example of effective free market environmentalism. While the cap is usually set by a political process, individual companies are free to choose how or if they will reduce their emissions. In theory, firms will choose the least-cost way to comply with the pollution regulation, creating incentives that reduce the cost of achieving a pollution reduction goal.

Emissions trading markets can be easier to enforce because the government overseeing the market does not need to regulate specific practices of each pollution source. However, monitoring (or estimating) of actual emissions is still required, which can be costly.

1 Major trading systems
2 Enforcement
3 Efficacy
4 See also
5 External links

[edit] Major trading systems

Perhaps the most successful emission trading system to date is the SO₂ trading system under the framework of the Acid Rain Program of the 1990 Clean Air Act in the USA. Under the program, which is essentially a cap-and-trade emissions trading system, SO₂ emissions are expected to be reduced by 50% from 1980 to 2010 [2].

Some experts argue that the "cap and trade" system of SO₂ emissions reduction reduced the cost of controlling acid rain by as much as 80% versus source-by-source reduction.

In 1997, the State of Illinois adopted a trading program for volatile organic compounds in most of the Chicago metropolitan area, called the Emissions Reduction Market System [3]. Beginning in 2000, over 100 major sources of pollution in 8 Illinois counties began trading pollution credits.

In 2003, New York State proposed and attained commitments from 9 Northeast states to cap and trade carbon dioxide emissions. Also in 2003, corporations began voluntarily trading greenhouse gas emission allowances on the Chicago Climate Exchange.

The European Union Emission Trading Scheme is the largest multi-national, greenhouse gas emissions trading scheme in the world. It commenced operation in January 2005 and 25 member states of the European Union participate in the scheme [4].

The Kyoto Protocol will bind ratifying nations to a similar system, with the UNFCCC setting caps for each nation. Under the proposed treaty, nations that emit less than their quota of greenhouse gases will be able to sell emissions credits to polluting nations.

Green tags are a kind of reverse carbon trading scheme, available in the U.S. A renewable energy provider is issued one green tag for each 1000KWh of energy it produces. The energy is sold into the electrical grid, and the green tag can be sold on the open market as additional profit.

Critics argue that emissions trading does little to solve pollution problems overall, as groups that do not pollute sell their conservation to the highest bidder. Overall reductions would need to come from a reduction of permits available in the system. Likely this would occur over time through central regulation, though some environmental groups acted more immediately by buying credits and refusing to use or sell them. Nevertheless, the transfer of wealth from polluters to non-polluters provides incentives for polluting firms to change, especially if the market price for pollution credits is very high.

[edit] Enforcement

Another critical part of the bargain is enforcement [5]. Without effective enforcement, the licenses have no value. Two basic schemes exist:

In one, the regulators measure facilities, and fine or sanction those that lack the licenses for their emissions. This scheme is quite expensive to enforce, and the burden falls on the agency, which then may need to collect special taxes. Another risk is that facilities may find it far less expensive to corrupt the inspectors than purchase emissions licenses. The net effect of a poorly financed or corrupt regulatory agency is a discount on emission licenses, and greater pollution.

In another, a third party agency certified or licensed by the government, verifies that polluting facilities have licenses equal or greater than their emissions. Inspection of the certificates is performed in some automated fashion by the regulators, perhaps over the Internet, or as part of tax collection. The regulators then audit licensed facilities chosen at random to verify that certifying agencies are acting correctly. This scheme is far less expensive, placing the cost of most regulation on the private sector. The transparency of this process helps act as a safeguard against corruption.

[edit] Efficacy

Experts doubt whether these trading schemes can work as there may be too many credits given by the government, such as in the European Union. Once a large surplus was discovered the price for credits bottomed out and the scheme effectively collapsed, with no noticeable reduction of emissions, and few purchases or trades of credits. [6].

Tight controls are necessary in order to establish a reverse commodity market. Regulatory agencies run the risk of issuing too many emission credits, diluting the effectiveness of regulation, and practically removing the cap. In this case instead of any net reductions of carbon dioxide emissions, beneficiaries of emissions trading simply do more of the polluting activity.

A mistake may also be made by giving away emission credits rather than auctioning them. Emission credits are, in effect, money and therefore should be treated as such. The giving away of emission credits may also have the negative result of turning down investment dollars that might have been spent on sustainable technologies, if the government chooses to. [7]