Emissions trading

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. The development of a carbon project that provides a reduction in Greenhouse Gas emissions is a way by which participating entities may generate tradeable carbon credits. Kyoto Protocol provides for this facet of its cap and trade program with the Clean Development Mechanism (CDM).

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 or face heavy penalties. 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. Thus companies that can easily reduce emissions will do so and those for which it is harder will buy credits which reduces greenhouse gasses at the lowest possible cost to society.

There are currently several trading systems in place with the largest being the European Union's. The carbon market makes up the bulk of these and is growing in popularity. Many businesses have welcomed emissions trading as the best way to mitigate climate change. Enforcement of the caps is a problem, but unlike traditional regulation, 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) and verifing of actual emissions is still required, which can be costly. Critics doubt whether these trading schemes can work as there may be too many credits given by the government, such as in the first phase of the European Union's scheme. Once a large surplus was discovered the price for credits bottomed out and effectively collapsed, with no noticeable reduction of emissions.

Overview

The overall goal of an emissions trading plan is to reduce emissions of the greenhouse gases that cause climate change. The cap is usually lowered over time - aiming towards a national emissions reduction target. 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 according to the law of demand. Corporations can also retire pollution credits by donating them to a nonprofit and then be eligible for a tax deduction. Allowances are accounted for in the balance sheet of the company as intangible assets, as recommended by the IAS 37 issued by IASB.

Because emissions trading uses 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.

Cap & trade vs. baseline & credit

The textbook emissions trading program can be called a "cap & trade" approach in which an aggregate cap on all sources is established and these sources are then allowed to trade amongst themselves to determine which sources actually emit the total pollution load. An alternative approach with important differences is a baseline & credit program In a baseline and credit program a set of polluters that are not under an aggregate cap can create credits by reducing their emissions below a baseline level of emissions. These credits can be purchased by polluters that are under a regulatory limit. Many of the criticisms of trading in general is targeted at baseline & credit programs rather than cap & trade type programs.

Major trading systems

United States

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.

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 area, called the Emissions Reduction Market System. 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.

In 2007, the California Legislature passed AB32, which was signed into law by Governor, Arnold Schwarzenegger. This bill is aimed at curbing Carbon emissions.

European Union

The European Union Emission Trading Scheme (or EU ETS) is the largest multi-national, greenhouse gas emissions trading scheme in the world and was created in conjunction with the Kyoto Protocol. It commenced operation in January 2005 with all 25 (now 27) member states of the European Union participating in it. It contains the world's only mandatory carbon trading program. The program caps the amount of carbon dioxide that can be emitted from large installations, such as power plants and carbon intensive factories and covers almost half of the EU's Carbon Dioxide emissions.

Whilst the first phase (2005 - 2007) has received much criticism due to oversupply of allowances and the distribution method of allowances (via grandfathering rather than auctioning), the European Commission have been tough on Member States' Plans for Phase II, dismissing many of them as being too loose again. In addition, the first phase has established a strong carbon market. Compliance has also been high in 2006, increasing confidence in the scheme.

Australia

On the 4th of June, 2007, Prime Minister John Howard announced a new carbon trading scheme to be introduced by the year 2010 but has been accused by the opposition that it is "too little, too late."

Kyoto Protocol

The Kyoto Protocol is a 1997 international treaty that took effect in 2005 which currently bind ratifying nations to a similar system, with the UNFCCC setting caps for each nation. Under the treaty, nations that emit less than their quota of greenhouse gases will be able to sell emissions credits to polluting nations.

Green tags

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.

The carbon market

This section deals with carbon emissions trading between nations. For carbon trading schemes for individuals, see Personal carbon trading.

Carbon emissions trading is emissions trading specifically for carbon dioxide (calculated in tonnes of carbon dioxide equivalent or tCO₂e) and currently makes up the bulk of emissions trading. It is one of the ways countries can meet their obligations under the Kyoto Protocol to reduce carbon emissions and thereby mitigate global warming.

Market trend

Carbon emissions trading has been steadily increasing in recent years. According to the World Bank's Carbon Finance Unit, 374 million metric tonnes of carbon dioxide equivalent (tCO₂e) were exchanged through projects in 2005, a 240% increase relative to 2004 (110 mtCO₂e) which was itself a 41% increase relative to 2003 (78 mtCO₂e).

Business reaction

With the creation of a market for trading carbon dioxide emissions within the Kyoto Protocol, the London financial markets has established itself as the centre of the carbon market: a potentially highly lucrative business; the New York and Chicago stock markets would like a share (which is unlikely as long as the current US administration rejects Kyoto). The European Union Greenhouse Gas Emission Trading Scheme (EU ETS) began operations on 1 January 2005.

23 multinational corporations have come together in the G8 Climate Change Roundtable, a business group formed at the January 2005 World Economic Forum. The group includes Ford, Toyota, British Airways and BP. On 9 June 2005 the Group published a statement stating that there was a need to act on climate change and stressing the importance of market-based solutions. It called on governments to establish "clear, transparent, and consistent price signals" through "creation of a long-term policy framework" that would include all major producers of greenhouse gases.

Business in the UK have come out strongly in support of emissions trading as a key tool to mitigate climate change, supported by Green NGOs.

Enforcement

Another critical part of the bargain is enforcement. 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.

Criticism

There are critics of the schemes, mainly environmental justice NGOs and movements who see carbon trading as a proliferation of the free market into public spaces and environmental policy-making. They point to failures in accounting, dubious science and destructive impacts of projects upon local peoples and environments as reasons why trading pollution rights should be avoided. Instead they advocate making reductions at the source of pollution and energy policies that are justice-based and community-driven. Most of the criticisms have been focused on the carbon market created through investment in Kyoto Mechanisms. Criticism of 'cap and trade' emissions trading has generally been more limited to lack of credibility in the first phase of the EU ETS.

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 sufficient and challenging reduction of allowances 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. The National Allocation Plans by member governments of the European Union Emission Trading Scheme came under fire for this recently when some governments issued more carbon allowances than emissions during Phase I of the scheme. They have also been criticised for the widespread practice of grandfathering, where polluters are given carbon credits by governments, instead of being made to pay for 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. Tight controls are necessary in order to establish a reverse commodity market like Green Tags as well. 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 reduction in carbon dioxide emissions, beneficiaries of emissions trading simply do more of the polluting activity.

Many environmental activists and foundations consider Al Gore's strong advocation of carbon trading to be a denial of the imminence of climate change and a formalized failure of international policy to address the gravity of the carbon increase. Critics of carbon trading, such as Carbon Trade Watch argue that it places disproportionate emphasis on individual lifestyles and carbon footprints, distracting attention from the wider, systemic changes and collective political action that needs to be taken to tackle climate change.

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.

The Financial Times argued on April 26th 2007 that "Carbon markets create a muddle". In the opinion of the FT these markets "...leave much room for unverifiable manipulation".

See also

• Acid rain
• Air pollution
• AP 42 Compilation of Air Pollutant Emission Factors
• Atmospheric dispersion modeling
• Carbon credit
• Coase Theorem
• Demand Responsive Transit Exchange
• Emission standards
• European Union Emission Trading Scheme
• Flexible Mechanisms
• Green certificate
• Green tags
• Greenwash
• Low-carbon economy
• Mobile Emission Reduction Credit (MERC)

External links

General trading

• The Carbon Folly: Policymakers have settled on 'emissions trading' as their favorite global-warming fix. But it isn't working. by Emily Flynn Vencat for Newseek, March 12, 2007
• Emissions trading: The carbon game news@nature.com Nov. 17, 2004
• Ministers know emissions trading is a red herring and won't work, by George Monbiot, The Guardian, December 19, 2006
• Uhhh, explain that carbon credit deal again please - Gene Logsdon
• Carbon trading's real colours by Clare Davidson, BBC News, May 16, 2006
• US EPA's Acid Rain Program
• Australasian Emissions Trading Forum
• ClimateTop50 Emissions Trading Websites
• Illinois' Emissions Reduction Market System
• Texas' Emissions Banking and Trading program
• International Emissions Trading Association
• Carbon Trading: A Critical Conversation on Climate Change, Power and Privatisation edited by Larry Lohmann, the Corner House
• Obscenity of Carbon Trading by Kevin Smith, Carbon Trade Watch, BBC News, Science and Nature

Carbon trading

• Reuters InterActive - Leading online community for carbon market and climate policy professionals
• GHG Emissions Project Development - Project Development & Financing Analysis Tools
• Gryphon Carbon Consultancy - carbon price analysis
• Point Carbon - independent carbon market analysis provider
• International Emissions Trading Association
• http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_index.cfm The Stern Review on the economics of climate change] - Chapters 14 and 15 have extensive discussions on emission trading schemes and carbon taxes
• The Case Against Carbon Trading - Rising Tide Factsheet
• Carry On Polluting - Comment and analysis piece by Larry Lohmann, published in New Scientist magazine on the 2nd December 2006
• Ways Forward - Chapter 5 of the book, "Carbon Trading: A Critical Conversation on Climate Change, Privatisation and Power", published October 2006 by Dag Hammarskjöld Foundation, Durban Group for Climate Justice and The Corner House.
• The New Carbon Cycle Blog dedicated to using carbon markets to harmonize human activities and economies with natural climate systems and cycles.
• EU shows carbon trading is not cutting emissions