Emissions trading 1

Emissions trading
Emissions trading (also known as cap and
trade) is a market-based approach used to
control pollution by providing economic
incentives for achieving reductions in the
emissions of pollutants.[1]
A central authority (usually a governmental
body) sets a limit or cap on the amount of a
pollutant that can be emitted. The limit or
cap is allocated or sold to firms in the form
of emissions permits which represent the
right to emit or discharge a specific volume
of the specified pollutant. Firms are required
to hold a number of permits (or carbon
credits) equivalent to their emissions. The
total number of permits cannot exceed the
cap, limiting total emissions to that level.
Firms that need to increase their emission
permits must buy permits from those who A coal power plant in Germany. Due to emissions trading, coal may become a less
[1] competitive fuel than other options.
require fewer permits. The transfer of
permits is referred to as a trade. In effect,
the buyer is paying a charge for polluting, while the seller is being rewarded for having reduced emissions. Thus, in
theory, those who can reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest cost
to society.[2]

There are active trading programs in several air pollutants. For greenhouse gases the largest is the European Union
Emission Trading Scheme.[3] In the United States there is a national market to reduce acid rain and several regional
markets in nitrogen oxides.[4] Markets for other pollutants tend to be smaller and more localized.

Overview
The overall goal of an emissions trading plan is to minimize the cost of meeting a set emissions target.[5] The cap is
an enforceable limit on emissions that is usually lowered over time aiming towards a national emissions reduction
target.[5] 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 participate, thus
environmental groups can purchase and retire allowances or credits and hence drive up the price of the remainder
according to the law of demand.[6] Corporations can also prematurely retire allowances by donating them to a
nonprofit entity and then be eligible for a tax deduction.
Emissions trading 2

Definitions
The economics literature provides the following definitions of cap and trade emissions trading schemes.
A cap-and-trade system constrains the aggregate emissions of regulated sources by creating a limited number of
tradable emission allowances, which emission sources must secure and surrender in number equal to their
emissions.[7]
In an emissions trading or cap-and-trade scheme, a limit on access to a resource (the cap) is defined and then
allocated among users in the form of permits. Compliance is established by comparing actual emissions with permits
surrendered including any permits traded within the cap.[8]
Under a tradable permit system, an allowable overall level of pollution is established and allocated among firms in
the form of permits. Firms that keep their emission levels below their allotted level may sell their surplus permits to
other firms or use them to offset excess emissions in other parts of their facilities.[9]

Market-based and least-cost

Economists have urged the use of "market-based" instruments such as emissions trading to address environmental
problems instead of prescriptive "command and control" regulation.[10] Command and control regulation is criticized
for being excessively rigid, insensitive to geographical and technological differences, and for being inefficient.[11]
However, emissions trading requires a cap to effectively reduce emissions, and the cap is a government regulatory
mechanism. After a cap has been set by a government political process, individual companies are free to choose how
or if they will reduce their emissions. Failure to reduce emissions is often punishable by a further government
regulatory mechanism, a fine that increases costs of production. Firms will choose the least-costly way to comply
with the pollution regulation, which will lead to reductions where the least expensive solutions exist, while allowing
emissions that are more expensive to reduce.

History
The efficiency of what later was to be called the "cap-and-trade" approach to air pollution abatement was first
demonstrated in a series of micro-economic computer simulation studies between 1967 and 1970 for the National
Air Pollution Control Administration (predecessor to the United States Environmental Protection Agency's Office of
Air and Radiation) by Ellison Burton and William Sanjour. These studies used mathematical models of several cities
and their emission sources in order to compare the cost and effectiveness of various control strategies.[12] [13] [14] [15]
[16]
Each abatement strategy was compared with the "least cost solution" produced by a computer optimization
program to identify the least costly combination of source reductions in order to achieve a given abatement goal.[17]
In each case it was found that the least cost solution was dramatically less costly than the same amount of pollution
reduction produced by any conventional abatement strategy.[18] This led to the concept of "cap and trade" as a means
of achieving the "least cost solution" for a given level of abatement.
The development of emissions trading over the course of its history can be divided into four phases:[19]
1. Gestation: Theoretical articulation of the instrument (by Coase,[20] Crocker,[21] Dales,[22] Montgomery[23] etc.)
and, independent of the former, tinkering with "flexible regulation" at the US Environmental Protection Agency.
2. Proof of Principle: First developments towards trading of emission certificates based on the "offset-mechanism"
taken up in Clean Air Act in 1977.
3. Prototype: Launching of a first "cap-and-trade" system as part of the US Acid Rain Program in Title IV of the
1990 Clean Air Act, officially announced as a paradigm shift in environmental policy, as prepared by "Project
88", a network-building effort to bring together environmental and industrial interests in the US.
4. Regime formation: branching out from the US clean air policy to global climate policy, and from there to the
European Union, along with the expectation of an emerging global carbon market and the formation of the
"carbon industry".
Emissions trading 3

Comparison of cap-and-trade with other methods of emission reduction

Cap-and-trade, offsets created through a baseline and credit approach, and a carbon tax are all market-based
approaches that put a price on carbon and other greenhouse gases and provide an economic incentive to reduce
emissions, beginning with the lowest-cost opportunities.
The textbook emissions trading program can be called a "cap-and-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 and credit
program.[24]
In a baseline and credit program polluters that are not under an aggregate cap can create credits, usually called
offsets, by reducing their emissions below a baseline level of emissions. Such credits can be purchased by polluters
that do have a regulatory limit.[25]

Economics of international emissions trading

It is possible for a country to reduce emissions using a Command-Control approach, such as regulation, direct and
indirect taxes. The cost of that approach differs between countries because the Marginal Abatement Cost Curve
(MAC) the cost of eliminating an additional unit of pollution differs by country. It might cost China $2 to
eliminate a ton of CO2, but it would probably cost Sweden or the U.S. much more. International emissions-trading
markets were created precisely to exploit differing MACs.

Example
Emissions trading through Gains from Trade can be more beneficial for both the buyer and the seller than a simple
emissions capping scheme.
Consider two European countries, such as Germany and Sweden. Each can either reduce all the required amount of
emissions by itself or it can choose to buy or sell in the market.
For this example let us assume that
Germany can abate its CO2 at a much
cheaper cost than Sweden, e.g. MACS
> MACG where the MAC curve of
Sweden is steeper (higher slope) than
that of Germany, and RReq is the total
amount of emissions that need to be
reduced by a country.

On the left side of the graph is the

MAC curve for Germany. RReq is the
amount of required reductions for
Germany, but at RReq the MACG curve
has not intersected the market
allowance price of CO2 (market Example MACs for two different countries

allowance price = P = ). Thus, given

the market price of CO2 allowances, Germany has potential to profit if it abates more emissions than required.

On the right side is the MAC curve for Sweden. RReq is the amount of required reductions for Sweden, but the
MACS curve already intersects the market price of CO2 allowances before RReq has been reached. Thus, given the
market allowance price of CO2, Sweden has potential to make a cost saving if it abates fewer emissions than
required internally, and instead abates them elsewhere.
Emissions trading 4

In this example, Sweden would abate emissions until its MACS intersects with P (at R*), but this would only reduce
a fraction of Swedens total required abatement. After that it could buy emissions credits from Germany for the price
P (per unit). The internal cost of Swedens own abatement, combined with the credits it buys in the market from
Germany, adds up to the total required reductions (RReq) for Sweden. Thus Sweden can make a saving from buying
credits in the market ( d-e-f). This represents the "Gains from Trade", the amount of additional expense that
Sweden would otherwise have to spend if it abated all of its required emissions by itself without trading.
Germany made a profit on its additional emissions abatement, above what was required: it met the regulations by
abating all of the emissions that was required of it (RReq). Additionally, Germany sold its surplus to Sweden as
credits, and was paid P for every unit it abated, while spending less than P. Its total revenue is the area of the graph
(RReq 1 2 R*), its total abatement cost is area (RReq 3 2 R*), and so its net benefit from selling emission credits is the
area ( 1-2-3) i.e. Gains from Trade
The two R* (on both graphs) represent the efficient allocations that arise from trading.
Germany: sold (R* - RReq) emission credits to Sweden at a unit price P.
Sweden bought emission credits from Germany at a unit price P.
If the total cost for reducing a particular amount of emissions in the Command Control scenario is called X, then to
reduce the same amount of combined pollution in Sweden and Germany, the total abatement cost would be less in
the Emissions Trading scenario i.e. (X 123 - def).
The example above applies not just at the national level: it applies just as well between two companies in different
countries, or between two subsidiaries within the same company.

Applying the economic theory

The nature of the pollutant plays a very important role when policy-makers decide which framework should be used
to control pollution.
CO2 acts globally, thus its impact on the environment is generally similar wherever in the globe it is released. So the
location of the originator of the emissions does not really matter from an environmental standpoint.
The policy framework should be different for regional pollutants[26] (e.g. SO2 and NOX, and also mercury) because
the impact exerted by these pollutants may not be the same in all locations. The same amount of a regional pollutant
can exert a very high impact in some locations and a low impact in other locations, so it does actually matter where
the pollutant is released. This is known as the Hot Spot problem.
A Lagrange framework is commonly used to determine the least cost of achieving an objective, in this case the total
reduction in emissions required in a year. In some cases it is possible to use the Lagrange optimization framework to
determine the required reductions for each country (based on their MAC) so that the total cost of reduction is
minimized. In such a scenario, the Lagrange multiplier represents the market allowance price (P) of a pollutant, such
as the current market allowance price of emissions in Europe and the USA.[27]
Countries face the market allowance price that exists in the market that day, so they are able to make individual
decisions that would minimize their costs while at the same time achieving regulatory compliance. This is also
another version of the Equi-Marginal Principle, commonly used in economics to choose the most economically
efficient decision.
Emissions trading 5

Prices versus quantities, and the safety valve

There has been longstanding debate on the relative merits of price versus quantity instruments to achieve emission
reductions.[28]
An emission cap and permit trading system is a quantity instrument because it fixes the overall emission level
(quantity) and allows the price to vary. Uncertainty in future supply and demand conditions (market volatility)
coupled with a fixed number of pollution credits creates an uncertainty in the future price of pollution credits, and
the industry must accordingly bear the cost of adapting to these volatile market conditions. The burden of a volatile
market thus lies with the industry rather than the controlling agency, which is generally more efficient. However,
under volatile market conditions, the ability of the controlling agency to alter the caps will translate into an ability to
pick "winners and losers" and thus presents an opportunity for corruption.
In contrast, an emission tax is a price instrument because it fixes the price while the emission level is allowed to vary
according to economic activity. A major drawback of an emission tax is that the environmental outcome (e.g. a limit
on the amount of emissions) is not guaranteed. On one hand, a tax will remove capital from the industry, suppressing
possibly useful economic activity, but conversely, the polluter will not need to hedge as much against future
uncertainty since the amount of tax will track with profits. The burden of a volatile market will be borne by the
controlling (taxing) agency rather than the industry itself, which is generally less efficient. An advantage is that,
given a uniform tax rate and a volatile market, the taxing entity will not be in a position to pick "winners and losers"
and the opportunity for corruption will be less.
Assuming no corruption and assuming that the controlling agency and the industry are equally efficient at adapting
to volatile market conditions, the best choice depends on the sensitivity of the costs of emission reduction, compared
to the sensitivity of the benefits (i.e., climate damages avoided by a reduction) when the level of emission control is
varied.
Because there is high uncertainty in the compliance costs of firms, some argue that the optimum choice is the price
mechanism. However, the burden of uncertainty cannot be eliminated, and in this case it is shifted to the taxing
agency itself.
Some scientists have warned of a threshold in atmospheric concentrations of carbon dioxide beyond which a
run-away warming effect could take place, with a large possibility of causing irreversible damages. If this is a
conceivable risk then a quantity instrument could be a better choice because the quantity of emissions may be capped
with a higher degree of certainty. However, this may not be true if this risk exists but cannot be attached to a known
level of GHG concentration or a known emission pathway.[29]
A third option, known as a safety valve, is a hybrid of the price and quantity instruments. The system is essentially an
emission cap and permit trading system but the maximum (or minimum) permit price is capped. Emitters have the
choice of either obtaining permits in the marketplace or purchasing them from the government at a specified trigger
price (which could be adjusted over time). The system is sometimes recommended as a way of overcoming the
fundamental disadvantages of both systems by giving governments the flexibility to adjust the system as new
information comes to light. It can be shown that by setting the trigger price high enough, or the number of permits
low enough, the safety valve can be used to mimic either a pure quantity or pure price mechanism.[30]
All three methods are being used as policy instruments to control greenhouse gas emissions: the EU-ETS is a
quantity system using the cap and trading system to meet targets set by National Allocation Plans; Denmark has a
price system using a carbon tax (World Bank, 2010, p.218),[31] while China uses the CO2 market price for funding
of its Clean Development Mechanism projects, but imposes a safety valve of a minimum price per tonne of CO2.
Emissions trading 6

Carbon leakage
Carbon leakage is the effect that regulation of emissions in one country/sector has on the emissions in other
countries/sectors that are not subject to the same regulation (Barker et al.., 2007).[32] There is no consensus over the
magnitude of long-term carbon leakage (Goldemberg et al., 1996, p.31).[33]
In the Kyoto Protocol, Annex I countries are subject to caps on emissions, but non-Annex I countries are not. Barker
et al.. (2007) assessed the literature on leakage. The leakage rate is defined as the increase in CO2 emissions outside
of the countries taking domestic mitigation action, divided by the reduction in emissions of countries taking domestic
mitigation action. Accordingly, a leakage rate greater than 100% would mean that domestic actions to reduce
emissions had had the effect of increasing emissions in other countries to a greater extent, i.e., domestic mitigation
action had actually led to an increase in global emissions.
Estimates of leakage rates for action under the Kyoto Protocol ranged from 5 to 20% as a result of a loss in price
competitiveness, but these leakage rates were viewed as being very uncertain.[34] For energy-intensive industries, the
beneficial effects of Annex I actions through technological development were viewed as possibly being substantial.
This beneficial effect, however, had not been reliably quantified. On the empirical evidence they assessed, Barker et
al.. (2007) concluded that the competitive losses of then-current mitigation actions, e.g., the EU ETS, were not
significant.

Trade
One of the controversies about carbon mitigation policy thus arises about how to "level the playing field" with border
adjustments.[35] One component of the American Clean Energy and Security Act, for example, along with several
other energy bills put before Congress, calls for carbon surcharges on goods imported from countries without
cap-and-trade programs. Even aside from issues of compliance with the General Agreement on Tariffs and Trade,
such border adjustments presume that the producing countries bear responsibility for the carbon emissions.
A general perception among developing countries is that discussion of climate change in trade negotiations could
lead to "green protectionism" by high-income countries (World Bank, 2010, p.251).[31] Tariffs on imports ("virtual
carbon") consistent with a carbon price of $50ton/CO2 could be significant for developing countries. World Bank
(2010) commented that introducing border tariffs could lead to a proliferation of trade measures where the
competitive playing field is viewed as being uneven. Tariffs could also be a burden on low-income countries that
have contributed very little to the problem of climate change.

Trading systems

Kyoto Protocol
As the IPCC reports came in over the years they shed abundant light on the true state of global warming and they
gave support to the environmental effort to address this unprecedented problem. However, the same discussions that
started decades back had never ceased and the crusade for a tangible solution to global climate change had gone on
all the while. In 1997 the Kyoto Protocol was adopted. The Kyoto Protocol is a 1997 international treaty which came
into force in 2005. In the treaty, most developed nations agreed to legally binding targets for their emissions of the
six major greenhouse gases.[36] Emission quotas (known as "Assigned amounts") were agreed by each participating
'Annex 1' country, with the intention of reducing the overall emissions by 5.2% from their 1990 levels by the end of
2012. The United States is the only industrialized nation under Annex I that has not ratified the treaty, and is
therefore not bound by it. The Intergovernmental Panel on Climate Change has projected that the financial effect of
compliance through trading within the Kyoto commitment period will be limited at between 0.1-1.1% of GDP
among trading countries.[37]
Emissions trading 7

The Protocol defines several mechanisms ("flexible mechanisms") that are designed to allow Annex I countries to
meet their emission reduction commitments (caps) with reduced economic impact (IPCC, 2007).[38]
Under Article 3.3 of the Kyoto Protocol, Annex 1 Parties may use GHG removals, from afforestation and
reforestation (forest sinks) and deforestation (sources) since 1990, to meet their emission reduction commitments.[39]
Annex 1 Parties may also use International Emissions Trading (IET). Under the treaty, for the 5-year compliance
period from 2008 until 2012,[40] nations that emit less than their quota will be able to sell Assigned amount units to
nations that exceed their quota.[41] It is also possible for Annex I countries to sponsor carbon projects that reduce
greenhouse gas emissions in other countries. These projects generate tradable carbon credits that can be used by
Annex I countries in meeting their caps. The project-based Kyoto Mechanisms are the Clean Development
Mechanism (CDM) and Joint Implementation (JI).
The CDM covers projects taking place in non-Annex I countries, while JI covers projects taking place in Annex I
countries. CDM projects are supposed to contribute to sustainable development in developing countries, and also
generate "real" and "additional" emission savings, i.e., savings that only occur thanks to the CDM project in question
(Carbon Trust, 2009, p.14).[42] Whether or not these emission savings are genuine is, however, difficult to prove
(World Bank, 2010, pp.265267).[31]

Objections to the Kyoto Protocol and U.S refusal to sign

The Kyoto Protocol was a huge leap forward towards an intergovernmental united strategy to reduce GHGs
emissions globally. But it wasnt without its objections. Some of the main criticisms were against categorizing
different countries into annexes, with each annex having its own responsibility for emission reductions based on
historic GHG emissions and, therefore, historic contribution to global climate change. Some of the criticism of the
Protocol has been based on the idea of climate justice (Liverman, 2008, p. 14).[26] This has particularly centered on
the balance between the low emissions and high vulnerability of the developing world to climate change, compared
to high emissions in the developed world. Other objections were the use of carbon off-sets as a method for a country
to reduce its carbon emissions. Although it can be beneficial to balance out one GHG emission by implementing an
equal carbon offset, it still doesnt completely eliminate the original carbon emission and therefore ultimately reduce
the amount of GHGs in the atmosphere.

U.S. History with the Protocol

Clinton Administration Vice President Al Gore was a main participant in putting the Kyoto Protocol together in
1997. President Bill Clinton signed the agreement in 1997, but the US Senate refused to ratify it, citing potential
damage to the US economy required by compliance. The Senate also balked at the agreement because it excluded
certain developing countries, including India and China, from having to comply with new emissions standards.[43]
Bush administration Similar objections to the Kyoto Protocol were why the Bush administration refused to sign.
They argued the division between Annex 1 and developing countries was unfair, and that both countries needed to
reduce their emissions unilaterally. President George W. Bush claimed that the cost of following the Protocols
requirements will stress the economy. George Bush made campaign promises in 2000 to regulate carbon dioxide as
a pollutant. However, in 2001, George Bush pulled the US out of the Kyoto accords as one of the first acts of his
presidency. Bush dismissed Kyoto Protocol as too costly, describing it as "an unrealistic and ever-tightening
straitjacket." The Bush administration questioned the validity of the science behind global warming, and claims that
millions of jobs will be lost if the US joins in this world pact.[43]
Anger Over Bush administration Withdrawal from Kyoto Protocol: "The evidence of this worsening crisis continues
to mount," said Al Gore yesterday, accusing Bush of showing the world "a stunning display of moral cowardice." [43]
"Kyoto's ability to survive the near-fatal attacks of the Bush administration is testimony to the urgency of the climate
problem." Worldwatch Institute [43] http:/ / usliberals. about. com/ od/ environmentalconcerns/ p/ KyotoProtocol.
htm "As the world celebrates the global warming pact's debut, Bush continues to pander to the energy industry."
Emissions trading 8

Laurie David, Natural Resources Defense Council [43]

Obama Administration President Obama was elected under widespread belief that shortly after arriving in office he
would take swift and decisive action to join the world in reducing GHG emissions and therefore helping battle global
climate change. Backed by large majorities in both houses of Congress, Obama was widely expected to quickly pass
a Kyoto-style domestic cap-and-trade program for greenhouse gases, positioning America to take the moral high
ground in Copenhagen, thus luring (or compelling) China and India to accept emissions targets.".[44] Signing the
Kyoto protocol seemed like the logical first step so it came as a surprise when he rejected the Kyoto protocol for
similar reason that former president Bush had used. The treatys fundamental flaws were well understood: It set very
ambitiousand costlytargets for the United States while allowing emissions from the developing world to
continue to rise unchecked. (And indeed today, despite Kyotos ratification, China has become the worlds leading
emitter of greenhouse gases.) Americans dont mind contributing to a solution, but Kyoto asked a lot of sacrifice for
little reward..[44] President Obama was also assumed to represent the U.S in Copenhagen and negotiate terms for the
extension of the Kyoto Protocol past 2012. Yet instead of the U.S. contributing to the development and signing of a
Kyoto-like treaty, the U.S. is suggesting extreme modifications of the Kyoto emission management system and
precipitating intense debates and clashes over the treaty which will follow Kyoto. Many countries fear these new
treaty additions will paralyze negotiations and stop many of the countries currently under the Kyoto Protocol from
resigning as well as stop new countries, like China and India, from signing. the Obama administrations proposals
could undermine a new global treaty and weaken the worlds ability to stave off the worst effects of climate
change.[45]
Many people feel that the combination of the U.S not signing the Kyoto Protocol (ensuring it will run out in 2012)
and the U.S. attempt to change almost the entire architecture of the Kyoto Protocol in Copenhagen means the end of
the Kyoto Protocol as we know it and perhaps a new global climate treaty. If Kyoto is scrapped, it could take
several years to negotiate a replacement framework, a delay that could strike a terminal blow at efforts to prevent
dangerous climate change. In Europe we want to build on Kyoto, but the US proposal would in effect kill it off. If we
have to start from scratch then it all takes time. It could be 2015 or 2016 before something is in place, who knows."
[45]

Australia

Garnaut Draft Report

In 2003 the New South Wales (NSW) state government unilaterally established the NSW Greenhouse Gas
Abatement Scheme[46] to reduce emissions by requiring electricity generators and large consumers to purchase NSW
Greenhouse Abatement Certificates (NGACs). This has prompted the rollout of free energy-efficient compact
fluorescent lightbulbs and other energy-efficiency measures, funded by the credits. This scheme has been criticised
by the Centre for Energy and Environmental Markets (CEEM) of the UNSW because of its lack of effectiveness in
reducing emissions, its lack of transparency and its lack of verification of the additionality of emission reductions.[47]
On 4 June 2007, former Prime Minister John Howard announced an Australian Carbon Trading Scheme to be
introduced by 2012, but opposition parties called the plan "too little, too late".[48] On 24 November 2007 Howard's
coalition government lost a general election and was succeeded by the Labor Party, with Kevin Rudd taking over as
prime minister. Prime Minister Rudd announced that a cap-and-trade emissions trading scheme would be introduced
in 2010,[49] however this scheme was initially delayed by a year to mid-2011,[50] and in May 2010, it was
subsequently delayed further until 2013.[51]
Australia's Commonwealth, State and Territory Governments commissioned the Garnaut Climate Change Review, a
study by Professor Ross Garnaut on the mechanism of a potential emissions trading scheme. Its interim report was
released on 21 February 2008.[52] It recommended an emissions trading scheme that includes transportation but not
agriculture, and that emissions permits should be sold competitively and not allocated free to carbon polluters. It
recognised that energy prices will increase and that low income families will need to be compensated. It
Emissions trading 9

recommended more support for research into low emissions technologies and a new body to oversee such research. It
also recognised the need for transition assistance for coal mining areas.[53]
In response to Garnaut's draft report, the Rudd Labor government issued a Green Paper[54] on 16 July that described
the intended design of the actual trading scheme.
Subsequent to this, the emission trading scheme proposed by the Government was defeated in the Senate, with the
Opposition, the Greens and two independent senators opposing the proposed legislation.[55]

New Zealand
The New Zealand Emissions Trading Scheme (NZ ETS) is a national all-sectors all-greenhouse gases uncapped
emissions trading scheme first legislated in September 2008 by the Fifth Labour Government of New Zealand[56] [57]
and amended in November 2009 by the Fifth National Government of New Zealand.[58]
Although the NZ ETS covers all-sectors and all-gases, individual sectors of the economy have different entry dates
when their obligations to report emissions and surrender emission units have effect. Forestry, a net sink which
contributed removals of 14 Mts of CO2e in 2008 or 19% of NZ's 2008 emissions,[59] entered on 1 January 2008.[60]
Emissions from stationary energy, industrial and liquid fossil fuel sectors (34 Mts in 2008, 45% of 2008
emissions,[59] entered the NZ ETS on 1 July 2010. Agricultural emissions (mainly 35 Mts of methane and nitrous
oxide emissions from pastoral ruminants or 47% of 2008 emissions[59] ) do not enter the scheme until 1 January
2015.[61]
Tradable emission units will be issued by free allocation to emitters, with no auctions in the short term.[62] The
fishing sector will receive free units on a historic basis, 90 per cent of their 2005 emissions (bullet points 9 & 10
MfE September 2009[61] ). Pre-1990 forests will receive a fixed free allocation of 60 emissions units per hectare.[60]
Allocation to emissions-intensive industry,[63] and agriculture[64] will be provided on an output-intensity basis,
which will be based on the industry average emissions per unit of output and will be uncapped.[65] Bertram and
Terry (2010, p 16 ) state that as there is no 'cap' on emissions, the NZ ETS is not a cap and trade scheme as
understood in the economics literature.[66]
A transition period will operate from 1 July 2010 until 31 December 2012. During this period the price of New
Zealand Emissions Units (NZUs) will be capped at NZ$25. Also, one unit will only need to be surrendered for every
two tonnes of carbon dioxide equivalent emissions, effectively reducing the carbon price to NZ$12.50 per tonne
(MfE 2009, second bullet point).[61]
Section 3 of the Climate Change Response Act 2002 (the Act) defines the purpose of the Act as to reduce emissions
from business-as-usual-levels and to fulfill New Zealand's international obligations under the United Nations Frame
Work Convention on Climate Change (UNFCCC) and the Kyoto Protocol.[67] Some stakeholders have criticized the
New Zealand Emissions Trading Scheme for its generous free allocations of emission units and the lack of a carbon
price signal (the Parliamentary Commissioner for the Environment),[68] and being ineffective in reducing emissions
(Greenpeace NZ).[69]

European Union
The European Union Emission Trading Scheme (or EU ETS) is the largest multi-national, greenhouse gas emissions
trading scheme in the world. It is one of the EU's central policy instruments to meet their cap set in the Kyoto
Protocol (Jones et al.., 2007, p.64).[70]
After voluntary trials in the UK and Denmark, Phase I commenced operation in January 2005 with all 15 (now 25 of
the 27) member states of the European Union participating.[71] The program caps the amount of carbon dioxide that
can be emitted from large installations with a net heat supply in excess of 20 MW, such as power plants and carbon
intensive factories[72] and covers almost half (46%) of the EU's Carbon Dioxide emissions.[73] Phase I permits
participants to trade amongst themselves and in validated credits from the developing world through Kyoto's Clean
Emissions trading 10

Development Mechanism.
During Phases I and II, allowances for emissions have typically been given free to firms, which has resulted in them
getting windfall profits (CCC, 2008, p.149).[74] Ellerman and Buchner (2008) (referenced by Grubb et al.., 2009,
p.11) suggested that during its first two years in operation, the EU ETS turned an expected increase in emissions of
1-2 percent per year into a small absolute decline.[75] Grubb et al.. (2009, p.11) suggested that a reasonable estimate
for the emissions cut achieved during its first two years of operation was 50-100 MtCO2 per year, or 2.5-5 percent.
A number of design flaws have limited the effectiveness of scheme (Jones et al.., 2007, p.64). In the initial 2005-07
period, emission caps were not tight enough to drive a significant reduction in emissions (CCC, 2008, p.149). The
total allocation of allowances turned out to exceed actual emissions. This drove the carbon price down to zero in
2007. This oversupply reflects the difficulty in predicting future emissions which is necessary in setting a cap.
Phase II saw some tightening, but the use of JI and CDM offsets was allowed, with the result that no reductions in
the EU will be required to meet the Phase II cap (CCC, 2008, pp.145,149). For Phase II, the cap is expected to
result in an emissions reduction in 2010 of about 2.4% compared to expected emissions without the cap
(business-as-usual emissions) (Jones et al.., 2007, p.64). For Phase III (201320), the European Commission has
proposed a number of changes, including:
the setting an overall EU cap, with allowances then allocated to EU members;
tighter limits on the use of offsets;
unlimiting banking of allowances between Phases II and III;
and a move from allowances to auctioning.
In January 2008 Norway, Iceland, and Lichtenstein, joined the European Union Emissions Trading System (EU
ETS) according to a publication from the European Commission.[76] The Norwegian Ministry of the Environment
has also released its draft National Allocation Plan which provides a carbon cap-and-trade of 15 million metric
tonnes of CO2, 8 million of which are set to be auctioned.[77] According to the OECD Economic Survey of Norway
2010, the nation "has announced a target for 2008-12 10% below its commitment under the Kyoto Protocol and a
30% cut compared with 1990 by 2020." [78]

Tokyo, Japan
The Japanese city of Tokyo is like a country in its own right in terms of its energy consumption and GDP. Tokyo
consumes as much energy as "entire countries in Northern Europe, and its production matches the GNP of the
worlds 16th largest country".[79] Originally, Japan had its own cap and trade system that had been in place for some
years, but was not effective.[80] Japan has its own emission reduction policy but not a nationwide cap and trade
program. This climate strategy is enforced and overseen by the Tokyo Metropolitan Government (TMG).[81] The
first phase, which is alike to Japan's scheme, runs up to 2014, these organizations will have to cut their carbon
emissions by 6%; those who fail to operate within their emission caps will from 2011 on be required to purchase
emission allowances to cover any excess emissions, or alternatively, invest in renewable energy certificates or offset
credits issued by smaller businesses or branch offices.[82] Firms whom fail to comply will face fines. According to
local reports, organizations that do not operate within their caps will also be ordered to cut emissions by 1.3 times
the amount they failed to reduce during the first phase of the scheme. The long term aim is to cut the metropolis'
carbon emissions by 25% from 2000 levels by 2020.[83]

United States
An early example of an emission trading system has been the SO2 trading system under the framework of the Acid
Rain Program of the 1990 Clean Air Act in the U.S. Under the program, which is essentially a cap-and-trade
emissions trading system, SO2 emissions were reduced by 50% from 1980 levels by 2007.[84] Some experts argue
that the cap-and-trade system of SO2 emissions reduction has reduced the cost of controlling acid rain by as much as
80% versus source-by-source reduction.[10] [85]
Emissions trading 11

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.[86] Beginning in 2000, over 100 major sources of pollution in eight
Illinois counties began trading pollution credits.
In 2003, New York State proposed and attained commitments from nine Northeast states to form a cap-and-trade
carbon dioxide emissions program for power generators, called the Regional Greenhouse Gas Initiative (RGGI). This
program launched on January 1, 2009 with the aim to reduce the carbon "budget" of each state's electricity
generation sector to 10% below their 2009 allowances by 2018.[87]
Also in 2003, U.S. corporations were able to trade CO2 emission allowances on the Chicago Climate Exchange
under a voluntary scheme. In August 2007, the Exchange announced a mechanism to create emission offsets for
projects within the United States that cleanly destroy ozone-depleting substances.[88]
Also in 2003, the Environmental Protection Agency (EPA) began to administer the NOx Budget Trading Program
(NBP)under the NOx State Implementation Plan (also known as the NOx SIP Call) The NOx Budget Trading
Program was a market-based cap and trade program created to reduce emissions of nitrogen oxides (NOx) from
power plants and other large combustion sources in the eastern United States. NOx is a prime ingredient in the
formation of ground-level ozone (smog), a pervasive air pollution problem in many areas of the eastern United
States. The NBP was designed to reduce NOx emissions during the warm summer months, referred to as the ozone
season, when ground-level ozone concentrations are highest. In March 2008, EPA again strengthened the 8-hour
ozone standard to 0.075 parts per million (ppm) from its previous 0.008 ppm.[89]
In 2006, the California Legislature passed the California Global Warming Solutions Act, AB-32, which was signed
into law by Governor Arnold Schwarzenegger. Thus far, flexible mechanisms in the form of project based offsets
have been suggested for five main project types. A carbon project would create offsets by showing that it has
reduced carbon dioxide and equivalent gases. The project types include: manure management, forestry, building
energy, SF6, and landfill gas capture.
Since February 2007, seven U.S. states and four Canadian provinces have joined together to create the Western
Climate Initiative (WCI),a regional greenhouse gas emissions trading system.[90] July 2010, a meeting took place to
further outline the cap-and-trade system which if accepted would curb greenhouse gas emissions by January
2012.[91]
On November 17, 2008 President-elect Barack Obama clarified, in a talk recorded for YouTube, that the US will
enter a cap-and-trade system to limit global warming.[92]
The 2010 United States federal budget proposes to support clean energy development with a 10-year investment of
US $15 billion per year, generated from the sale of greenhouse gas (GHG) emissions credits. Under the proposed
cap-and-trade program, all GHG emissions credits would be auctioned off, generating an estimated $78.7 billion in
additional revenue in FY 2012, steadily increasing to $83 billion by FY 2019.[93]
The American Clean Energy and Security Act(H.R. 2454) , a cap-and-trade bill, was passed on June 26, 2009, in the
House of Representatives by a vote of 219-212. The bill originated in the House Energy and Commerce Committee
and was introduced by Rep. Henry A. Waxman and Rep. Edward J. Markey.[94]
Emissions trading 12

Renewable energy certificates

Renewable Energy Certificates, or "green tags", are transferable rights for renewable energy within some American
states. A renewable energy provider gets issued one green tag for each 1,000 kWh of energy it produces. The energy
is sold into the electrical grid, and the certificates can be sold on the open market for profit. They are purchased by
firms or individuals in order to identify a portion of their energy with renewable sources and are voluntary.
They are typically used like an offsetting scheme or to show corporate responsibility, although their issuance is
unregulated, with no national registry to ensure there is no double-counting. However, it is one way that an
organization could purchase its energy from a local provider who uses fossil fuels, but back it with a certificate that
supports a specific wind or hydro power project.

Carbon market
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)[95] which was itself a 41% increase relative to 2003 (78
mtCO2e).[96]
In terms of dollars, Felipe de Jesus Garduo Vazquez uses the World Bank has estimated that the size of the carbon
market was 11 billion USD in 2005, 30 billion USD in 2006,[95] and 64 billion in 2007.[97]
The Marrakesh Accords of the Kyoto protocol defined the international trading mechanisms and registries needed to
support trading between countries, with allowance trading now occurring between European countries and Asian
countries. However, while the USA as a nation did not ratify the Protocol, many of its states are now developing
cap-and-trade systems and are looking at ways to link their emissions trading systems together, nationally and
internationally, to seek out the lowest costs and improve liquidity of the market.[98] However, these states also wish
to preserve their individual integrity and unique features. For example, in contrast to the other Kyoto-compliant
systems, some states propose other types of greenhouse gas sources, different measurement methods, setting a
maximum on the price of allowances, or restricting access to CDM projects. Creating instruments that are not truly
fungible would introduce instability and make pricing difficult. Various proposals are being investigated to see how
these systems might be linked across markets, with the International Carbon Action Partnership (ICAP) as an
international body to help co-ordinate this.[99] [100]

Business reaction
With the creation of a market for mandatory trading of carbon dioxide emissions within the Kyoto Protocol, the
London financial marketplace has established itself as the center of the carbon finance market, and is expected to
have grown into a market valued at $60 billion in 2007.[101] The voluntary offset market, by comparison, is projected
to grow to about $4bn by 2010.[102]
23 multinational corporations came together in the G8 Climate Change Roundtable, a business group formed at the
January 2005 World Economic Forum. The group included Ford, Toyota, British Airways, BP and Unilever. On
June 9, 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.[103] By December 2007 this had grown to encompass 150 global businesses.[104]
Emissions trading 13

Business in the UK have come out strongly in support of emissions trading as a key tool to mitigate climate change,
supported by NGOs.[105] However, not all businesses favor a trading approach. On December 11, 2008, Rex
Tillerson, the CEO of Exxonmobil, said a carbon tax is "a more direct, more transparent and more effective
approach" than a cap-and-trade program, which he said, "inevitably introduces unnecessary cost and complexity". He
also said that he hoped that the revenues from a carbon tax would be used to lower other taxes so as to be revenue
neutral.[106]
The International Air Transport Association, whose 230 member airlines comprise 93% of all international traffic,
position is that trading should be based on benchmarking, setting emissions levels based on industry averages,
rather than grandfathering, which would use individual companies previous emissions levels to set their future
permit allowances. They argue grandfathering would penalise airlines that took early action to modernise their
fleets, while a benchmarking approach, if designed properly, would reward more efficient operations".[107]

Measuring, reporting, verification (MRV)

An emissions trading system requires measurements at the level of operator or installation. These measurements are
then reported to a regulator. For greenhouse gases all trading countries maintain an inventory of emissions at
national and installation level; in addition, the trading groups within North America maintain inventories at the state
level through The Climate Registry. For trading between regions these inventories must be consistent, with
equivalent units and measurement techniques.
In some industrial processes emissions can be physically measured by inserting sensors and flowmeters in chimneys
and stacks, but many types of activity rely on theoretical calculations for measurement. Depending on local
legislation, these measurements may require additional checks and verification by government or third party
auditors, prior or post submission to the local regulator.

Enforcement
Another significant, yet troublesome aspect is enforcement.[108] Without effective MRV and enforcement the value
of allowances is diminished. Enforcement can be done using several means, including fines or sanctioning those that
have exceeded their allowances. Concerns include the cost of MRV and enforcement and the risk that facilities may
be tempted to mislead rather than make real reductions or make up their shortfall by purchasing allowances or offsets
from another entity. The net effect of a corrupt reporting system or poorly managed or financed regulator may be a
discount on emission costs, and a (hidden) increase in actual emissions.
According to Nordhaus (2007, p.27), strict enforcement of the Kyoto Protocol is likely to be observed in those
countries and industries covered by the EU ETS.[109] Ellerman and Buchner (2007, p.71) commented on the
European Commission's (EC's) role in enforcing scarcity of permits within the EU ETS.[110] This was done by the
EC's reviewing the total number of permits that member states proposed that their industries be allocated. Based on
institutional and enforcement considerations, Kruger et al. (2007, pp.130131) suggested that emissions trading
within developing countries might not be a realistic goal in the near-term.[111] Burniaux et al.. (2008, p.56) argued
that due to the difficulty in enforcing international rules against sovereign states, development of the carbon market
would require negotiation and consensus-building.[112]
Emissions trading 14

Views on emissions trading

Criticisms
Emissions trading has been criticised for a variety of reasons.
In the popular science magazine New Scientist, Lohmann (2006)
argued that trading pollution allowances should be avoided as a climate
change policy. Lohman gave these reasons for this view. First, global
warming will require more radical change than the modest changes
driven by previous pollution trading schemes such as the US SO2
market. Global warming requires "nothing less than a reorganisation of
society and technology that will leave most remaining fossil fuels Chicago Climate Justice activists protesting cap
and trade legislation in front of Chicago Climate
safely underground." Carbon trading schemes have tended to reward
Exchange building in Chicago Loop
the heaviest polluters with 'windfall profits' when they are granted
enough carbon credits to match historic production. Carbon trading
encourages business-as-usual as expensive long-term structural changes won't be made if there is a cheaper source of
carbon credits. Cheap "offset" carbon credits are frequently available from the less developed countries, where they
may be generated by local polluters at the expense of local communities.[113]

Lohmann (2006b) supported conventional regulation, green taxes, and energy policies that are "justice-based" and
"community-driven."[114] According to Carbon Trade Watch (2009), carbon trading has had a "disastrous track
record." The effectiveness of the EU ETS was criticized, and it was argued that the CDM had routinely favoured
"environmentally ineffective and socially unjust projects."[115]
Annie Leonard provided a critical view on carbon emissions trading in her 2009 documentary The Story of Cap and
Trade. This documentary emphasized three factors: unjust financial advantages to major pollutors resulting from free
permits, an ineffectiveness of the system caused by cheating in connection with carbon offsets and a distraction from
the search for other solutions.[116]

Offsets
Forest campaigner Jutta Kill (2006) of European environmental group FERN argued that offsets for emission
reductions were no substitute for actual cuts in emissions. Kill stated that "[carbon] in trees is temporary: Trees can
easily release carbon into the atmosphere through fire, disease, climatic changes, natural decay and timber
harvesting."[117]

Supply of permits
Regulatory agencies run the risk of issuing too many emission credits, which can result in a very low price on
emission permits (CCC, 2008, p.140).[74] This reduces the incentive that permit-liable firms have to cut back their
emissions. On the other hand, issuing too few permits can result in an excessively high permit price (Hepburn, 2006,
p.239).[118] This is one of the arguments in favour of a hybrid instrument, that has a price-floor, i.e., a minimum
permit price, and a price-ceiling, i.e., a limit on the permit price. A price-ceiling (safety value) does, however,
remove the certainty of a particular quantity limit of emissions (Bashmakov et al.., 2001).[119]
Emissions trading 15

Incentives
Emissions trading can result in perverse incentives. If, for example, polluting firms are given emission permits for
free ("grandfathering"), this may create a reason for them not to cut their emissions. This is because a firm making
large cuts in emissions would then potentially be granted fewer emission permits in the future (IMF, 2008,
pp.2526).[120] This perverse incentive can be alleviated if permits are auctioned, i.e., sold to polluters, rather than
giving them the permits for free (Hepburn, 2006, pp.236237).[118]
On the other hand, allocating permits can be used as a measure to protect domestic firms who are internationally
exposed to competition (p.237). This happens when domestic firms compete against other firms that are not subject
to the same regulation. This argument in favour of allocation of permits has been used in the EU ETS, where
industries that have been judged to be internationally exposed, e.g., cement and steel production, have been given
permits for free (4CMR, 2008).[121]

Auctioning
The revenues from auctioning go to the government. These revenues could, for example, be used for research and
development of sustainable technology.[122] Alternatively, revenues could be used to cut distortionary taxes, thus
improving the efficiency of the overall cap policy (Fisher et al.., 1996, p.417).[123]

Distributional effects
The Congressional Budget Office (CBO, 2009) examined the potential effects of the American Clean Energy and
Security Act on US households.[124] This Act relies heavily on the free allocation of permits. The Bill was found to
protect low-income consumers, but it was recommended that the Bill be changed to be more efficient. It was
suggested that the Bill be changed to reduce welfare provisions for corporations, and more resources be made
available for consumer relief.

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Further reading
Chichilnisky, C. and G. Heal (eds) (2000). "Environmental Markets: Equity and Efficiency" (http://www.
chichilnisky.com/publication.php). Print version: Columbia University Press, New York, Chichester, West
Sussex. Web version: Graciela Chichilnisky's website. Retrieved 2010-05-12.
Gilbertson, T. and O. Reyes (1 November 2009). "Carbon Trading: how it works and why it fails" (http://www.
carbontradewatch.org/publications/carbon-trading-how-it-works-and-why-it-fails.html). Dag Hammerskjold
Foundation. Retrieved 2010-05-14.
IEA (2005). "Act Locally, Trade Globally- Emissions Trading for Climate Policy" (http://www.iea.org/
publications/free_new_Desc.asp?PUBS_ID=1579). International Energy Agency (IEA), Head of Publications
Service, 9 rue de la Fdration, 75739 Paris Cedex 15, France. p. 236. Retrieved 2010-05-12.
Lin Feng and Jason Buhi (2009). "Emissions Trading Across China: Incorporating Hong Kong and Macau into an
Urgently Needed Air Pollution Control Regime Under 'One Country, Two Systems'" (http://papers.ssrn.com/
sol3/papers.cfm?abstract_id=1441395). Florida State University Journal of Transnational Law & Policy, Vol.
19, 2009. Retrieved 2010-10-17.
Norregaard, J. and V. Reppelin-Hill (1 January 2000). "Taxes and Tradable Permits as Instruments for
Controlling Pollution: Theory and Practice. Working Paper No. 00/13" (http://www.imf.org/external/pubs/
cat/longres.cfm?sk=3411.0). International Monetary Fund, Fiscal Affairs Department. Retrieved 2010-05-12.
Reinaud, J. and C. Philibert (22 November 2007). "Emissions trading: trends and prospects" (http://www.iea.
org/publications/free_new_Desc.asp?PUBS_ID=2001). International Energy Agency website. p. 43. Retrieved
Emissions trading 21

2010-05-12.

External links
Q&A with Dr. Daniel Fine on Cap and Trade legislation and policy (http://www.opednews.com/Diary/
Dr-Daniel-Fine-on-Cap-and-by-Helen-Fine-090617-238.html)
Dr. Daniel Fine of the New Mexico Center for Energy Policy on Cap and Trade (http://nmcep.nmt.edu/index.
php/NMCEP-and-Related-News/cap-and-trade-changing-everything.html)
Emissions Trading and CDM (http://www.iea.org/subjectqueries/keyresult.asp?KEYWORD_ID=4124)
International Energy Agency website
Greenhouse Gas Emissions Trading (http://www.oecd.org/env/cc/emissiontrading) Organisation for
Economic Co-operation and Development website
US EPA's Acid Rain Program (http://www.epa.gov/airmarkets/progsregs/arp/index.html)
Illinois Emissions Reduction Market System (http://www.epa.state.il.us/air/erms/)
Texas Emissions Banking and Trading program (http://www.tceq.state.tx.us/permitting/air/nav/
air_banking.html)
"The Making of a Market-Minded Environmentalist" (http://www.strategy-business.com/press/article/
08201?pg=0), article by Fred Krupp in Strategy+Business (registration reqd) that articulates some of the
reasoning and history behind emissions trading in California
International Emissions Trading Association (http://www.ieta.org/)
EU-ETS for airlines (http://www.aviaso.com/)
Article Sources and Contributors 22

Article Sources and Contributors

Emissions trading Source: http://en.wikipedia.org/w/index.php?oldid=401591457 Contributors: 5 albert square, ALYGREANAN, Academic13, AdjustShift, Adoptatreetoday, Aergoth, Aitias,
Akasaka, Alan Liefting, Alex S, Alias Flood, Allmedia, Allstarecho, Altermike, Andre Engels, Andrewlp1991, Anna Lincoln, AnnuitSophia, Antagonist, Antandrus, Anyjay, Arthur Rubin,
AshtonBenson, Atreklin, Avant Guard, Barek, Beagel, Bearian, Beland, Bert McLeod, Bgwhite, Billtubbs, Blood Red Sandman, Bluerasberry, Bobbo, Bobo192, BomberJoe, Borgx, Bovineone,
Boyd Reimer, Brusegadi, Bryan Derksen, Bucephalus, CO2 insanity, Calaguiman, Calmer Waters, Cannaya, Carbonconsultant, Carbontradewatch, CattleGirl, Cbsimpson, Cguysea,
Champben2002, Charlie36r, Chealer, Chendy, Chicco3, Chris Howard, ChrisCarsonThompson, ChrisCork, Ckatz, CleanGreen, Closedmouth, Cogniac, Collegiate21, Cometstyles, Corpx, Crunk,
CurtisSwain, Cutler, Cyfal, Daniel5127, Danielfolsom, Dariusz Peczek, Darrinstern, DaveDixon, David (davd), DavidConrad, Dcoetzee, Dean1970, Deeahbz, Delhi3, Diderot's dreams,
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