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Benefits of a cap and trade system

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benefits of a cap and trade system

Emissions trading or cap and trade is a government-mandated, market-based approach to controlling pollution by providing economic incentives for achieving and in the emissions of pollutants. Various countries, states and groups of companies have adopted such trading systems, notably for mitigating climate change. A central authority usually a governmental body allocates or sells a limited number of permits to discharge specific quantities of a specific pollutant per time period.

Polluters that want to increase their emissions must buy permits from others willing to sell them. In theory, polluters who can reduce emissions most cheaply will do so, achieving the emission reduction at the lowest cost to society. There are active trading programs in several air pollutants. For greenhouse gaseswhich cause climate change, permit units are often called carbon credits. The largest greenhouse gases trading program is the European Union Emission Trading Scheme[12] which trades primarily in European Union Allowances EUAs ; the Californian scheme trades in California Carbon Allowances, the New Zealand scheme in New Zealand Units and the Australian scheme in Australian Units.

Pollution is the prime example of a market externality. An externality is an effect of some activity on an entity such as a person that is not party to a market transaction related to that activity. Emissions trading is a market-based approach, among others, to address pollution. The overall goal of an emissions trading plan is to minimize the cost of meeting a set emissions target.

In an emissions trading system, the government sets an overall limit on emissions, and defines permits also called allowancesor limited authorizations to emit, up to the level of the overall limit.

The government may sell the permits, but in many existing schemes, it gives permits to participants regulated polluters equal to each participant's baseline emissions. The baseline is determined by reference to the participant's historical emissions. To demonstrate compliance, a participant must hold permits at least equal to the quantity of pollution it actually emitted during the time period. If every participant complies, the total pollution emitted will be at most equal to the sum of individual limits.

In effect, the buyer pays a charge for polluting, while the seller gains a reward for having reduced emissions. In many schemes, organizations which do not pollute and therefore have no obligations may also trade permits and financial derivatives of permits. In some schemes, participants can bank allowances to use in future periods.

Thus, environmental groups may buy and retire permits, driving up the price of the remaining permits according to the law of demand. Usually, the government lowers the overall limit over time, with an aim towards a national emissions reduction target. According to the Environmental Defense Fund, cap-and-trade is the most environmentally and economically sensible approach to controlling greenhouse gas emissions, the primary cause of global warming, because it sets a limit on emissions, and the trading encourages companies to innovate in order to emit less.

Three issues are key to developing constructive cap between international trade and climate agreements: Economy-wide pricing of carbon is the centre piece of any policy designed to reduce emissions at the lowest possible costs.

Many economists have urged the use of market-based instruments such as emissions trading to address environmental problems instead of prescriptive "command-and-control" regulation.

Failure to report emissions and surrender emission permits is often punishable by a further government regulatory mechanism, such as a fine that increases costs of production. Firms will choose the least-cost 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.

Under an emissions trading system, each regulated polluter has flexibility to use the most cost-effective combination of buying or selling emission permits, reducing its emissions by installing cleaner technology, or reducing its emissions by reducing production. The most cost-effective strategy depends on the polluter's marginal abatement cost and the market price of permits. In theory, a polluter's decisions should lead to an economically efficient allocation of reductions among polluters, and lower compliance trade for individual firms and for the economy overall, compared to command-and-control mechanisms.

For emissions trading where greenhouse gases are regulated, one emissions permit is considered equivalent to one metric ton of carbon dioxide CO 2 emissions. Other names for emissions permits are carbon creditsKyoto units, assigned amount unitsand Certified Emission Reduction units CER.

These permits can be sold privately or in the international market at the prevailing market price. These trade and settle internationally, and hence allow permits to be transferred between countries. Each international transfer is validated by the United Nations Framework Convention on Climate Change UNFCCC. Each transfer of ownership within the European Union is additionally validated by the European Commission.

Emissions trading programmes such as the European Union Emissions System System EU ETS complement the country-to-country trading stipulated in the Kyoto Protocol by allowing private trading of permits.

Trading exchanges have been established to provide a spot market in permits, as well as futures and options market to help discover a market price and maintain liquidity. Carbon prices are normally quoted in euros per tonne of carbon dioxide or its equivalent CO 2 e. Other greenhouse gases can also be traded, but are quoted as standard multiples of carbon dioxide with respect to their global warming potential. These features reduce the quota's financial impact on business, while ensuring that the quotas are met at a national and international level.

Currently, there are six exchanges trading in UNFCCC related carbon credits: NASDAQ OMX Commodities Europe listed a contract to trade offsets generated by a CDM carbon project called Certified Emission Reductions. Many companies now engage in emissions abatement, offsetting, and sequestration programs to generate credits that can be sold on one of the exchanges.

At least one private electronic market has been established in Louis Redshaw, head of environmental markets at Barclays Capitalpredicts that "carbon will be the world's biggest commodity market, and it could become the world's biggest market overall.

An emission license directly confers a right to emit pollutants up to a certain rate. In contrast, a pollution license for a given location confers the right to emit pollutants at a rate which will cause no more than a specified increase at the pollution-level.

For concreteness, consider the following model. As an example, consider three countries along a river as in the fair river sharing setting. Therefore, a polluter that affects water quality at a number of points has to hold a portfolio of licenses covering all relevant monitoring-points. In the above example, if country 2 wants to emit a unit of pollutant, it should purchase two permits: Montgomery shows that, while both markets lead to efficient license allocation, the market in pollution-licenses is more widely applicable than the market in emission-licenses.

The international community began the long process towards building effective international and domestic measures to tackle GHG emissions carbon dioxide, methane, nitrous oxide, hydroflurocarbons, perfluorocarbons, sulphur hexafluoride in response to the increasing assertions that global warming is happening due to man-made emissions and the uncertainty over its likely consequences. That process began in Rio inwhen countries agreed the UN Framework Convention on Climate Change UNFCCC.

The UNFCCC is, as its title suggests, simply a framework; the necessary detail was left to be settled by the Conference of Parties CoP to the UNFCCC. 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 and 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. 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.

Pechan continued improving [35] and advancing [36] these computer models at the newly created U. The agency introduced the concept of computer modeling with least-cost abatement strategies i. The development of emissions trading over the course of its history can be divided into four phases: In the United States, the " acid rain "-related emission trading system was principally conceived by C.

Boyden Graya G. Gray worked with the Environmental Defense Fund EDFwho worked with the EPA to write the bill that became law as part of the Clean Air Act of The new emissions cap on NO x and SO 2 gases took effect inand according to Smithsonian magazine, those acid rain emissions dropped 3 million tons that year. One important economic reality recognised by many of the countries that signed the Kyoto Protocol is that, if countries have to solely rely on their own domestic measures, the resulting inflexible limitations on GHG growth could entail very large costs, perhaps running into many trillions of dollars globally.

The purpose of these benefits is to allow the parties benefits find the most economic ways to achieve their targets.

These international mechanisms are outlined under Kyoto Protocol. On April 17,the Environmental Protection Agency EPA formally announced that it had found that greenhouse gas GHG poses a threat to public health and the environment EPA a. This announcement was significant because it gives the executive branch the authority to impose carbon regulations on carbon-emitting entities. A carbon cap-and-trade system is to be introduced nationwide in China in [47] China's National Development and Reform Commission proposed that an absolute cap be placed on emission by In the United States, most polling shows large support for emissions trading often referred to as cap-and-trade.

They are, however, ambivalent on cap-and-trade. More than three-quarters of respondents, According to PolitiFactit is a misconception that emissions trading is unpopular in the United States because of earlier polls from Zogby International and Rasmussen which misleadingly include "new taxes" in the questions taxes aren't part of emissions trading or high energy cost estimates.

Cap and trade is the textbook emissions trading program. Other market-based approaches include baseline-and-credit, and pollution tax. They all put a price on pollution for example, see carbon priceand so provide an economic incentive to reduce pollution beginning with the lowest-cost opportunities. By contrast, in a command-and-control approach, a central authority designates pollution levels each facility is allowed to emit.

In a baseline and credit program, polluters can create permits, called credits or offsets, by reducing their emissions below a baseline level, which is often the historical emissions level from a designated past year.

Emissions fees or environmental tax is a surcharge on the pollution created while producing goods and services. Both can have a range of scopes, points of regulation, and price schedules. They can be fair or unfair, depending on how the revenue is used. Both have the effect of increasing the price of goods such as fossil fuels to consumers. Yet, many commentators sharply contrast the two approaches. The main difference is what is defined and what derived. A tax is a price control, while cap-and-trade method acts is a quantity control instrument.

Cap-and-trade has the advantage that it adjusts to inflation changes to overall prices automatically, while emissions fees must be changed by regulators. Responsiveness to cost changes: It is not clear which approach is better. It is possible to combine the two into a safety valve price: This point is closely related to responsiveness to cost changes, because recessions cause a drop in demand.

Under cap and trade, the emissions cost automatically decreases, so a cap-and-trade scheme adds another automatic stabilizer to the economy - in effect, an automatic fiscal stimulus. However, a lower pollution price also results in reduced efforts to reduce pollution. If the government is able to stimulate the economy regardless of the cap-and-trade scheme, an excessively low price causes a missed opportunity to cut emissions faster than planned. Instead, it might be better to have a price floor a tax.

This is especially true when cutting pollution is urgent, as with greenhouse gas emissions. A price floor also provides certainty and stability for investment in emissions reductions: Trade with cost changes, in a world of uncertainty, it is not clear whether emissions fees or cap-and-trade systems are more efficient—it depends on how fast the marginal social benefits of reducing pollution fall with the amount of cleanup e.

The magnitude of the tax will depend on how sensitive the supply of emissions is to the price. The permit price of cap-and-trade will depend on the pollutant market. A tax generates government revenue, but full-auctioned emissions permits can do the same.

A similar upstream cap-and-trade system could be implemented. An upstream carbon tax might be the simplest to administer. Setting up a complex cap-and-trade arrangement that is comprehensive has high institutional needs. Command and control is a system of regulation that prescribes emission limits and compliance methods for each facility or source. It is the traditional approach to reducing air pollution. Command-and-control regulations are more rigid than incentive-based approaches such as pollution fees and cap and trade.

An example of this is a performance standard which sets an emissions goal for each polluter that is fixed and, therefore, the burden of reducing pollution cannot be shifted to the firms that can achieve it more cheaply. As a result, performance standards are likely to be more costly overall. Setting firmer limits on emissions, and mandating that all goods sold in-country be produced according to the same emission standards, and partially subsidizing costs would meet emissions targets without an excessive increase in cost to consumers, and would naturally increase funding to and competition in the pollution abatement industry, driving innovation in lower-cost and more efficient emission reduction methods and systems.

It is possible for a country to reduce emissions using a Command-Control approach, such as regulation, direct and indirect taxes. International emissions-trading markets were created precisely to exploit differing MACs.

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.

Suppose Germany can abate its CO 2 at a much cheaper cost than Sweden, i. On the left side of the graph is the MAC curve for Germany. Thus, given the market price of CO 2 allowances, Germany has potential to profit if it abates more emissions than required. On the right side is the MAC curve for Sweden. R Req is the amount of required reductions for Sweden, but the MAC S curve already intersects the market price of CO 2 permits before R Req has been reached.

Thus, given the market price of CO 2 permits, Sweden has potential to make a cost saving if it abates fewer emissions than required internally, and instead abates them elsewhere. After that it could buy emissions credits from Germany for the price P per unit. The internal cost of Sweden's own abatement, combined with the permits it buys in the market from Germany, adds up to the total required reductions R Req for Sweden.

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: Additionally, Germany sold its surplus permits to Sweden, and was paid P for every unit it abated, while spending less than P.

If the total cost for reducing a particular amount of emissions cap the Command Control scenario is called Xthen 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. The example above applies not just at the national level, but also between two companies in different countries, or between two subsidiaries within the same company. The nature of the pollutant plays a very important role when policy-makers decide which framework should be used to control pollution.

CO 2 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 matter from an environmental standpoint. The policy framework should be different for regional pollutants [61] e. SO 2 and NO xand also mercury because the impact of these pollutants may differ by location.

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 matters 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 price of emission permits in Europe and the USA.

Countries face the permit market 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 Principlecommonly used in economics to choose the most economically efficient decision. There has been longstanding debate on the relative merits of price versus quantity instruments to achieve emission reductions.

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 permits creates an uncertainty in the future price of pollution permits, 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.

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.

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. The overwhelming majority of climate scientists have repeatedly 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 damage.

With such a risk, a quantity instrument may be a better choice because the quantity of emissions may be capped with more certainty. However, this may not be true if this risk exists but cannot be attached to a known level of greenhouse gas GHG concentration or a known emission pathway.

A third option, known as a safety valveis 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 buying 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 benefits, the safety valve can be used to mimic either a pure quantity or pure price mechanism.

All three methods are being used as policy instruments to control greenhouse gas emissions: In the Kyoto Protocol, Annex I countries are subject to caps on emissions, but non-Annex I countries are not. The leakage rate is defined as the increase in CO 2 emissions outside the countries taking domestic mitigation action, divided by the reduction in emissions of countries taking domestic mitigation action.

However, this beneficial effect had not been reliably quantified. On the empirical evidence they assessed, Barker et al.

Under the EU ETS rules Carbon Leakage Exposure Factor is used to determine the volumes of free allocation of emission permits to industrial installations. To understand carbon trading, it is important to understand the products that are being traded.

The primary product in carbon markets is the trading of GHG emission permits. Under a cap-and-trade system, permits are issued to various entities for the right to emit GHG emissions that meet emission reduction requirement caps. One of the controversies about carbon mitigation policy is how to "level the playing field" with border adjustments.

Besides issues of compliance with the General Agreement on Tariffs and Tradesuch 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,p. World Bank commented that introducing border tariffs and 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. As the Intergovernmental Panel on Climate Change 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 the Kyoto Protocol was adopted. The Kyoto Protocol is a international treaty that came into force in In the treaty, most developed nations agreed to legally binding targets for their emissions of the six major greenhouse gases. 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 IPCC has projected that the financial effect of compliance through trading within the Kyoto commitment period will be limited at between 0.

Despite the failure of the United States and Australia to ratify the protocol, the agreement became effective inonce the requirement that 55 Annex I predominantly industrialized countries, jointly accounting for 55 percent of Annex I emissions, ratify the agreement was met. 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. Annex I Parties may also use International Emissions Trading IET.

Under the treaty, for the 5-year compliance period from until[75] nations that emit less than their quota will be able to sell assigned amount units each AAU representing an allowance to emit one metric tonne of CO 2 to nations that exceed their quotas. 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.

There are four such international flexible mechanisms, or Kyoto Mechanism, [77] written in the Kyoto Protocol. Article 17 if the Protocol authorizes Annex 1 countries that have agreed to the emissions limitations to take part in emissions trading with other Annex 1 Countries. Article 4 authorizes such parties to implement their limitations jointly, as the member states of the EU have chosen to do.

Article 6 provides that such Annex 1 countries may take part in joint initiatives JIs in return for emissions reduction units ERUs to be used against their Assigned Amounts. Art 12 provides for a mechanism known as the clean development mechanism CDM[78] under which Annex 1 countries may invest in emissions limitation projects in developing countries and use certified emissions reductions CERs generated against their own Assigned Amounts.

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. In the New South Wales NSW state government unilaterally established the NSW Greenhouse Gas Abatement Scheme [80] 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.

Both the incumbent Howard Coalition government and the Rudd Labor opposition promised to implement an emissions trading scheme ETS before the federal election. Labor won the election, with the new government proceeding to implement an ETS. The government introduced the Carbon Pollution Reduction Schemewhich the Liberals supported with Malcolm Turnbull as leader. Tony Abbott questioned an ETS, saying the best way to reduce emissions is with a "simple tax".

This left the government unable to secure passage of the bill and it was subsequently withdrawn. Julia Gillard defeated Rudd in a leadership challenge and promised not to introduce a carbon tax, but would look to legislate a price on carbon [83] when taking the government to the election. In the first hung parliament result in 70 years, the government required the support of crossbenchers including the Greens.

One requirement for Greens support was a carbon price, which Gillard proceeded with in forming a minority government.

A fixed carbon price would proceed to a floating-price ETS within a few years under the plan. The fixed price lent itself to characterisation as a carbon tax and when the government proposed the Clean Energy Bill in February[84] the opposition claimed it to be a broken election promise. The bill was passed by the Lower House in October [86] and the Upper House in November The New Zealand Emissions Trading Scheme NZ ETS is a partial-coverage all-free allocation uncapped highly internationally linked emissions trading scheme.

The NZ ETS was first legislated in the Climate Change Response Emissions Trading Amendment Act in September under the Fifth Labour Government of New Zealand [91] [92] and then amended in November [93] and in November [94] by the Fifth National Government of New Zealand. The NZ ETS covers forestry a net sinkenergy Individual sectors of the economy have different entry dates when their obligations to report emissions and surrender emission units take effect.

Forestry, which contributed net removals of The waste sector landfill operators entered on 1 January From Novemberagriculture was to enter the NZ ETS on 1 January [96]. The NZ ETS is highly linked to international carbon markets as it allows the importing of most of the Kyoto Protocol emission units.

However, as of Junethe scheme will effectively transition into a domestic scheme, with restricted access to international Kyoto units CERs, ERUs and RMUs. The commercial fishery sector who are not participants system a free allocation of units on a historic basis.

For this sector, there is no set limit on the number of units that may be allocated. 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[] and for being ineffective in reducing emissions Greenpeace Aotearoa New Zealand.

The NZ ETS was reviewed in late by an independent panel, which reported to the Government and public in September 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.

After voluntary trials in the UK and Denmark, Phase I began operation in January with all 15 member states of the European Union participating.

Credits are gained by investing in clean technologies and low-carbon solutions, and by certain types of emission-saving projects around the world to cover a proportion of their emissions. During Phases I and II, allowances for emissions have typically been given free to firms, which has resulted in them getting windfall profits.

A number of design flaws have limited the effectiveness of the scheme. This drove the carbon price down to zero in This oversupply was caused because the allocation of allowances by the EU was based on emissions data from the European Environmental Agency in Copenhagen, which uses a horizontal activity-based emissions trade similar to the United Nations, the EU ETS Transaction log in Brussels, but a vertical installation-based emissions measurement system.

Phase II saw some tightening, but the use of JI and CDM offsets was allowed, with the system that no reductions in the EU will be required to meet the Phase II cap.

In JanuaryNorway, Iceland, and Liechtenstein joined the European Union Emissions Trading System EU ETSaccording to a publication from the European Commission. Based on figures for by the European Environment Agency, EU emissions averaged This means the EU over-achieved its first Kyoto target by a wide margin. 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 world's 16th largest country". A scheme to limit carbon emissions launched in April covers the top 1, emitters in Tokyo, and is enforced and overseen by the Tokyo Metropolitan Government. Japan had an ineffective voluntary emissions reductions system for years, [] but no nationwide cap-and-trade program.

An early example of an emission trading system has been the SO 2 trading system under the framework of the Acid Rain Program of the Clean Air Act in the U. Under the CSAPR, the national SO 2 trading program was replaced by four separate trading groups for SO 2 and NO x. Inthe State of Illinois adopted a trading program for volatile organic compounds in most of the Chicago area, called the Emissions Reduction Market System. InNew 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.

Also inU. In Augustthe Exchange announced a mechanism to create emission offsets for projects within the United States that cleanly destroy ozone -depleting substances. Also inthe Environmental Protection Agency EPA began to benefits 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 cap created to reduce emissions of nitrogen oxides NO x from power plants and other large combustion sources in the eastern United States. NO x is a prime ingredient in the formation of ground-level ozone smoga pervasive air pollution problem in many areas of the eastern United States. The NBP was designed to reduce NO x emissions during the warm summer months, referred to as the ozone season, when ground-level ozone concentrations are highest.

Inthe California Legislature passed the California Global Warming Solutions Act, ABwhich was signed into law by Governor Arnold Schwarzenegger. Thus far, flexible mechanisms in the form of project based offsets have been suggested for three main project types.

The project types include: However, a recent ruling from Judge Ernest H. Goldsmith of San Francisco's Superior Court states that the rules governing California's cap-and-trade system were adopted without a proper analysis of alternative methods to reduce greenhouse gas emissions. If the decision is made final, the state would not be allowed to implement its proposed cap-and-trade system until the California Air Resources Board fully complies with the California Environmental Quality Act.

In Februaryfive U. On 17 November President-elect Barack Obama clarified, in a talk recorded for YouTubehis intentions for the US to enter a cap-and-trade system to limit global warming. SO 2 emissions from Acid Rain Program sources have fallen from Ozone season NOx emissions decreased by 43 percent between andeven while energy demand remained essentially flat during the same period.

NOx reductions due to the NOx Budget Trading Program have led to improvements in ozone and PM2. The American Clean Energy and Security Act H. The bill originated in the House Energy and Commerce Committee and was introduced by Representatives Henry A. Waxman and Edward J. Some of the emitters obtain allowances for free, which is for the electric utilities, industrial facilities and natural gas distributors, whereas some of the others have to go to the auction.

South Korea's national emissions trading scheme officially launched on 1 Januarycovering entities from 23 sectors. With a three-year cap of 1. This amounts to roughly two thirds of the country's emissions. In NovemberChina approved pilot tests of carbon trading in seven provinces and cities — Beijing, Chongqing, Shanghai, Shenzhen, Tianjin as well as Guangdong Province and Hubei Province, with different prices in each region.

Their successes or failures will therefore have far reaching implications for carbon market development in China in terms of trust in a national carbon trading market. When the market launched, it will be the largest carbon market in the world. Trading is set to begin in after a three-year rollout period. India has pledged a 20 to 25 per cent reduction in emissions intensity from levels by Under the scheme, annual efficiency targets will be allocated to firms. Tradable energy-saving permits will be issued depending on the amount of energy saved during a target year.

Renewable Energy Certificates occasionally referred to as or "green tags" [citation required]are a largely unrelated form of market-based instruments that are used to achieve renewable energy targets, which may be environmentally motivated like emissions reduction targetstrade may also be motivated by other aims, such as energy security or industrial policy.

Carbon emissions trading is emissions trading specifically for carbon dioxide calculated in tonnes of carbon dioxide equivalent or tCO 2 e 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. Trading can be done directly between buyers and sellers, through several organised exchanges or through the many intermediaries active in the carbon market. The price of allowances is determined by supply and demand. As many as 40 million allowances have been traded per day. In terms of dollars, the World Bank has estimated that the size of the carbon market was 11 billion USD in30 billion USD in[] and 64 billion in The Marrakesh Accords of the Kyoto protocol defined the international trading mechanisms and registries needed to support trading between countries sources can buy or sell allowances on the open market.

Because the total number of allowances is limited by the cap, emission reductions are assured. However, while the USA as a nation did not ratify the Protocol, many of its states are developing cap-and-trade systems and considering ways to link them together, nationally and internationally, to find the lowest costs and improve liquidity of the market. For example, in contrast to 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 fungible exchangeable could introduce instability and make pricing difficult. Various proposals for linking these systems across markets are being investigated, and this is being coordinated by the International Carbon Action Partnership ICAP.

The group included FordToyotaBritish AirwaysBP and Unilever. On June 9, the Group published a statement stating the 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 NGOs. On December 11,Rex Tillersonthe CEO of Exxonmobilsaid 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 benefits that the revenues from a carbon tax would be used to lower other taxes so as to be revenue neutral. 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".

Assuring compliance with an emissions trading scheme requires measuring, reporting and verification MRV. These measurements are reported to a regulator. For greenhouse gases, all trading countries maintain an inventory of emissions at national and installation level; in addition, 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 instead of measurement. Depending on local legislation, measurements may require additional checks and verification by government or third party auditorsprior or post submission to the local regulator.

A firm might buy a small amount of allowances but emit a much larger amount of pollution. This creates a troublesome moral hazard problem. This problem may be solved by a centralized regulator. The regulator should perform Measuring, Reporting and Verification MRV of the actual pollution levels, and enforce the allowances. Enforcement methods include fines and sanctions for polluters that have exceeded their allowances.

Concerns include the cost of MRV and enforcement, and the risk that facilities may lie about actual emissions. 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, strict enforcement of the Kyoto Protocol is likely to be observed in those countries and industries covered by the EU ETS.

Based on institutional and enforcement considerations, Kruger et al. An alternative to centralized regulation is distributed regulation, in which the firms themselves are induced to inspect the other firms and report their misbehavior. It is possible to implement such systems in subgame perfect equilibrium.

Moore and Repullo [] present an implementation with unbounded fines; Kahana and Mealem and Nitzan [] present an implementation with bounded fines. Their work extends the work of Duggan and Roberts [] by adding a second component which takes care of the moral hazard.

For example, in the popular science magazine New ScientistLohmann argued that trading pollution allowances should be avoided as a climate stabilization policy for several reasons. First, climate change requires more radical changes than previous pollution trading schemes such as the US SO 2 market.

It requires reorganizing society and technology to "leave most remaining fossil fuels safely underground". Carbon trading schemes have tended to reward the heaviest polluters with 'windfall profits' when they are granted enough carbon credits to match historic production.

Expensive long-term structural changes will not be made if there are cheaper sources of carbon credits which are often available from less developed countries, where they may be generated by local polluters at the expense of local communities.

Research by Preston Teeter and Jorgen Sandberg has shown that the flexibility, and thus complexity, inherent in cap and trade schemes has resulted in a great deal of policy uncertainty surrounding these schemes. Such uncertainty has beset such schemes in Australia, Canada, China, the EU, India, Japan, New Zealand, and the US.

As a result of this uncertainty, organizations have little incentive to innovate and comply, resulting in an ongoing battle of stakeholder contestation for the past two decades.

Lohmann b supported conventional regulation, green taxes, and energy policies that are "justice-based" and "community-driven. Annie Leonard 's documentary The Story of Cap and Trade criticized carbon emissions trading for the free permits to major polluters giving them unjust advantages, cheating in connection with carbon offsetsand as a distraction from the search for other solutions.

Forest campaigner Jutta Kill of European environmental group FERN argued that offsets for emission reductions were not 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. Regulatory agencies run the risk of issuing too many emission credits, which can result in a very low price on emission permits.

On the other hand, issuing too few permits can result in an excessively high permit price. However, a price-ceiling safety value removes the certainty of a particular quantity limit of emissions. If polluters receive emission permits for free "grandfathering"this may be a reason for them not to cut their emissions because if they do they will receive fewer permits in the future. This perverse incentive can be alleviated if permits are auctioned, i.

Revenues from auctioning go to the government and can be used for development of sustainable technology [] or to cut distortionary taxes, thus improving the efficiency of the overall cap policy. On the other hand, allocating permits can be used as a measure to protect domestic firms who are internationally exposed to competition. This argument in favor of allocation of permits has been used in the EU ETS, where industries that have been judged to be internationally exposed, e.

This method of distribution may be combined with other forms of allowance distribution. The US Congressional Budget Office CBO, examined the potential effects of the American Clean Energy and Security Act on US households. The Bill was found to protect low-income consumers, but it was recommended that the Bill be made more efficient by reducing welfare provisions for corporations, and more resources be made available for consumer relief. Distinct cap-and-trade systems can be linked together through the mutual or unilateral recognition of emissions allowances for compliance.

Linking systems creates a larger carbon market, which can reduce overall compliance costs, increase market liquidity and generate a more stable carbon market.

Inthe provinces of Ontario and Manitoba agreed to join the linked system between Quebec and California. The International Carbon Action Partnership brings together regional, national and sub-national governments and public authorities from around the world to discuss important issues in the design of emissions trading schemes ETS and the way forward to a global carbon market.

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Garnaut Climate Change ReviewCarbon Pollution Reduction Schemeand Clean Energy Bill New Zealand Emissions Trading Scheme and Climate change in And Zealand.

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2 thoughts on “Benefits of a cap and trade system”

  1. Alexdm says:

    A conservative is a man who is too cowardly to fight and too fat to run.— Elbert Hubbard.

  2. Anna86 says:

    Remember that people always want to talk and debate about things, so they will always be engaged in some interesting discussions if you choose to go with such a topic.

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