Emissions Trading

We hear about one of the suggested solutions to manage carbon footprint growth to have come out of the Kyoto Protocol is the establishment of emissions trading schemes. Below is a brief overview of what emissions trading is and how it works to lower the production of greenhouse gases. I’ve tried to present this in layman’s terms where possible.

What Is Emissions Trading?

Emissions trading is a way in which government or regulatory bodies can control the level of carbon emissions produced, usually within a single country, although the EU trading scheme has been in place for a few years now. It's done by issuing emissions permits to companies that give them the right to produce a certain level of carbon emissions. To get emissions permits companies must earn credits and one of the ways they can get these credits is to buy them off companies who don't produce as much greenhouse gas as their limit dictates.

Emissions trading seeks to put a cap on the carbon emissions produced by rewarding those companies who have reduced their carbon emissions while creating an incentive for those who haven't.

Over time the carbon emissions cap is reduced which will ensure that all companies will continue to seek ways in which they can reduce the level of greenhouse gases they produce. The theory is that those who can easily reduce carbon emissions will do so at little cost allowing the focus to turn towards the larger polluters who, hopefully, will have begun to reduce their carbon emissions levels too.

Success of Emissions Trading

The success of an emissions trading scheme depends on having a tradable commodity with willing buyers and sellers. To get the buyers you need to make participation mandatory in certain sections of the economy. The ultimate success or failure of an emissions trading scheme will depend on the strength of the regulatory structure overseeing it.

Type of Emissions Trading Schemes

There are two major types of emissions trading schemes: cap and trade (e.g. the European Union’s emissions trading scheme) and baseline and credit (e.g. the NSW Greenhouse Gas Abatement Scheme).

Baseline and Credit schemes give credit to reductions relative to a projected future ‘baseline’ growth in emissions that in practice can become identical with business-as-usual. With this approach, there is no guarantee that emissions will ever be reduced in absolute terms. In the NSW scheme over 95% of abatement certificates issued in 2003 went to installation built prior to the commencement of the scheme. Coal-fire power stations have been the beneficiaries of payments due to minor efficiency improvements made that most likely would have been made even if the scheme weren’t in place. The fact that the major contributors to the problem are the ones receiving funds highlights a basic flaw in the system, particularly when you consider that any workable greenhouse gases solution would not involve the presence of coal-fired power stations.

Cap And Trade schemes put solid limits on total emissions in future years. Depending on how well designed, operated and regulated the scheme is, only enough permits are issued to reach that limit. Initially some of the European countries involved in the European Union Emissions Trading Scheme issued more permits than were needed to cover their emissions. This is an oversight that should be corrected when phase two has been properly implemented and the provision to lower the cap will see allowable emissions levels come down regularly. As countries begin to gain control of their carbon emissions and the trading part of this scheme really takes hold we should see significant drops in emissions numbers.

A further aspect to note about the introduction of an emissions trading scheme is the allocation of emissions permits through grandfathering clauses. What this means is that existing industries, often the big producers of greenhouse gases, are allowed to carry on as before the scheme was introduced to avoid large economic losses and possible major disruption of supply to consumers. A controlled revaluation of grandfathered permits need to be regulated over a period of years.

There are actually many ways in which an emissions trading system can be designed and implemented with important choices made between schemes that:

• Either reduce emissions that can be physically measured, or include ‘reductions’ that are uncertain.
• Either allocate emission permits free of charge to industries in proportion to their current positions, or auction permits with everyone entitled to bid.
• Either define the liable parties to only those industries who directly produce the emissions, or define the consumers who indirectly produce emissions through their purchase of goods and services.
• Either focus on carbon emissions alone, or include other greenhouse gases with emissions measured in carbon dioxide equivalents.