Cap and Trade

Definition

Cap and Trade is a market-based climate strategy for reducing greenhouse gas emissions. The environmental regulator establishes an aggressive limit or cap on the amount of emissions from a group of polluters such as power plants. The amount of cap is then divided into individual permits or allowances in terms of tons of carbon. Companies have to reduce emissions and meet the allowed permit. Those who cannot can buy permits from those companies who successfully reduce emissions.

Design features

A well designed cap and trade program may have the following features:

• strict limits on emissions for pollution reduction
• fixed number of allowances or permits for each polluter
• incentives for pollution reduction
• high standards of compliance and transparency
• compatibility with local programs
• flexibility for polluters to decide when, where and how to reduce emissions

Capping Emissions

The cap on emissions can be established in the following three ways:

• Annual intensity reduction by reducing emissions per unit of gross domestic product (GDP)
• Static stair-step cap has one or two emissions over a period of time. For example: capping emissions at 2000 levels by 2010 and then at 1990 levels by 2015.
• Declining cap with slow and steady reduction goals. For example: reducing emissions by 3% per year up to 2015; then by 6% per year up to 2035; end goal to achieve 20% below 1990 levels by 2050.

Allowance allocation

The method of distribution of allowances or permits to polluters can be done in the following three ways:

• Grandfathering: In this, the historical information is used to give away allowances to polluters at no cost.
• Public auction: Polluters pay same price in an auction for purchasing allowances.
• Hybrid: A combination of grandfathering and public auction.

Benefits of Cap and Trade

• achieves emissions reduction in a cost effective manner
• promotes innovation of technology for emission reduction at low costs
• market forces set the price on emissions
• flexibility of technology use for cutting emissions

Cap and Trade Practices

There are several cap and trade practices throughout the world and several others are under development. Some of them are listed below:

• EU Emissions Trading System: This was launched in 2005 and covers power plants and five major industries. The system limits CO2 emissions from 12,000 facilities in the EU member states.
• Regional Greenhouse Gas Initiative (RGGI): A mandatory cap and trade program for CO2 from power plants located in the northeastern and mid-Atlantic states of the U.S. The program will cap emissions at current levels in 2009 and target a goal of 10% reduction by 2019.
• California and the west (Arizona, New Mexico, Oregon, Washington, Utah, Montana and the Canadian Provinces of British Columbia & Manitoba): Under development, this system has set a target of 15% reduction below the 2005 levels by 2020.
• Midwestern Accord (Illinois, Iowa, Kansas, Michigan, Minnesota, Wisconsin and the Canadian Province Manitoba): Under development.