Why carbon trading makes sense

Cap-and-trade schemes are increasingly on the agenda as the EU Emission Trading Scheme brings on new sectors and the US, Japan, New Zealand and Australia attempt to push schemes through their respective parliaments. In this article, we give you the reasons why cap-and-trade is a sensible cornerstone for the international response to climate change.

In theory

Cap-and-trade is designed to deliver a known level of emission reductions for the cheapest possible cost. The two main alternatives are ‘command-and-control’, in which the regulator demands that each organisation reduces its own emissions by a certain amount, and tax, in which emissions are charged at a fixed rate.

Cap-and-trade allows organisations that can reduce their emissions cheaply to reduce as far as possible, and sell their excess carbon credits to organisations that would find it more expensive to make reductions. Effectively, funds are pooled and spent on the cheapest methods of reducing emissions. This means that the emissions cap should be met through implementation of the cheapest projects.

Command and control will meet the desired reductions, but the cost will be higher. This is because each organisation has to make reductions, even if it is very difficult.

Tax may or may not meet the desired reduction, depending on the level of the tax. It is difficult for the government to predict how a tax will affect carbon emissions, because it depends on how much organisations value the ability to pollute - they might just pay the tax and carry on polluting.

Click here to see an example of how these three policies affect the costs and emissions of three imaginary companies.

In practice

Implementations of cap-and-trade are never perfect, but the EU Emission Trading Scheme, which is a real, large scale example, shows how it can work. While there were difficulties in the first phase related to a misallocation of credits, the second phase has been robust. It has given a known, market price for carbon dioxide emissions.

According to Point Carbon’s ‘Carbon 2009’ survey, approximately half of companies included in the EU ETS have already made reductions as a result of being included in the scheme.

Source: Point Carbon 2009

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