Cap and Trade Programs Explained

There's a tremendous amount of talk lately about Emissions Cap and Trade programs. All of the major presidential candidates have a national program at the center of their environmental proposals. But the concept is new to most US citizens.

How cap and trade works
Here's a grossly dumbed down overview of how cap-and-trade programs work:

First, a central authority, like a government, sets a limit (a cap!) on the amount of a pollutant that can be emitted. Let's use carbon in this example.

Then, companies and other groups are issued emission permits that allot them a certain number of carbon credits.

Over time, the government can work towards their carbon goals by lowering the number of carbon credits that are available.

At the same time, companies that can cheaply reduce their emissions can choose to do so.

These companies can make additional money by selling or trading their excess carbon credits to other companies that need them. Companies that don't want to reduce their emissions have to consider the price of buying or trading credits from these other companies.

What this type of program ensures is that the most cost-effective emissions reductions happen the fastest, easing the burden of the change on the economy.

Cap and Trade Programs in Action

• The European Union runs the only mandatory carbon cap-and-trade system in the world, which begun in January 2005.
• The EU program is in-part modeled off a US cap-and-trade system focused on the gases that create acid rain.
• Australia's new government plans to start their carbon program in 2010.
• The Kyoto Protocol, which the US has not signed, includes a worldwide cap-and-trade program.

Cap and Trade: Coming soon to the US
Cap-and-trade programs are slowly coming to the US. In the absence of federal leadership, Washington, Arizona, California, New Mexico, Oregon and Washington have partnered with two Canadian provinces to form the Western Climate Initiative. This group is planning an independent cap-and-trade system across the region. Yesterday, Washington state passed important state legislation to lay the groundwork for program implementation.

In the Northeast, the Regional Greenhouse Gas Initiative would establish the first collective effort in America to adopt mandatory controls for carbon dioxide emissions. The governors of Connecticut, Delaware, Maine, New Hampshire, New Jersey, New York and Vermont signed a memorandum to create a cap-and-trade program covering all power plants that includes a trading program.

Cap and Trade Concerns
There are concerns over the complexity of the cap-and-trade systems. The programs will force difficult accounting practices on business, and difficult oversight on government to ensure that businesses are reporting their carbon emissions accurately. Still, out of all possible carbon taxes and programs designed to cutback emissions, US businesses would rather adopt this type of program than any other, because it makes it possible to balance environment and economic concerns.

Similarly, environmental groups worry that cap-and-trade systems won't go far enough in forcing businesses to cut back emissions at the rate required. 

Comments

[sara]

there's a question i've always had about cap-and-trade programs that i wonder if you can answer. suppose a company decides to just ignore the program and keep with their current level of carbon emissions (or goes with a less detectable cheating method). then aren't we just back to command-and-control? it seems like this just allows companies to choose from a range of acceptable levels--but they can certainly still exceed those levels, and it's not clear to me what sorts of punishments are put in place for that?

[Brave New Leaf]

Excellent question, Sara. The oversight on these companies is the lifeblood of the program's successful operation. Here's how the EU does it:

1. They lay out very strict regulations on how companies need to monitor and report on their data.
2. They require the companies to submit a regular report on their activites.
3. That report goes through a rigorous verification process. The highly-trained verifiers become intimate with the detail and data of the facilities and provide oversight on the reports.
4. They work with the companies to correct errors, unintentional or otherwise. They normalize the data reporting and auditing methodology the company is using.
5. Then, with the company, they form a verification plan. This plan basically consists of site visits to the facilities to make sure that the companies are doing what they say they're doing.

The penalties for non-compliance are stiff. This year, EU penalties increased to 100 Euros/tonne of CO2. Given that the average coal-fired plant produces about 4 million tons of CO2/year, those penalties can really add up.

To top it off, non-compliance also results in a reduction of your carbon allowance for the next year. And criminal penalties can be added to the mix as well.

If you want to read up on the details of the EU's oversight and penalties, this is a good source:
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32004D0156:EN:NOT