How trading works

Imagine an organization, Xco. that finds itself included under a C&T scheme. Xco. must register its operations, and then have them validated by an approved environmental auditor. It will then receive allocations of permitted emissions under the relevant process: either though an auction or by the process known as grandfathering whereby allocations are made pro rata with reference to Xco.’s previous emissions. Xco. must then assess the relative costs, in its own situation, of the following four options: to meet its allocation in full; over-emit and buy permits; under-emit and sell permits (or bank them into a future allocation perios, if permitted under the scheme); or to pay a penalty.

If required, it will arrange sale or purchase of allocations through a broker. It must report trades to the allocation registry, and then show compliance with relevant legislation. It can be appreciated that substantial transaction costs will be incurred by Xco. through this process.

Such trading systems have been applied to environmental problems since the early 1990s, principally in the US. Experience has been mixed: a successful example is the Acid Rain Program introduced by the US Environmental Protection Agency, which has been credited with halving SO, emissions from 1990-2002. The program turned out to be much cheaper than expected (possibly by half, saving up to $1.4bn): reductions were achieved by fuel substitutions rather than by the installation of scrubbing equipment.

Carbon trading

How are pollutant trading systems applied to the reduction of greenhouse gases such as carbon dioxide? There are distinct types of instrument which can be traded.

• Project-based greenhouse gas emission reduction credits, created and exchanged through a given activity: essentially a flexibility mechanism for command and control schemes [42]

US developments

There have been a number of differing proposals for carbon trading systems in the US. Discussion has been conducted at a theoretical level (see for example CBO 2001, Jacoby and Ellerman 2002) until the recent debut of the Chicago Climate Exchange. Much debate has centered around the cost effectiveness of alternative schemes: whether for example to issue allowances to “upstream” energy suppliers or “downstream” energy consumers; and how to balance the requirements of capping carbon emissions and limiting overall costs to the economy.

However slow progress on these issues may be within the Federal government, there is considerable state level activity — including the establishment of carbon registries, for example in California, which will provide the institutional framework for trading in the future. At a regional level, there are proposals for multipollutant trading that effectively extend the EPA’s Acid Rain to other pollutants: so-called 3P and 4P schemes may include S0x, N0x, Hg and C02. In further political developments, the front-running Democratic candidate for the November 2004 presidential election — John Kerry — promotes carbon trading and re-engagement with the Kyoto process. And in a bi­partisan effort, a bill to promote carbon trading was introduced by Senators McCain and Liebermann and just narrowly defeated in the US Senate in early November 2003.