Emission Trading Systems

The European Union Emission Trading Scheme (ETS) is an example of a carbon permits trading system. The test phase of ETS operated from 2005-07, and is slated for operation in the European Union (EU) during the Kyoto commitment period 2008-12. In the system, the aggregate cap on emissions is set by each EU government agency, and the total number of emissions allowances is defined to provide the owner the right to emit units of emissions. The amount of emissions is capped, whereas the permit prices are uncertain.

These permit prices are determined by economic conditions, generally, stronger economic growth means a higher permit price. Critics claim that the ETS has done more for power-generating companies, than it has curbed pollution. First, power generators emit a tremendous amount of pollution and monopolize the carbon market. Also, permit holders find they have unexpectedly valuable property rights because carbon permits are usually handed out for free, rather than auctioned. Second, there are no signals that the carbon permit is helpful in switching to cleaner fuel. That is not just because gas has been so much more expensive than coal, but because the first phase of the ETS lasts only three years. Because investments to reduce emissions have payback periods of five or more years, investors are wary.

The ETS was originally designed to meet the targets set by the Kyoto Protocol. The Kyoto Protocol was an international treaty negotiated in Kyoto, Japan, in December 1997 that took effect on February 16, 2005. As of December 2006, a total of 169 countries and other governmental entities had ratified the agreement. Its objective is to stabilize the greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system. In the Kyoto Protocol, mechanisms such as International Emissions Trading (IET), Joint

Implementation (JI) and the Clean Development Mechanism (CDM) provide options for members to fulfill their targets. IET provides the trading of assigned amount units (AAUs) between Annex I Parties in the Kyoto Protocol, JI enables Annex I parties to get credits for join projects to reduce emissions, CDM enables Annex I parties to get credit for projects resulting in emissions reductions in non-Annex I parties.

In the United States, the example of a successful emission trading system to date is the SO2 trading system under the framework of the Clean Air Act (CAA). Under this program, SO2 emissions are expected to fall by 50 percent 1980-2010. Compared to the proven success of the SO2 trading program in the United States, carbon trading has some specific features that make it more complicated.

Carbon emissions are an international issue, rather than a domestic one. Complexities may arise in setting up baseline projections against which to monitor and verify net emissions reductions, particularly with regard to the CDM. Usually, large amounts of SO2 come from coal-burning generation plants, making it relatively easy to monitor a plant's fuel use and emissions, rather than to construct and maintain a trading system to ensure compliance. On the other hand, carbon emissions come from many different sources, such as households, commercial and industrial facilities, transportation systems, and fossil-fired generating plants. Therefore, the development and operation of a monitoring and trading system for carbon emissions would be complicated.

carbon permits vs. carbon taxes

There has been debate on the relative merits of carbon permits versus carbon taxes to achieve emission reductions. Carbon permit systems fix the overall carbon emission level, while prices vary. On the other hand, carbon taxes fix the price, while the emission level quantity is allowed to vary according to economic activity. Therefore, carbon permits and carbon taxes are called quantity and price instruments, respectively. There are major drawbacks for each system. Carbon permits create uncertainty about the cost of compliance for firms, because the price of a permit is unknown; carbon taxes cannot guarantee the amount of emissions reduction.

Recently, a third option known as a safety valve has been suggested. It is a hybrid of the price and quantity instruments. The system is similar to a carbon permit system, but the maximum permit price is limited. Permits can be either purchased from the carbon market, or government, at a specified price. This system is designed to overcome the fundamental disadvantages of both systems, while providing flexibility.

SEE ALSO: Carbon Cycle; Carbon Emissions; Carbon Footprint; Clean Air Act, U.S.; Economics, Cost of Affecting Climate Change; Emissions, Trading; Kyoto Protocol.

BIBLIOGRApHY. P. Cramton and S. Kerr, Tradeable Carbon Permit Auctions: How and Why to Auction Not Grandfather (University of Maryland, 1999); R. Green, Carbon Tax or Carbon Permits: The Impact on Generators' Risks (University of Birmingham, 2007); Organisation for Economic Cooperation and Development (OECD), Tradeable Permits: Policy Evaluation, Design and Reform (OECD Publication, 1998); United Nations Framework Convention on Climate Change, An Introduction to the Kyoto Protocol Compliance Mechanism (United Nations Framework Convention on Climate Change, 2006); U.S. Energy Information Administration, Impact of the Kyoto Protocol on U.S. Energy Markets and Economic Activity (U.S. Department of Energy, 1998).

Jun-Ki Choi Bhavik R. Bakshi Ohio State University

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