What is Cap and Trade?
Since the 1980s, many economists have believed that the most efficient way to reduce pollution is to set a cap on a particular pollutant, reduce the cap over time, and issue permits to polluting companies that can be freely traded among them. They argue that trading allows companies to reduce their costs of mitigating pollution: companies that are able to reduce their emissions fastest can sell their excess allowances to companies whose initial costs are higher. Economic models suggest that an optimal rate of pollution reduction results from this exercise in ‘cap-and-trade.’
It hasn’t quite worked out that way in the real world. Pollution trading, or cap-and-trade has been used to address air pollution in southern California, acid rain-causing sulfur dioxide across the US, and in other instances. In these relatively small-scale experiments, the largest players have proved adept at gaming and manipulating the system. In the end, most pollution reductions resulted from regulatory actions rather than the cap and trade regime.
Trading did save polluters money in the short run, by allowing them to buy their way (cheaply) into compliance instead of reducing their emissions, and in a number of instances, inferior technologies were chosen over superior ones because they were more cost effective in the short run. Even though the value of the free permits given to polluters was supposed to be passed on to consumers to ease the burden of increased costs, polluters charged consumers for permits anyway and pocketed windfall profits, as in the case of EU’s Emissions Trading Scheme. In the long run, easy compliance enabled by permit trading directly costed the US auto industry, and wind turbine industry, among others, the leading edge they once enjoyed, causing them to lag behind in an increasingly competitive world marketplace.
Taking this concept to a global scale, to address the global climate crisis, where virtually every energy producing or consuming facility above a certain size is affected, is extremely complex and prone to gaming and difficulties. All carbon cap and trade schemes are designed to cap at the messy “downstream” side of the life of fossil fuels, based on emissions, rather than on the carbon content at the upstream end of fuel production or importation. In the US alone, tens of thousands of entities will be issued permits and trading on the carbon market. That’s on top of all the speculators who will find the carbon derivatives market a gold mine larger than any they have laid eyes on before.
Cap and trade lies at the heart of both the House ACESA and the drafted Senate climate bills. This has largely been thanks to pressure from the USCAP, a partnership between a handful of corporate environmental NGOs and representatives of the most polluting industries including Shell, Duke Energy, BP, DuPont and the like.
Climate SOS believes that such a trading system is incapable of dealing with the global climate emergency and enriches polluting companies while ultimately postponing real action to save the climate. By then, it will certainly be too late to prevent worst-case, irreversible disruptions to the earth’s climate systems.
Here is a little more detail.
To set up a cap and trade system:
• You define which sectors will be subject to the cap.
In the house –passed climate bill, ACESA, the CO2 cap covers sectors that, combined, accounted for about 85% of total US emissions in 2005. A separate cap applies to “HFC” (HFCs are a class of compounds used in refrigerants that are very damaging to ozone and an extremely potent greenhouse gas). The HFC cap covers a further 1.7% of U.S. 2005 emissions.
• You must define how much total emission you’ll allow under the cap for each year – so if that 85% of US emissions in 2005 amounted to 7 billion tons, – you would define a path for the cap to decline over a period of time, say from 7 to 6 to 5 billion tons…and so on. This, in effect, demands that companies reduce their emissions progressively over time so the entire US emissions from those covered entities reduces over time. (in theory)
• The size of the cap (for example 7 billion tons at the onset in example above) determines how many permits will be released to the market that year. Each permit represents the “right to pollute”, or emit 1 metric ton of CO2 equivalent of greenhouse gases. Permits can be given out for free, (as most of them are in the initial years of the proposed program) or they can be auctioned off on the market. (Peter Orszag, director of the Office of Management and Budget, testified before a Congressional Hearing saying that free allowances “would represent the largest corporate welfare program that has ever been enacted in the history of the United States.” President Obama, before he was elected said he would demand auctioning of permits, not giveaways). Where they are to be purchased, the cost of a permit is determined by the auction price (4 times a year), and by the daily trading on the carbon market, just like any other commodity.
• Now, capped entities can pollute in accordance with the permits they hold, and buy additional or sell excess permits on the market. Hence the “trade”.
• As a cost containment mechanism, in the House bill ACESA, if permit prices hit a certain minimum value, more permits, held in a “Strategic Reserve” will be available for auction. Although the reserve is partially filled with allowances that are taken from under the cap, it is also filled with international offset credits that the reserve’s fund purchases, there by bloating the cap and further compromising its ability to actually restrict US emissions. In the Senate version, a “price collar” is used. In this case, if market prices rise as high as the price collar value, more permits will be released, which also directly pushes up the cap.
• Permits can be banked (indefinitely under ACESA) for future use, as well as borrowed from future years (up to 5 years ahead) for use in the current year. Borrowing again effectively pushes up the cap on a continuous basis.
In theory, as the cap is lowered over time, and the number of permits is reduced, and banked and borrowed permits are used up, and permit prices are maintained at a level making them effective, then….emissions should go down.
BUT: making all of this far less likely is a giant “hole” in the cap provided by offsets. Offsets are essentially a loophole that industries can use to avoid reducing their own emissions by paying someone else, somewhere else, to supposedly reduce their emissions instead. The over 2 billion tons of offset provisions under both house and senate bills could make it possible for polluters to avoid making any real emissions reductions until about 2029. (See “WHAT ARE OFFSETS” on this website)
There is tremendous concern that the massive carbon market created by using cap and trade and offsets, will generate a derivatives market – to the tune of trillions of dollars, that could crash like other unstable and unregulated markets have done in recent time. In fact, carbon markets have already been proven to be highly unstable. In Europe, excess allowances provided to politically powerful corporations initially drove the value of greenhouse gas allowances to near zero, essentially removing any incentive for industries to reduce pollution, and rendering the entire cap and trade system impotent
In sum: cap and trade with offsets is a means of making things look good on paper. It is intended to make it easy, gentle and indeed profitable for polluting industries, as well as Wall Street and agribusinesses. But there is little chance that it will actually achieve the kinds of emission reductions we need.
 Emissions trading: A mixed record, with plenty of failures, published in Grist, by Gar Lipow
 Carbon trading: A Critical Conversation on Climate Change, Privatization and Power, by Larry Lohmann