Cap-and-trade 101

What are greenhouse gases?

 Three forms of naturally occurring greenhouse gases are being affected by industrial activities. These are carbon dioxide, methane and nitrogen oxide. Of these three, carbon dioxide is by far the most prevalent – coming primarily from man-made incineration of fossil fuels. 

 changes in CO2The accompanying chart from EPA shows the changes in greenhouse gas emission since 1990 in absolute terms. The unit MMTCE refers to million of metric tons of carbon equivalent.  

 The idea of regulating carbon dioxide was given a push by the Supreme Court in its 2007 decision (Massachusetts v. EPA) where it affirmed (once again) that EPA has the authority under the Clean Air Act to regulate any pollutant that is found by the agency to be harmful to human health.

 So just what exactly is cap-and-trade?

 First of all, cap-and-trade is not a new concept. It was used in the 80s to control the emission of sulfur dioxide as part of the legislation to reduce acid rain. Cap-and-trade is also being used in California by the South Coast Air Quality Management District to reduce the emission of nitrogen oxides and sulfur dioxide from industries under its Regional Clean Air Incentives Market (RECLAIM) program.

Here is how cap-and-trade works. The regulatory agency places a maximum amount of emission that a facility can emit for a particular pollutant – say carbon dioxide. That’s the cap part. Once this cap is in place, the agency provides an emission allowance to industries that can be applied against the cap. The allowance may be as large as the cap during the first few years of the program. It then decreases gradually over time. This decrease in allowance has the effect of reducing the amount of carbon dioxide that can be emitted each year.

The whole idea of cap-and-trade is to provide a disincentive to industry to continue to emit harmful pollutants such as greenhouse gas (primarily carbon dioxide from coal power plant).

Faced with this decreasing allowance – which is in effect a more restrictive limit on emission over time – the regulated industry has two options to comply with the cap. It can install pollution control equipment to reduce its emission to make up for the decreasing allowance in order to meet the cap. Or it can purchase credit in an open market to make up for any short fall. That’s the trading part of cap-and-trade. Conversely, if a facility comes in below the cap as a result of installing pollution control devices, it may have “surplus allowance” that it can sell in the open market and make money.

That’s the whole idea of cap-and-trade. If you cannot meet the emission limit, you have to go to the open market and purchase emission credits. For those companies that choose to install pollution control equipment, they would not have to pay millions to purchase emission credits. They may even have unused allowances that they can sell in an open market. The underlying intent of the bill is to control emission by creating an incentive to the development and installation of pollution control technology.

There have been a lot of complaints from opponents of the proposed bill that cap-and-trade is a “tax” on industries.

Cap-and-trade is a pollution “tax” in much the same way that regulations that control the disposal of toxic wastes constitute a “tax” because they impose additional costs on industry. Companies that generate hazardous wastes will have to pay more to have them disposed of properly. The incentive there is to either change the manufacturing process to reduce the amount of toxic wastes generated or pay to have the wastes disposed of properly.

Another example of pollution tax is tailpipe emission control from automobiles. The cost of the catalytic converter increases the manufacturing cost of a car and is passed on to the consumers. So are the costs of seat belts and air bags. 

Why should carbon emission control be treated any differently?

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One response to “Cap-and-trade 101

  1. Pingback: Cap-and-trade 101 revisited « Norman’s Environmental Blog

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