Emissions Trading

What is Emissions Trading?
Emissions trading, under a cap and trade policy, is an approach to controlling large amounts of emissions from a group of emitters. Emissions trading uses market forces to allow emitters to reduce emissions at costs that are lowest for each emitter’s individual circumstance.

In a cap-and-trade system, the government sets the total amount of a pollutant that can be put into the environment by an entire industry or class of emitters. The government establishes emission allowances, which can be bought and sold among companies in the industry. The only requirements are that emitters completely and accurately measure and report all emissions and then turn in the same number of allowances as emissions at the end of the compliance period.

For example:
Companies A and B both emit 100,000 tonnes of CO₂ per year. In their national allocation plans their governments give each of them emission allowances for 95,000 tonnes, leaving them to find ways to cover the shortfall of 5,000 allowances. This gives them 3 choices:

• Reduce their emissions by 5,000 tonnes
• Purchase 5,000 allowances in the market
• Take a position somewhere in between.

Before deciding which option to pursue they compare the costs of each. In this example, the market price of an allowance at that moment is € 10 per tonne of CO₂e.

Company A calculates that cutting its emissions will cost € 5 per tonne, and so decides to do this because it is cheaper than buying the necessary allowances. Company A even decides to take the opportunity to reduce its emissions not by 5,000 tonnes but by 10,000, to ensure that it will have no difficulty holding within its emission limit for the next few years.

Company B is in a different situation. Its reduction costs are € 15 per tonne, i.e. higher than the market price, so it decides to buy allowances instead of reducing emissions.

Company A spends € 50,000 on cutting its emissions by 10,000 tonnes at a cost of € 5 per tonne, but then receives € 50,000 from selling the 5,000 allowances it no longer needs at the market price of € 10 each. This means it fully offsets its emission reduction costs by selling allowances, whereas without the Emissions Trading Scheme it would have had a net cost of € 25,000 to bear (assuming that it cut emissions by only the 5,000 tonnes necessary).

Company B spends € 50,000 on buying 5,000 allowances at a price of € 10 each. In the absence of the flexibility provided by the ETS, it would have had to cut its emissions by 5,000 tonnes at a cost of € 75,000.

Emissions Trading Example

In this example, emissions trading brings a total cost-saving of € 50,000 for the companies involved. Since Company A chose to cut its emissions (because this was the cheaper option in its case), the allowances that Company B purchased represent a real reduction in emissions, even though Company B did not reduce its own emissions.

Why are cost savings so significant?
Cost savings are significant because the government does not impose specific reductions on each emitter. Instead, individual emitters choose whether to reduce emissions or purchase allowances. Some may be able to reduce emissions below the market price for allowances, while others may be able to purchase allowances for less than it would cost to reduce their emissions.

Why is cap and trade effective?
Cap and trade is effective because:

The cap always protects the environment.

As the economy grows, sources must find ways to keep emissions beneath the cap.

Complete and consistent emissions measurement and reporting by all sources guarantees that total emissions do not exceed the cap.
The design and operation of the program is relatively simple which helps keep compliance and administrative costs low.

When is it appropriate to use this policy approach?
This approach is best used when:

The problem occurs over a relatively large area
There are a significant number of emitters responsible for the problem
The cost of controls varies from emitter to emitter
Emissions can be consistently and accurately measured

Has this approach been used successfully?
Cap and trade was first tried in the U.S. to control emissions that were causing severe acid rain problems over very large areas of the country. Legislation was passed in 1990 and the first compliance period was 1995. Sulfur dioxide (SO₂) emissions have fallen significantly, and costs have been even lower than the designers of the program expected. In a short time, the U.S. Acid Rain Program has achieved greater emission reductions than any other single program to control air pollution.

A cap and trade program also is being used to control SO₂ and nitrogen oxides (NOx) in the Los Angeles, California area. The Regional Clean Air Incentives Market (RECLAIM) program began in 1994.

Finally, states in the northeast U.S. cooperatively designed a regional NOx cap and trade program to control transport of ground-level ozone. Reductions began in 1999. EPA is expanding the NOx control effort to include more sources and states.

Greenhouse Gas Cap & Trade
In the greenhouse gas market, the European Union Emissions Trading Scheme (EU ETS) is a cap and trade program that went into effect January 1, 2005 for the 25 EU member states. More than 12,000 installations now have a cap on CO₂ emissions, and trading of allowances has begun. The second phase will be in effect from 2008 – 2012 to coincide with the Kyoto Protocol. Subsequent 5 year phases are expected.

The Kyoto Protocol is another greenhouse gas cap and trade program that specifies the level of emission reductions, the deadlines, and methodologies that signatory countries (countries who have signed the Kyoto Protocol) are to achieve. The first phase of the Kyoto Protocol is 2008 – 2012. Flexible mechanisms have been introduced to help address the reduction needs of participating countries.

Clean Development Mechanism (CDM)
The CDM is a mechanism established by Article 12 of the Kyoto Protocol for project-based emission reduction activities in developing countries. The CDM is designed to meet two main objectives: to address the sustainable development needs of the host country, and to increase the opportunities available to Parties to meet their reduction commitments. CDM reductions are called Certified Emission Reductions (CERs).

Joint Implementation (JI)
JI is a project-based mechanism developed under the Kyoto Protocol, designed to assist Annex 1 countries in meeting their emission reduction targets through joint projects with other Annex 1 countries, meaning that JI projects can only be implemented between capped industrialised countries. One or more investors (governments, companies, funds, etc.) will agree with partners in a host country to participate in project activities which generate Emission Reduction Units (ERUs), in order to use them for compliance with targets under the Kyoto Protocol.

How Does AgCert™ Participate?
AgCert™ develops projects in developing countries to participate in CDM. AgCert™ offers CERs from our CDM projects as an option to emitters to meet their caps. Each CER is 1 metric tonne of CO₂e reduction. In the EU ETS or Kyoto schemes, CERs can be used for compliance purposes. In addition, CERs can be banked to the second phase of the EU ETS (2008 – 2012), although EUAs (government allowances) cannot.

AgCert™ will also participate in JI. JI ERUs cannot be used for compliance until 2008.