ultra quick and dirty explanation of emissions trading

26 08 2008

What I wrote in about 4 minutes in a chat session. Will clean later!

quite important to appreciate that emissions trading (ETS) is not equal to ‘carbon offsets’, ‘carbon neutral’, or for that matter even projects under Kyoto’s ‘clean development mechanism’ (ie, energy projects in developing world countries).

each emitter must surrender a number of permits every year that covers their assessed emissions. each permit is worth a set amount of emissions, say 1 tonne CO2-eq. permits can be obtained in a number of ways, the best being by auction from the government; ie, you must buy the permit in the first place. the trading part comes in because firms (polluters) trade these permits on a market between themselves — that’s important because firm A might be able to reduce emissions much easier than firm B, so they do so and sell their excess permits to firm B for a profit. end result is same level of reduction but at ‘least cost’. and finally the cap — cap and trade — comes in because the government (via a new statutory authority set up for the purpose) explicitly limits the number of permits available. # of permits = cap on # of tonnes CO2-eq per year. the cap is then constantly reduced over time, with clearly published trajectories, and that forces emissions down.
as they do so the price of a permit naturally increases — this is the ‘price signal’ — because the ability to emit GHGs is made ‘artificially’ scarcer
it’s only artificial in the sense that it is made scarce by gov action in the form of regulation, but that regulation/scarcity of course reflects the very real impact of GHG emissions in the real world. hence that impact — the ‘negative externality’ — is ‘internalised’ into the market price and thereby gives a price signal to move away from GHG goods and processes
biggest effect will be to finally make energy supply more accurately reflect its true cost to society and the environment, so renewables become much cheaper by comparison. then their use goes way up and renewables themselves become cheaper and cheaper due to economies of scale, innovation, better understanding, etc. etc.
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