Energy Policies

Cap and Trade

It is consensus among many political analysts that Cap and Trade legislation to reduce the amount of CO2 released into the atmosphere is only a matter of time. So, what exactly does Cap and Trade mean?

Under cap and trade legislation, a government assigns a financial incentive for reductions in pollution. First, an environmental regulatory agency sets a “cap” on the total amount of carbon dioxide that a given group of polluters, such as energy producers, can emit. This pollution level is set slightly lower than the group of polluters’ current emissions. The available emissions are divided up into a set number of permits, each permit giving the right to a certain amount of pollution, usually one ton. Since the cap restricts the amount of pollution allowed and upgrading facilities to be cleaner costs the industry money, the permits take on a financial value.

Companies who are able to reduce their emissions at a low cost can upgrade their facilities and sell their leftover permits to companies whose emissions reductions would be more costly. This flexibility in achieving emissions targets gives industries time to develop technology that will make them compliant and able to obtain emissions goals. Ideally, over time, the cap for the industry is lowered to reduce net carbon emissions.

Cap and trade is an effective way of limiting new pollutant emitting factories from coming on line within a limited area, like the US. However, cap and trade is highly problematic. For a global situation such as climate change, cap and trade in one place is ineffective if the neighboring country or a global trading partner does not limit emissions. If the energy to produce a good is too costly in the US, many manufacturers will simply move their production facilities elsewhere. Secondly, it requires a regulatory agency with enough funding to monitor emissions. It follows that the regulatory agency then must be able to in some way punish non-compliant polluters. Lastly, a major problem with cap and trade is the question of allocation of permits. Some proponents of the cap and trade system suggest that the most permits should be given to the biggest polluters since they face the largest challenges in reducing emissions. Others suggest that carbon permits should be auctioned off, however, this is also problematic because those people who cannot afford permits are unlikely to be able to upgrade their technology in a manner sufficient to meet reduction standards.

For more analysis of this topic, please download Al Weed's article Cap and Trade: The Debate Matters, in MS Word format.

Other Subsections of This Issue

• Carbon Fees
• Decoupling
• Renewable Energy Credits

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