Carbon emissions trading, or cap and trade, places an economic cost on carbon emissions, with a government setting a price and cap on emissions. Companies can reduce emissions or buy credits from others. Human-related carbon emissions upset the balance of CO2 in the atmosphere, causing a warming effect. Cap and trade was invented in the US in the 1960s and evolved into the EU. Critics argue it diverts motives from conservation to profit.
Carbon emissions trading, also known as cap and trade, is an environmental policy device that places an economic cost on carbon emissions. A government sets a price for carbon emissions and companies then have to pay for the amount of carbon they produce, creating an economic incentive not to pollute. In a cap and trade system, governments also set a cap, or limit, on the amount of carbon each company can emit. Companies can then reduce their emissions to operate below the limit, or they can operate above the limit and buy emission rights from another company. Cap and trade is the traditional model for carbon emissions trading, but there is also an alternative model, called baseline and credit.
Carbon dioxide (CO2) emissions occur when carbon dioxide is released into the atmosphere, either naturally or through human activities such as the burning of fossil fuels. The Earth has natural processes that remove carbon from the atmosphere, so natural carbon emissions, such as the respiration of animals and plants, do not dramatically change the carbon concentration in the atmosphere. Human-related carbon emissions, however, have upset this balance so that the concentration of CO2 in the atmosphere has increased dramatically since the Industrial Revolution in the 1700s. This creates a problem because carbon dioxide is a greenhouse gas, a gas that it traps heat as it travels away from Earth into space. If there is too much CO2 in the atmosphere, too much heat will be trapped on Earth, creating a warming effect that could have life-threatening effects.
The U.S. National Air Pollution Control Administration invented carbon trading in the late 1960s and began incorporating components of emissions trading into U.S. environmental policy in the Clean Air Act of 1977. The cap and trade continued to evolve into the US acid rain program and was eventually implemented in the European Union. The coverage of carbon trading programs has expanded to include many sources of emissions and business and government sectors.
The main components involved in a cap and trade scheme are cap, hedging and tracking. An international, federal or local governing body sets the cap, a fixed amount of carbon a source can emit. The government then decides on the coverage, i.e. the sectors and carbon sources that must comply with this limit. To ensure compliance with this limit, systems must also exist to monitor sources, checking and verifying the reporting of each source of carbon emissions. Sources, however, can go over their allowances, or over their limit, if they have negotiated with another source.
Imagine that there are two companies, Company X and Company Y, which must meet the same emissions limit and carbon prices. Both companies have to pay five dollars per unit of carbon production and can only emit up to ten units a month. Company X emits only eight units of carbon per month, giving it two extra credits, and Company Y regularly emits twelve, meaning it produces two more units than it is allowed to. Company X can save or store its two unused credits in case it exceeds its deductible in the future, or it can sell its credits to a company that emits more carbon, such as Company Y. Company Y can buy these credits or it can reduce its carbon production by two to meet the limit.
Emissions trading ensures that collective carbon production is at or below the limit, even when a single company releases more than its carbon quota. Alternatively, a basic carbon emissions trading and credit program does not put a cap on carbon emissions. Instead, sources get credits by reducing carbon output below a certain baseline level. These credits can then be purchased by companies operating under a cap and trade program, so there is still an economic incentive to reduce carbon output and an emphasis on collective emissions reductions. Critics complain, however, that carbon trading diverts motives away from conservation towards the drive for profit and that it narrows the scope of climate change efforts.
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