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Trading on Carbon: How Markets Will Save the World

Utilities should plan for U.S.-wide CO2 emissions restrictions that will be more effective than state efforts.

Fortnightly Magazine - January 2007

benefit to this approach is that the emissions reductions are known with certainty. Credits also can be distributed through auction to offset the implementation costs associated with such a program. With a cap-and-trade program, regulators can set a ceiling price for credits based on the penalties imposed for over-emitters. This ensures that the cost of compliance under a cap-and-trade system would not become excessive.

Opponents of a cap-and-trade system say that it would set a limit on annual emissions improvement and therefore only give firms incentive to do the very least. A strict program could result in costs higher than the actual benefits intended, while a cap-and-trade system that includes a “safety valve” would not guarantee compliance.

A cap-and-trade program can be implemented from either of two different approaches—upstream and downstream trading. Upstream trading programs are implemented at the point where carbon enters the economy ( i.e., fossil-fuel importers and producers). Since the number of fossil-fuel producers is concentrated, implementation would be relatively easy. This scenario can be seen as most beneficial since it would place a cap on all potential carbon emissions. Opponents to upstream trading may point out that the impact is too far from the consumer, reducing exposure and incentives to reduce end-use emissions.

Downstream trading focuses on carbon emissions from end users (at the point of combustion). This type of program could be seen as beneficial because it is closest to the consumer and would therefore have the greatest exposure and impact. The difficulty in running such a program comes from the size and diversity of end users.

Initial downstream programs would regulate only the largest carbon emitters—electric utilities. This type of system is similar to that implemented in the European Union. This system also was implemented in the United States in 1995 to reduce SOx and NOx emissions, and has been widely hailed as a success.

The major problem with the SOx/NOx program is that it does not act to restrict concentration of polluting sources. This is not a concern when dealing with CO 2 restrictions, since CO 2 restrictions will be implemented to reduce global, rather than local, concentrations of atmospheric CO 2. Given that the electric utilities market already is comfortable with SOx/NOx trading programs, implementation of a carbon-trading scheme would be relatively easy. The main concern with this approach is that alone, it only addresses roughly 40 percent of the total current carbon emissions.

The Government Option: Carbon Tax, Subsidies, or Grants

A form of emissions control would tax each ton of CO 2 produced. This tax ideally would affect the price of all goods and services associated with CO 2 production. Proponents of this approach say that “a carbon tax would motivate consumers to control emissions up to the point where the cost of doing so was equal to the tax.” In this manner, the tax (cost) can be set to equal the damage created by CO 2.

Opponents of a carbon tax point out that it does not guarantee that the intended target of emissions reduction would be met.