Trading on Carbon: How Markets Will Save the World


Utilities should plan for U.S.-wide CO 2 emissions restrictions that will be more effective than state efforts.

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

Fortnightly Magazine - January 2007

If carbon dioxide (CO 2) emissions restrictions are mandated at a federal level, the method almost certainly will be a cap-and-trade system based on both the European Union and United States emissions trading systems. A cap-and-trade system likely will be chosen over other alternatives for four fundamental reasons: 1) dramatic success of the U.S. SOx and NOx cap-and-trade systems; 2) compatibility with other regional trading frameworks; 3) economic efficiency in distributing credits, and; 4) business acceptance due to flexibility of abatement options.

The U.S. SOx and NOx cap-and-trade system, implemented in 1995, has been hailed widely as a success and has familiarized U.S. companies with emissions trading. However, the major problem with the SOx/NOx program is that it does not restrict a local geographic concentration of polluting sources. SOx and NOx are “local pollutants” that cause the most damage when concentrated within a specific geography. The problem of local concentration does not apply to CO 2, since CO 2 restrictions are designed to reduce global rather than local concentrations of atmospheric CO 2.

To mitigate climate change, a reduction in CO 2 is equally useful regardless of geography. This makes a cap-and-trade program even better suited to CO 2 than to SOx and NOx. The global scope of the climate-change problem justifies that restrictions be implemented at a federal rather than at a state level, and it ensures that the restrictions eventually will be extended to facilitate a global emissions-trading system.

Although the U.S. federal government has not yet taken steps to limit CO 2 emissions, many states have taken the initiative to develop their own restrictions. 1 In September 2006, California passed legislation that would reduce its current CO 2 emission levels 25 percent by the year 2020, bringing the state’s emissions to 1990 levels. The legislation also mandates a reduction of CO 2 emission to 80 percent below 1990 levels by 2050. To assist in this effort, California plans to participate in a cap-and-trade plan already in development with seven Northeastern states. 2

With multiple other states considering similar measures, it is easy to assume that federal CO 2 emission restrictions are no longer a question of “if” but “when.” These restrictions can be enacted in the following ways: 1) cap-and-trade; 2) carbon tax; 3) subsidies, grants or tax incentives; and 4) a combination of approaches.

How Cap-and-Trade Works

Cap-and-trade sets an annualized emissions limit over specific geographies and industries. Within this limit, or “cap,” firms would be able to sell or trade the rights to these emissions. This program imposes the lowest cost for a given cap since the industry is able to pursue the lowest cost-abatement options. An obvious