The dynamic described in the image above triggers the emissions trading market (also known as cap and trade (CAT), or emissions trading scheme (ETS).
Cap and trade (CAT) programs are a type of flexible environmental regulation that allows organizations and markets to decide how best to meet policy targets.
This is in contrast to command-and-control environmental regulations (such as best available technology (BAT) standards and government subsidies).
As aforementioned, Emissions trading is a market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants.
A central authority (usually a regional or governmental body) allocates or sells a limited number of permits that allow a discharge of a specific quantity of a specific pollutant over a set time period.
Polluters are required to hold permits in amount equal to their emissions. Polluters that want to increase their emissions must buy permits from others willing to sell them.
Financial derivatives of permits can also be traded on secondary markets, just as it’s done on the stock market.
Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation, or getting access to otherwise hard-to-trade assets or markets.
The allocation problem in emissions trading
The allocation of emission entitlements, the “allowances”, is undoubtedly the most relevant issue in the implementation of an emissions trading scheme.
Each stake holder strives to maximize its allocation of allowances. Consequently, national allocation plans (NAP) are an extremely sensitive issue in political terms.
The emissions trading directive only provides broad criteria for member states concerning how to establish allocation plans.
Consequently, intense lobbying and political struggles could be observed in nearly all the EU member states.
In most cases, those efforts resulted in lax emissions targets, complex special allocations to powerful interest groups and in some cases even in an over-allocation compared to actual emissions.
The issues can get really technical and intricate. Numerous research article have been written on the subject of allocation alone.
On the whole though, ET is still a successful alternative means of controlling pollution For instance, a 2020 study found that although much criticized, the European Union Emissions Trading System (EU ETS) successfully reduced CO2 emissions even though the prices for carbon were set at low prices.
This write up is only to explain what ET is, how it is launched and point out its associated issues.
We at EnvironCompass will keep watching the interest of the viewers in this regard and perhaps delve deeper into the issues should there be enough.