An emissions trading system is designed to achieve a reduction of a specific type of pollutant through the use of exchangable emission permits. In an emissions trading system, the regulator (a summarizing expression for policy makers) determines an aggregated emissions target for a given type of pollutant(s). The aggregated emissions level is then allocated among the regulated industries, either by free distribution (grandfathering) or auction. Emissions trading will take place if firms faces asymmetrical emissions reduction costs (abatement costs). The firms with relatively low emission reduction costs compared to other firms can have an incentive to invest in emissions reductions (technologies) and sell the excess permits in the market. This exchange process will ensure that the reductions takes place at the most efficient firms or countries, and this ensures that both buyers and sellers are better off.

Contents 1 Background 2 Tradable vs non tradable permits 3 Trading and economic efficiency 3.1 Advantages 3.2 Examples

BackgroundEdit

The US was the first country to introduce emissions trading in the mid-1970s. The fundamental idea was to combine direct "command and control" regulations with market based instruments. Since the mid 1970s emissions trading has grown to be the preferred tool for international environmental regulation. Ref: The Kyoto Protocol, the EU ETS, the US Clean Air Act etc.

Tradable vs non tradable permitsEdit

An effective emissions trading scheme must be a tradable (cap and trade). A tradable emissions permit system is the most widely used design and the reason for this is that the emissions target can be reached at a lower cost compared to a non tradable scheme. Under a tradable scheme the regulator only settles the emissions target (or cap) and let the market find the cheapest way to meet any necessary emission reductions. The Kyoto Protocol and the European Union emissions trading system (called the EU ETS) are both based on this approach.

Trading and economic efficiencyEdit

Emission reductions are achieved at a lower cost than other policy approaches. For a emissions tax regime to be as effective as tradable permits, the regulator need perfect information.

AdvantagesEdit

• The total emissions is reduced as determined by the aggregated emissions cap and therefore considered a "quantity-based" policy instrument. This also makes emissions trading more conducive to international environmental agreements, such as the Kyoto Protocol, because specific emissions reduction levels can be agreed upon more easily than tax rates etc. Emissions trading can be seen as more equipped than taxes to deal with all six GHGs included in the Kyoto Protocol in one comprehensive strategy.

• A well functioning emissions trading system allows emissions reductions to take place wherever abatement costs are lowest. If emissions reductions are cheaper to make in Poland than in Norway, emissions should be reduced first in the former where costs are lower.

• Emissions reductions can contribute to R&D and the implementation of improved technology

• Since the aggregated emissions target is given and that the reallocations of permits will be solved in the market, the administration costs can be reduced compared to command-and-control regulation

ExamplesEdit