Emissions Trading - The Basics

Introduction

Emissions Trading is a market-based instrument used for environmental protection. It has been adopted as one of the primary tools for international cooperation to reduce greenhouse gas emissions under the Kyoto Protocol.

Tradable rights for pollution control were first proposed in 1968 and trading programmes have been implemented to reduce emissions of SOx, NOx , CO2 and other pollutants.

Where is it Operating?

Emissions Trading Schemes (ETS) are increasingly becoming the preferred greenhouse gas policy instrument.

 

on a regulated basis:

  • worldwide: the Kyoto Protocol
  • regional: The EU ETS
  • domestic: UK-ETS, NZ ETS (to be amended), Au CPRS (to be legislated)

 

or on a voluntary basis:

  • Chicago Climate Exchange (CCX)

How does it Work?

By giving an economic value to each unit of emissions reduced, emissions trading creates an incentive to find ways to lower the cost of emission control technologies and to implement measures that reduce emissions.

 

There are three basic types of emissions trading programmes:

  • 'cap and trade'
  • 'baseline and credit' and
  • 'offset'.

Cap and Trade

Cap and Trade is becoming the dominant system design and is in use in the biggest market the EU ETS and is the basis for the NZ ETS and Au CPRS.

In a cap and trade programme, the regulator establishes an overall limit on emissions - the 'emissions cap' - the total amount of a pollutant that the participants in the programme are allowed to emit in a given period (e.g. emission of a number of tonnes of the pollutant per year). Allowances equal to all of the emissions permitted under the cap are then distributed. There are two types of distribution: free or by auction. Once the allowances are distributed, they may be traded freely.

Baseline and Credit

The participants in a baseline and credit (or 'averaging') programme have to 'earn' credits before they can begin trading. First, an emission baseline is defined for each participant by the regulator.

Each participant then makes reductions and monitors or calculates its actual emissions using specified procedures. At the end of the compliance period, the regulatory authority compares the baseline calculation with the actual emissions from the source during the period. Participants whose actual emissions are lower than their baseline receive 'credits' equal to the difference. Credits can then be traded freely. A participant whose actual emissions exceed its baseline must purchase credits equal to its excess emissions to achieve compliance.

Offset

Offset programmes are used to compensate for (i.e. offset) the additional emissions from a new source or expansion of an existing one. Under such schemes those responsible for the new or expanding source purchase credits equal to emission reductions achieved by existing sources. The requirement to offset is mandatory for the new or expanding source but the decision by existing sources to reduce is voluntary. In effect, the existing sources are given a free allocation equivalent to the baseline from which their emissions reductions are calculated. For the new and expanding sources, the baseline is any emissions they are not required to offset; if they are required to offset all of the increase in their emissions the baseline is zero.

What is the Currency of trading?

The currency of carbon trading is a tonne of carbon dioxide equivalent or tCO2e. This is commonly abbreviated to a unit of carbon and this can be confusing to all involved. Even though the industry refers to carbon trading the trades are measured in tonnes of CO2e.

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