Cap-and-trade

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Cap-and-trade markets, in their simplest form, put a cap on the amount of greenhouse gases certain countries or industries are allowed to emit. Participants in those networks are alloted, either through auctions or for free, carbon dioxide (CO2), sulfur dioxide (SO2) or nitrous oxide (NO2 or NOx) emission credits. If, say, a power plant exceeds its carbon credit allocation, it must then buy carbon credits from others in the market in order to meet its emissions levels. If that power plant is able to lower its emissions under the set emissions level, it may sell them. The level of over overall emissions are then reduced gradually, theoretically making carbon credits more expensive as time goes forward.

There are several cap-and-trade markets around the world. The U.S. federal government defined the first emissions cap-and-trade market for sulfur dioxide under the Clean Air Act of 1990. The federal SO2 trading that began in 1994 across the U.S.--Southern California’s Regional Clean Air Incentives Market (RECLAIM)--was the first program to implement cap-and-trade markets in 1993. The NOx cap-and-trade market began in 1999 for the Ozone Transport Commission. [1]

The European Union Emissions Trading Scheme or EU ETS was the first CO2 cap-and-trade market created for the EU countries in January 2005. A growing OTC market emerged from EU ETS as well as several exchanges including European Climate Exchange, Nord Pool, Powernext now renamed as BlueNext and European Energy Exchange. Another carbon cap-and-trade market is being set up in the U.S. by the Regional Greenhouse Gas Initiative, or RGGI, which is aimed at utilities in nine northeastern states. The first auction is set for September 2008.

Success Factors

Experience in North America and Europe demonstrate key elements are critical for success of any greenhouse gas and trade program in the United States. These are:

  • Emissions reporting and vertication are critical for setting and meeting the cap. The cap can be met only by using rigorous methods and procedures for measuring, reporting and verifying facility emissions.
  • Reliable tracking of allowances, offset credits and market activity is needed. A tracking system provides certainty regarding the ownership and status of allowances and offset credits, and generates confidence in the market system.
  • Penalties must be in place and enforced. A level must be set that is substantially higher than the market price of allowances.
  • Transparency is important for planning. Having access to up-to-date information on market conditions is important to enable capped and other market participants to forecast allowance demand and to plan for compliance.
  • A liquid allowance market provides entities with compliance opportunities. The design of the cap and trade system can greatly influence the liquidity of the market. Such as reducing transaction costs of trading - such as trading platforms, participation of market intermediaries, and simply and straightforward trading rules and auctions can all help add liquidity.
  • Market oversight can prevent market manipulation. Evolving GHG markets will need greater transparency and greater market oversight compared to other air markets due to the fact projections are the GHG markets will be much larger. [2]

References

  1. Cap-and-trade. Global Environmental Markets.
  2. Cap And Trade Success Factors. APX.