Emissions trading
Emissions trading, also known as cap and trade, is a market-based approach to control air pollution and reduce greenhouse gas emissions. It originated under the US Clean Air Act Amendments of 1990, specifically targeting sulfur dioxide (SO2) pollution. In this system, government-issued emission permits, or allowances, can be bought and sold among various entities, allowing for flexible compliance with pollution reduction targets. The US's sulfur dioxide program was the world’s first application of emissions trading, demonstrating significant reductions in emissions at lower costs than expected.
Globally, emissions trading gained traction with the development of the Kyoto Protocol, which established a framework for trading greenhouse gas emissions among participating countries. The system includes various types of credits, such as Certified Emission Reductions (CERs) and Emission Reduction Units (ERUs), which can be generated through specific projects aimed at reducing emissions. The European Union Emission Trading Scheme (EU ETS) is a prominent example of this international compliance market.
In addition to regulated markets, there are voluntary emissions trading systems, notably the Chicago Climate Exchange, which predate the Kyoto Protocol. More recently, the Paris Agreement has further shaped the landscape of emissions trading by encouraging international cooperation and the transfer of credits to assist countries in meeting climate targets, emphasizing the importance of collective action against climate change.
Subject Terms
Emissions trading
Summary: Emissions trading began under the US Clean Air Act Amendments of 1990 to control sulfur dioxide pollution and has now evolved into a global marketplace for greenhouse gas emissions trading.
Emissions trading, which is referred to as cap and trade, is a mechanism to address air pollution. Essentially, government-issued emission permits (allowances) and project-based emission reductions (credits or offsets) are traded between buyers and sellers.
The United States sulfur dioxide (SO2) program was the world’s first emissions trading scheme. In 1970, the US Congress passed the Clean Air Act, and on December 2, 1970, the US Environmental Protection Agency (EPA) was established.
The Clean Air Act Amendments of 1990 brought major revisions to US environmental policy by focusing on acid rain, urban air pollution, and toxic air emissions. In the 1990 amendments, there were seven major revisions (titles), and while each of the seven titles was important, the most relevant to the emergence of emissions trading was Title IV.
Title IV, “Acid Deposition Control,” created two phases: Phase one required 110 power plants to reduce emissions to a 1985–87 baseline level starting in 1995, and phase two required 2,000 utilities to reach the same baseline level of 1985–87. In order to monitor levels, sources were mandated to install systems to track progress and assure compliance.
Allowances were granted to sources and gave utilities the ability to trade allowances among themselves. Title IV also required sources always to have adequate allowances, or they were subject to a fee of $2,000 per ton and required to offset the emissions the following year. This was the foundation of emission trading to address air pollution.
According to the Environmental Defense Fund, the emissions trading system devised for SO2 accomplished greater reductions in a shorter time period with fewer costs than originally predicted.
One essential question is whether the same model, which was effectively implemented for SO2, could be utilized to address greenhouse gases (GHG). While SO2 in the United States largely came from coal-fired power plants in the Midwest, global climate change was caused by anthropogenic GHG emissions, which came from a larger sectoral and geographic collection of sources. Nevertheless, a functioning international compliance market for trading GHG emissions and a voluntary GHG market was established.
The International Compliance Market
The Intergovernmental Panel on Climate Change (IPCC), according to its website, was created in 1989 by the World Meteorological Organization and the United Nations Environmental Programme to “provide the governments of the world with a clear scientific view of what is happening to the world’s climate.”
The IPCC’s findings greatly contributed to the development of the United Nations’ Framework Convention on Climate Change (UNFCCC), which was entered into on March 21, 1994, and was ratified by 191 countries plus the European Union. With the UNFCCC in place, the Kyoto Protocol was established (again per the IPCC Website) as “an international and legally binding agreement to reduce greenhouse gas emissions worldwide, [and] entered into force on 16 February 2005.”
Under this treaty, Annex I countries were required to meet their targets primarily through national measures, but the Kyoto Protocol offered an additional three market-based mechanisms: emissions trading, the clean development mechanism (CDM), and joint implementation (JI). The CDM and JI were project-based certification standards for the generation of certified emission reductions (CERs) and emission reduction units (ERUs). Under the CDM, an Annex I party could earn tradable credits by supporting a project hosted in a non-Annex I country (for example, Italy could fund a wind energy project in China) to earn CERs. Under the JI, an Annex I party could support a project in another Annex I country to earn ERUs.
It is also important to note that CERs and ERUs are distinct from assigned allowance units (AAUs), which are permits issued to Annex I countries for the right to pollute 1 metric ton of carbon dioxide equivalent emissions (CO2e). European Union allowances (EUAs) are permits granted under the European Union Emission Trading Scheme (EU ETS) to specific polluting installations for the right to emit 1 metric ton of CO2e. Thus, the international compliance market for emissions trading incorporates CERs, ERUs, and EUAs and is exemplified by the EU ETS.
The Voluntary Market
Although the United States did not ratify the Kyoto Protocol, it has developed a robust voluntary emissions trading system, which actually preceded the international compliance market and the Kyoto Protocol.
The origins of this GHG emission trading scheme, while being influenced by Title IV of the Clean Air Act Amendments of 1990, was originally researched and then later founded as the Chicago Climate Exchange (CCX) by Dr. Richard Sandor in 2000–01. The CCX, along with the European Climate Exchange and the Chicago Climate Futures Exchange, was owned by the InterContinental Exchange.
As the CCX was the first trading system for carbon dioxide emissions, the CCX led to the development of global industry and specifically an interconnected system of trading exchanges, registries, and certification standards.
The Paris Agreement
The most significant change in the world of emissions trading since the Kyoto Protocol came with the establishment of the Paris Agreement in the mid-2010s. First negotiated by 195 members of the 2015 United Nations Climate Change Conference and signed into force the following year, the Paris Agreement was a major international climate accord aimed at addressing the growing threat of climate change. It stressed the need to limit global warming to 1.5 degrees Celsius by the end of the century.
Article 6 of the Paris Agreement tackled concerns about emissions trading by providing a framework through which countries could voluntarily cooperate in order to reach their climate targets. Specifically, Article 6 allowed countries to transfer the credits they earn by reducing greenhouse gas emissions to aid one or more other countries in reaching their climate targets. Article 6 also established a carbon crediting mechanism designed to encourage countries to embrace more ambitious climate goals by identifying and promoting opportunities for verifiable emission reductions, attracting the funding necessary for their implementation, and allowing for cooperation between countries and other entities to capitalize on these opportunities.
Bibliography
“About CTX.” Carbon Trade Exchange.
“The Cap and Trade Success Story.” Environmental Defense Fund.
“Convention.” United Nations Framework Convention on Climate Change.
“Emission Reduction Commitment.” Chicago Climate Exchange.
“Emissions Trading System.” European Commission Climate Action.
“History.” Intergovernmental Panel on Climate Change.
“Overview: The CAA Amendments of 1990.” US Environmental Protection Agency.
“Paris Agreement Crediting Mechanism.” United Nations Climate Change, 2024, unfccc.int/process-and-meetings/the-paris-agreement/article-64-mechanism. Accessed 1 Aug. 2024.
“What Is Emissions Trading.” US Environmental Protection Agency, 14 Nov. 2023, www.epa.gov/emissions-trading-resources/what-emissions-trading. Accessed 1 Aug. 2024.