Emissions trading systems

Definition

Emissions trading systems (ETS) are market-based approaches designed to reduce greenhouse gas emissions by allowing companies to buy and sell allowances that permit them to emit a certain amount of pollutants. These systems create a financial incentive for companies to lower their emissions, as they can sell excess allowances if they emit less than their allocated limit. By capping total emissions and enabling trading, ETS aim to promote cost-effective reductions in pollution while encouraging innovation and investment in cleaner technologies.

5 Must Know Facts For Your Next Test

1. The main goal of emissions trading systems is to reduce overall greenhouse gas emissions in a cost-effective manner by creating a financial incentive for companies to lower their pollution levels.
2. ETS typically involves setting a cap on total emissions for regulated sectors, which is gradually reduced over time to drive down overall pollution levels.
3. Companies that reduce their emissions below their allocated allowances can sell their surplus credits to others that are struggling to meet their limits, thus creating a flexible compliance mechanism.
4. Several countries and regions have implemented ETS, including the European Union with its EU Emissions Trading System, which is one of the largest and most established systems worldwide.
5. Critics argue that while ETS can be effective, they may also lead to market manipulation, loopholes, or inadequate caps if not designed and monitored properly.

Review Questions

• How do emissions trading systems incentivize companies to reduce their greenhouse gas emissions?
  • Emissions trading systems provide financial incentives by allowing companies that reduce their emissions below a set limit to sell excess allowances to those who exceed their limits. This creates a direct economic benefit for companies that invest in cleaner technologies or processes. Additionally, the overall cap on emissions decreases over time, which encourages ongoing reductions as the market adjusts and competition among firms increases.
• Evaluate the effectiveness of emissions trading systems in achieving environmental goals compared to traditional regulatory approaches.
  • Emissions trading systems can be more flexible and cost-effective than traditional regulatory approaches because they allow for market-driven solutions to pollution reduction. Companies can choose how to achieve compliance, whether through technology upgrades or purchasing allowances. However, their effectiveness depends on well-defined caps and enforcement mechanisms; poorly designed systems may fail to drive significant emissions reductions or lead to inequities among businesses.
• Assess the potential economic implications of implementing an emissions trading system on both local industries and global markets.
  • Implementing an emissions trading system can have mixed economic implications. Locally, industries may face increased operational costs due to purchasing allowances, which could affect competitiveness if neighboring regions lack similar regulations. Conversely, it may spur innovation and create new markets for green technology. Globally, such systems can lead to a shift in investment towards cleaner technologies but could also result in carbon leakage if companies relocate operations to areas with less stringent regulations, potentially undermining the environmental goals of the system.

Related terms

cap-and-trade: A system where a limit (cap) is set on total greenhouse gas emissions, and companies can trade allowances to emit within this cap.

carbon credits: Certificates that represent the right to emit one metric ton of carbon dioxide or its equivalent in other greenhouse gases, which can be traded in carbon markets.

carbon market: A marketplace where carbon credits are bought and sold, enabling the trading of emissions allowances under various regulatory frameworks.