Cap-and-trade

Definition

Cap-and-trade is an environmental policy tool designed to reduce greenhouse gas emissions by setting a limit (cap) on emissions and allowing companies to buy and sell allowances (trade) for those emissions. This system encourages businesses to innovate and invest in cleaner technologies since companies that reduce their emissions can sell their excess allowances to those that need more time to comply with the cap. It combines regulatory oversight with market-based mechanisms, making it a key strategy for climate change mitigation.

5 Must Know Facts For Your Next Test

1. The cap is usually lowered over time, resulting in decreasing overall emissions as companies adapt to the stricter limits.
2. Cap-and-trade systems are implemented at various levels, including national and regional programs, with the European Union Emissions Trading System being one of the largest and most established.
3. The revenue generated from auctioning allowances can be used to fund renewable energy projects and other climate initiatives.
4. Critics argue that cap-and-trade can create price volatility in carbon markets and may lead to companies purchasing allowances instead of making substantial emission reductions.
5. Successful cap-and-trade programs have been shown to achieve significant emission reductions while promoting economic growth, demonstrating that environmental protection and economic activity can coexist.

Review Questions

• How does cap-and-trade create incentives for companies to reduce their greenhouse gas emissions?
  • Cap-and-trade creates incentives for companies by allowing them to profit from reducing their emissions. When companies lower their emissions below the cap, they can sell their surplus allowances to other companies that are struggling to meet the cap. This market-driven approach encourages innovation in cleaner technologies and practices because businesses aim to minimize their compliance costs while maximizing potential revenue from selling unused allowances.
• What are some potential drawbacks of implementing a cap-and-trade system for reducing greenhouse gas emissions?
  • Some potential drawbacks of a cap-and-trade system include market volatility and the risk of 'carbon leakage,' where companies move operations to countries with less stringent regulations. Critics also point out that it may create a false sense of security if companies focus more on buying allowances rather than making actual emission reductions. Additionally, if not properly regulated, it could lead to manipulation or speculation in carbon markets, undermining its effectiveness.
• Evaluate the effectiveness of cap-and-trade as a climate change mitigation strategy compared to other regulatory approaches.
  • Evaluating the effectiveness of cap-and-trade reveals that it often provides a more flexible and cost-effective solution for reducing greenhouse gas emissions compared to command-and-control regulations. By allowing the market to determine how emissions reductions occur, businesses are incentivized to find innovative solutions that work best for their operations. However, its success largely depends on the design of the system, including the stringency of the cap, enforcement mechanisms, and how allowances are distributed. In contrast, other regulatory approaches may enforce specific technologies or practices but lack the adaptive flexibility that market mechanisms provide.

Related terms

Carbon Credits: Permits that represent the right to emit one ton of carbon dioxide or its equivalent in other greenhouse gases, which can be bought and sold in carbon markets.

Emissions Trading System (ETS): A market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants.

Greenhouse Gases (GHGs): Gases that trap heat in the atmosphere, contributing to climate change; the most common are carbon dioxide, methane, and nitrous oxide.