Pros and Cons of Carbon Trading

The effectiveness and costs of any carbon trading scheme depends on its structure and method of permit distribution.

Cap and Trade:

Under a Cap-and-Trade scheme, an explicit national cap is set on greenhouse gas emissions. That cap is then divided into tradable permits, which are then distributed to all regulated firms for a a set fee, through an auction, for free, or though a combination of those methods. As the number of tradable permits remains constant, achieving the countries emissions target is easy, albeit costly. A notable example includes the Clean Air Act of 1990, which implemented a successful sulfur dioxide and nitrous oxide trading system, within five years, participating power plants reduced emissions by more than 20% at a cost less than one-third of the lowest estimates originally made.

Baseline and Credit:

Under a baseline and credit scheme, an implicit national cap is set on greenhouse gas emissions. The cap is constructed as the sum of individual baseline levels of emissions for all regulated firms. That is the key difference between baseline and cap and trade. Under cap and trade the number of permits is constant. Under baseline, they aren't. The reason is that the baseline is constructed as the product of firm size and a constant which measure desired firm efficiency (in terms of emissions vs energy usage). As a firm grows in size, its baseline increases, as the efficiency constant remains the same. The effectiveness of this type of plan is held to be reduce their emission to 5.2% below their 1990 baseline by 2012. However, since the protocols creation in 1997 there have been several revisions, and most participatory nations have formed their own carbon trading markets, like the EU.

General Costs vs Benefits:

When permits aren't distributed at auction, the costs of polluting are reduced, lowering the effectiveness and economic impact of the scheme. So, phase 1 of the EU's scheme which had a very small impact on lowering emissions, also had a very small cost, estimated at 1%-1% of GDP over the scheme's 3 years (.033%-37% on an annual basis) The costs and benefits of carbon trading are, therefore, looked at in two ways. One, in the benefits accrued in the future versus the costs borne in the present, and two, the effectiveness of carbon trading versus the effectiveness of other forms of regulation, like carbon taxes, federal grants or tax incentives for research into clean energy and energy efficiency.

In terms of the first, although there is scientific consensus that global warming is occurring and that it will cause a loss of agricultural output, a loss of biodiversity, an increase in water scarcity, an increase in the spread of disease, an increase in coastal flooding and shoreline erosion, and an increase in environmental insurance expenses, there is no consensus on the magnitude of said changes. According to the Stern Review, the costs of global warming will reach numbers like $9 trillion dollars, well above the costs of carbon trading. ON the other hand, other estimates place the costs at $100 billion, below the costs of carbon trading. However, combined with the eventual reality of peak oil, there is scientific consensus that global warming mitigation strategies like carbon trading deserve serious and possible implementation.

Carbon Trading vs. Carbon Taxation:

Carbon trading's largest competitor is carbon taxation. Taxation is simpler. Find out how much fossil fuels a company is using and a government can accurately estimate its level of carbon emissions.Then, apply a fixed fee for every ton of estimated emissions. There are fewer outcomes involving failure, where the cost of pollution becomes disproportionately high or low. On the other hand, carbon trading schemes involve an implicit or explicit cap in emissions, while estimating the long-term impact of a tax on polluting behavior would involve a lot of guesswork. Furthermore, it often makes sense for a company in a hard environmental situation to simply pay another company to reduce carbon emissions, rather than spending the resources required to do so for itself. With taxation, the burden can't be traded on the market to the companies most cheaply able to carry it. Also, carbon trading already has a lot of support internationally (the Kyoto Protocol). More important than all of that, however, is the design of the strategy picked, rather than the type of strategy. Both strategies have the potential to fail (or succeed) depending on the details. For the market, both strategies make polluting carbon more expensive, with the key difference that taxation would cut financial intermediaries out of the picture.

Source: "WikiInvest"