Cap and Trade

A general issue with cap and trade programs has been over-allocation, whereby the cap is high enough that sources of emissions do not need to reduce their emissions.

Some of the key problems with cap and trade are:

The “cap” has too many holes and sometimes caps nothing. The cap is only as tight as the least stringent part of the system. This is because permits are sold by those with a surplus, and the cheapest way to produce a surplus is to be given too many permits in the first place.

The “trade” component does not require any emissions reductions. It simply allows companies to buy cheaper “emissions allowances” or “carbon offsets” which are supposed to represent emissions reductions elsewhere.

Offsets burst the cap. While cap and trade in theory limits the availability of pollution permits to trading between polluters, offset projects are a license to print new, even cheaper and less regulated ones. Virtually all current and proposed cap and trade schemes allow offset credits to be traded inside them through “linking mechanisms” – including the European Union Emissions Trading System (EU ETS) and a proposed cap and trade scheme in California, USA.

Locking in pollution. In chasing after the cheapest short-term cuts, cap and trade tends to encourage quick fixes to patch up outmoded power stations and factories – delaying more fundamental changes. What is cheap in the short-term does not translate to an environmentally effective or socially just outcome over the long-term.

The price will never be right. Carbon markets claim to set a “price signal” that encourages polluters to switch to cleaner technologies. But carbon prices are incredibly volatile and prone to major crashes –  in large part because “carbon” is a commodity that does not exist as a single entity outside of the numbers displayed on trading screens. The result is that these markets emit, at best, a very weak signal. The practice of “hedging” carbon permit prices against shifts in energy prices and currency exchanges then cancels out this signal altogether.