Trading of emissions

California is already capping emissions and is allowing trading of emission allotments, and a dozen northeastern states are copying these cap-and-trade strategies in order to reduce the emissions of their power and transportation industries. 

Directly, the cost calculations can be a basis for restricting emissions using economic instruments such as emission fees or trading of emission permits. This might, for instance, have important applications for emissions of dioxins and other substances from combustions. The examples above indicate that the costs of a detriment can be substantial in relation to the value of the product, which is usually in the range of 1-10 Euros per kg. Consequently, such economic instruments might be expected to lead to substantial reductions in emissions. 

The 1990 Clean Air Act amendment (CAAA) further reduced SO2 emissions to 50% of their 1980 levels by the year 2000, and caps SO2 emissions at that level. The new standards not only affect new sources, but also require a constant total emissions allowed from all electric utility generation rmits of 8.1 x 10 metric tons of SO2 per year. The Act contains provisions for trading of emission allowances among units in order to achieve the most econorrrical application of control technologies. 

A tradable permit system is defined as quantity-based environmental policy instrument. The regulatory authority stipulates the allowable total amount of emissions (cap) and the right to emit becomes a tradable commodity. Under a cap-and-trade system, prices are allowed to fluctuate according to market forces. Thus, the price of emissions is established indirectly. Permits could be allocated to firms through auction or free allocation. 

Second, it is possible to establish an agreement that sets quantitative limits of emissions and allocates emission permits to firms (or States) but allows to trade among countries, in order to minimize abatement costs. The starting allocation of permits can be set through either an auction or a grandfather allocation. Under an auction, government (or the international community) sells the emission permits, whereas under the grandfather rule, the allocation of emission permits is based on historical records. 

International emissions trading Annex-I parties may trade their emission allowances with other Annex-I parties. The aim is to improve the overall flexibility and economic efficiency of emissions cuts. 

The business-led ETG offers a forum for discussion and resolution of all aspects of emissions trading and enables communication to take place between commerce and industry, and the UK Government. 

Second, information was gathered through contacts with EPA Regional, State, and local air pollution control agencies. Copies of emission test results were requested and analyzed to determine the effect of burning tires either as the sole fuel or as a supplemental fuel. Permit applications and permits were reviewed to determine the processes using tires, the control techniques used, the limits set, and the permit conditions under which the permits were approved. Trade associations provided information on companies burning tires, and other available information. 

Although unprecedented in its scale and scope, the main pillars of the EU ETS were built on many years of economic research into theories of emissions trading, combined with practical experience of emission trading schemes principally in the USA. Yet the analogies are far from exact, and the emerging experience with the EU ETS is beginning to highlight the profound nature of the differences - many of which have thus far been under-appreciated in economic and policy analysis. 

Box 1 Five principles underlying the economic impacts of emissions trading... 

The aim of emissions cap-and-trade is to secure emission reductions at the lowest possible overall cost the trading allows companies to seek emission reductions to meet the aggregate cap wherever and however it is cheapest to do so. Five principles underlie the practical economic impact of an emissions trading system applied to C02 ... 

Some other analysts express the opposite concern, that prices might rise to levels deemed to pose an unacceptable risk to European industry, and that to prevent this risk the system should contain a price cap or safety valve (e.g. Bouttes et al., 2006). Our assessment of phase II, in terms of both supply-demand balance and the economics of competitiveness over the 5-year period, leads us to be sceptical that this is a realistic concern. It is, however, true that a planned response to any such eventuality would be better than a panic-based reaction such as occurred in the California NOx trading system. Should prices rise to levels that were judged to pose a credible threat to competitiveness of a particular sector, and State-aid rules prevented auction revenues being used to assist it (or the country concerned had not conducted any auctions), the most obvious first step would be to relax supplementarity constraints, and possibly expand the scope of emission credits that could qualify for compliance purposes. We do not consider issues of price ceilings or safety valves beyond this. 

The EU ETS is a cap-and-trade system based primarily on the free allocation of a fixed amount of emission allowances to a set of covered installations. Companies can either use these allowances to cover the emissions resulting from the production of these installations or sell them to other companies that need additional allowances (Reinaud, 2005). Hence, for a company using an emission allowance, this represents an opportunity cost, regardless of whether the allowances are allocated for free or purchased at an auction or market. Therefore, in principle and in line with economic theory, a company is expected to add the costs of C02 emission allowances to its other marginal (variable) costs when making (short-term) production or trading decisions, even if the allowances are granted for free (Burtraw et al., 2002, 2005 Reinaud, 2003). 

An important question is how the pass-through of C02 opportunity costs affects the profitability of power stations. A main purpose of the free allocation of emissions allowances under the US cap-and-trade programmes for S02 and NOx, as well as under the EU ETS for C02, is to obtain the political support of large emitters. Thus, the free allocation aims to ensure that the introduction of the ETS does not reduce the profitability of the eligible companies. 

As COMPETES includes detailed information at the operational level for all (major) power companies in the countries covered by the model, it can also be used to estimate the impact of emissions trading on firms profits at the aggregated level as well as at the level of major individual companies. Such quantitative results are helpful in order to understand the qualitative impact, but the numbers should only be taken as an indication of the order of magnitude involved. We discuss this aspect in more detail at the end of the section. 

Once the additional profits due to grandfathering are accounted for, however, all companies benefit from emissions trading under both scenarios presented in Table 4. As coal- and other carbon-intensive companies (such as RWE, STEAG AG and Vattenfall Europe) receive relatively large amounts of C02 emission allowances for free, they benefit relatively more from this effect of emissions trading on firms profits. 

The 25 national allocation plans (NAPs) established autonomously by the EU Member States (MSs) are central to the EU emissions trading scheme (ETS). According to Articles 9-11 and Annex III of the ETS Directive (2003/87/EC), NAPs must state how the total quantity of emissions allowances will be distributed to installations within their jurisdiction for each trading phase. The process of deciding the second phase allocation is currently under way. Each MS must submit their NAPs for 2008-2012 to the EU Commission by 30 June 2006. Over the subsequent 3-month period, these will be assessed by the Commission according to criteria outlined in the Directive. 

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