Geoscience Reference
In-Depth Information
up buyers and sellers. Firm A would look for the highest bids, and fi rm
B would seek the lowest offers. They might settle on a price of $25
per ton.
The advantage of establishing a market in allowances is to ensure
that emissions are used in the most productive manner. In our exam-
ple, fi rm A might have stayed in business if it couldn't sell the allow-
ance, but the value might be only $2 per ton. Similarly, purchasing fi rm
B might fi nd that the allowances are actually contributing $202 of net
value in the new product. Hence, by allowing the trade, economic wel-
fare is improved by $200 per ton.
These ideas are not just some wild theoretical scheme. They have
been used in a wide variety of contexts over the last half century. Per-
mits are auctioned for the rights to drill for oil, to harvest trees, and to
use the electromagnetic spectrum. In the environmental area, the most
successful example is the use of allowances to limit the emissions of
sulfur dioxide (SO
2
) since 1990. This program proved very successful in
reducing overall emissions and did so much less expensively than many
analysts had predicted. The U.S. SO
2
program was so successful that it
was used as the basis for the Kyoto Protocol's GHG emissions plan and
then for the European Union's CO
2
Emissions Trading Scheme.
In the context of CO
2
emissions, the cap-and-trade plan squeezes
the most economic value out of the limited emissions. It accomplishes
this through the mechanism of prices and markets, not through gov-
ernmental micromanaging of businesses. Because emissions are capped
below the unregulated or free-market level, they are a scarce resource,
like land or oil. The market price of CO
2
allowances rises high enough
to reduce emissions to the quantitative limit. Just as a high corn price
squeezes corn demand to fi t into the available supply, the carbon price
induces producers and consumers to reduce their use of carbon-
emitting goods to fi t within the capped quantity. A binding cap-and-
trade regime would indirectly lead to a positive rather than zero price
for carbon.
The cap-and-trade idea for CO
2
was implemented by the European
Union through its Emissions Trading Scheme. Figure 35 shows the
