Rationale Behind Emissions Trading Schemes

What are greenhouse gases and what is their impact?

The six main greenhouse gases addressed initially at Kyoto Protocol of 1997 were carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride. Each of these gases have different characteristics and varying impacts on the climate. This is referred to as their Global Warming Potential (GWP). However, carbon dioxide serves as a common denominator, and the GWP of all gases is measured relative to carbon dioxide in metric tonnes of CO2e, tCO2e.’ This can be understood as follows: nitrous oxide has a GWP of 298 which implies it is 298 times as potent as carbon dioxide. 1tN2O = 298tCO2e.

How can capping and trading emissions help stop rising greenhouse gas emissions?

The initial theory of capping and trading emissions had three steps:

• Calculate and place a cap on total global emissions
• Share out permits to reach this global cap on an equal per capita basis
• Buy and sell permits as necessary to cover emissions

The theory was originally suggested by Professor Michael Grubb in his report The Greenhouse Effect: Negotiating Targets (1989).

The main fact underpinning the theory of capping and trading emissions is that although gases are emitted from different locations, the effect on the global environment is the same; the environment does not distinguish where the emissions - or reductions - come from. If permits were allocated on an equal per capita basis, industrialised countries would not have enough permits to cover their emissions while developing countries would have an excess that they could sell.  The countries short of permits would consider whether they could reduce their own emissions (to reach their permitted allocation) or buy more permits from other countries.(Michael Grubb suggested the currency for buying permit would be technology transfer.) In this way, the system not only ensures the global cap is not crossed, but also ensures that it is done in an economic and cost efficient manner. 

How capping and trading works in a practical scenario?

Consider a scenario where factory A emits 10,000tCO2e and factory B emits 8,000tCO2e. If an emissions cap of 9,0000tCO2e is placed and 9,000 permits each to cover 1tCO2e are allocated to both factories, factory A is 1000 permits short. To meet the regulations, they have to reduce emissions either by reducing activity and output, buying new more efficient plant or equipment or by buying an extra 1000 permits from another entity in the market (factory B). If permits are the cheapest option, these will be bought.  As the total number of permits is limited to the mandated pre-agreed total emissions cap, this means both factories meet the regulations and also the environmental goal is met - and all at least cost.