Emissions trading actually began in the United States and has been occurring for many years with respect to volatile organic compounds, which lead to ground level ozone pollution or smog in our major cities, nitrous oxides, which also contribute to smog formation, sulfur dioxide, and particulate matter, which has health effects in terms of breathing the particles in and lodging in the lungs. Emissions trading in essence is the ability to trade or buy and sell credits or allowances to emit a particular pollutant.
I first learned about emission markets or cap and trade over 20 years ago in my environmental law class at Harvard Law School from Richard Stewart, who was a professor there at the time. Though I doubted the concept then, I have seen it work in practice in the United States where I have been involved in advising clients on obtaining and trading emission reduction credits in volatile organic compounds, nitrous oxides, and particulate matter. A market also exists for sulfur dioxide emissions, primarily from coal-burning power plants. All of these programs were created through the federal Clean Air Act and similar state statutes that provided the basis for the creation of emission trading programs by the U.S. Environmental Protection Agency and state environmental agencies. Thus, the concept of emissions trading, while derided by the far left and far right, have been working in this country for many years.
Such regulatory and economic systems depend on a concept called cap and trade. A "cap" of total emission of a pollutant in an area and on specific facilities or air emission sources is created to require these facilities to over time reduce their air emissions. This creates a need to purchase credits for "offsets" from other faculties and therefore creates a scarcity in the market and demand in the market for these credits.
Such a cap-and-trade system results in the emergence of a economic incentives and a market for investment in reductions in the emissions of pollutants. As stated above, government agency sets the limit the amount of a pollutant that can be emitted. The emitting entity must find a source of credits to purchase in order to keep operating, or be faced with reducing its level of production, and thereby, its emissions. Alternatively, the entity can install emission control devices or systems and reduce its emissions below the level for which it has been assigned credits. In the event the entity can reduce its emissions to such an extent that it has more credits than it has emissions, it can then sell those credits to other entities that have not found a means to reduce its emissions in a cost effective manner, or that is seeking to expand its operations.
In the international arena under the Kyoto Protocol, those nations that are required to reduce their emissions in the developed world can buy credits within their country, among developed countries, or more commonly what has occurred is they buy credits for reduction in carbon dioxide, or CO2, and other greenhouse gases in developing countries. This program is referred to as the Clean Development Mechanism (CDM), and Certified Emission Reductions (CERs) have been selling in a market that has seen tens of billions of dollars exchanged.
The European Union (EU) has been operating a carbon market called the EU Emissions Trading System (ETS). This system is about to complete an experimental run ending in 2007. The mistake made by the EU was the over issuance of emission trading credits. This led to the collapse of the market in 2007. In the next phase, 2008 to 2012, the EU is working on cutting back on the credits assigned to each member country to avoid an over subscription. Even though the program was going through an experimental stage and some mistakes were made, tens of billions of Euros were invested in carbon reduction projects and in carbon credit trading. As an initial experiment, the ETS demonstrates that a global cap-and-trade system can work to reduce greenhouse gas emissions.
Emission markets are initially created by a government agency, but then are left open to the market to develop reductions and distribute capital, without a centralized planning agency. Thus, the most efficient process for addressing pollution emerges, as those from the science of complexity would say, from the self-organizing process. If set up right, the least-cost approach will develop out of a market-based system in a way that could not be specifically planned and implemented or specifically predicted.
As a result, emissions trading allows what I call self-organizing regulation, whereby individuals and individual entities, without any command-and-control regulation or central planning by governments or otherwise, identify actions, seek and obtain capital, and develop in an organic, self-organizing way the process to reduce pollution. The government acts, like it does in any market, as the developer of laws and regulations that establish and set the general rules for the market, and then the individual participants, what Complexity scientists call "adaptive agents", make their own individual choices and take their own actions. These numerous choices collectively result in the market and the ultimate reduction in pollution. In the right context, emission trading markets provide a more efficient and effective alternative to the traditional command-and-control regulatory system.
