Will Carbon Trading Work?

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The idea behind carbon trading - to allow those who can reduce emissions at low cost to sell emissions allowances to those who can only reduce emissions at high cost - is not new. It’s this difference in relative costs that underpins any kind of trade.

In practice, the gains from trade enable policymakers to meet emissions reduction goals at the lowest possible cost. For example, the cost of meeting the emissions reduction goal in the US cap and trade program for SO 2 and NOx emissions was just one quarter of the original estimates.  

In addition, the ability of participants to use credits from project-based emissions reductions (offsets), from sectors and countries that are not regulated by the cap, can even further reduce the cost of the program. An EPA analysis of the US cap and trade program proposed by Senators Lieberman and Warner estimated that emission allowance prices would fall by 71% if the use of domestic and international offsets were permitted without limitation.  

Some opponents of emissions trading and offsets argue that allowing entities to buy emissions reductions enables them to put off difficult structural changes. The problem with this criticism is that the implied alternative of forcing energy-intensive industries to make significant emissions reductions on their own means that many will have to retire valuable high-carbon assets and some will have to shut down completely. This is neither realistic nor necessary. If a cap and trade program is designed with sufficient longevity and tight enough caps, industries will gradually be required to transition to lower-emitting processes, at the same time ensuring that the needed emissions reductions begin today.

Of course, for trading to work, especially with regard to project-based offsets, rules need to be in place to ensure that an offset does what it promises, which is reduce emissions. To this end, a number of quality standards, which can be incorporated into cap and trade programs, have been developed to ensure that an offset represents a real emissions reduction.