Will Carbon Trading Work?

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One of the benefits of carbon trading, as part of a cap and trade program, is that it places an absolute limit on the quantity of greenhouse gas (GHG) emissions. As long as the cap is set below the actual level of emissions, emissions will be reduced. For example, the US cap and trade program on SO 2 and NOx emissions established under the 1990 Clean Air Act Amendments, reduced SO 2 emissions from power plants by 41% from 1980 levels and NOx emissions from power plants by 33% from 1990 levels by 2002. Similarly, the recent proposal for a US cap and trade program on GHG emissions from Senators Joe Lieberman (I-CT) and John Warner (R-VA) was estimated by the Environmental Protection Agency (EPA) to be able to reduce emissions by 40% from the reference case by 2030. (Estimates from the US Energy Information Administration [EIA] were slightly higher, with reductions of at least 45% by 2030.)

Opponents of carbon trading sometimes cite a lack of emissions reductions under Phase I of the European Union Emissions Trading Scheme (EU ETS), the EU cap and trade program on GHG emissions that began in 2005. This occurred because the Phase I cap was set at a level higher than actual emissions for that period. So while the EU met its cap, emissions reductions did not occur as envisioned. Furthermore, the oversupply of emissions allowances caused the price of allowances to fall to below €1, rendering them almost worthless.

To solve this problem, the EU tightened its caps in Phase II and is now on track for emissions reductions. In addition, it began allowing regulated facilities to use their unused emissions allowances for future compliance periods (banking), which has led to a much more stable allowance price in Phase II. Indeed, most new US proposals for a cap and trade program also allow for the banking of allowances: an example of learning from experience that suggest future emissions trading programs are not doomed to repeat the mistakes of the past.