What is emissions trading?
8. There are two main types of emissions trading
systems: cap and trade schemes, and offset schemes. In a cap and
trade scheme, an overall cap on emissions is divided up into individual
emissions permits (EU ETS permits represent one tonne of CO2).
These permits are then acquired byand traded betweenparticipants,
who use them up in line with the emissions arising from their
activities. A participant who runs out of permits must either
buy some from other participants with a surplus to sell, or cease
emitting. The three main benefits of a cap and trade scheme are
intended to be:
- a cap imposing an absolute
limit on the amounts that participating organisations can emit;
- the limited number of permits within this cap
giving them scarcity value, and hence putting a price on carbon
(this is meant to encourage participants to reduce their emissions,
either by adopting more efficient operations or by investing in
low-carbon technology); and
- the ability of organisations to trade permits
allowing emissions reductions to take place in the most cost-effective
9. The most prominent international example of a
cap and trade scheme is the EU ETS. The Government explained how
it is meant to work:
The overall number of allowances allocated should
be set below industry's normal emissions levels; each company
with a shortfall must either reduce its own carbon emissions or
buy allowances from other companies. This enables companies who
can easily lower their carbon emissions to make large cuts in
emissions and sell their allowances to those who find it harder
to do so. The benefit of creating such a market is that it allows
emissions reductions to occur where it is most cost effective.
In the EU ETS, if participants do not have enough
allowances (or project credits) to match their emissions they
must pay a fine.
10. In offset schemes, where there is no overall
cap on emissions, participants receive offset credits (again,
each representing a quantity of emissions) in return for making
investments that should reduce emissions (for instance, in the
construction of hydroelectric dams). Offsets can then be sold
to individuals, businesses or governments to mitigate their own
greenhouse gas emissions voluntarily. For example, a company might
choose to buy offsets to cover emissions associated with its business
travel. We examined the voluntary offset market in 2007
and we do not cover it further in this report. Offsets can also
be bought in order to meet a formal obligation to reduce emissions.
For example, a government in a developed country might buy offsets
from a project in a developing country in order to meet its Kyoto
Protocol targets. Often offset credits do not represent an absolute
reduction in emissions, but rather a reduction below the level
of previously projected emissions growth under 'business-as-usual'.
11. In practice, offset schemes work together with
cap and trade schemes. Offset credits are bought by businesses
that are subject to a cap, to use them as additional permits to
emit. Under the current design of the EU ETS, for instance, over
the period 2008-2020, up to 1.6 billion offset credits, mainly
from the Clean Development Mechanism (paragraph 39), can be used
by European installations as additional emissions permits.
There is a dual rationale commonly given for this relationship
between offset and cap and trade schemes: first, it can be cheaper
for businesses in the developed world to pay for others in developing
economies to make part of their required emissions cuts; second,
this provides flows of funding for climate change mitigation and
adaptation into the developing world.
The Government's twin policy aims
12. The Government has made clear that emissions
trading is one of the most important aspects of its climate change
strategy. In November 2007, in his first major speech on the environment
as Prime Minister, the Rt Hon Gordon Brown MP said: "A global
carbon market is at the heart of our approach, [
the power of the market to set the global price for carbon, rewarding
the most efficient and innovative action to tackle climate change".
In June 2009, the then Minister of State at the Department of
Energy and Climate Change (DECC), the Rt Hon Mike O'Brien QC MP,
told us that the key aim of emissions trading was to set a cap
to ensure emissions were reduced and to get those emissions reductions
at the least cost.
He also spelt out a related but subsidiary aim of creating "a
carbon price [that] will help assist certain technologies and
make them much more viable".
13. In this report we examine how successful the
EU ETS has been in meeting these twin objectives (in Parts 3 and
4), and how emission trading systems might be joined together
to extend their coverage (Part 5).
12 Department of Trade and Industry, The Energy
Challenge, Cm 6887, July 2006, p 28 Back
Sixth Report of Session 2006-07, The Voluntary Carbon Offset
Market, HC 331 Back
National Audit Office, European Union Emissions Trading Scheme,
Fig 23, p 59 Back
DECC, The Road to Copenhagen, Cm 7659, p43 Back
Q 217 Back