Harnessing the Opportunity of Carbon Cap-and-Trade

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Symbol CO2 from clouds
Source: ZE

In recent years, there has been a growing worldwide effort to reduce carbon emissions. Many initiatives are in place to reduce or minimize the effect of carbon emissions, including the introduction of stricter energy and fuel efficiency standards; the development of carbon capture and storage (CCS) facilities; the development of alternative energy sources to coal;  and, perhaps the most popular, putting a price on carbon (IETA).

Solutions to Pollution

Aside from paying fees and fines to the regulatory bodies for emissions exceeding allowed limits, there are several common ways of turning carbon pollution into a financial cost for emitters.

Carbon taxation charges a fixed fee for products and services that emit high levels of CO2.  The government taxes consumers and corporations alike for the pollution they emit. Essentially, carbon tax places a monetary value on the cost of pollution to our economy and planet.  As higher emitters will be taxed more severely, the tax is a financial motivator for households and companies to use more environmentally friendly technologies. Sweden is one of many countries to have implemented carbon taxation. Since its inception 22 years ago, the tax is estimated to have reduced emissions in Sweden by 17 percent (Government of Sweden).

Another solution is cap-and-trade, or emissions trading. In a cap-and-trade scheme, the government places a cap on how much carbon each sector can emit, and then either grants or auctions carbon permits to large emitters. The cap is reduced every year in order to reach a target amount. These permits can then be traded; if one organization has more permits than they need, they may sell to an organization that emits beyond their permissions. In this way, the price of emissions is set by the market.

This is not a new approach; in the early 1990s, the United States government signed the Clean Air Act to initiate a cap-and-trade scheme in an attempt to reduce acid rain emissions caused by NOx and SO2. Time has proven that it is a cost-effective method to reduce emissions, costing utilities just $3 billion a year to control acid rain- as opposed to a cost of $25 billion projected under other methods (Smithsonian). As worldwide attention has turned to the problem of global warming, limiting carbon emissions has become an urgent priority. Cap-and-trade is becoming an increasingly common method of addressing carbon emissions in many countries.

A benefit of the cap-and-trade system is that it presents more certainty about the amount of emissions that will be cut down, whereas a carbon tax provides more confidence about the price of emissions.

There is also the possibility of creating a “hybrid” system, combining the cap-and-trade system with the carbon tax system. In this case, polluters must both pay a carbon tax, and purchase a permit. The system will set a base price for carbon permits- so if there are fewer buyers than permits, permit prices do not drop significantly. If carbon pollution prices crash, there is less inclination to invest in environmentally friendly energy- which has already occurred in the U.S., Europe and Australia. A hybrid scheme is meant to mitigate both the risk of unknown emissions reduction with carbon taxation, and the price risk of cap-and-trade (SMH).

Current Cap-and- Trade Programs

Currently, there are approximately ten carbon markets worldwide, and new markets emerge every year. The oldest and largest is the EU Emissions Trading Scheme (ETS), which is a cap-and-trade system. It opened in 2005, and includes 21 countries across Europe (International Carbon Action Partnership).

China opened a carbon emissions trading market in Shanghai on the 26th of this month, and is poised to open another in Beijing in the near future. China produces the highest amount of greenhouse gas emissions globally; the Shanghai carbon emissions trading market alone is set to encompass between 100-150 million tons of carbon dioxide (IB Times).

In 2006, California passed the Global Warming Solutions Act, which commits the golden state to reducing their greenhouse gas emissions to 1990 levels by 2020. The California Cap-and-Trade Program is at the heart of this act. Carbon offsets included in the act allow companies to finance emission-lowering activities- voluntary actions which businesses may not choose to undertake otherwise, and which are not necessary by law. Offsetting initiatives, such as funding the long-term conservation of a forest overseas, are less expensive than directly cutting down emissions (Huffington Post).

The emissions market will grow as existing trading schemes begin to link to each other to increase liquidity. Australia is already planning to link to the EU ETS by 2015, and the California Cap-and-Trade Program will link to Québec by January 2014 (International Carbon Action Partnership).This linkage can provide benefits such as lowering the cost of emissions, boosting market liquidity, and securing the carbon emissions price (European Commission). A potential downside is that ETS regulators may have less control; therefore, a joint regulatory body may be needed (PIK).

Managing Emissions Data with ZEMA

For businesses that operate in areas where carbon emission controls are mandatory, keeping track of market prices can allow companies to take full advantage of opportunities to sell surplus allowances and permits at higher prices, or buy them at lower prices. A facility that needs to offset an extra 800 tonnes of emissions, for instance, could spend only €3200 at a low price of €4/tonne, or as much as €24,000 if carbon prices rose to €30/tonne, which was originally recommended as a target price by the UK (UK Parliament).

Figure 1: This graph shows how different the price of EU Emissions Allowance (EUA) futures is compared with the price of California’s Climate Action Reserve (CAR) emission futures on CME NYMEX. The price for a tonne of CO2 is noticeably cheaper in California.

ZE covers a comprehensive range of emissions data feeds to help our clients stay on top of the cost of emissions:

Figure 2: Emissions Data in ZEMA.

To learn how the ZEMA Suite can help companies track and use valuable emissions data, book a free demo now.

By: Joanna Musiala and Karen Hung

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