What is cap and trade? What do legislative proposals

currently in Congress say about it?

Brent SohngenDepartment of Agricultural, Environmental &

Development EconomicsSohngen.1@osu.edu

“Cap-and-Trade” System• Sets a limit on CO2 emissions• Allows large emitters to trade CO2 amongst themselves• Allows additional supply from land based sources…

COCO22COCO22

• Overall cap set• Individual cap set (Firms

get permits)• Firms can trade permits

depending on their emissions.Init Em 1000 t CO2 2000 t CO2

Initial Emission = 3000 t CO2

Total Cap = 2700 t CO2

Cap 900 t CO21800 t CO2

Emit 700 t CO2 2000 t CO2

Trade sell 200 buy 200

33

COCO22

$$$$

$$

$$

“Cap-and-Trade” System

Credits for sale = 200 t CO2

COCO22COCO22

Init Em 1000 t CO2 2000 t CO2

Initial Emission = 3000 t CO2

Total Cap = 2700 t CO2

Cap 900 t CO21800 t CO2

Emit 700 t CO2 2000 t CO2

Trade sell 200 buy 200

• Sets a limit on CO2 emissions• Allows large emitters to trade CO2 amongst themselves• Allows additional supply from land based sources…

Debate on land-based credits• Role of land-based options and importation of

credits– Scientific uncertainties have been resolved.– Land-based can provide 30% of carbon

abatement– Can reduce costs by 40%.– National land-based program and international

component are complements, not substitutes.• National program will be less efficient without an

international program.

Cap and Trade Pros and Cons

• Pros– A cap actually will limit

emissions.– Establishes clear price

signal ($/ton CO2).– Imposes stringency of

market on abatement decisions (investments will flow to “best” alternatives).

– Reduces costs.**

• Cons– Creates a difficult

negotiation over “rights” for permits

• Auction or free allocation?

• Who gets free permits?– Can be very stringent– May be too costly if it

turns out that abatement costs are high.

Climate Policy Update• United Nations Process Continues….

– In the Kyoto Protocol commitment period now (2008-12)• Markets active in Europe & Australia• International trading through Clean Development Mech.

– Continuing negotiation over successor treaty• Still much debate about what will emerge from Copenhagen…• US is working hard to reduce expectations….

• US Policy is very active– Regional initiatives (CA, RGGI)– Supreme Court decision (Massachusetts vs. US EPA) and

EPA response– Energy legislation– We have moved from 95-0 on Byrd-Hagel in 1997 to

Waxman-Markey (h.r. 2454) passing the House last spring.

Key issues in Waxman-Markey (HR 2454)

• Carbon Cap and Trade System2020 17%2030 42%2050 80%

• Permit Allocation– Designed to limit electricity price increases

• Offsets– Up to 2 billion t CO2, with 1 billion t from outside the US

• Renewable Portfolio Standards– 20% of electricity from renewables by 2020

Senate Action: Kerry-Boxer

• Introduced recently for discussion this fall

• Not clear if the “stars” will align, but renewed hope after Kerry-Graham Op-Ed in the NY Times this past Sunday– Nuclear– Clean coal– Border tax adjustments**

Summary• Cap and Trade works by limiting overall emission (e.g.,

putting a cap in place)– Reduces costs relative to other methods of achieving the

same goal.

• Land based offsets are likely to be part of the system in the US, both domestic and international.– Scale differs between House and Senate so far.

• Policy is moving forward with or without federal legislation.

• Important future questions about the role of nuclear, coal, renewables, and border tax adjustments.