How does emissions trading work?
The emissions trading system works on the "Cap and Trade" principle. By setting a ceiling or cap, the state takes a political decision as to the maximum amount of CO2equivalent allowed to be emitted. A rigorous climate cap will ensure that CO2 becomes a scarce commodity so that trade creates a price for CO2 on the market therefore generating an incentive to invest in abatement measures.
All companies that participate in emissions trading with their installations or aircrafts in accordance with the legal provisions must surrender one emission allowance for each tonne of CO2equivalent emitted. A limited number of emission allowances are allocated from the cap free of charge to some of the companies based on harmonised allocation rules applicable across Europe. Companies that do not receive free emission allowances or where the allocation is not sufficient must acquire allowances at the regular auctions or buy them from other companies. If they have too many emission allowances, they can sell them. Therefore, the term "emissions trading" is used. Strictly speaking, allowances, rather than emissions, are traded in order to be allowed to emit the relevant quantity of greenhouse gases.
Through the auctions and the trade between companies a market price for emission allowances emerges. If the emission allowances (supply) are available in abundance to the companies (demand), the market price stays low. However, if the emission allowances are scarce because fewer allowances are available for achieving climate protection targets, the price increases.
At higher prices, it is becoming increasingly viable for companies to take measures to reduce their greenhouse gas emissions. Because if it is more cost-effective to avoid a tonne of CO2equivalent than to buy an emission allowance, then it is worth taking abatement measures..
How does emissions trading work?
Why has the European Emission Trading System been introduced?
Emissions trading in Europe was introduced as a result of the Kyoto Protocol on Climate Change. In Kyoto, in 1997, the heads of state and government for the first time agreed internationally binding stabilisation and reduction targets for greenhouse gas emissions in industrialised countries. Overall, between 2008 and 2012 the annual emissions of industrialised countries should be reduced by an average of 5.2 percent compared to 1990. The EU has committed itself to a reduction of 8 percent. In order to achieve this and future climate protection targets, the European Emissions Trading System was introduced in 2005
What is the significance of the Paris Climate Protection Agreement for emissions trading?
In December 2015, a new agreement was reached at the UN Paris Climate Conference, which entered into force in 2016. In the Paris Climate Protection Agreement, the countries concerned agreed to limit global warming to well below 2 °C, and if possible to 1.5 °C. Instead of stipulating emissions reductions for individual countries as in the Kyoto Protocol, the new agreement provides for countries as individuals to set reduction targets and adjust them continuously. However, the reduction targets reported so far are not yet sufficient to limit climate warming to 2 °C so that the measures envisaged by the Paris Agreement need to be further negotiated. The EU has committed itself to reducing its greenhouse gas emissions by at least 40 percent by 2030 (base year 1990).
The way of reliably achieving this 40 percent reduction target will be clarified in detail in the coming years and the European Emission Trading System will play an important role here.
Why is emissions trading economically advantageous?
Various instruments are used to achieve environmental objectives. Prohibitions, regulations and limits – so-called regulatory instruments – are, for example, useful in protecting humans and ecosystems from toxic substances. Subsidies and market incentive programmes may support the introduction of new technologies.
Rigid requirements such as uniform limits or volume restrictions however, have the disadvantage that all regulated energy and industrial installations must comply with these requirements. However, this will cause diverse costs to the operators, so for some companies it is easier to meet a certain limit while others must invest a lot of money to achieve this. Here, market-based instruments such as environmental taxes or emissions trading offer advantages to the national economy. The aim of market-based instruments is that environmental pollution creates costs for the polluters, e.g. companies, and they then need to decide whether it is more favourable for them to reduce the burden or pay for the burden. As a result, those environmental protection measures will first be taken that are cost-effective from a macroeconomic perspective. If overall satisfactory environmental protection is achieved, more expensive environmental protection measures can be disregarded. This means that market-based instruments can achieve certain environmental targets at lower economic costs than other instruments.
If environmental protection measures taken are insufficient in a case where environmental taxes apply, taxes must be increased. However, environmental targets are difficult to precisely achieve by practical taxes and levies. An additional advantage of emissions trading is that emission targets can be directly achieved at the predetermined time by allocating the proper quantity of emission allowances. This means that there is no risk for stipulating a too high or too low tax. Summing up, it is characteristic of emissions trading that it can reliably achieve the stipulated environmental targets at economically favourable costs.
Why are there still regulations, uniform limits and other measures for climate protection?
Although emission trading is a very efficient tool, it is not equally well suited across the board. For example, if the number of participants is very large and their respective emissions are relatively low, the cost-benefit ratio is more likely to be against emissions trading. For this reason, an effective and cost-conscious climate policy requires the use of several coordinated and interacting tools and measures. These include the promotion of renewable energies, which primarily focuses on new techniques.