Cap-and-Trade
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Because the emissions cap restricts the amount of pollution allowed, permits that give a company the right to pollute take on financial value. Companies are free to buy and sell permits in order to continue operating in the most profitable manner available to them. So, those that are able to reduce emissions at a low cost can sell their extra permits to companies facing high costs (which will generally prefer to buy permits rather than make costly reductions themselves). A key advantage of a cap-and-trade system compared with other emission reduction strategies is that it gives companies flexibility in the manner in which they may achieve their emission targets. Another advantage is that it sets a clear limit on emissions. Traditional approaches often focus on emission rates or require the best available technology, but do not always require that specific environmental goals be met. For example, an emissions tax penalizes polluters but does not guarantee the degree to which the environment will benefit, because some companies might find it easier to pay the tax instead of reducing emissions. A Small-Scale Example In a real-world cap-and-trade system, permits would be traded between many polluters and at varying prices. Let us consider a simplified example involving only two power plants: Plant A emits 600 tons of CO2 each year, and Plant B emits 400 tons, for a combined annual total of 1,000 tons. An environmental agency then establishes a CO2 emissions cap of 700 tons per year (a 30 percent reduction). Under a traditional approach, both plants could be ordered to reduce their emissions by 30 percent, which would force Plant A to reduce its annual emissions to 420 tons (a reduction of 180 tons) and Plant B to reduce its emissions to 280 tons (a reduction of 120 tons). The cost for each plant to make emission reductions depends on factors such as plant efficiency and the type of fuel used (e.g., coal, natural gas); in this example, it would cost Plant A an average of $50 per ton and Plant B an average of $25 per ton to meet these reductions, for a total cost of $12,000. Under a cap-and-trade system, each plant seeks out the lowest-cost way to reduce emissions. Initially, Plant B is able to reduce its emissions at a lower cost than Plant A, so it can sell permits to Plant A. However, the more Plant B reduces its emissions, the more expensive it becomes to make further cuts. Eventually, both plants reach a point where their cost to reduce an additional ton of pollution is equal. The end result of the cap-and-trade system is that the two plants are able to reach the emission reduction goal set under the cap, but at a lower cost. In our example, we calculate a total cost of $9,000—a savings of 25 percent compared with the traditional approach. |
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