What is Cap and Trade? - ABA YLD 101 Practice Series

By Nichole Jongsma Derks

Cap and trade legislation is a hot topic as various entities across the globe, governmental agencies, and Congress attempt to address reducing pollution and global warming. Effectively, cap and trade legislation seeks to promote economic development and industry while rewarding efficiency and innovation.

Cap and trade programs seek to reduce overall pollution due to carbon emissions. The U.S. government sets limits or caps on emissions for various sources of pollution. If an entity surpasses the cap level, it must pay a penalty for allowances to exceed the cap level. Emitters are free to buy or sell units to meet their needs, or they can store up credits for future use. The government sets various goals based on the industry and strictly monitors emitters for compliance. Which sources of emissions are subject to caps depend on the particular legislation. Cap and trade programs administered by the Environmental Protection Agency include the Acid Rain Program, NOx Budget Program, Clean Air Interstate Rule, and Clean Air Visibility Rule. 1

Key elements of Cap and Trade Programs: 2

  • An emissions cap establishes a fixed quantity of allowable emissions for each compliance period.
  • Coverage determines sources and/or sectors included.
  • Rigorous emission monitoring, reporting and verification ensures program integrity, transparency, and confidence.
  • Allowance distribution provides initial allowances to the regulated community and others (based on political decisions).
  • Allowance trading allows companies to choose (and change) compliance options, which leads to cost savings.
  • Stringent, automatic penalties penalize noncompliance.
  • Assessment evaluates achievements of the program and determines additional required actions.

Cap and trade programs are beneficial because they seek to keep overall pollution down while the ability to buy, sell, or trade units assists high volume emitters with staying below the required caps in a cost effective manner.

Continuing, traders are rewarded for their already low emissions. For all types of emissions trading, the basic concept is similar: trading provides companies with the flexibility to develop cost effective emission reduction strategies. 3

Critically, cap and trade programs do not help to clear up a targeted area of pollution. There are heavily concentrated areas where high volume emitters routinely exceeding the caps and are willing to pay the penalties or buy up units from lighter emitters. Such a situation is unlikely to improve due to cap and trade programming.


1 http://www.epa.gov/capandtrade/captrade-101.html
2 Id
3 http://www.epa.gov/capandtrade/documents/tradingtypes.pdf

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