Critical Examination of the Cap-and-Trade Emissions Trading Schemes - Example

A Critical Examination of the Cap-and-Trade Emissions Trading Schemes Name Institution Affiliation A Critical Examination of the Cap-and-Trade Emissions Trading Schemes Global warming is a major concern across the world. Notably, radiations from the sun heat up the earth’s surface to produce the Greenhouse Effect which supports life on earth. For example, the Greenhouse Effect promotes photosynthesis, which is a major component of the ecosystem. However, human activity has interfered with the balance in the ecosystem resulting in the unprecedented rise in global temperature. This has intensified the Greenhouse Effect causing global warming (Robertson, 2014). Human activity such as industrialisation, the use of nuclear weapons and combustion of fossil fuels release greenhouse gases into the atmosphere that deplete the ozone. Incidentally, it is the ozone that screens the rays of the sun filtering out violent and harmful radiations. Depletion of the ozone layer allows UV rays into the atmosphere, causing a rise in global temperature. Most of the climatic and environmental problems are caused by global warming. Some parts of the world have witnessed prolonged drought. As a result, many forests have dried up and forest fires are a common incident today. Prolonged drought has caused famine, particularly in areas where agriculture is dependent on rainfall. Malnutrition, disease, and death of livestock are major concerns in these areas. According to Robertson (2014), global warming has led to the melting of ice caps, resulting in flooding of seas and oceans. Floods can potentially displace people and even cause injury and death. In addition, global warming causes excessive evaporation which produces immoderate precipitation, which can destroy property and infrastructure. The UV rays can also cause skin infections, and such are some of the damages that have been attributed to global warming, hence the need to put in place effective measures to combat the scourge. Discussion Cap-and-trade is an approach that has been employed in many countries, particularly in the US and Europe to address the problem of global warming. According to Kossoy and Guigon (2010), a cap is a ceiling on greenhouse gas emissions. However, with time the ceiling is lowered so that emission is also restricted and total emissions keep falling. Once the cap is determined, companies can then acquire emission allowances. The supply of allowances is restricted to giving them value; otherwise, there would be no incentive to purchase the allowances. Notably, there is a restricted portion of allowances that are offered free of charge. As the need arises the companies can trade the allowances among themselves. In addition, any time there is an international project that aims to reduce emissions; a company can buy a certain limit of credits and again trade them with other companies when a need arises. At the close of every year, each company that had acquired the emission allowances is required to surrender adequate allowances that will cover all the emissions attributed to it (Caney, 2010). Noncompliance leads to the imposition of heavy fines on the defaulting companies. Suppose a company reduces its emissions during a particular year, it is left with surplus allowances. The company can retain the allowances for future use. Alternatively, it can sell them to another company that is in need of allowances. The element of trade in the system is crucial because it introduces flexibility into the system such that companies can easily cut emissions where the reduction costs are low. In addition, the interactions between the forces of demand and supply produce a sturdier price that encourages investment in low-carbon technologies as a cost-cutting measure (Murray, Newell and Pizer, 2009). The larger the proportion of emissions from a company; the higher the value of permits required to sustain the operations. For instance, burning gas produces lower levels of carbon compared with burning coal. Therefore, coal plant operators would require more permits than gas operators. Suppose a company intends to venture into power generation, given the two options, the company would most likely choose gas over coal. Although both options would potentially increase the cost of operation, the cost associated with coal is higher than that of gas. According to Ellerman and Buchner (2007), the EU has the most sizable emissions trading system, ETS in the world. The scheme was conceived in 2005. The projects covered produce carbon emissions that account for half of the total emissions in Europe. Under this arrangement, the set limit is bound to fall by 1.74% every year to produce a consistent reduction that will see the emissions fall to about 20% below where the level was in 2005 (Ellerman and Buchner, 2007). The value of an allowance stood at €16 by mid-2011. Presently, the annual volume of trade in allowances under ETS is worth $150bn. The ETS has been successful in regulating 50% of Europe’s emissions. The regulation has made it difficult for companies to release carbon and other emissions to the atmosphere by attaching a cost to the emission. In the case of the EU, the member states are using a blanket cap that is uniform across the nations. This move has replaced individual caps whose application was restricted to national borders. The previous arrangement produced a system of caps that bore a national tag and harmonisation was difficult, particularly with regard to cross-border engagements. Besides free allocation of allowances, the EU has embraced auctioning as an alternative approach to the allocation whereby the value of the emission allowances acquired depends on the bidder’s price offer. According to Caney (2010), among the changes adopted by the EU is widening the scope of coverage in terms of sectors and gases. Examples of gases brought into the system include carbon dioxide (CO2), which results from projects dealing with the generation of heat and power and those projects that run on high energy requirements such as steelworks, oil refineries, steel industries and commercial aviation. Other gases that are included in the new regime are those resulting from the production of aluminium and certain acids (Kossoy and Guigon, 2010). When it comes to individual companies, certain small companies are excluded while only companies of a particular size are included. When it comes to the aviation sector, the new regime covers those flights that take place only among the airports in the EU. According to Jotzo and Betz (2009), Australia’s ETS came into existence in 2012 as a fixed price scheme whereby the price was determined by the government and not the market system as in the case of the EU. Establishing a cap helps the government determine the amount of carbon pollution to be released into the atmosphere. This helps Australia in achieving the country’s emissions targets. The government issues emission quotas, aggregating the amount of emissions that a company can release under the cap. Under this arrangement, a company that falls short of allowances has three options at their disposal (Jotzo and Betz, 2009). First, the company can lower down its emissions. This is actually the overall objective of the ETS and it directly helps the governments achieve her targets. Second, the company can purchase credits from the Carbon Farming Initiative, CFI. The initiative was conceived in 2011 to allow landowners, farmers and land managers to obtain a credit score when they store greenhouse gases on their farms or reduce emissions. They can then sell them to companies that seek to counter out their emissions. Third, the company can buy emission permits from other places, including an Australian enterprise and/or a qualified overseas market. Since its inception, Australia’s ETS has recorded a good deal of achievements. For example, within the first year, the scheme was able to reduce carbon emissions from the production of electricity by 7.4%. In addition, it recorded a 12% decrease in electricity production from brown coal. More importantly, the scheme produced a 30% increase in production of renewable energy. It is also interesting to note that while these regulations were being enforced; industrial production grew by 5.1%, while the economy grew by about 2.5%. This created about 150,000 new jobs (Jotzo and Betz, 2009; Kossoy and Guigon, 2010). From the look of things, we would expect the regulations to create a burden on the economy and perhaps reduce productivity. However, this is not always the case. Many people think that the concept of trading permits or rights to pollute is inappropriate, particularly in the wake of rapid industrialisation. One such person is the renowned philosopher Michael J. Sandel, who holds the view that the whole subject of ETS is unethical. Perhaps a critical examination of this subject can justify this position. To begin with, the surface meaning of this argument is justifiable on grounds that any form of pollution is harmful to human health and the environment in general. For this reason, many organisations and institutions are keen on mitigating the harmful effects of pollution. Indeed, it is the responsibility of all and sundry to be proactive in environmental conservation initiatives. In this regard, creating a business venture that appears to counter the many years of environmental conservation arouses some resentment. From a philosophical point of view the phrase ‘to trade emissions’ is rife with irony. One important principle of trade is environmental sustainability. Any trading activity must be seen to be advancing the values of environmental management in one way or another (Caney, 2010). On the other hand, the emission of greenhouse gases causes global warming, which is a major cause of most adverse climatic changes that the world is grappling with in the modern times. Looking at the word-to-word meaning of the phrase ‘to trade emissions’, a philosopher would discern a conflict of interest in the wording. From a philosopher’s perspective, there should not be anything like a ‘right to pollute’ if at all the world is truly committed to combating human activities that create an imbalance in the ecosystem. According to Caney (2010), irrespective of the nature of the occupation, no business or company should be granted the right to pollute the environment. Perhaps the coded language is a disincentive for companies to tackle pollution right from within because they have already secured the ‘right to pollute’. The perception that one company can grant another company the right to pollute by way of trade is inconceivable. It is almost as if the system is rewarding one of the greatest evils in the society. Another important principle of trade is the respect for human rights. One of the fundamental human rights is the right to a safe and clean environment. Indeed, pollution causes the environment to be uninhabitable. For example, water pollution interferes with access to safe and clean water, which is a major component of life. This puts the affected community at risk of getting infected with water-related illnesses. Essentially, the pollution has interfered with the community’s right to life. By trading the rights to pollute, the system is unwittingly legitimising an activity that seemingly can curtail the fundamental rights of people (Robertson, 2014). Then there is the element of profitability in any trade deal. The fact that conventional businesses can make a profit margin by trading the right to pollute is inappropriate on moral grounds. A philosopher would argue that no one should be allowed to profit from a phenomenon that would make people sustain losses whether financially or otherwise. Away from the philosophical interpretations of the concept of cap-and-trade ETS some opponents have sought to discredit the scheme on technical bases. To begin with, a significant number of the emission allowances are given freely to companies, meaning there is no cost incurred to acquire them. Certainly, costs would have a deterrent effect of discouraging pollution (Murray, Newell and Pizer, 2009). On another angle, dishing out the allowances to companies on one hand and auctioning them on the other hand waters down the effects of the emissions trade schemes so that optimal trade benefits are not attained. A company that seeks to expand their emissions would incur no costs. On the other hand, the increase in emissions would create negative externalities for the local economy. According to Sorrell and Sijm (2003), a prolific costing system in the ETS would allow the company to absorb the damaging effects of the externalities implicated upon the local economy. However, when the allowances are given out freely the local economy does not receive any economic gain. The idea of ETS has also been written off based on the fiscal implications it has on an economy. According to Jotzo and Betz (2009), in the case of Australia’s ETS the businesses and the government have access to the emissions allowances. In this arrangement, the two institutions have a significant stake in the ETS market. The position of the government in this trade is to safeguard the socioeconomic interests of its people (Sorrell and Sijm, 2003). One important issue in this arrangement is that once a credit is issued it can also be cancelled and eliminated from the flow. Considering that governments acquire credits using taxpayers’ money, the cancellation and removal of the allowances is tantamount to a loss of public funds. From a fiscal perspective, such moves would stifle the development of certain industries and it is also a misapplication of public funds. On the same token, cancellation, removal or failure to use the credits acquired creates an artificial shortage causing an artificial rise in market prices. This strategy has been used by environmental agencies that hold on credits indefinitely with the aim of making a kill out of it. Indeed, this malpractice compromises the integrity of a free market system. According to Kuik and Mulder (2004), sometimes the price of emissions credits is a disincentive for innovation. Often the price of acquiring the credits is cheaper than the cost of converting to using a new energy source. For example, in the case of industries that rely on fossil fuels, the cost of acquiring credits is lower than the cost of reverting to using renewable sources of energy. For this reason, it is more convenient for the industries to hold on to emissions credits rather than invest in renewables. In addition, the lack of measuring devices in many industries to track the output levels produced periodically weakens the credibility of the ETS system. Many businesses have used this inefficiency to misreport their emissions, particularly when they have exceeded their credit limits. There is a need for enforcement agencies to step up surveillance and monitoring to curb the cheating and make the system more efficient (Ellerman and Buchner, 2007). Additionally, the lack of a common cap across the world undermines the effectiveness of the system. Different countries produce different amounts of emissions depending on the level of industry. For example, Australia is more industrialised than Nigeria. That means Australia creates more emissions than Nigeria. Essentially the definition of a maximum cap would vary between the two countries. Also, some countries are stricter on credits and emissions caps than others. These factors make it difficult to harmonise the ETS across the word. The whole point of the ETS is to conserve the environment. Since the idea was implemented, it has recorded a good number of achievements. The first institution to roll out this idea was the EU. The EU ETS became operational in 2005 and it is also the largest in the world. For such a long time the EU had accounted for 10% of the global volume of greenhouse emissions. However, the formulation of EU ETS saw this percentage reduce by 22%. The EU envisions a 40% reduction in greenhouse emissions by 2030 (Kossoy and Guigon, 2010). The organisation has outlined a framework on how to achieve this target, including setting out emissions targets for member states and certain sectors that are not yet covered in the current plan. ETS has also been instrumental in creating new energy solutions that promote the use of clean renewable energy. For example, ETS has played a big role in helping Sweden create heating technologies that rely on green energy in place of fossil fuels. At the same time, ETS has seen an increase in productivity and job creation across many countries such as Australia, Sweden, and Canada. According to Kuik and Mulder (2004), cap-and-trade ETS is an alternative source of resources. The system operates in such a manner that a company that reduces green gas emissions incurs lower costs in doing so. The company can then sell the surplus credits at a profit. The sale of surplus credits creates an additional stream of income for the company. The new source of income is quite certain because the company is in direct control of the emissions it can create in a particular period as opposed to conventional business income which is rather chancy. This implies that the company can base certain decisions on a relatively steady flow of income, making the success rate of such decisions high. In addition, an extra source of income improves the liquidity position of the company and the overall financial position which gives the company a good credit rating with lenders. The company can also direct the additional income towards innovation of renewable sources of energy, hence promoting environmental sustainability (Sorrell and Sijm, 2003). The company can also pursue other investment options, creating new employment opportunities and increasing a nation’s productivity. According to Murray and Pizer (2009), the certainty of a cap-and-trade ETS is possible because the maximum level of emissions is determined in advance. The company can then work on their operations to work out the reductions in the emissions. One advantage of this arrangement is that companies are actively involved in managing the system objectively. Arguably participation can spur innovation. The system can be improved significantly because the input of every player is relevant in running the ETS making it possible to improve the operations. A predetermined level of emissions enhances accountability. Companies that operate within this regulation can track the emissions they create in the atmosphere (Kuik and Mulder, 2004. As such, it is possible for a company to independently assess the environmental impact of its emissions with certainty. Appreciating the effects that a company’s emissions have on the environment is an incentive for taking corrective action. The company appreciates that it is socially obligated to lock in the negative effects its activities have on the society. This makes the compliance rate under ETS to be high because the system is not subjective. Cap-and-trade ETS give the government an opportunity to augment revenue from taxpayers. In the past, governments relied more on taxes to fund their operations. However, modern economies are exploring alternative sources of revenue to run the government, and ETS is one potential source of revenue for governments. The government buys credits and sells them to companies at a profit when the need arises. The income from these ventures can be used to offset budget deficits (Sorrell and Sijm, 2003). In addition, the income can be invested in innovations that seek to create alternative sources of energy for environmental conservation. More importantly, a cap-and-trade ETS gives the consumers an opportunity to get involved in conserving the environment by abstaining from buying products of companies that are non-compliant or those who attempt to manipulate the system for selfish motives. Conclusion A cap-and-trade ETS is a noble idea that can potentially cut down the emission of greenhouse gases in the world. So far, it has effectively achieved this objective in many parts of the world. Environmental agencies and other organisations are working on consolidating these gains into long-term environmental sustainability. Although the system is faced with many challenges, an objective investigation into the strengths and weaknesses of cap-and-trade ETS would produce a robust system. References Caney, S. (2010). Markets, morality and climate change: What, if anything, is wrong with emissions trading? New Political Economy, 15(2), 197-224. Ellerman, A. D., & Buchner, B. K. (2007). The European Union emissions trading scheme: origins, allocation, and early results. Review of environmental economics and policy, 1(1), 66-87. Jotzo, F., & Betz, R. (2009). Australia's emissions trading scheme: opportunities and obstacles for linking. Climate Policy, 9(4), 402-414. Kossoy, A., & Guigon, P. (2010). State and trends of the carbon market 2012 (No. 13336). The World Bank. Kuik, O., & Mulder, M. (2004). Emissions trading and competitiveness: pros and cons of relative and absolute schemes. Energy Policy, 32(6), 737-745. Murray, B. C., Newell, R. G., & Pizer, W. A. (2009). Balancing cost and emissions certainty: An allowance reserve for cap-and-trade. Review of Environmental Economics and Policy, ren016. Robertson, M. (2014). Sustainability principles and practice. Abingdon, Oxon: Routledge. Sorrell, S., & Sijm, J. (2003). Carbon trading in the policy mix. Oxford review of economic policy, 19(3), 420-437. Read More