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Tackling climate change will require innovative and coordinated efforts. One way to stimulate GHG emissions reductions is to create an economic climate that promotes changes in behaviour.
Emission Trading is a system that controls pollution by providing economic incentives for achieving emission reductions. To simplify it, emitters are given a limit or cap on emissions. They are regulated to stay within their limit. If that cap is exceeded they must buy credits equal to the difference, and if they exceed their reduction target they can sell allowances to others who missed their targets. In essence, the buyer is being fined for polluting and the seller is being rewarded for overachieving. Emissions’ trading facilitates the lowest cost options for reducing greenhouse gas (GHG) emissions caused by human activities. Emissions’ trading allows regulated entities which over-achieve their emissions reduction targets to sell their emissions allowances to other entities that are unable to stay within their limit. Emissions trading:
- Encourages over-compliance
- Takes advantage of economies of scale
- Allows for efficient allocation of resources
- Provides a price signal
By providing a market for emissions reductions, emissions’ trading creates an incentive for organizations to reduce their emissions beyond their regulatory target. Over-achievers can generate revenue by selling excess emission reductions. Combined with a project based emissions reduction program (also called an offset program), emissions trading can also drive cost effective emissions reductions in sectors and areas of the economy which are not covered by the greenhouse gas regulation. Buying and selling of emissions reductions can occur bilaterally between counterparties, or on an exchange.
As a proven market solution, an emissions exchange can provide an independent and transparent trading platform, with counterparty risk management through clearing.*
Some key points about emissions trading**:
- Does not reduce emissions in and of itself - it is a mechanism that facilitates the reduction of emissions in a more cost-effective way.
- Does not replace regulation - it complements regulation. Emissions trading systems work best when they are supported by strong regulatory frameworks.
- Is not the only tool available to regulators - other emissions reduction tools that are being used or considered include regulations, sectoral agreements, tax measures, targeted subsidies and direct financial incentives for system improvements
For detailed information go to the Project Toolbox.
* Adapted from: Canadian Climate Exchange
** Emissions Trading Primer, Pollution Probe 2003