Climate change has become one of the most pressing issues of our age.  Broad agreement has coalesced around the understanding that temperatures are climbing, at least partly due to increasing carbon emissions from us.  Many ideas have offered to arrest rising temperatures: government mandates, climate treaties that lack enforcement, and carbon taxes.  Now coming to the fore is an old idea whose time may have finally come to apply on a national basis: carbon trading.

What is carbon trading?  

The model used is called cap-and-trade, which places a price on carbon emissions.  How do you create a market where none yet exists?  Introduce scarcity.  The U.S. government would decide how many tons of allowable carbon dioxide emission over any period – the cap – and would issue permits for that limit. Allowable emissions would decline over time to work towards established goals.

These permits will have value – the trade.  A polluter must hold enough permits to cover the emissions it releases.  Some companies will emit fewer tons of carbon than the permits received.  They can then enter the market to sell their permits to companies that emit more tons of carbon than their existing permits will allow.  For example, electric vehicle manufacturer Tesla is expected to earn $1-2 billion in 2021 through the sale of carbon permits.

Has this been tried before?

The European Union Emission Trading System (EU ETS), launched in 2005, was the first emissions trading scheme, and it remains the biggest.  Nine states in the U.S. Northeast are part of the Regional Greenhouse Gas Initiative (RGGI), a cap-and-trade system that began in 2009.  California instituted a cap-and-trade program in 2010.  So did Tokyo, a city with a larger carbon footprint than many industrialized nations.  The U.S. National Academy of Science estimated that the EU cut its carbon emissions by 3.8% between 2008-2016.  Results for RGGI and California are unclear.

Cap-and-trade has been tried before.  It successfully reduced emissions of sulfur dioxide and nitrous oxide, two ingredients responsible for acid rain.

Why haven’t we tried this nationally yet?  

The answers are politics and the lobbying power of the American Petroleum Institute.  The API has worked to abort carbon trading proposals, last brought up in 2010, that threatened to diminish the ability of oil producers to pump as much oil as possible.  The political landscape is now shifting.

With the increased focus on climate change, the impact of energy production and usage, and so many oil companies slowly adjusting their focus to green energy production, the API is reluctantly becoming open to the idea of putting a price on carbon emissions.

Who will benefit?

The intended beneficiary is the environment, but specific winners will arise across sectors.  Companies that demonstrate commitment to reducing their carbon footprint will stand to gain the most.  As their energy usage declines below the amount allowed by their credits, the value they realize will drop straight to their bottom line.  Companies whose business is energy-intensive and do not make any effort to reduce their energy usage will take on additional costs borne by shareholders.  Cap-and-trade may be an opportunity for companies to demonstrate their environmental bona fides and find market rewards in the process.

What problems remain?

Even if carbon trading is implemented effectively in the U.S., challenges remain. It remains unclear that cap-and-trade will reduce carbon emissions effectively. Carbon does not respect state or national boundaries, so advances made in one jurisdiction may matter little if neighboring bodies make no effort to reduce their carbon usage. In an ideal scenario to maximize effectiveness, carbon trading would become a global market.

It remains unclear whether carbon trading is the answer to climate change. Nevertheless, it is a vital step in putting a price on the carbon we emit daily. Markets can have a positive impact on changing market behavior. The time for a national application of carbon trading may have finally arrived.