Emission Trading Systems

In 1972, the Meadows Report claimed that in the upcoming years, humanity will have exhausted all-natural resources available on earth. The proposed way to avoid such a disastrous conclusion was to halt economic progress. The Meadows Report was one of the first movement of political ecology.

Since then, environmental movements have exploded around the world, as illustrated by Greta Thunberg's elevation to "TIME's 2019 Person of the Year." There are various reasons for the rapid growth of environmental movements around the world.

In 2021, the Overshoot day, that is the day the planet is no longer able to regenerate the resources we use each year, was reached on July 29. This means that we are currently depleting natural resources at a 1.75 times faster rate than they can be replenished by the Earth. Greenhouse Gas Emissions have also seen a worrying rise. As of the start of 2017, only 4 years were left until the carbon budget was used to remain under a 1.5°C above pre-industrial levels.

A lack of real political changes and policies is also a major factor in the emergence of global ecological movements. People believe that governments are not applying the necessary tools and policies to mitigate climate change. Scientific study backs this up: if economic growth continues on its current course without intervention or adjustments in production process, global warming is expected to reach 4.1°C to 4.8°C over pre-industrial by 2100.

Due to the need to reduce natural resources consumption and limit greenhouse gas emission, a variety of climate-oriented policies have emerged in recent years. One of them refers to Emission Trading Systems (ETS) and is the focus of this week’s blog post.

R.H. Coase proposed the attribution of property rights as a new technique of preventing corporations from polluting in a 1960 essay published in The Journal of Law and Economics. A company can pollute as long as it owns the property rights to the pollution it produces. However, if it produces a pollution type for which it does not have a property right, it must either purchase the right or compensate the sectors that suffer negative externalities.

This idea of property rights was implemented in 2005 by the European Union under the name of the Emissions Trading System. The EU Emissions Trading System covers more than 11’000 heavy energy-using firms (power plants, industrial plants, airlines) in 31 countries. Companies regulated by ETS jointly bear 45% of EU CO2 emissions. This system works by setting a certain threshold for greenhouse gas emissions and dividing it into "certificates". These certificates will be distributed free of charge or auctioned. But most importantly, they can be traded between firms on a secondary market. That is, if a firm does not emit as much as it is allowed by its allowances, it can trade with firms that pollute more than they are permitted. However, if a firm is not able to purchase enough allowances and still pollutes more than allowed, it will have to pay a fine of 40€ per ton of CO2. This system creates an incentive for firms to reduce their pollution in order to decrease costs and even make a profit from selling allowances.

The principle of the Emissions Trading System can easily be scalable and implemented to a broader industrial sector range. However, for such a system to work, key elements need to be considered. Currently, the ETS creates too many allowances, implying that it still does not cost much for firms to pollute. Additionally, a great number of allowances are allocated free of charge implying that a large quantity of carbon is still emitted for free.

However, there are many possible solutions to the ETS. Reducing the supply of allowances distributed would go a long way in increasing the cost of pollution. An even more promising adjustment would be to stop giving away allowances for free and auctioning all of them. This would have two benefits: increasing the cost of polluting, whilst increasing the revenues of Member States that could in turn use these revenues to invest in sustainable and energy efficient projects.

Sources:

Active Sustainability (2021). Meadows Report

Geneva Environment Network (2021). Earth Overshoot Day 2021

Carbon Brief (2021). Carbon Countdown

European Commission (2021). EU Emissions Trading System

R. H. Coase (1960). The Problem of Social Cost

Dutch Emissions Authority (2021)