Emissions trading system

Definition

An emissions trading system (ETS) is a market-based approach used to control pollution by providing economic incentives for reducing the emissions of pollutants, particularly greenhouse gases. It allows companies or organizations with low emissions to sell their excess allowances to larger emitters, promoting cost-effective reductions in overall emissions while maintaining economic growth. This system aligns with environmental policies aimed at mitigating climate change, especially in the energy sector.

5 Must Know Facts For Your Next Test

1. An emissions trading system works by capping the total level of greenhouse gas emissions and allowing companies to buy and sell emission allowances.
2. Companies that reduce their emissions below their allocated cap can sell their excess allowances to those who exceed their limits, creating a financial incentive for reducing pollution.
3. The effectiveness of an ETS depends on setting a realistic and enforceable cap that effectively limits overall emissions while allowing for flexibility among participants.
4. Several countries and regions have implemented ETS, including the European Union Emission Trading Scheme (EU ETS), which is one of the largest and most established systems globally.
5. An emissions trading system aims not only to reduce emissions but also to encourage innovation in clean technologies as firms seek cost-effective ways to meet their targets.

Review Questions

• How does an emissions trading system promote cost-effective reductions in greenhouse gas emissions?
  • An emissions trading system encourages cost-effective reductions by allowing companies with lower emission levels to sell their surplus allowances to larger emitters. This creates a financial incentive for companies to invest in cleaner technologies and reduce their emissions below their allocated caps. The flexibility of buying and selling allowances means that reductions can occur where they are most economically viable, leading to overall lower costs for achieving emission reduction targets.
• Evaluate the potential challenges faced by an emissions trading system in achieving its environmental goals.
  • One major challenge faced by an emissions trading system is ensuring that the cap on emissions is set at a level that effectively reduces overall greenhouse gas outputs without compromising economic growth. If the cap is too lenient, it may not drive significant reductions. Additionally, there can be issues with market manipulation, the distribution of allowances, and ensuring compliance among all participants. The integrity of the system relies on rigorous monitoring and enforcement mechanisms to maintain trust and effectiveness.
• Assess the impact of implementing an emissions trading system on energy companies and their operational strategies.
  • Implementing an emissions trading system significantly impacts energy companies by forcing them to rethink their operational strategies to minimize costs associated with buying emission allowances. Companies may invest more in renewable energy sources or energy efficiency measures to lower their carbon footprint. This shift can drive innovation and competition within the sector as companies seek ways to adapt to stricter emission regulations while still meeting energy demands. Ultimately, this may lead to a broader transition towards sustainable energy practices within the industry.

Related terms

Cap-and-Trade: A cap-and-trade system sets a limit on total greenhouse gas emissions and allows companies to buy and sell allowances within that cap.

Carbon Credits: Certificates representing the right to emit a certain amount of carbon dioxide or its equivalent in other greenhouse gases, which can be traded under an ETS.

Carbon Tax: A tax imposed on the carbon content of fuels, intended to reduce carbon dioxide emissions by making fossil fuels more expensive.