Using Emissions Trading to Combat Climate Change: Programs and Key Issues

Abstract

Emissions trading has emerged as the major policy approach for addressing climate change, as evidenced by programs and proposals in the Australia, Europe, the United States, and elsewhere. A host of choices need to be made to design and implement a greenhouse gas emissions trading program, choices that are important both to the performance of the program and to the many private firms and groups that are affected. This article provides an overview of the major programs and proposals and summarizes the key design choices that governments will be making. We note that private firms and sectors need to understand how their costs and revenues might be affected by greenhouse gas cap-and-trade programs - including differences depending upon various policy alternatives - and to determine how to take advantage of the flexibility provided by emissions trading. The development of a carbon market as well as the other market effects of a climate change program also will affect key decisions such as the development of new capacity or the retirement of existing plants and equipment. Understanding these influences will help firms and sectors to respond effectively and, in the process, allow the trading programs to achieve the goal of meeting key climate change objectives at lowest cost to society.

Keywords: emissions trading, cap-and-trade, climate change, environment, carbon

JEL Classification: Q48, Q25, K32