Emissions Trading

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1: Greenhouse gases are gases in an atmospherethat absorb and emit radiation within the thermal infrared range. This radiation is
the fundamental cause of the heating of the surface of a planet known as greenhouse effect.
2: The cap is enforceable limit on emission that is usually lowered over time –aiming towards a national emission.
3: One CER is equivalent to reduction of one tonneof carbon dioxide.
4: Presently, five carbon exchanges are operational around the globe: Chicago Climate Exchange, European Climate Exchange,
Nord Pool, Power Next and the European Energy Exchange.
Emissions trading
Introduction:
Emissions trading or cap-and-trade is a market-based approach used to control pollution by
providing economic incentives for achieving reductions in the emissions of pollutants.
A central authority or governmental body sets a limit or cap on the amount of a pollutant that
may be emitted. The limit or cap is allocated or sold to firms in the form of emissions permits
which represent the right to emit or discharge a specific volume of the specified pollutant. Firms
are required to hold a number of permits or allowances or carbon credits equivalent to their
emissions. The total number of permits cannot exceed the cap limiting total emissions to that
level. Firms that need to increase their volume of emissions must buy permits from those who
require fewer permits.
Definitions:
The economics literature provides the following definitions of cap and trade emissions trading
schemes.
A cap-and-trade system constrains the aggregate emissions of regulated sources by creating a
limited number of tradable emission allowances which emission sources must secure and
surrender in number equal to their emissions.
In emissions trading or cap-and-trade scheme a limit on access to a resource is defined and then
allocated among users in the form of permits. Compliance is established by comparing actual
emissions with permits surrendered including any permits traded within the cap.
What is Emission Trading?
The transfer of permits is referred to as a trade. In effect the buyer is paying a charge for
polluting while the seller is being rewarded for having reduced emissions. Thus those who can
reduce emissions most cheaply will do so achieving the pollution reduction at the lowest cost to
society.

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Pollution as an externality:
By definition an externality is an activity of one entity that affects the welfare of another entity in
a way that is outside the market mechanism. Pollution is the prime example most economists
think of when discussing externalities. There are many different ways to address these from a
public economics perspective including emissions fees, cap-and-trade and command and control
regulation. Here we will discuss cap-and-trade as the chosen public response to externalities.
Cap and Trade:
Cap and trade is one method for regulating and ultimately reducing the amount of pollution
emitted into the atmosphere. It is viewed as a more democratic solution to regulating pollution
than a carbon tax as it creates a commodity out of the right to emit carbon and allows the
commodity to be traded on the free market.
The main goal behind a cap and trade system is to lower greenhouse gas emissions but it has yet
to be decided if it is the best solution. Many economists and politicians say that a carbon tax
would work much better leaving out the chance for a misused market open to being taken
advantage and almost everyone agrees that greenhouse gas emissions need to be lowered in order
to slow down climate change but there is not the same agreement over the best method to do so.
Greenhouse gas emissions – a new commodity:
Emissions trading as set out in of the Kyoto Protocol allow countries that have emission units to
spare - emissions permitted them but not used to sell this excess capacity to countries that are
over their targets. Thus a new commodity was created in the form of emission reductions or
removals. Since carbon dioxide is the principal greenhouse gas people speak simply of trading in
carbon. Carbon is now tracked and traded like any other commodity. This is known as the carbon
market.
Different trading programs:
There are active trading programs in several air pollutants. For greenhouse gases the largest is
the European Union Emission Trading Scheme whose purpose is to avoid dangerous climate
change. In the United States there is a national market to reduce acid rain and several regional
markets in nitrogen oxides. Markets for other pollutants tend to be smaller and more localized.


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The goals of emission trading:
The overall goal of an emissions trading plan is to minimize the cost of meeting a set emissions
target or cap. The cap is an enforceable limit on emissions that is usually lowered over time -
aiming towards a national emissions reduction target. In some systems a proportion of all traded
permits must be retired periodically causing a net reduction in emissions over time. In many cap-
and-trade systems organizations which do not pollute may also participate in trading.
Thus environmental groups may purchase and retire emission permits and hence drive up the
price of the remaining permits according to the law of demand. Corporations can also
prematurely retire allowances by donating them to a nonprofit entity and then be eligible for a
tax deduction.
Market-based and least-cost:
Economists have urged the use of market-based instruments such as emissions trading to address
environmental problems instead of prescriptive "command and control" regulation Command
and control regulation is criticized for being excessively rigid insensitive to geographical and
technological differences and inefficient. However, emissions trading require a cap to effectively
reduce emissions, and the cap is a government regulatory mechanism. After a cap has been set by
a government political process, individual companies are free to choose how or if they will
reduce their emissions. Failure to report emissions and surrender emission permits is often
punishable by a further government regulatory mechanism, such as a fine that increases costs of
production. Firms will choose the least-cost way to comply with the pollution regulation which
will lead to reductions where the least expensive solutions exist, while allowing emissions that
are more expensive to reduce.
Emission markets:
For emissions trading where greenhouse gases are regulated, one emissions permit or allowance
is considered equivalent to one metric ton of carbon dioxide emissions. Other names for
emissions permits are carbon credits Kyoto units assigned amount units and Certified Emission
Reduction units.
These permits or units can be sold privately or in the international market at the prevailing
market price. These trade and settle internationally and hence allow allowances to be transferred
between countries. Each international transfer is validated by the United Nations Framework
Convention on Climate Change Each transfer of ownership within the European Union is
additionally validated by the European Commission.

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Trading exchanges have been established to provide a spot market in permits as well as futures
and options market to help discover a market price and maintain liquidity. Carbon prices are
normally quoted in Euros per tone of carbon dioxide or its equivalent other greenhouse gases can
also be traded, but are quoted as standard multiples of carbon dioxide with respect to their global
warming potential. These features reduce the quota's financial impact on business, while
ensuring that the quotas are met at a national and international level.
Role of Emission trading in financial services:
Currently there are five exchanges trading related carbon credits trading in emission permits is
one of the fastest-growing segments in financial services in the City of London with a market
estimated to be worth about €30 billion in 2007.
Carbon emissions trading have been steadily increasing in recent years. According to the World
Bank's Carbon Finance Unit, 374 million metric tones of carbon dioxide equivalent were
exchanged through projects in 2005 increase relative to 2004.
which was itself a 41% increase relative to 2003 In terms of dollars the World Bank has
estimated that the size of the carbon market was 11 billion USD in 2005, 30 billion USD in 2006,
and 64 billion in 2007.
Other methods of emission reduction:
Cap and trade offsets created through a baseline and credit approach and a carbon tax are all
market-based approaches that put a price on carbon and other greenhouse gases and provide an
economic incentive to reduce emissions beginning with the lowest-cost opportunities.
The emissions trading program can be called a cap-and-trade approach in which an aggregate cap
on all sources is established and these sources are then allowed to trade emissions permits
amongst themselves to determine which sources actually emit the total pollution load. An
alternative approach with important differences is a baseline and credit program.
In a baseline and credit program polluters that are not under an aggregate cap can create permits
or credits, usually called offsets by reducing their emissions below a baseline level of emissions.
Such credits can be purchased by polluters that have a regulatory limit.

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Relationship to domestic and regional emissions trading schemes:
Emissions trading schemes may be established as climate policy instruments at the national level
and the regional level. Under such schemes governments set emissions obligations to be reached
by the participating entities. The European Union emissions trading scheme is the largest in
operation.
Economics of international emissions trading:
It is possible for a country to reduce emissions using a Command-Control approach such as
regulation direct and indirect taxes. The cost of that approach differs between countries because
the Marginal Abatement Cost Curve the cost of eliminating an additional unit of
pollution differs by country. International emissions-trading markets were created precisely to
exploit differing MACs.
MACs for two different countries:
Emissions trading through Gains from Trade can be more beneficial for both the buyer and the
seller than a simple emissions capping scheme.
Assume that the two countries such as Germany and Sweden. Each can either reduce all the
required amount of emissions by itself or it can choose to buy or sell in the market.

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We assume that Germany can abate its CO2 at a much cheaper cost than Sweden
E.g. MACS > MACG where the MAC curve of Sweden is steeper than that of Germany, and RReq
is the total amount of emissions that need to be reduced by a country.
On the left side of the graph is the MAC curve for Germany. RReq is the amount of required
reductions for Germany, but at RReq the MACG curve has not intersected the market emissions
permit price of CO2 market permit price = P = λ.
The market price of CO2 allowances Germany has potential to profit if it abates more emissions
than required.
On the right side is the MAC curve for Sweden. RReq is the amount of required reductions for
Sweden but the MACS curve already intersects the market price of CO2 permits before RReq has
been reached.

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The market price of CO2 permits Sweden has potential to make a cost saving if it abates fewer
emissions than required internally, and instead abates them elsewhere.
In this example Sweden would abate emissions until its MACS intersects with P at R* but this
would only reduce a fraction of Sweden’s total required abatement.
After that it could buy emissions credits from Germany for the price per unit. The internal cost of
Sweden’s own abatement combined with the permits it buys in the market from Germany, adds
up to the total required reductions for Sweden. Thus Sweden can make a saving from buying
permits in the market (Δ d-e-f).
This represents the Gains from Trade the amount of additional expense that Sweden would
otherwise have to spend if it abated all of its required emissions by itself without trading.
Germany made a profit on its additional emissions abatement above what was required it met the
regulations by abating all of the emissions that was required of it.
Additionally, Germany sold its surplus permits to Sweden, and was paid P for every unit it
abated, while spending less than P. Its total revenue is the area of the graph (RReq 1 2 R*)
Its total abatement cost is area (RReq 3 2 R*) and so its net benefit from selling emission permits
is the area(Δ 1-2-3) that is Gains from Trade.
The two R* on both graphs represent the efficient allocations that arise from trading.
Germany: sold (R* - RReq) emission permits to Sweden at a unit price P.
Sweden bought emission permits from Germany at a unit price P.
Carbon Trading:
Carbon emission trading is emission trading specially for carbon dioxide and currently makes up
the bulk of emission trading .it is one of the obligation under the KP to reduce carbon emission
and thereby reduce by global warming.

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Carbon Trading in Pakistan:
Inter governmental Panel on Climate Change has identified Pakistan as one of the countries that
can be hit hardly by climate change.
This is mainly due to the dependency of the economy on agriculture and its low forest cover with
a high rate of deforestation at around 0.2-0.4 every year. Though government has allocated funds
to compensate for the estimated annual loss of US $1.8 billion due to climate change ministry of
environment has indicated the gap of 67 million rupees in the allocated budget. Realizing the
vital role of climate change for sustainable development, Pakistan has started participating in the
international arena of environment.
Pakistan has been signatory to all significant international declarations of environment including
Kyoto Treaty Millennium Declaration however, the relatively active participation of the country
at international level started with the acceptance of KP in January 2005. KP has provided the
country an entry avenue in the form of carbon trading to the international environment market.
For clean development mechanism projects Ministry of Environment has been declared a focal
point while its National Operational Strategy was approved in 2006.
Another critical factor for Pakistan to participate in carbon trading can be the fear of exclusion.
Fear of exclusion refers to the larger opportunity cost of non-participation for any country when
other countries are participating. This opportunity cost can be huge for Pakistan as not only its
peer countries are participating but one of its biggest export markets- Europe has got serious
concerns about Pakistan’s environment standards.
The concern of Europe may result in restricting our exports to the region thus adversely affecting
the export earnings and BoP of the country. The country’s current ranking on Environment
Performance Index 124th among 149 countries is not satisfactory as well. An active participation
at international level towards environment sustainability can not only improve the environment
status of the country, but may also enable the country to enhance its credibility internationally in
this regard.

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Current Status:
Currently, Pakistan has 14 approved clean development mechanism projects with a status of host
country while six projects are in pipeline. The main objective of these projects is to bring
positive impact on socio-economic status of the country along with its contribution towards
environment sustainability. To achieve this, the government has set conditions on the following
four criterions for projects approval environment criteria, social criteria, economic criteria and
technological criteria.
According to clean development mechanism cell, Ministry of Environment Pakistan, these
projects are expected to bring US $ 345 million foreign investment along with 3.35 million tones
GHG reduction per year as well as a positive impact on agriculture productivity, employment
opportunity and technology transfer.
Pakistan at present possesses a very small share 0.4 percent of the Carbon trading market. One
possible explanation for this small share can be that a country having significant population
below poverty line cannot afford to allocate significant resources for monitoring climate change.
So climate uncertainties can have more devastating impact on poor and vulnerable societies.
The inclusion of sustainable environment in millennium development goals is an indication of
universal consensus on the linkage between poverty reduction and environment sustainability.
Acknowledging the relationship the government has included environment not only as an
important aspect of Poverty Reduction Strategy but has also made it part of the Public Sector
Development Program 38.39 million rupees have been allocated for Carbon Trading. The
government is also responsive to the needs of capacity building and mass awareness to increase
market participation in carbon trading. In this regard, the ministry has not only arranged many
workshops and seminars but has also initiated few joint ventures with donors.
Sector Wise CDM Projects (percent)
Pakistan
Sectors Global CurrentProjects Pipeline Projects
Energy 64.96 57.14 58.33
Waste management 19.45 28.57 16.67
Industrial process 9.63 14.29 16.67
Transportation 0.13 0 0
Landuse & forestation 0.08 0 8.33
Agriculture & livestock 5.78 0 0
Source: UNFCC & CDM Cell, MOE , GOP

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Conclusion:
Pakistan has yet to maximize benefits of carbon trading in terms of technology transfer and
resource inflow. This avenue can be utilized for economic development and poverty alleviation
by integrating it with development policies. Capacity building along with strengthening of CDM
set-up in the country may help in creating conducive environment for the efficient functioning of
the domestic environment market. As mentioned earlier a major criticism on KP is its uncertain
status after 2012. However, Pakistan should focus on KP as an opportunity for addressing
environmental issues while capitalizing on economic benefits of the protocol.
References:
1:www.sbp.org.pk/reports/quarterly/fy10/first/SpecialSection1.pdf - (SBP)
2:en.wikipedia.org/wiki/Emissions trading
3:www.men.gov.jm/...Policy/Policy_for_Trading_of_Carbon_Credits_October_5_2010.pdf
4:www.epa.gov/region7/air/nsr/nsrmemos/emtradp.pdf

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