Cap and Trade

As society focuses on tackling the challenges of greenhouse gas emissions, market-based solutions have emerged as a means for reducing emissions in the most economically efficient manner, i.e. at the lowest possible cost. Cap-and-trade programs cap the levels of emissions for a particular sector of the economy, but provide compliance flexibility to capped facilities in order to contain costs. Two main products are often used in these programs – allowances and offsets.

Cap and Trade

Allowances (or permits) are tradable units that represent the right to emit a specific volume of a particular pollutant. They represent the currency of a cap-and-trade program. Initially, a quantity of allowances equal to the size of the cap is distributed by a regulatory body into the market either through allocation, by auction or a combination of both. Subsequently, allowances can be bought and sold under the cap-and-trade program. Facilities need to ensure they have sufficient allowances to submit for every compliance period.

Carbon Offsets

Many cap-and-trade programs include the use of offsets (to varying extents), sometimes known as Certified Emission Reductions (CERs)or Verified Emission Reductions (VERs). Offsets represent project-based reductions of emissions that are undertaken outside of the capped sector(s) and that are above and beyond any legal requirement to do so. These emission reductions are used to offset a like amount of the buyer’s own emissions. They are particularly common in cap-and-trade programs that regulate greenhouse gases.

Carbon Offsets