An interest in reducing environmental impacts and achieving climate sustainability is growing significantly within the U.S. government, especially with the Biden Administration’s pledge to cut the country’s Greenhouse Gas (“GHG”) emissions in half by 2030. To achieve this commitment, the federal government is considering various policy measures and strategies to reduce its GHG emissions into the atmosphere in order to meet this commitment.
One measure the U.S. government is considering is a system that prices carbon to reduce GHG emissions by establishing a regulatory carbon market. Regulatory or compliance carbon markets are usually organized by governments to target certain industries or sources that emit GHGs into the atmosphere. Typically, the government places a cap on GHG emissions, and the industry or source emitters are required to obtain pollution allowances or credits in order to meet the emission cap limits. These emitters are allowed to trade unused credits to other emitters or financial intermediaries to make a profit.
Currently, several different countries operate a government-run regulatory market to regulate and reduce the amount of carbon emitted within their boarder. Additionally, there are regulatory carbon markets currently operating in some individual states within the U.S. As the U.S. seeks to establish a climate strategy, lawmakers may consider establishing a regulatory carbon market at the federal level. Such a market, if implemented, may operate under a similar framework used by the various regulatory markets currently operating within the U.S. and internationally.
Carbon Market Origins
The carbon market industry began to develop under a United Nations (“UN”) international treaty known as the Kyoto Protocol (“Protocol”). The Protocol was adopted on December 11, 1997, and it became the first major international agreement to reduce GHG emissions. Although this treaty did not directly establish a carbon market, it was the initial factor that led to the establishment of the carbon market industry that is still currently operating.
Article 2 of the Protocol explains that the main goal of the treaty is to reduce and control human-emitted GHGs to “prevent dangerous…interference with the climate system.” To achieve this goal, certain countries participating in the Protocol were required to limit their country’s GHG emissions to achieve a set emission-reduction target. The countries bound to the emission limitation were the industrialized, developed countries responsible for most of the GHGs being emitted into the atmosphere. The U.S. qualified as one of these countries, but the U.S. chose not to participate in the Protocol, which means it was not required to reduce GHG emissions under the treaty.
The Protocol required participating countries to use all available mechanisms the country had to reduce its GHG emissions, however it also provided some suggested measures that would help a participating country achieve its emission-reduction target. One important mechanism the Protocol suggested was the creation of emission trading schemes (“ETS”) (i.e., regulatory GHG emissions credit markets). According to the Protocol, these ETS, which are also commonly known as cap-and-trade markets, could assist participating countries in achieving their emission-reduction commitments.
When the Protocol went into effect on February 16, 2005, only one participating member established an ETS. The European Union (“EU”), a geo-political union made up of several different countries, created the European Union Emission Trading Scheme (“EU ETS”) in order to satisfy the GHG emission-reduction commitment it set under the Protocol. The Protocol, which expired in 2020, has been replaced by another UN international treaty known as the Paris Agreement, which is now the framework used by many countries to reduce GHG emissions. Nevertheless, the Protocol was the initial step towards the creation of the carbon market industry.
International Carbon Markets
The EU ETS is the first GHG emissions credit market, and it is currently still operating even though the Protocol is no longer used by the international community. In fact, this market still functions under the original framework implemented by the EU when the market launched in 2005. As a result, other countries have used the EU ETS framework when implementing their own regulatory market.
The EU designed the EU ETS using a cap-and-trade framework in order to regulate the amount of carbon dioxide and other GHGs being emitted into the atmosphere by certain industries. To regulate specific GHG-emitting industries, the EU places caps on how much carbon specific industries or source emitters can emit within a specific timeframe. Under the EU ETS, emitters are required to obtain pollution permits or credits in order to meet the emission cap limits. These regulated emitters trade unused allowances to other emitters or financial intermediaries to make a profit.
Since the implementation of the EU ETS, the EU has operated the market in phrases called “trading periods.” Within the first trading period, which lasted from January 2005 to December 2007, the market regulated emissions from power plants and certain industrial factories. The second phrase ran from 2008 to 2012 and the third phrase was from 2013 to 2020. With each trading period, more industries were added to the list of regulated sectors subject to the EU ETS. Also, the EU placed more restrictive caps on the amount of carbon these emitters were allowed to emit and further regulated the amount of credits circulating within the market. Currently, the EU ETS is in its fourth trading phrase, which will run until 2030, and there are several sectors subject to a cap on carbon dioxide emissions. A few of the regulated emitters include steel plants, cement factories, glass factories, paper and carboard mills, factories producing iron, power plants, and some commercial aviation.
One important aspect of the EU ETS is that it is an international marketplace. The EU is currently made up of 27 different countries, and each of these countries participate in the EU ETS. A few non-EU countries—Iceland, Norway, and Liechtenstein—are also participants in the EU ETS. Additionally, in January 2020, Switzerland’s emissions trading market formally linked with the EU ETS. This linkage of markets allows credits from either market to be traded between the two schemes. Overall, the EU ETS gives participating countries the ability to trade credits to emitters that are located in a different country. Therefore, this international marketplace helps advance the EU’s goal of reducing the amount of carbon emitted into the atmosphere by capping certain industries across several different countries.
The EU ETS has demonstrated to other countries that a large-scale emissions credit market can be implemented in an effort to achieve a climate neutrality target. Accordingly, the EU ETS has encouraged other countries to establish their own emissions trading markets. In fact, the EU has previously assisted some countries in establishing their own market. Since the creation of the EU’s market, countries such as China, South Korea, Canada (Québec and Nova Scotia), and New Zealand have established their own national market. Each of these markets operate under a cap-and-trade framework that is similar to the EU ETS.
U.S. Carbon Markets
Although the U.S. federal government does not operate an emission trading market, one state is currently operating its own cap-and-trade market within the U.S. In 2006, the California legislature passed the California Global Warming Solutions Act, which created a state-wide emissions trading market. Similar to the EU ETS, California’s market operates under a cap-and-trade framework in order to regulate large carbon-emitting industries to reduce the state’s carbon emissions. California’s credit market regulates industries and emitters that are responsible for 80% of the state’s GHG emissions, such as electricity generators, large industrial facilities, and distributors of transportation and natural gas.
According to California’s Air Resources Board, the state’s cap-and-trade market is “designed to link with similar trading programs in other states and regions.” In fact, on January 1, 2014, California linked its regulatory market with the Québec Cap-and-Trade System. This means that industries and emitters regulated by these markets may obtain credits from either market in order to satisfy compliance obligations.
Another regulatory carbon market within the U.S. is the Regional Greenhouse Gas Initiative (“RGGI”). This cap-and-trade market is made up of eleven northeastern states, which include Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont, and Virginia. These RGGI states cap the amount of carbon that certain fossil-fueled power plants can emit within their state. Each participating state must implement their own statutes or regulations—based on the “RGGI Model Rule”—which establishes the caps on emissions, how many allowances (i.e., credits) are available within their state, and the process of selling credits.
Because RGGI states cap the amount of carbon that certain electric power plants can emit, these regulated power plants must obtain credits in order to emit carbon. Most credits offered by RGGI states are sold at quarterly auctions. Each RGGI state offers and sells their own credits to regulated power plants and other qualified buyers at the auction, and each state has discretion over the proceeds they earn from auctioning credits.
RGGI states reinvest some of the proceeds generated from the auctions into different “decarbonization” programs. In general, these programs focus on energy efficiency projects, implementing new clean and renewable energy systems, and providing benefits to consumers with RGGI states. The largest portion of RGGI investments go towards programs that provide energy efficiency. These types of programs provide improvements to homes and businesses, such as installing new appliances, lighting, HVAC system, or insulation, in order to reduce the amount of energy needed for a house or office building. Because of the RGGI market and investments by participating states, according to the organization, the region’s power sector carbon emissions have decreased over 50% since the market became effective in 2009.
Currently, there is no regulatory carbon market at the federal level. However, there are many cap-and-trade markets operating nationally and international. As the United States seeks to establish a climate strategy, lawmakers may consider establishing a regulatory carbon market under a similar framework used by the various regulatory markets in order to reduce the nation’s GHG emissions and achieve its emission-reduction commitment.
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