World Resources Institute WRI

The Bottom Line Series: Cap-and-trade

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Courtesy of World Resources Institute WRI

Cap-and-trade programs are the foundation of many climate policy proposals and have been a focus of debate in state, regional, and national legislatures. This fact sheet provides answers to some of the basic questions about cap-and-trade programs and reviews how such a system might work in the United States.

What is a cap-and-trade program?

A cap-and-trade program sets a maximum limit, or a “cap,” on greenhouse gas (GHG) emissions from those facilities and sectors covered by the regulation. An emitter covered by the cap has two primary obligations:

  1. The emitter must measure, monitor, and report emissions.
  2. At the end of each compliance period, the emitter must have enough allowances to cover its reported emissions (an allowance is a permit that allows the holder to emit a specified amount of greenhouse gas emissions).

The cap limits the total amount of allowances available. This scarcity creates a market price for the allowances based on supply and demand. Regulated emitters may buy and sell allowances, so companies that can cheaply or easily reduce emissions can sell allowances to other companies for which such reductions are more expensive or difficult. This flexibility lowers overall compliance costs by allowing companies to pursue the most cost-effective emission reduction options.

Who is regulated under a cap-and-trade program?

Cap-and-trade programs can have differing scopes of coverage. Some existing programs cover one sector, such as the electric power sector. Other programs and policy proposals cover multiple sectors. Different policy proposals also specify different points of regulation, focusing on “upstream” emission sources, “downstream” emission sources, or some combination of the two. A cap-and-trade program focused on upstream sources regulates energy producers, suppliers, and transporters, such as oil and gas companies, coal mining operations, petroleum refineries, and fuel shippers/importers. A cap-and trade program focused on downstream sources regulates emissions at the point of combustion or use (i.e., at the “smokestack” level). Because of the vast number of downstream sources and the associated administrative cost and complexity, regulated downstream sources are often limited to large-scale emitters, such as fossil fuel-fired power plants and energy-intensive industrial sources.

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