Using emissions trading to regulate global greenhouse gas emissions

The inclusion of emissions trading in the Kyoto Protocol reflects an important decision to address climate change issues through flexible market mechanisms. This Article addresses a number of policy issues that must be considered in designing and implementing an international greenhouse gases (GHG) emissions trading scheme. These include emissions trading models, the initial allocation of emissions permits and its competitiveness concerns, banking and borrowing, the liability rules for non-compliance, and bubbles. The following conclusions emerge from the discussion. First, although emissions trading could take place either on an inter-governmental basis or on an inter-source basis, sub-national legal entities are the best entities to trade emissions permits. Allocating permits to individual emissions sources will facilitate private participation in emissions trading. Moreover, it has been argued that individual governments should be left free to devise their own ways of allocating assigned amounts. Second, it has been pointed out that although national emissions trading systems could be modelled as either upstream or downstream or hybrid systems, the distinguishing features of broad coverage and administrative simplicity would make an upstream system the more attractive approach. Moreover, national emissions trading systems should incorporate the maximum degree of flexibility in banking. Third, the liability rules are essential to the success of an international GHG emissions trading scheme. In general, a seller beware liability works well in a strong enforcement environment. In the Kyoto Protocol, however, it may not always work. By contrast, a buyer beware liability could be an effective deterrent to non-compliance, but the costs of imposing it are expected to be very high. To strike a middle ground, it has been suggested a combination of preventive measures with strong but feasible end-of-period punishments to ensure compliance with the Kyoto emissions commitments. Such measures aim to maximize efficiency gains from emissions trading and at the same time, to minimize over-selling risks.