29 May 2009:
What is Emissions Trading?

An ETS is an economic policy instrument designed to limit greenhouse gas emissions by providing economic incentives to emitters to reduce their emissions. It may also be referred to as a ‘cap and trade’ scheme.

An ETS may be national, such as the Australian and New Zealand schemes (the proposed CPRS and the NZ ETS respectively), or regional, such as the European Union emissions trading scheme (the EU ETS).

Within an ETS, the Government sets a cap – or limit – on total emissions allowed within the market for that year, and issues a number of permits equal to the cap. For example, if the cap specified 553 Mt CO2-e, 553 million permits would be issued (Australia's net greenhouse gas emissions were 553 Mt CO2-e in 2008, which was 1.1 per cent more than the previous year). Emitters that emit greenhouse gases above a certain threshold are then required to acquire a permit for every tonne of greenhouse gas that they emit. At the end of each commitment period, each liable emitter would surrender a number of permits equal to the number of tonnes of emissions they produced in that year. Emitters have the choice of either purchasing permits to meet their emissions liabilities, or reducing their emissions and selling the permits they hold - depending on the cost effectiveness for the particular entity.

Emitters that choose to buy permits are, in effect, paying for the right to emit, and emitters that sell permits are able to profit from reducing their emissions. This means that those emitters that are able to reduce their emissions cheaply will do so, achieving a reduction in total emissions at the lowest possible cost. As the total cap of emissions is reduced each year so that, over time, less permits are available to trade, it is likely the price of permits will increase. This, in theory, provides an appropriate price signal and economic incentive for emitters to reduce their emissions.