Carbon offsetting

Conceptual and legislative context—compliance markets

Development of tradable permit schemes (as part of a regulatory framework) can be traced from the 1970s (for example, power station sulphur dioxide air emissions under the USEPA Acid Rain Program and the application of tradable permit schemes in various other contexts, including the fisheries management and waste management).

Emissions trading is a way of pricing negative externalities, that is, pricing the impacts of an activity that would not otherwise be factored into the cost of that activity, such as pollutant emissions.

Pricing of negative externalities could also be achieved by taxing the activity. However, under a taxing arrangement, while the level of cost (tax) is set, the benefit (eg level of reduced pollution) is not set, but rather is a function of the level at which the tax has been set. On the other hand, with emissions trading the desired level of pollution reduction is set (in other words, the level of pollution is ‘capped’), then the market determines how much it will cost polluters to stay within the cap.

Emission trading might be set up as:

1. •

   cap and trade—entities will have a cap imposed on their level of emissions and are either allocated or buy allowances in respect of those emissions. If their emissions exceed their cap, they need to purchase from other entities that have allowances to spare, or otherwise