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Cap and Trade

Cap and Trade

As society focuses on tackling the challenges of air emissions, market-based solutions have emerged as a means for reducing emissions in the most economically efficient manner, i.e. at the lowest possible cost. Cap-and-trade programs cap the levels of emissions for a particular sector of the economy, but provide compliance flexibility to capped facilities in order to contain costs. Two main products are often used in these programs – allowances and offsets.

Allowances

Allowances (or permits) are tradable units that represent the right to emit a specific volume of a particular pollutant. They represent the currency of a cap-and-trade program. Initially, a quantity of allowances equal to the size of the cap is distributed by a regulatory body into the market either through allocation, by auction or a combination of both. Subsequently, allowances can be bought and sold under the cap-and-trade program. Facilities need to ensure they have sufficient allowances to submit for every compliance period.

If the market value of the allowances is greater than a facility’s cost to reduce its emissions, it will likely invest capital to reduce its emissions, freeing up allowances for others to use. Conversely, a facility with emission reduction costs higher than the market price of allowances available to it will purchase these surplus allowances. In this way, the market price for the allowances encourages facilities to seek the cheapest emission reduction opportunities, and to pursue them.

Market Facts

The EPA’s Acid Rain program, covering emissions of sulfur dioxide (SO2), was the original cap-and-trade program in the United States. Since then, a number of other programs have been developed, all of which follow the same basic principle of cap-and-trade:

  • NOx emissions in the northeast are covered by the NOx State Implementation Plan (SIP) Call Program
  • The Houston-Galveston Area Council has an emissions program to reduce NOx emissions in the area by 80%
  • Southern California’s RECLAIM (Regional Clean Air Incentives Market) program for NOx has similar objectives to the Houston Galveston program
  • The first carbon market in the US is the new Regional Greenhouse Gas Initiative (RGGI), a commitment by 10 Northeastern states to cap carbon dioxide emissions from the power sector
  • In Canada, Alberta’s provincial carbon program regulates the greenhouse gas (GHG) emissions of the largest emitters in the province

Offsets

Many cap-and-trade programs include the use of offsets (sometimes known as Verified Emission Reductions (VERs) . Offsets represent project-based reductions of emissions that are undertaken outside of the capped sector(s) and that are above and beyond any legal requirement to do so. These emission reductions are used to offset a like amount of the buyer’s own emissions. They are particularly common in cap-and-trade programs that regulate greenhouse gases.

Market Facts

  • Offsets are created by the actions of specific projects that reduce emissions of air pollutants or increase their rate of removal from the atmosphere. An example of the former would be capturing and destroying the methane produced by a landfill as organic matter decomposes. An example of the latter would be a reforestation program, where trees sequester carbon dioxide out of the atmosphere; 
  • Emission levels under the project scenario are compared to those under a "business as usual" baseline to determine the quantity of emissions reduced – the measurement of this baseline is a critical issue to ensure the reduction is real and would not have happened anyway; and 
  • Emission reduction projects are verified by an independent auditor to ensure that calculations have been made correctly, and that the project developer has ownership of the emission reductions.


Renewable Energy

Promoting renewable energy is key to developing new technologies and demonstrating their commercial applicability. Many states have Renewable Portfolio Standards that mandate a certain percentage of electricity to be generated by renewable resources. In addition, many individuals and corporations are promoting the development of renewable resources through the acquisition of Renewable Energy Credits (RECs). RECs are tradable instruments that reflect the environmental attributes of electricity generated from renewable sources, such as wind, biomass, solar or hydro. RECs are an important revenue stream for many renewable projects – by purchasing a REC, the buyer is directly supporting that project’s development.

Many states have authorized the use of RECs to demonstrate compliance with their Renewable Portfolio Standards. Shell Energy is active in all of these markets. Some states (for example California) also require power to be imported into the region to support the underlying environmental attributes, and through our operations in the power markets, Shell Energy can provide solutions for this as well.

Market Facts

  • REC purchases drive demand in the renewable energy market, which can foster new clean energy projects; 
  • One MWh roughly covers the amount of electricity a North American residential customer would use in a month; 
  • A coal-fired power plant emits approximately one ton of CO2 to generate one MWh of electricity; and 
  • RECs are often used to meet Renewable Portfolio Standards

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