smokestackCarbon “cap-and-trade” has become the ultimate buzzword when it comes to climate change and the legislation being drafted to address it. But what exactly does it mean?

Here’s the basic idea: A government agency (the Environmental Protection Agency in the U.S., one might assume) decides on an acceptable total for emissions of various pollutants, with emphasis on greenhouse gases, in absolute terms like metric tons, barrels, stones, drams, etc. (depending on where you are in the world). This total is then be divided into credits, which are sold by governments to polluting companies like tire manufacturers, utilities and major retailers. When the total or “cap” is reached, companies that have generated less emissions than their allotted credits are able to sell or trade their leftovers to other companies which, presumably, wish they had bought more.

This approach to regulation applies ye olde economist Adam Smith’s theory of the “invisible hand” (the power of the free market, essentially) to curtail pollution with less human intervention and at a lower cost. As is, California spends close to $500 billion annually regulating businesses’ emissions. The U.S. is trying to avoid this on a national level. But the idea of cap-and-trade can’t be traced all the way back to Smith. Instead, it began with a 1960s-era supercomputer.

Many of you have seen computers from that time — large clunky affairs providing the very humble beginnings of sentience and policy authorship in this area. Under the guidance of Ellison Burton and William Sanjour, one of these computers was used to run micro-economic simulations for a few U.S. cities. What it found was that a streamlined, transactional regulatory plan for air pollution appeared to be dramatically better than anything humans had come up with yet. The cap-and-trade system we may establish today, if one of two Senate bills passes, is an approximation of that experiment’s results.

Now, here’s the rub: The quantity of allowable pollutants is controlled in this system, but their price isn’t. Future demand for emissions credits is unpredictable (at best), and the price is variable. Together, these two factors make for a volatile, unstable market. In this environment, the supervising body brokering all of these deals (the EPA) could give or withdraw favor from a given company by raising or lowering the national carbon emissions “cap.” Corruption, incompetent micromanagement and financial setbacks are all possible — and you better believe carbon trading opponents are hip to this fact.

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For those who don’t support carbon trading — either due to the above or other arguments — but who still want the government to rein in emissions, a carbon emissions tax is the other major option. Quantities of emissions wouldn’t be under regulation, but their cost definitely would be — a percentage tax would be levied on top of any forms of carbon purchased (like gasoline, as a prime example). This proposal has elicited even more of a backlash than carbon trading. Not only would it affect more average people, but it would probably hike up prices on basic commodities just as we’re coming out of a recession — not a popular or politically viable idea — at least not yet in the U.S.

There is a lesser-discussed third option as well: a hybrid, “safety valve” system. This would include a cap-and-trade-style exchange where maximum and minimum permit prices are controlled by the government, and polluting companies still have the option of buying permits from the government or each other. The difference is that by changing the maximum and minimum sell prices, the EPA or other controlling agency could actually mimic a tax-based system with great accuracy in response to market forces.

As of yet, all of these ideas are still basically theories. None of them have been applied on a large enough scale, or for a long enough period to generate real or truly insightful results. Unfortunately, the only way to do so seems to be to make them law — a classic chicken-and-the-egg debacle. However, we have seen vaguely similar policies in practice — with mixed results.

In 1997, the global community drafted and signed the Kyoto Protocol setting limits for greenhouse gases, especially carbon dioxide, methane, nitrous oxide and sulfur hexafluoride. In all, 184 countries agreed to reduce their own emissions from 1990 levels by 5.2 percent — not including the elephant in the room, the U.S., which decided to walk out on the talks.

For those who did sign the pact, the chief methods of implementation have been cap-and-trade and clean development machanics, whereby industrialized countries invest in green projects in the developing world instead of cleaning up their own backyards. But so far, cap-and trade has played the biggest role, keeping the 184 signatories moving slowly toward a common goal.

The controversy surrounding Kyoto has recently been renewed with the U.S. debating the establishment of a national cap-and-trade scheme, and hoping to lock down key policies before arriving for what is being billed as Kyoto Part II — the United National Climate Change Conference in Copenhagen in December. The related legislation — the Kerry-Boxer and Waxman-Markey bills, both languishing in the Senate as health care reform dominates — has even split Demcorats between emissions-heavy industrial states and their non-industrial peers. Sure, questions like where to set the cap and how much to charge for credits will take even longer to work out, but only after the Senate decides to go with a carbon-trading system (despite a slow economy and powerful lobbying opposition).

Those standing against cap-and-trade, mostly power companies that own coal plants, their largest dependents, and libertarians, are claiming that instituting such a system will prove to be too expensive for the average taxpayer, with estimates ranging from $100 to a nearly absurd $7,000 per household. It would also financially hobble power companies that would have to pay vast sums for what they used to get for free, they cry.

That said, not all utilities are egregious carbon emitters. Nuclear, wind, solar and geothermal energy generation are all nearly carbon free. Companies providing the technologies to tap these sources, and the utilities that are already championing renewables are actually coming around to favor cap-and-trade, perhaps in no small part because it would give them a steep competitive edge against their fossil-fuel burning brethren.

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