Introduction

A unique feature of cap-and-trade systems

Cap-and-trade systems operate through the creation and distribution of tradable rights to emit, usually called allowances, to installations. Since a constraining cap creates a scarcity rent, these allowances have value, and there are many claimants for them, not least the owners of installations required to surrender allowances equal to their emissions. The distribution of these rights, usually for free, is what is called allocation, and it is the unique feature of cap-and-trade systems.

Allocation is often portrayed as contentious and sordid, but it should be remembered that similar rights, rents and value are created by any system that effectively constrains emissions. An emissions tax is relatively straightforward. It creates a fixed price on emissions, instead of a fixed quantity limit, and the right to emit is acquired by paying the tax. The government is typically the recipient of the tax revenues, although cases exist in which the revenues are returned to emitters, such as the NOx (nitrogen oxides) tax in Sweden (Millock and Sterner 2004). ‘Command-and-control’ approaches are more common and less transparent, but they create the same rights and rents. Firms acquire implicit rights to emit by meeting the prescribed regulatory standard, or whatever derogations may be granted. The value created by the constraint is conveyed to facilities meeting the new standard through the increase in the price of output due to the new regulatory requirement, which often places more demanding standards on new entrants.