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New Energy Economics: Carbon Cap and Trade

Cole Gustafson, NDSU Biofuels Economist Cole Gustafson, NDSU Biofuels Economist
Under cap-and-trade, the government sets an annual cap on carbon emissions.

By Cole Gustafson, Biofuels Economist

NDSU Extension Service

The Obama administration is developing a cap-and-trade program for reducing carbon dioxide emissions. This is an important development for the renewable-energy industry because carbon credits created from the use of biofuels and wind energy will help meet established national goals. It also is of concern for the northern Plains because coal is used extensively for plant heating and electrical generation, so any reduction in emissions will raise user costs.

Under cap-and-trade, the government sets an annual cap on carbon emissions. President Obama’s budget calls for a cap 14 percent below 2005 emission levels by 2020 and 83 percent below 2005 emission levels by 2050. To assist affected firms, the government will issue a fixed number of credits for emissions under the cap. Unlike implementation of Europe’s plan, under which the credits were handed out, President Obama proposes to auction off these credits.

Money that will be collected from the initial sale of carbon credits - $78.7 billion in the first year (2012) - is included in the president’s federal budget. By 2019, revenues from cap-and-trade are expected to exceed $525 billion. President Obama’s deficit reduction plans heavily rely on this new source of revenue.

To offset some of the burden of the program, the president proposes to use some of the auction revenue for tax relief. Approximately $15 billion a year will be used to fund research on new clean-energy technology. A $400-per-person tax credit also is being proposed to help individuals defray the higher energy costs that are expected.

Cap-and-trade is not the only strategy for reducing carbon emissions. A carbon tax also has been proposed. Economists generally prefer a carbon tax over cap-and-trade because it is more transparent and firms can plan accordingly. At the moment, it is uncertain what the prevailing value of carbon credits in the new cap-and-trade auction market will be worth. Consequently, firms have a tough time deciding if they should be bidding on those credits or purchasing new clean energy technology to reduce emissions and avoid having to buy carbon credits. With a tax, firms know exactly what the cost will be and can budget for it thoughtfully.

It is uncertain what the prevailing price of a carbon credit will be. In the U.S., carbon credits on the Chicago Climate Exchange generally have been trading for under $5 per ton. In Europe, carbon credits have been trading in auction markets for some time and are worth four to five times that level, depending on economic conditions and energy policy.

Regardless of whether cap-and-trade or a carbon tax is implemented, carbon credits generated from renewable energy will become more valuable. For example, coal-fired electricity releases 2.13 pounds of carbon dioxide for each kilowatt-hour produced. Wind energy releases zero pounds. Thus, a 2-megawatt wind turbine can create 2.13 tons of carbon credits that could be worth $14 a ton, according to recent energy market studies.

The program’s value for biofuels is far less clear. A couple of key issues are documenting actual savings generated at farm and plant locations. Farmers will have to prove they actually are reducing net carbon levels from their operations at the present. Even though a producer may have adopted minimum tillage and reduced applied inputs in the past, the new benchmark will be to determine how much reduction has occurred from the operation as it currently exists. In addition, the whole use-of-land issue debated nationally again arises. To what extent does land taken for the production of biofuels in the U.S. result in a greater use of land in a foreign country?

NDSU Agriculture Communication

Source:Cole Gustafson, (701) 231-7096,
Editor:Rich Mattern, (701) 231-6136,
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