Okay, show of hands -- who stopped reading halfway through Hazelnut's writeup? He's against solar and wind power, he's skeptical that global warming is real, he assumes that environmentalists are self-serving yuppies... If you're coming from an environmentalist viewpoint, it's all a little hard to stomach. But as it turns out, he's mostly right.
The first thing you need to know about emissions trading is that it's not for you. Real emissions trading is not targeted at you, and you do not need to go through any sort of agency that claims to balance your carbon production against your carbon credits. If you have money to invest in saving the rainforest, buying energy star products, installing solar power, planting your own garden, or any of a hundred other things you can do to help the environment, then by all means do so! But if all you're doing is cleansing yourself of guilt ("the world may be going down the toilet, but at least it's not my fault!"), then you're out of luck; no good cleanser exists. Emission credit trading is for the big players, companies that don't care about saving the Earth or staying 'in balance', but who just want a good profit.
Emissions trading or 'Cap and Trade' is not a new idea. The first major program of this sort was created in 1990, when the USA modified its Clean Air Act to establish a market based trading system for sulfur dioxide (SO2), in an attempt to limit acid rain. The first auction for SO2 credits took place in 1993. By 2002 SO2 emissions had dropped 40%, and the cost of this reduction was only one tenth as much as industry leaders had projected. This set the stage for emission trading for other pollutants, but it certainly didn't prove we had a fool-proof system for reducing all types of pollution.
Cap and trade type programs work by limiting how much of a given pollutant can be let loose in a given area (usually country-wide) or industry (for example the power industry). Then the right to produce a unit of pollution is sold to the highest bidder. This is a great way to parcel out pollution rights, as it means that the cost of pollution is proportionate to the value of pollution to the producer, and it gives permission to pollute to those who need it the most.
If the government were to simply say "no one can pollute more than X", some polluters would be unable to curb their production, and might have to go out of business. At the same time, other polluters that could easily cut back might not, just because they come in under the maximum allowed amount. Under the cap and trade system those polluters that can easily reduce their output of pollution will do so, and will save money because they don't have to buy pollution credits. Those that can't reduce their output can continue to pollute as long as they pay. The added cost of buying pollution credits will encourage them to upgrade as soon as possible. This works wonderfully in fields where there's variation in the costs associated with polluting.
It is usually a feature of this type of system that as time goes on the amount of emissions credits put up for sale decreases. This keeps the price of the credits high enough to keep polluters looking for ways of reducing emissions, and keeps reducing pollution indefinitely. It is usually not a feature of these systems to try to set the final price of polluting in any relation whatsoever to the cost that pollution imposes on society.
Because the SO2 reduction program was such a raging success, many environmentalists expect that cap and trade systems on other pollutants will also be successful. This is not impossible, but there are some requirements that need to be met before this can be true.
Regulation and Governmental Oversight: Currently most cap and trade systems depend on the self-reporting of polluters. This is an obvious flaw. In addition, cap and trade plans are often heavily influenced by lobbyists from the regulated industries, and are often not kept up at an effective level. The Regional Clean Air Incentives Market (RECLAIM) in California is an example of a poorly kept emissions trading market. After nine years of regulating nitrogen oxides and sulfur dioxide in Southern California it was evaluated by the EPA; they found that it had reduced emissions much less than it should have, due to accounting abuses and emission caps being set much too high -- 60% higher than the actual emissions level. This was a well established governmental program, but a lack of management and effective regulation had rendered it worthless.
Appropriate Targets: Not every pollutant is equally appropriate for a cap and trade program. There has been some debate on whether or not mercury should be regulated by emissions trading; mercury produced by power plants tends to precipitate out of the atmosphere along with the fly ash, affecting the local environment rather then being spread evenly throughout the atmosphere. In 2005 the American EPA passed the Clean Air Mercury Rule, including a cap and trade system for mercury. This has come under attack as producing hot spots of mercury pollution, where power plants released dangerously high levels of mercury into some localities. It is likely that the EPA will move to a system that puts specific caps on the amount of mercury that any plant can produce, without the option of buying additional pollution rights.
Nitrogen oxides and SO2 also tend to have somewhat localized effects, although they are not as concentrated in their effects as mercury. Carbon dioxide is one of the best possible candidates for an international emissions trading market, as the effects of carbon emissions are felt around the globe -- there is no more appropriate target for this sort of market than carbon dioxide.
Economics: The mathematics behind producing a successful emissions trading market are complex, and have to take into account the current production levels, the possible reductions per year, the cost of making these reductions, and (hopefully) how volatile the market changes resulting for the emissions market will be. President Bush refused to sign the Kyoto protocol because he was afraid that it would hurt the American economy, and some of the countries that did sign are finding that they are falling badly behind their goals, while will have economic consequences. Getting an emissions trading market right on the first try is hard enough, but it is nearly impossible when you're working on a global scale. Of course, we've seen similar problems in regulating the housing market, the stock market, and even the supermarket, and no one is talking about scraping those.
Private citizens, or more often, environmental groups, can indeed enter into these emission trading markets. It's common enough for a group to pool its money to buy a pollution credit, and then not use it. This is an effective (if expensive) method of reducing pollution below the government mandated caps. But for this to be an effective strategy, it is necessary for the emissions market to be established and well regulated. If there is no real punishment for those who break emission caps, if the emissions caps are not realistic, or if polluting industries can be outsourced to other parts of the world, then buying credits is a waste of your money. You need to research before you invest! it's true in the stock market, and it's true in the emissions market. If you are 'investing' in clean air or lower carbon emissions, you need to double and triple check what you are doing.
When looking at regulating carbon emissions many environmentalists favor a carbon tax; this has the advantages of being a lot simpler for all concerned, easier to modify to deal with changing circumstances, and harder for companies to manipulate. A carbon tax is also easier to apply across all industries and systems, while carbon credits tend to be applied only to larger pollution sources.
References:
www.epa.gov/airmarkt/cap-trade/docs/ctresults.pdf
http://www.peer.org/news/news_id.php?row_id=200
http://en.wikipedia.org/wiki/Regional_Clean_Air_Incentives_Market
http://en.wikipedia.org/wiki/Emissions_trading
http://www.carbontax.org/issues/carbon-taxes-vs-cap-and-trade/
http://www.mercuryanswers.org/regulation.htm
Also for Wintergreen: An Earth Quest.