Can someone please explain the concept of 'cap and trade' ?

[Earlybird]

It is regularly referred to in financial and legislative articles/editorials, and I don't know what it means.

Thanks in advance for the tutorial.

Effectively it is a means of efficiently regulating the output of something, usually something that you want to reduce/restrict the output of.

It's used, for example, for the emission of greenhouse gases. Each large company that emits greenhouse gases will have a "cap" on how much they can emit every year, with the cap slowly reducing year on year.

However, there will be some of these companies (say company A) that won't need all their cap - they won't emit that much gas; and some that will need to exceed it, as they won't be able to become efficient in time (say Company B). So the two companies "trade" some of their allowance, or Cap - company A sells some to company B.

This means that the overall amount of greenhouses gas emitted stays at the Cap, but the split between companies changes. It also rewards the most efficient companies, with the idea that the reduction in emissions is met at the lowest cost to the economy. Governments might also sell or auction the permits to emit, which creates a revenue stream.

Does that make sense?

Rebeccaj - thanks for the explanation. It is one of those things I hear being referred to constantly, but have never fully understood.

I have now educated myself further that the program came as a result of the Kyoto Protocol, and is administered by the United Nations. Also didn't realise what a big business it is for commodity traders.

My intellectual stimulation for the week...........