Cap Setting
The cap is the systemwide (i.e., inclusive of all covered enterprises) emissions that can be emitted in a specific compliance period. The systemwide cap will include the sum-total of enterprise-specific emission limits and reflects any associated increases (accounting for growth allowances) and/or decreases necessary to meet program-defined obligations. A cap can be measured in terms of absolute emissions or emissions intensity.
A cap with an absolute emission limit is generally recognized as being necessary in order to achieve an reduction in absolute emissions. A cap with a growth allowance can be useful to accommodate programs that expect to see a rising quantity of systemwide emissions.
Systemwide caps are generally set at levels that are consistent with the jurisdiction’s greenhouse gas emission reduction goal. Once set the systemwide cap is proportionally divided amongst included enterprises through an oftentimes negotiated process that considers historical emissions, emission intensities relative to industry benchmarks, competitive concerns, along with equity considerations and the dictates of interim and long-term programmatic goals.
Allowance price levels are a function of how many allowances are available under the cap, how easy it is for installations to reduce emissions and other factors such as drivers of consumption and economic growth. These variables need to be taken into consideration when defining a cap. Though the carbon price also depends on these other factors, a generous emissions cap will tend to lead to the market being long and will generate a low allowance price, reducing incentives for abatement. By contrast, a relatively tight cap means a more limited supply of allowances, or the market being short, resulting in a higher allowance price and a greater fiscal incentive to reduce emissions.
Setting a cap also implies choosing a baseline against which emissions are to be reduced. The cap is usually set in relation to historical emissions, often referred to as a base year, or projected future emissions (e.g., against a business-as-usual scenario). Clear communication of the trajectory, or the path from the basis to the target, helps capped entities plan investments to reduce emissions.
