‘Capping’ creates a ‘global’ limit on the right to use a natural resource. This involves dividing up the global limit, which is usually set by government, so that each resource user has a defined ‘permit’ or ‘right’ to the resource. Caps can also be placed on harmful by-products such as salt or pollution to contain them within sustainable limits.
Cap-and-trade mechanisms are quantity-based market-based instruments (MBIs), designed to work in conjunction with other regulatory mechanisms. In a capped system, no new rights can be authorised unless old rights are surrendered or cancelled simultaneously. The holders of the ‘rights’ can trade them in a formal market.
In these systems, new market entrants must purchase permits from existing permit holders at the market price.
The cap-and-trade approach to managing environmental pollution and sustainable natural resource use has been widely applied to industrial air pollution, such as sulphur dioxide and to natural resources such as fisheries, water and forests. In some instances, cap-and-trade mechanisms have been applied to agricultural issues and landscapes.
Examples include:
- managing irrigation water in fully-allocated systems
- managing point-source water pollution emissions
- managing dryland salinity and irrigation salinity.
A cap-and-trade mechanism is most likely to be effective when the cap is achievable, the issues are well known and documented, the cap is accepted by stakeholders and monitoring and enforcement can be undertaken at low cost.
Despite the benefits of cap-and-trade mechanisms, they can be costly to establish and operate. The scale, costs and institutional arrangements required to create and run them generally preclude regional natural resource management (NRM) groups from using them directly as an NRM policy tool. However, there are a number of, as yet, largely under-utilised strategic opportunities for regional NRM groups be involved in cap-and-trade mechanisms.
There are a number of benefits of using cap-and-trade mechanisms.
- Using a ‘global’ cap provides a level of certainty that environmental thresholds will not be exceeded.
- cap-and-trade mechanisms enable economic growth without compromising environmental quality or sustainable resource yield.
- Participants in cap-and-trade markets have a continuous incentive to find the most cost-effective ways to reduce their use of the resource or reduce their discharge of a pollutant because unused rights can be sold to the market. Alternatively, firms with abatement costs higher than the market price can choose to purchase additional rights from the market as required. These ‘gains from trade’ result in innovation and ongoing efficiency over time.
Cap-and-trade mechanisms can be costly to establish and operate because:
- establishing and distributing initial caps can involve costly scientific (environmental equivalence measures), economic and legal investigations and processes, and
- ongoing market operation and regulation can be expensive, particularly measuring and enforcing compliance with permits and overseeing and verifying market transactions.
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