The winter holiday has come and gone, and my third post about participatory activities that are useful in teaching climate change law is finally here. This post will discuss how to use a simulation of emissions trading to teach students the basics of a cap and trade regulatory system. After a brief introduction to cap and trade (through assigned reading and a brief lecture), I break my class into eight groups of two students, who will represent eight different companies in the emission trading game. The other students (two to four) will play the role of allowance traders, intermediaries that facilitate the buying and selling of allowances among the companies.
Each company is given information about its projected emissions and its annual caps over the five years (rounds) of the program. They are also told that the program as a whole is designed to reduce emissions by 50% over the program. Each year, the companies have an opportunity to buy pollution control technology (at a given cost, which differs among the companies). Also, at the beginning of each year, I make an announcement as to whether any other external factors have changed their projected emissions (for example, in a recessionary year, all the companies’ projected emissions may be 50% lower). Each year, the students calculate their emissions and make their compliance decisions, including the decision of whether to buy or sell allowances through the allowance trader. The allowance trader announces the market rate for allowances at the end of each year.
After the game, we debrief. Through the game, students get a good sense of how companies in a cap and trade program decide whether or not to reduce their emission. Most importantly, how does the price of allowance compare with the price of reducing emissions? And will the price of allowances rise or fall in the future? If it rises, then investing in pollution control technology to reduce emissions now might pay off. But if the price falls, then the company may have saved money by buying allowances to comply instead of actually reducing its emissions. So for any given company, the decision to reduce emissions becomes a matter of market strategy and forecasting rather than of legal or moral obligation. Students also see how more large, sophisticated companies may have an advantage over small companies; they are able to afford to hire the expertise necessary to play this new regulatory game. And students see how the costs of compliance depend of the stringency of the cap, which explains why cap-setting and allowance allocation decisions are so political. While actual cap and trade programs are inevitably much more complex, a simplified version such as this provides the students with a solid footing for discussing many of the pros and cons of this regulatory approach.