1. Cap-and-trade is a system that sets a maximum allowable level of pollution, issues permits to companies specifying how much carbon they may emit per year and then penalizes them if they exceed their limit. If a company wants to emit more than their limit, it must buy extra permits from companies that are under-emitting their cap — in other words, they can trade permits, putting the "trade" in cap-and-trade.
2. Quebec and California have linked their systems. Now Ontario will join in, meaning Ontario companies can buy permits from (or sell to) companies in California and Quebec, and companies in California and Quebec may trade permits with Ontario companies.
3. Some free permits are given to companies by governments, usually to those in sectors that could suffer from competitors in jurisdictions without cap and trade. The free permits are aimed at ensuring companies won't face a competitive disadvantage that could force them to relocate to a cap-and-trade-free zone. Quebec's aluminum producers, for example, have been given free permits, as have two oil refineries in the province.
4. Ideally, industries can plan ahead under a cap-and-trade system. Each year, the cap creeps down on a gradual and predictable schedule. Relatively low-cost emissions cuts that increase efficiency allow companies to profit by selling cap room to companies that have more difficulty reducing emissions.
5. Nonetheless, in the U.S., the Environmental Protection Agency has found that trading permits is generally only a small component of how companies are attempting to meet emissions limits. In fact, the largest polluters have chosen instead to significantly reduce their emissions before buying allowances from other sources.
Source: The Environmental Protection Agency, the Environmental Defence Fund
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