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Many people don’t understand how cap and trade for carbon emissions work. Two frequently heard objections: overall emissions are not reduced but just shifted between players and trading in certificates becomes just another form of financial speculation. This is not true. I will try to explain cap & trade in a very unorthodox way.

Say you have a brother called John and a sister called Jane. The three of you have an alcohol problem: each of you drink a bottle of wine every day, totaling 30 bottles a month. Your mom is worried and wants the three of you to reduce drinking by 90%, bringing down alcohol consumption to three bottles a month each. You all agree that it would be a great idea but you don’t know how to achieve this. Your mom comes up with a great plan to do this in nine months, starting in January.

 

She does a deal with all the stores selling wine in your area: the three of you can only buy a bottle of wine if you give the seller a coupon, your “wine permit.” Your mother will issue the permits. The number of permits will be reduced every month: 27 each in the first month, 24 each in the second, 21 each in the third, and so on, until you reach 3 permits each in the ninth month. The permits are only valid for the month they are issued.

1st month, January: 31 days and 27 permits each
Each of you develop a different strategy to cope with the plan. You decide to stop drinking on Mondays. Jane decides to skip Mondays and Wednesdays in the first fortnight and drink everyday afterwards. John can’t come up with any good strategy and decides to keep drinking as long as his permits last and go dry in the last 4 days.

In the middle of the month Jane realizes that she can live well not drinking two days a week and makes John an offer he can’t refuse: she sells him her four left-over permits.

Jane and John have discovered the beauty of trading in permits. Average alcohol consumption down by 10%.

2nd month, February: 28 days, 24 permits each
Since February is shorter month, the three of you can follow the same strategy as in January: You don’t drink on Mondays, Jane doesn’t on Mondays and Wednesdays, and John buys Jane’s leftover permits and drinks every day.

You think this is not fair and complain to your mother. Jane is making money exploiting John’s alcohol addiction. This is morally repulsive. Your mom tells you to keep cool: the average alcohol consumption will be reduced to 24 bottles each this month, according to plan. And Jane is exploiting John’s stupidity, not his addiction. If John does the math he will realize that his strategy won’t solve his problem for long.

Time is running against John. Average alcohol consumption down by 20%.

3rd month, March: 31 days, 21 permits each
A very tough month: 10 days without drinking for you and 20 days for Jane, since she wants to sell John the 10 permits he needs to continue drinking daily. At around the 20th of the month you get a promotion at work and want to invite some friends over to celebrate.

But you only have five permits left! You are willing to use them up and go dry for the rest of the month but you still need at least another 5 for your party. You go ask your sister. She tells you that she has 10 permits left, but she had promised to sell them to John. You ask her to sell five to you and five to John.

She smells a good deal and invites John over for an auction: the one bidding the most gets the permits. You and John get into a vicious bidding war. John gets the permits, but they cost him more than the wine itself. He is angry. So are you: you will have to cancel your party.

Jane is happy. She is starting to understand the financial possibilities of trading in permits. And so are you. Average alcohol consumption down by 30%.

4th month, April: 30 days, 18 permits each
You know that John needs 12 permits and will buy them from Jane. You call John and offer him 12 permits 20% cheaper than the price he normally pays Jane. This will be your sweet revenge: you will ruin Jane''s business! John tells you this sounds great and that he will call you back.

Later on John calls you and says that Jane offered him the permits with a 40% discount. You can’t believe it: John is playing you against Jane! You play along, selling your permits with a 95% discount after many rounds of bidding.

Both you and Jane learn that oversupply of permits ruins the market. Average alcohol consumption down by 40%.

5th month, May: 31 days, 15 permits each
John needs 16 extra permits this month to keep drinking daily. Even if Jane stops drinking altogether and sells him her 15 permits, he is still one permit short. He is expecting to play you and Jane against each other, again. Jane calls you with a plan: each one of you offers John 8 permits only for double the regular price. You both win and John loses. That’s called market manipulation!

John complains to mom. She tells him it’s his own fault: he should stop buying permits! Time is running against him. The sooner he starts reducing his drinking, the better. Then mom call you and Jane to tell you that you will be fined 10 permits each for inside trading.

John decides to start drinking every other day. You and Jane have only 5 permits each for the month.

There is no trade in permits this month. Average alcohol consumption down by 50%.

6th month, June: 30 days, 12 permits each
John seems to have earned his lesson. He is not buying permits anymore. You and Jane have more permits than you both seem need. You make Jane an offer: she gives you 10 permits so that you can throw a party this month. You reciprocate next month, so that Jane can also throw a party of her own.

You have a great party. Average alcohol consumption down by 60%.

7th month, July: 31 days, 9 permits each
Jane has also a great party this month.

You start to appreciate how clever your mom is. Average alcohol consumption down by 70%.

8th month, August: 31 days, 6 permits each
The three of you have some permits left at the end of the month. Average alcohol consumption down by 80%.

9th month, September: 30 days, 3 permits each
Average alcohol consumption down by 90%.

You have reached your goal: each of you is drinking only 3 bottles of wine a month!

You got there with the help of cap & trade. It seems messy and complicated, but it works!

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