In this article we will discuss about:- 1. Introduction to Carbon Trading 2. Units of Emission Trade 3. Introduction to Kyoto Mechanisms 4. Emissions Trading System.
Introduction to Carbon Trading:
A series of workshops and conferences related to global warming, climatic changes and GHGs emission finally concluded with adding new chapter to human society in the name of carbon trading. Carbon trading is emissions trading specifically for carbon dioxide calculated in tons of carbon dioxide equivalent (tCO2e) and currently makes up the bulk of emissions trading. Emission trading is a market-based approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants.
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The concept of carbon trading came into existence as a result of increasing awareness about the need for pollution control. It was formalized in the Kyoto Protocol, an agreement made to set target for reduction of emission of greenhouse gases (GHG) from 1990 levels by about 5 per cent in the period of 2008-2012.
Carbon trading emerges out as an asset to minimize the cost of reducing emission up to desirable level. At today’s perspective, carbon trading is a business of buying and selling of the carbon credits achieved either by carbon sequestration or reducing the emission of GHGs lower than emission allowance. This trading can be done in between the nations, states, even industries.
The carbon market can be divided into the following:
1. Compliance Markets.
2. Voluntary Markets.
1. Compliance Markets:
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It generates and trade greenhouse gas emission reductions known as certified emission reductions (CERs), emission reduction units (ERUs), assigned amount units (AAUs) and removal units (RMUs) that are regulated and directly initiated under the Kyoto Protocol.
2. Voluntary Markets:
It generates and trade greenhouse gas emission reductions that are not regulated or directly initiated by the Kyoto Protocol and known as verified emission reductions (VERs).
Carbon Credit:
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A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one ton of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent to one ton (tCO2e). Carbon credits are a tradable permit scheme and they provide a way to reduce greenhouse gas emissions by giving them a monetary value (based on the market carbon price e.g., about $5 to $10).
International treaties such as the Kyoto Protocol set quotas on the amount of greenhouse gases that countries can produce and countries in turn, set quotas on the emissions of businesses. Businesses that are over their quotas must buy carbon credits for their excess emissions, while businesses that are below their quotas can sell their remaining credits. Credits can be exchanged between businesses or bought and sold in international markets at the prevailing market price.
Units of Emission Trade:
Emissions reduction projects or carbon projects can be created by a national government or by an operator within the country. In reality, most of the transactions are not performed by national governments directly, but by operators who have been set quotas by their country. The government can set a limit for GHGs emission within the country. It can issue permits also called allowances or quotas to emit greenhouse gases.
i. Assigned Amount Units (AAUs):
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Each Annex I Party that ratifies the Kyoto Protocol has a GHG emissions limitation commitment for 2008-2012, which is its “assigned amount.” If a country’s emissions are lower than that amount, it may sell the unused units.
ii. Certified Emission Reductions (CERs):
Carbon credits are measured in units of Certified Emission Reductions (CERs). For trading purposes, one allowance or Certified Emission Reduction (CER) is considered equivalent to one metric ton of CO2 emissions reduction. An emission permit is a certificate that gives the holders the right to emit a certain amount of greenhouse gases to the atmosphere.
Greenhouse gas reduction of any Clean Development Mechanism (CDM) project is measured according to internationally agreed methods and quantified in standard units called Certified Emission Reductions (CERs). These are expressed in tons of carbon dioxide (CO2) equivalents.
CERs can be used by an Annex I Party to help meet its emissions limitation commitment under the Kyoto Protocol. The credits issued for sink enhancements achieved by afforestation or reforestation projects under the CDM are either temporary CERs (tCERs), or long-term CERs (ICERs) that are subject to provisions to protect against possible reversals of the sink enhancements.
iii. Emission Reduction Units (ERUs):
These are credits issued for emission reductions or removals achieved by a project under the Joint Implementation (JI) mechanism as defined in Article 6 of the Kyoto Protocol. ERUs can be used by an Annex I Party to help meet its emissions limitation commitment under the Kyoto Protocol. Each ERU equals 1 ton of carbon dioxide equivalent (CO2e) reduced.
iv. Removal Units (RMUs):
These are credits issued for net sink enhancements achieved by eligible activities under Articles 3.3 and 3.4 of the Kyoto Protocol. RMUs can be used by an Annex I Party to help meet its commitment under the Kyoto Protocol. Each RMU equals 1 metric ton of CO2e.
v. Verified Emission Reduction (VERs):
Greenhouse gas reduction outside Kyoto Protocol is measured according to internationally agreed methods and quantified in standard units called verified emission reductions (VERs). These are also expressed in tons of CO2e.
Introduction to Kyoto Mechanisms:
The concept of carbon emission activities in one country being used by other countries as credits is well recognized. Institutions are being developed to allow these multi-country activities and transactions to be made. It also leads to the evolution and rapid growth of a whole new class of investment and securities related to environmental impact mitigation or environmental improvement including proposals for emission trading.
It comprises:
i. Joint Implementation (JI):
A way to earn credits as ERUs by investing in emission reduction projects in developed countries that have taken on a Kyoto target.
ii. The Clean Developmental Mechanism (CDM):
A way to earn credits as CERs by investing in emission reduction projects in developing countries.
iii. International Emissions Trading (IET):
It will permit developed countries that have taken on a Kyoto target to buy and sell emission credits among themselves.
Under Joint Implementation, one Annex B country is allowed to purchase carbon credits by undertaking carbon reducing activities in another Annex B country. Clean Development Mechanisms is designed to allow some types of multi-country purchases and trades between Annex B and non-Annex B countries.
i. Joint Implementation (JI):
Article 6 of the protocol allows a system under which advanced countries jointly implement an emissions reduction project. Developed countries are allowed to obtain emission credits for projects undertaken in another developed country.
JI project are a means by which firm in developed countries can invest in other developed countries, including those with economies in transition in central and Eastern Europe, in ways that reduce or avoid GHG emissions. Credit will be earned in the form of emission reduction unit.
Joint implementation implies that an industrialized country pay for measures to reduce emissions in another industrialized country. This will give the buyer the right to emit more domestically, while the seller will be required to emit correspondingly less. JI can be a tool to transfer environmentally sound technology.
ii. The Clean Development Mechanism (CDM):
Article 12 of the protocol allows firms in the developed countries to invest in projects in developing countries that reduce or avoid net GHGs emissions. This promises to be an important new avenue through which government and private corporations will transfer clean technologies and promote sustainable development. Credit will be earned in the form of certified emission reduction.
The CDM allows industrialized countries to acquire emissions credit (the right to emit greenhouse gases) by paying for emissions reduction measures in developing countries that do not have emission targets. These measures must also contribute to sustainable development in the recipient country. Detail rules and regulations to ensure that the emissions reduction measures meet all the requirements are worked out.
The CDM has the potential to assist the start of a transition towards sustainable energy in developing countries and, in the long-term, benefit the climate. CDM projects must demonstrate that they add “real, measurable and long term benefits related to the mitigation of climate change” and are meant to contribute to sustainable development in developing countries. Whether or not these goals are reached depends very much on the rules for the CDM.
iii. International Emission Trading (IET):
Article 17 of the protocol permits the trading of emission credits among countries. Countries with surplus credits can sell these credits to countries with capped emissions. It provides for countries with emission reduction commitments to buy and sell part of their assigned amount of CO2 emissions among themselves. Reporting rules, a verification system and guidelines are being developed for IET. The idea is to foster a free market in emission credits and reward countries that are most efficient at meeting their target.
Emissions Trading System:
There are three main approaches to emissions trading system:
i. Cap and trade system.
ii. Baseline and credit system.
iii. Carbon Offsets.
i. Cap and Trade System:
A regulatory body would first need to set an overall limit on emissions – the ’emissions cap’- the total amount of a pollutant that the participants in the programme are allowed to emit in a given period (e.g., emission of a number of tons of the pollutant per year).
Allowances equal to all of the emissions permitted under the cap are then distributed. The way in which allowances are distributed is a key for emissions trading system design and there are two types of distribution – free or by auction. Once allowances are distributed, they may be traded freely.
Defined groups of emitters would be allocated either for free or via auctioning a proportion of the total allowed amount, which they could then trade among one another in the form of permits. Thus emitters that took measures to reduce their pollution below the level represented by permits they held could sell their unused permits to other emitters that were emitting at the level higher than that represented by their permits.
Participants that emitted beyond their limits without the necessary permits would face stiff penalties. This system would guarantee that the overall environmental objective was met because total emissions would be limited under the cap.
ii. Baseline and Credit System:
Participants in a baseline and credit programme have to earn credits before they can begin trading. First, an emission baseline is defined for each participant by the regulator and the baseline often varies with the level of output. Each participant then makes reductions and monitors or calculates its actual emissions using specified procedures.
In this credit trading system, companies would be allowed to certify emissions reductions below a certain voluntary or imposed level as “tradable credit” that could then be sold to emitters that needed them to meet their own target level of emissions.
Baseline and credit trading could be used in conjugation with a cap and trade system to enable sources not regulated by the cap to gain credit for reduction in greenhouse gases caused by their new initiatives. However, it is anticipated that credit creation would be limited to certain sectors and activities.
Emissions trading involving SO2 and NOx emissions are called downstream programmes. When emissions are related to the characteristics of a product, they can be regulated prior to their release to the atmosphere. Programmes involving this type of control are upstream programmes. By reducing lead content or choosing low carbon content fuels, it is possible to regulate emissions prior to the point of release. A hybrid programme is one which combines elements of both downstream and upstream ones.
iii. Carbon Offsets:
Carbon emission credits have been suggested in the energy sector as a vehicle for improving the efficiency of carbon mitigating activities. A similar instrument, carbon offsets, is also being considered under voluntary market. Offsets are greenhouse gas reductions achieved by non-regulated market participants.
Greenhouse gas mitigation achieved by non-regulated parties can be purchased as offsets by a regulated party (e.g., large electric power plants) to meet the required cap. Offset opportunities relevant to farms include methane capture from farming operations, end-use efficiency for natural gas, propane or heating oil and afforestation.
The concept is that carbon offsets could be added to the stock of emission credits, thus expanding the number of credits in the system and thereby lowering costs and improving efficiency. Indeed, Kyoto protocol offers a variant of this possibility under the JI and perhaps under the CDM. In recent years, some electrical utilities have expanded their capacity and offset the increased carbon emissions through forestry activities.
Carbon offset credits are being considered for protecting forests that otherwise would be destroyed, creating new forests and reducing carbon emissions from the some current practices, e.g., low-impact logging. Such activities would need some method of carbon certification by some certifying firms. Through voluntary offsets market, companies, individuals and events buy emission reductions to reduce their carbon footprint.
Emission Trading Scheme:
The UK Emissions Trading Scheme (UK ETS) was the world’s first economy-wide greenhouse gas emissions trading scheme. The UK Emissions Trading Scheme was a voluntary emission trading system created as a pilot prior to the mandatory European Union Emission Trading Scheme which it now runs in parallel with. It ran from 2002 and it closed to new entrants in 2009.
The European Union Emission Trading Scheme (EU ETS) also known as the European Union Emissions Trading System, is the largest multi-national, greenhouse gas emissions trading scheme in the world launched in 2005. It is one of the EU’s central policy instruments to meet their cap set in the Kyoto Protocol.
Since February 2007, seven U.S. states and four Canadian provinces have joined together to create the Western Climate Initiative (WCI), a regional greenhouse gas emissions trading system. In USA, Regional Greenhouse Gas Initiative (RGGI) program was launched in 2009 with the aim to reduce the carbon “budget” of each state’s electricity generation sector to 10 per cent below their 2009 allowances by 2018.
California’s cap and trade system was launched in 2011 to minimize climate change pollution, becoming the first state in the nation with a cap and trade program The New Zealand Emissions Trading Scheme (NZ ETS) is a national all-sectors all-greenhouse gases uncapped emissions trading scheme. Many countries are in the process of setting up their own emission trading schemes.
Emission and Carbon Markets:
Carbon emissions trading have been steadily increasing in recent years. According to the World Bank’s Carbon Finance Unit, global carbon market stalled at $142 billion for the year 2010. As CDM and AAU market segments declined, the dominance of the European Union Allowances (EUAs) market became more pronounced in 2010 which accounted for 84 per cent of global carbon market value.
While the international regulatory environment remains uncertain, national and local initiatives have noticeably picked up and may offer the potential to collectively overcome the international regulatory gap. Low-carbon initiatives have gained increasing traction in developing economies such as Brazil, China, India and Mexico.
In carbon trading, allowances or CERs can be sold privately or in the international market at the prevailing market price. These trade and settle internationally and hence allow allowances to be transferred between countries. Each international transfer is validated by the UNFCCC. Each transfer of ownership within the European Union is additionally validated by the European Commission.
Climate exchanges have been established to provide a spot market in allowances, as well as futures and options market to help discover a market price and maintain liquidity. Carbon prices are normally quoted in Euros per ton of carbon dioxide or its equivalent (CO2e). Other greenhouse gasses can also be traded, but are quoted as standard multiples of carbon dioxide with respect to their global warming potential. These features reduce the quota’s financial impact on business, while ensuring that the quotas are met at a national and international level.
Currently there are six exchanges trading in carbon allowances: the Chicago Climate Exchange, European Climate Exchange, NASDAQ OMX Commodities Europe, Power Next, Commodity Exchange Bratislava and the European Energy Exchange. NASDAQ OMX Commodities Europe listed a contract to trade offsets generated by a CDM carbon projects called Certified Emission Reductions (CERs).
Many companies now engage in emissions abatement, offsetting and sequestration programs to generate credits that can be sold on one of the exchanges. Carbon credits at Commodity Exchange Bratislava are traded at special platform – Carbon place.