Reduction in emissions as mandated and allocated as per the Kyoto Protocol has a cost and it depends on:
- Whether the technology is available to cut emissions or not
- How old have the processes been?
- How easy it is to pass the cost to customer?
In such cases, efficiency is incentivized through carbon trade — buying and selling the rights to emit GHGs in the atmosphere or emission allowances and reduction credits in order for companies to meet their GHG emissions targets.
In order for the Carbon Markets to work, some groundwork was done:
- Setting the currency: GHGs are measured in C02 equivalents that’s because CO2, while not being potent, is produced in very large quantities and therefore, its effect is much greater than all other GHGs combined. GWP — Global Warming Potential was taken to be the factor describing the degree of harm to the atmosphere. Example, CO2 = 1 GWP, Methane = 21 GWP.
- Setting the scope or boundary: GHG acounting is the practice of measuring corporate emissions that has established a set of standards and principles to guide data collection and reporting in this field.
WRI and WBCSD has released the GHG protocol which offers two alternative approaches to set organizational boundaries:
- Equity share approach — when org reports emissions that are wholly owned.
- Control Approach — when org reports all emissions from sources that are under entity’s control
Scope 1- emissions that occur from sources owned and controlled by reporting entity
Scope 2- Indirect emissions resulting from the activities of the entity but occur at sources owned and controlled by another entity. Eg. Purchased electricity.
Scope 3- Emissions associated with company’s activities such as employee travel, distribution, consumption and disposal etc.
- Calculation of the carbon footprint
- Reporting to public GHG registries and databases.
Kyoto Protocol — Ways to meet reduction targets
- Emissions Trading
The government sets the total GHG allowances to industries/unit. These allowances can then be sold and brought by companies belonging to this industry.
Allowances can come only from annex 1 countries.
- Creation of Offsets
GHGs anywhere in the world are the same and are long lived. Therefore reduction at a given location would mean that world wide levels would be reduced. Reduction in emissions at anyplace in the world is an offset.
Offset can be done either through reduction, removal, storag or avoidance in GHGs.
Offsets can be used as either credits to meet the GHG reduction requirements or meet voluntary targets in countries such as Australia.
There are two types of Offset based transactions:
- CDM or Clean Development Mechanisms — when offsets are created in non-annex countries in order to incentivize Annex 1 countries to do emission reduction projects in developing countries without targets. CERs meaning Certified Emission Reductions are earned by CDM projects to meet reduction requirements in Kyoto and EU ETS. 1 CER = 1 Tonne CO2 reduction.
Three formats of Sale of CERs:
1. Selling marginal credits as they becccome available (Spot market)
2. Selling PV of expected future credits (Futures market)
3. Holding on to the accumulated credits in the hope of increasing prices. Carrying forward or banking will take place only in the a specificed period that the regulator decides.
-> Primary CER Market however has risks of expected project performance, registration risks with UNFCC, host country risks, contractual risks. Therefore prices tend to be lower to account for the risks with CERs.
-> Secondary CER Market: Delivery is assured and hence prices go up.
- Joint Implementation when offset based projects are taken in the developed world or the annex 1 countries. Earnings are Emission Reduction Units. Not every company in such countries have a cap and if a project is taken in companies that do not have a cap, they’re issued ERUs.
Types of Carbon Markets
Kyoto Market that sets legally binding limits on GHG emissions and promotes market based mechanisms to keep the cost of curbing emissions low using tools a discussed above.
EU ETS (Emission Trading Scheme) to reduce CHG emissions to 92% of 1990 by 2012. EU ETS is the first every regulatory enforced commercial market for CERs
Major exchanges: European Climate Exchange, Nordpool, Bluenext, EEX.
They identified major companies that emitted and assigned allowances to them as well as allocated allowances to countries. Member countries can auction upto 10% of their allownces in Phase 1 and 50% in Phase 2. Such revenue can be used for R&D and Clean Development
National Action Plan for Climate Change in India that made 8 voluntary commitments to the world resulted in Renewable Energy Certificates that requires 5% of country’s share of electricity to be renewable in 2010 increasing 1% per year for 10 years. These are also tradable.
Perform Achieve and Trade (PAT) for energy efficiency certification which are tradeble instruments
Not forced by the market but companies want to showcase to its stakeholders that they’re reducing their emissions. They may reduce it or buy offsets voluntarily. In voluntary offsets markets, the regulatory body is WWF (Gold Standard) or WBSCD etc. They’re buying it for the sake of their own social conscience. What gets traded is VERs Verified emission reductions.
Do carbon markets result in a win-win? Or does it make firms complacent?
Its likely the former because firms tend to want to minimze their costs and risks and given the rules and regulations associated with emissions reduction, in the short run, while companies might want to trade carbon, in the long run it would work towards fixing its systems to reduce emissions tangibly.