CARBON TRADING

 



 

 INTRODUCTION:

A trade in environmental study typically occurs when a company seeking to reduce its emissions purchases emissions credits from a company that has reduced its emissions beyond its requirements to do so. This transaction can benefit both participants. Purchasers are able to reach goals that require more emissions reductions than they can cost-effectively achieve through their own operational changes. And sellers are rewarded financially for their investments in emission reductions.

 

A growing number of companies are looking to carbon trading i.e. emissions trading as a key part of their climate strategies. In addition, a few large companies have developed internal trading mechanisms in order to reach company-wide goals cost-effectively. An emissions trade may be made as an individual company, by joining a group established to develop trading expertise cooperatively, or through the auspices of an official trading program. To date, most companies have arranged exchanges through independent agreements - though often the reductions are verified by an independent consultant. However, since market-based mechanisms for emissions trading are commonly viewed as the most cost-effective response to climate change, a number of mandatory and voluntary emissions trading programs are under development. For instance, the European Union is developing a Europe-wide trading program to meet its obligations under the Kyoto Protocol. As such programs take shape, interest is shifting to the emissions credits and allowances generated under their support.

Because emissions trading is such a young field, numerous organizations have stepped forth to educate businesses and others on its growth and potential. The Pew Center on Climate Change, (Arlington, USA), for instance, has produced a steady stream of reports chronicling the evolution of emissions trading programs as well as current activities by leadership companies. The Partnership for Climate Action, a project of Environmental Defense, is an example of a collaborative group with an explicit focus on emissions trading. Several members have brokered trades with each other in order to begin working out the finer points of GHG trading.

 

 

ROOT CAUSE OF CARBON / EMISSIONS TRADING

 

 

Ø            GLOBAL WARMING – CLIMATE CHANGE

 

 

Global warming is an observed increase in the average temperature of the Earth’s  atmosphere and oceans. Part of this increase may be due to natural processes, and would have occurred independently of human activity. The remainder is due to a human-induced intensification of the greenhouse effect..

Climate change affects all of us – and we can all be part of the solution. Climate refers to the average weather experienced over a long period. This includes temperature, wind and rainfall patterns. The climate of the Earth is not static, and has changed many times in response to a variety of natural causes.

Graph indicating how the climate is changing over the years

The main human influence on global climate is likely to be emissions of green house gases such as carbon dioxide (CO2) and methane. At present, about 6.5 billion tonnes of CO2 is emitted globally each year, mostly through burning coal, oil and gas for energy.  

Climate change is already happening. Globally, the ten hottest years on record have all occurred since the beginning of the 1990s. Current climate models predict that global temperatures could warm from between 1.4 to 5.8oC over the next 100 years, depending on the amounts of greenhouse gases emitted and the sensitivity of the climate system. 

Key impacts

However effective policies are to reduce emissions of greenhouse gases, the world will now experience a significant degree of climate change. This is likely to have far-reaching effects on all aspects of the world's environment, economy and society including:

Rising sea levels:- Sea level is expected to rise by over 40 centimetres by the 2080s because of thermal expansion of the oceans as temperatures rise and because of melting of land ice. This will threaten the existence of some small island states and put millions of people at risk.

Impact of rise in Sea Levels

Flooding in poor countries:- The poorest countries are likely to be the most vulnerable to the effects of climate change. 60% of the additional 80 million people projected to be at risk of flooding are expected to be in Southern Asia (Pakistan, India, Sri Lanka, Bangladesh and Myanmar) and 20% in South East Asia (from Thailand to Vietnam, including Indonesia and the Philippines).

Food shortage and disease:- Africa is expected to experience significant reductions in cereal yields, as are the Middle East and India. And an additional 290 million people could be exposed to malaria by the 2080s, with China and Central Asia likely to see the largest increase in risk.

Severe water shortages:- In some areas, water resources for drinking and irrigation will be affected by reduced rainfall or as ground water in coastal zones suffers from salination as sea levels rise. People's lives may be put at risk from an increased frequency of droughts and flooding.. Northern Africa, the Middle East and the Indian subcontinent will be the worst affected.

Loss of tropical forests:- By the 2070s, large parts of northern Brazil and central southern Africa could lose their tropical forests because of reduced rainfall and increased temperatures. If this happens, global vegetation which currently absorbs carbon dioxide at the rate of some 2-3 gigatonnes of carbon (GtC) per year will become a carbon source generating about 2 GtC per year by the 2070s and further adding to carbon dioxide build up in the atmosphere. (Current global man-made emissions are about 6-7 GtC per year). This will make climate change even more severe.

Ø           GREEN HOUSE EFFECT

Some of the energy from the sun is trapped inside our atmosphere as it is reflected back from the earth towards space.  This natural process is called the greenhouse effect, as the atmosphere acts like the glass walls of a greenhouse, which allows the sun’s rays to enter but keeps the heat in. 

The gases which make this happen “green house gases: are mainly water vapour and carbon dioxide.  As humans emit more carbon dioxide and other greenhouse gases into the atmosphere the greenhouse effect becomes stronger.  This causes the earth’s climate to change unnaturally.

Ø           GREEN HOUSE GASES

The most important greenhouse gases are carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride. These are the gases that are covered by the Kyoto Protocol

Chlorofluorocarbons (CFCs) and hydro chlorofluorocarbons (HCFCs) are also powerful greenhouse gases but they are being progressively phased out under the Montreal Protocol as they also damage the stratospheric ozone layer. They are part of a longer list of greenhouse gases covered by the Kyoto Protocol.

 

Each greenhouse gas has a different capacity to cause global warming, depending on its radiative properties, its molecular weight and its lifetime in the atmosphere. Its so-called global warming potential (GWP) encapsulates these. The GWP is defined as the warming influence over a set time period of a gas relative to that of carbon dioxide. A 100-year time horizon is used in the Kyoto Protocol. When the warming effect of current greenhouse gas emissions over the next 100 years is calculated, it is seen that carbon dioxide will be responsible for about two thirds of the expected future warming.

Ø            IMPROVEMENT OF ENVIRONMENTAL CONDITION BY CO2 REDUCTION

World leaders gathered in Kyoto, Japan, in December 1997 to consider a world treaty restricting emissions of ''greenhouse gases,'' chiefly carbon dioxide (CO2), that are thought to cause ''global warming'' severe increases in Earth's atmospheric and surface temperatures, with disastrous environmental consequences. Predictions of global warming are based on computer climate modeling, a branch of science still in its infancy. The empirical evidence actual measurements of Earth’s temperature show no man-made warming trend. Indeed, over the past two decades, when CO2 levels have been at their highest, global average temperatures have actually cooled slightly.

CO2 levels have increased substantially since the Industrial Revolution, and are expected to continue doing so. It is reasonable to believe that humans have been responsible for much of this increase. But the effect on the environment is likely to be benign. Greenhouse gases cause plant life, and the animal life that depends upon it, to thrive. What mankind is doing is liberating carbon from beneath the Earth's surface and putting it into the atmosphere, where it is available for conversion into living organisms. Hence Carbon Trading is seen as an effective way to reduce CO2 levels.

 

Increase in CO2 levels

 

HOW CARBON TRADING CAME INTO EXISTENCE – HISTORY

The climate change issue and its potential implications are areas of concern globally to the public and policy makers alike. As a result, most of the leading industrialised nations have signed up to the Kyoto Protocol and made a commitment to reducing greenhouse gas emissions.

 

Ø            WHAT IS KYOTO PROTOCOL?

 

The Kyoto Protocol or Kyoto Protocol to the United Nations Framework Convention on Climate Change is an international treaty on climate change. Countries that ratify this protocol commit to reduce their emissions of carbon dioxide and five other greenhouse gases, or engage in emissions trading if they maintain or increase emissions of these gases.

 

It is an agreement under which industrialized countries will reduce their collective emissions of greenhouse gases by 5.2% compared to the year 1990 (but note that, compared to the emissions levels that would be expected by 2010 without the Protocol, this target represents a 29% cut). The goal is to lower overall emissions from six greenhouse gases - carbon dioxide, methane, nitrous oxide, sulfur hexafluoride, HFCs, and PFCs - calculated as an average over the five-year period of 2008-12. National targets range from 8% reductions for the European Union and some others to 7% for the US, 6% for Japan, 0% for Russia, and permitted increases of 8% for Australia and 10% for Iceland."

 

POSITION OF INDIA

 

India signed and ratified the Protocol in August, 2002. Since India is exempted from the framework of the treaty, it is expected to gain from the protocol in terms of transfer of technology and related foreign investments. At the G-8 meeting in June 2005, Indian Prime Minister Manmohan Singh pointed out that the per-capita emission rates of the developing countries are a tiny fraction of those in the developed world. Following the principle of common but differentiated responsibility, India maintains that the major responsibility of curbing emission rests with the developed countries, which have accumulated emissions over a long period of time.

 

 

Ø            FLEXIBILITY MECHANISMS

 

The Kyoto Protocol broke new ground by defining three innovative “flexibility mechanisms” to lower the overall costs of achieving its emissions targets. These mechanisms enable Parties to access cost-effective opportunities to reduce emissions or to remove carbon from the atmosphere in other countries. While the cost of limiting emissions varies considerably from region to region, the benefit for the atmosphere is the same, wherever the action is taken. Flexible mechanisms refers to the Clean Development Mechanism, Joint Implementation and Emissions Trading.

 

EMISSION TRADING:-

 

Carbon emissions trading involves the trading of permits to emit carbon dioxide (and other greenhouse gases, calculated in tonnes of carbon dioxide equivalent, tCO2e). It is one of the ways countries can meet their obligations under the Kyoto Protocol to reduce emissions and thereby mitigate global warming. 107 million metric tonnes of carbon dioxide equivalent (tCO2e) have been exchanged through projects in 2004, a 38% increase relative to 2003 (78 mtCO2e).

 

CLEAN DEVELOPMENT MECHANISM:-

 

The Clean Development Mechanism (CDM) is an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment (so-called Annex 1 countries) to invest in emission reducing projects in developing countries as an alternative to what is generally considered more costly emission reductions in their own countries.

 

JOINT IMPLEMENTATION:-

 

Joint implementation (JI) is an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment (so-called Annex 1 countries) to invest in emission reducing projects in another industrialised country as an alternative to emission reductions in their own countries. Countries with relatively high costs for emission reductions can reduce costs of complying with their Kyoto targets by using credits from JI projects, as costs of emission reductions are significantly lower in some countries.

CARBON TRADING

 

 

Ø            SIGNIFICANCE OF CARBON TRADING

 

 

Carbon trading, or more generically emissions trading, is the term applied to the trading of certificates representing various ways in which carbon-related emissions reduction targets might be met. Participants in carbon trading buy and sell contractual commitments or certificates that represent specified amounts of carbon-related emissions that either:

 

  • are allowed to be emitted;
  • comprise reductions in emissions (new technology, energy efficiency, renewable energy); or
  • comprise offsets against emissions, such as carbon sequestration (capture of carbon in biomass).

 

People buy and sell such products because it is the most cost-effective way to achieve an overall reduction in the level of emissions, assuming that transaction costs involved in market participation are kept at reasonable levels. It is cost-effective because the entities that have achieved their own emission reduction target easily will be able to create emission reduction certificates "surplus" to their own requirements. These entities can sell those surpluses to other entities that would incur very high costs by seeking to achieve their emission reduction requirement within their own business. Similarly, sellers of carbon sequestration provide entities with another alternative, namely offsetting their emissions against carbon sequestered in biomass.

 

As mentioned earlier, Emissions trading is one of the flexibility mechanisms allowed under the Kyoto Protocol to enable countries to meet their emissions reduction target. Countries/companies with high internal emission reduction costs would be expected to buy certificates from countries/companies with low internal emission reduction costs. The latter entities would also be expected to maximise their production of low cost emission reduction so as to maximise their ability to sell certificates to high cost entities. The overall outcome is that the emission reduction target is met, but at a much lower cost than would be incurred by requiring each entity to achieve the emission reduction target on their own.

Restricting the emission of GHGs will have a profound impact on the market dynamics of carbon-intensive industries. On one hand, compliance regulations may be a barrier to entry for new competitors. On the other, existing businesses may find themselves with stranded assets. A coal-fired power station, for example, may no longer be economically efficient when the cost of carbon has been included. Some company’s products may be replaced altogether by low-carbon substitutes.

Emissions Trading: The Lowest-Cost Method of Reducing GHGs

WITHOUT TRADING

WITH TRADING

Companies A and B each
reduce emissions by ten units

Company B reduces by 20
units; Company A buys rights
to ten for $75 per unit

Reductions cost Company A
$100 per unit, or $1,000

Company B costs:

$1,000
-750
$250

Reductions cost Company B
$50 per unit, or $500

Company A costs: $750

Total Costs = $1,500

Total Costs = $1,000

 

New suppliers of abatement technology will enter the market, and increasing numbers of consumers and investors will hold companies accountable for their environmental performance. Moreover, carbon-intensive businesses will have to develop new skills and competencies—for example, in emissions monitoring and trading. The companies that are most successful at using carbon emissions trading as an additional source of revenue will be able to reduce their cost of capital and gain competitive advantage.

 

 

Ø            UNDERTAKING CARBON TRADING

The simplest type of carbon trade involves an entity preparing a contract that describes and specifies the kind of activity they are undertaking to either reduce or offset emissions. The contract may or may not be independently verified, although doing so will increase buyer confidence and probably attract a higher price. This contractual commitment is then sold to another entity that wishes to make use of the specified amount of the reduction or offset.

Contractual commitments are usually traded "over the counter" (OTC), which means that the trade is usually a bilateral one between a willing buyer and a willing seller without the need for a market to exist. OTC trades are usually single trades where the terms are either partially or fully confidential. OTC markets are relatively simple and operate where there is limited "liquidity" (that is, not many trades are occurring) or where the product being traded is somewhat unique for each trade.

In contrast, a carbon trading market is more akin to a share market. Products traded on a market are generally more homogeneous; for example, all types of carbon sequestration that meet the rules defining the creation of a "carbon sequestration certificate" may be deemed to be identical in the market. This increases the liquidity of the product and helps market participants understand and have more confidence in the product being traded. The existence of a set of enforced rules associated with the creation of both emission reduction and emission offset certificates also increases market confidence in the product.

Ø            WHO CAN PARTICIPATE…

One of the implications of having in place a range of structures that give participants in a carbon trading market the confidence to buy and sell is that compliance and transaction costs are often substantial. Such costs can be spread over a portfolio of carbon certificates in the case of a large industry or forest grower, but that option does not exist for small forest growers/farmers.

In short, this is likely to mean that only large entities can participate in the carbon market. Over time, increasing activity in the market and the achievement of a reasonable price for carbon will attract intermediaries into the market. These companies will act as a pooling mechanism for a range of small forest growers/farmers, whereby accounting and risk management occur at the pool level rather than the individual grower level. Such a mechanism is the most likely pathway for small growers/farmers to participate in the carbon trading market

Ø            BENEFITS OF CARBON TRADING

The benefits to the General community of trading emission reduction certificates in a market include:

·         the reduction in overall cost of meeting emission reduction targets,

·         the progressively improved definition of a "price" for carbon, particularly as the market becomes more liquid and active, and assuming that all carbon certificate products are fungible, meaning that they are equivalent ways of addressing emission reduction;

·         the opportunity to generate income from activities that previously attracted no additional revenue, such as investment in emission reduction, renewable energy generation, greenhouse friendly fuels and carbon sequestration;

·         the ability to use revenue from carbon sequestration to help fund additional planting of trees and other vegetation, for benefits such as salinity amelioration, biodiversity enhancement, conversion to greenhouse gas friendly fuels and energy, and employment and wealth creation in rural areas.

In addition there are several motivations for companies to take part in emissions trading:

·         Demonstrating leadership:- Companies that participate in emissions trading play a visible role on an issue of public concern.

·         Achieving commitments economically:- Emissions trading is a common complement to efficiency improvements for companies striving to meet voluntary reduction goals at the lowest possible cost.

·         Hedging risk:- Some companies are purchasing reductions now, with the expectation that their price will rise as GHG restrictions are enacted.

·         Learning by doing.:- Some companies have begun trading principally to learn the skills necessary to compete successfully in what may be one of the coming century’s most important financial markets.

·         Informing public policy:- By participating in the birth of trading schemes, companies earn experience and credibility, which, in turn, can help them influence regulations.

·         Generating revenue:- Selling emissions reductions helps companies receive value for achievements that previously had no economic value.

Ø      LIMITATIONS OF CARBON TRADING

 

 The carbon trading has various limitations which are as follows:-

·         Regulatory uncertainty:- Thus far, most emissions trades have been of so-called Verified  Emissions Reductions, meaning that they have been verified by a third party but not registered with a formal registry. These may be recognized under future regulatory schemes, but such recognition is not guaranteed.

·         Extensive research:- To trade emissions strategically, companies must assess abatement options in order to evaluate what price to pay, gain in-house approval and reflect the value of GHG assets on company balance sheets. This can require additional time and effort.

·         Patchwork trading schemes:- In the absence of a global GHG trading scheme, today’s emissions trading markets each cover different sectors and somewhat different GHG gases. Shaping a company program to fit any one of these schemes now may mean playing catch-up later on to meet the requirements of future trading schemes.

·         Controversy:- Some environmentalists frown on emissions trading, considering it to be a way for companies to buy their way out of their reduction obligations.

 

 

 

 

 

 

 

 

 

 

 

 

 

CASE STUDIES OF CARBON TRADING

 

Case I:-

The UK emissions trading scheme is the world's first economy-wide greenhouse gas emissions trading scheme, which began in March 2002.

Thirty-three organisations ("direct participants" in the scheme) have voluntarily taken on emission reduction targets to reduce their emissions against 1998-2000 levels. They have committed to reducing their emissions by 3.96m tonnes of carbon dioxide equivalent (CO2e) by the end of the Scheme. Over the lifetime of the scheme (2002-2006), this equates to 11.88m tonnes of CO2e emissions releases avoided.

The scheme is also open to the 6000 companies with Climate Change Agreements. These negotiated agreements between business and Government set energy-related targets. Companies meeting their targets receive an 80% discount from the Climate Change Levy, a tax on the business use of energy. These companies can use the scheme either to buy allowances to meet their targets, or to sell any over-achievement of these targets. Anyone can open an account on the registry to buy and sell allowances.

In the first year (2002), the Participants achieved emission reductions of 4.64 million tonnes CO2e against their baselines. Over the first two years (2002 and 2003) the Scheme delivered emissions reductions of almost 5.2 million tCO2e, and over the first three years (2002, 2003 and 2004), the Scheme delivered emissions reductions totaling 5.9 million t CO2e.

 

Case II :-

A highly successful emissions market was established in the United States in the 1990s to reduce acid rain causing emissions of SOx. This scheme gave power plant operators the flexibility to choose the most cost effective means to reduce emissions.

Over 400 power plants were able to comply with their emissions targets to cut acid rain at a far less cost than anticipated. Between 1995 and 1997, SOx emissions from these plants were reduced by 30% more than originally required under the Clean Air Act. This trading scheme will run until 2010, but this initial evidence indicates that trading is an effective tool in terms of cost savings and environmental benefit.

CONCLUSION

 

We conclude that carbon trading or rather emissions trading has come a long way since the first theoretical insights forty years ago and the first tentative application almost a quarter of a century ago. Since then, the use of emissions trading has expanded steadily and significant experience has been gained. Although not the dominant form of controlling pollution in the United States or elsewhere, emissions trading now seems firmly established as a valuable instrument and its future use seems sure to increase. It can be said that this trend toward greater use of emissions trading will improve the performance of environmental regulation, including efforts to control GHG emissions.

Carbon trading allows industries in developed countries to off-set their emissions of carbon dioxide by investing in reforestation and clean energy projects in developing countries. It has a valuable role to play but the limitations of such schemes need to be recognised. In particular the compliance costs for companies associated with monitoring and verifying emissions are considerable and therefore participation is not suitable for smaller enterprises or indeed the retail and general transport sectors.

Emissions trading have emerged as a practical framework for introducing cost-reducing flexibility into environmental control programs and reducing the costs associated with conventional command-and-control regulation of air pollution emissions. Over the last two decades considerable experience with various forms of emissions trading has been gained, and today nearly all proposals for new initiatives to control air emissions include some form of emissions trading. This report has attempted to summarize that experience and to draw appropriate lessons that may apply to proposals to limit GHG emissions. In doing so, we hope that the reader has gained a better understanding of emissions trading and the reasons for its increasing importance as an instrument for addressing environmental problems.

 

 

 

 

 

RECOMMENDATIONS

 

On the basis of our study we would like to recommend that in order to achieve success as regards environmental improvement one should try to observe the following:-

·     Quickly identify and implement the lowest cost carbon reduction options.

·     Improve energy efficiency - a key target in the short term.

·     Investigate / develop new low carbon fuels and technologies and develop policies to implement  these fuels and technologies.

·     Raise awareness of the importance of carbon reduction and guide society so that behaviour is  influenced and changed.

·     Learn best practice from other countries.

·     Work with other countries to establish international reduction plans and develop low carbon fuels and technology.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

REFERENCES