Implications
Carbon credits create a market for reducing greenhouse emissions by giving a monetary value to the cost of polluting the air. Emissions become an internal cost of doing business and are visible on the balance sheet alongside raw materials and other or .
TRADING OF CARBON CREDITS
Market
We should consider the impact of manufacturing alternative energy sources. For example, the energy consumed and the Carbon emitted in the manufacture and transportation of a large wind turbine would prohibit a credit being issued for a predetermined period of time.
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One seller might be a company that will offer to through a project in the developing world, such as recovering methane from a swine farm to feed a power station that previously would use fossil fuel. So although the factory continues to emit gases, it would pay another group to reduce the equivalent of 20,000 ton of carbon dioxide emissions from the atmosphere for that year.
- Another seller may have already invested in new low-emission machinery and have a surplus of allowances as a result. The factory could make up for its emissions by buying 20,000 ton of allowances from them. The cost of the seller's new machinery would be subsidized by the sale of allowances. Both the buyer and the seller would submit accounts for their emissions to prove that their allowances were met correctly.
SETTING A MARKET PRICE FOR CARBON :
The price of carbon needs to be high enough to motivate the changes in behaviour and changes in economic production systems necessary to effectively limit emissions of greenhouse gases.
Achieves three goals :
- Provides signals to consumers
- high-carbon goods and services
- Provides signals to producers
- which inputs use more carbon (such as coal and oil) and which use less or none (such as natural gas or nuclear power),
- Provides market incentives for inventors and innovators
- to develop and introduce low-carbon products and processes that can replace the current generation of technologies.
CREDIT VERSUS TAXES :
- Carbon credits and carbon taxes each have their advantages and disadvantages.
- Credits chosen by the signatories to the Kyoto Protocol as an alternative to Carbon taxes.
- Tax-raising schemes are frequently not hypothecated.
- Main advantages of a tradable carbon credit over a carbon tax are argued to be:
- the flexible mechanisms of the Kyoto Protocol help to ensure that all investment goes into genuine sustainable carbon reduction schemes through an internationally-agreed validation process.
- if correctly implemented a target level of emission reductions may somehow be achieved with more certainty,
- it may provide a framework for rewarding people or companies who meet standards.
ADVANTAGES OF A CARBON TAX :
- Less complex, expensive, and time-consuming to implement,
- Reduced risk of certain types of cheating,
- Reduced incentives for companies to delay efficiency improvements,
- When credits are grandfathered, this puts new or growing companies at a disadvantage relative to more established companies.
- Allows for more centralized handling of acquired gains
- Worth of carbon is stabilized by government regulation rather than market fluctuations.
Example
Emissions trading through Gains from Trade can be more beneficial for both the buyer and the seller than a simple emissions capping scheme.
Consider two European countries, such as Germany and Sweden. Each can either reduce all the required amount of emissions by itself or it can choose to buy or sell in the market.
Example MACs for two different countries
For this example let us assume that Germany can abate its CO2 at a much cheaper cost than Sweden, e.g. MACS > MACG where the MAC curve of Sweden is steeper (higher slope) than that of Germany, and RReq is the total amount of emissions that need to be reduced by a country.
On the left side of the graph is the MAC curve for Germany. RReq is the amount of required reductions for Germany, but at RReq the MACG curve has not intersected the market allowance price of CO2 (market allowance price = P = λ). Thus, given the market price of CO2 allowances, Germany has potential to profit if it abates more emissions than required.
On the right side is the MAC curve for Sweden. RReq is the amount of required reductions for Sweden, but the MACS curve already intersects the market price of CO2 allowances before RReq has been reached. Thus, given the market allowance price of CO2, Sweden has potential to make a cost saving if it abates fewer emissions than required internally, and instead abates them elsewhere.
In this example, Sweden would abate emissions until its MACS intersects with P (at R*), but this would only reduce a fraction of Sweden’s total required abatement. After that it could buy emissions credits from Germany for the price P (per unit). The internal cost of Sweden’s own abatement, combined with the credits it buys in the market from Germany, adds up to the total required reductions (RReq) for Sweden. Thus Sweden can make a saving from buying credits in the market (Δ d-e-f). This represents the "Gains from Trade", the amount of additional expense that Sweden would otherwise have to spend if it abated all of its required emissions by itself without trading.
Germany made a profit on its additional emissions abatement, above what was required: it met the regulations by abating all of the emissions that was required of it (RReq). Additionally, Germany sold its surplus to Sweden as credits, and was paid P for every unit it abated, while spending less than P. Its total revenue is the area of the graph (RReq 1 2 R*), its total abatement cost is area (RReq 3 2 R*), and so its net benefit from selling emission credits is the area (Δ 1-2-3) i.e. Gains from Trade
The two R* (on both graphs) represent the efficient allocations that arise from trading.
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Germany: sold (R* - RReq) emission credits to Sweden at a unit price P.
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Sweden bought emission credits from Germany at a unit price P.
If the total cost for reducing a particular amount of emissions in the Command Control scenario is called X, then to reduce the same amount of combined pollution in Sweden and Germany, the total abatement cost would be less in the Emissions Trading scenario i.e. (X — Δ 123 - Δ def).
The example above applies not just at the national level: it applies just as well between two companies in different countries, or between two subsidiaries within the same company.
Ensuring Demand for an Increased Supply of Credits
One of the key benefits of expanding market mechanisms under the new post-2012 agreement is a larger quantity of GHG emission reductions.
But the question is whether the resulting flow of credits from developing countries would find buyers or to what extent the price of carbon would reach disastrous lows. There will also need to be consideration of who will buy the credits. Developed countries are putting restrictions on the use of CDM by limiting the percentage of CDM and JI credits that can be used by firms and not allowing the use of credits generated by sink projects.
The EU-ETS excludes forestry CDM credits and in Phase II of the EU-ETS the United Kingdom will limit a firm’s use of credits from CDM or JI to 8 per cent of its obligation. The proposed Lieberman-Warner bill in the U.S. would allow companies regulated under the national cap-and-trade program to meet up to 15 per cent of their compliance obligations with allowances from a foreign GHG trading market, likely including the CDM.
The proposed Canadian framework, Turning the Corner, limits the use of CDM credits to 10 per cent of a firm’s regulatory obligation and refuses to accept credits from forest sink CDM projects for compliance with Canadian regulations.
Moving Towards Copenhagen
- Endorses the continuation of the Kyoto Protocol and scientific calls for global warming to be kept to 2 degrees centigrade above pre-industrial levels
- Developing countries, specially these with low-emitting economies should be provided incentives to continue to develop on a low-emission pathway
- Agrees that developed countries would raise funds of $30 billion from 2010-2012 of new and additional resources
- Agrees a "goal" for the world to raise $100 billion per year by 2020, from "a wide variety of sources", to help developing countries cut carbon emissions
- Establishes a Copenhagen Green Climate Fund, as an operating entity of the financial mechanism,
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Establishes a Technology Mechanism to accelerate technology development and transfer...guided by a country-driven approach"
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Calls for "an assessment of the implementation of this Accord to be completed by 2015...
Criticisms :
Some of the key criticisms include:
- The accord itself is not legally binding
- No decision was taken to agree on a legally binding successor or complement to the Kyoto Protocol.
- The accord sets no real targets to achieve in emissions reductions.
- The accord was drafted by only five countries.
- The deadline for assessment of the accord was drafted as 6 years, by 2015.
- The mobilisation of 100 billion dollars per year to developing countries will not be fully in place until 2020.
- There is no guarantee or information on where the climate funds will come from or how much individual countries would contribute to or benefit from any funds.
Conclusion and Comments
Effective international market mechanisms are needed to help countries meet their targets in a cost-effective manner and to encourage the participation of developing countries in meeting the goal of the UNFCCC. It is important to note that the more attractive an MMSD becomes in a post-2012 regime, other things being equal, the less incentive any developing country has to take on targets that entail lost access to the mechanism.
If the post-2012 regime includes a radically expanded MMSD that covers sectoral and NAMA initiatives, it is offering governments the opportunity to fund a variety of policies and programs that they might have as current priorities, but for which they lack the requisite resources. This clearly counts as a more attractive MMSD.
Several questions need to be answered over the next eight months as the world comes closer to elaborating a post-2012 regime for international action on climate change, including:
1. Which market mechanisms offer the greatest potential for developing country participation in a post-2012 regime?
2. What types of transition mechanisms might encourage large developing country emitters and advanced developing countries to take on meaningful actions and/or commitments?
3. Should developed countries be encouraged to allow greater access to international credits within their regulatory regimes? What steps should be taken to improve the integrity of such credits? What are the best approaches for dealing with additionality?
4. What is the best way to deal with the permanence issues in crediting mechanisms for REDD or soil carbon sequestration to encourage increased developing country participation in the carbon market?
5. How do we ensure that LDCs, small island developing states and African nations become involved in and benefit from carbon markets?
Appendix - Abbreviations and Acronyms
AAU Assigned Amount Unit
AF Adaptation Fund
A/R afforestation/reforestation
AWG-KP Ad Hoc Working Group on Further Commitments for Annex I Parties
under the Kyoto Protocol
AWG-LCA Ad Hoc Working Group on Long-term Cooperative Action under the
Convention
BAP Bali Action Plan
BAU business as usual
CCS carbon capture and storage
CDM Clean Development Mechanism
CER Certified Emission Reduction
CO2 carbon dioxide
CO2e carbon dioxide equivalent
COP Conference of the Parties
ERU Emission Reduction Unit
EU-ETS European Union Emission Trading Scheme
GHG greenhouse gas
GWP global warming potential
HFC hydrofluorocarbon
IET International Emissions Trading
IETA International Emissions Trading Association
IPCC Intergovernmental Panel on Climate Change
JI Joint Implementation
lCER long-term Certified Emission Reduction
LDC least developed country
LULUCF Land Use, Land-use Change and Forestry
MMSD market mechanism for sustainable development
MRV measurable, reportable and verifiable
Mt megatonne (millions of tonnes)
NAMA nationally appropriate mitigation actions
REDD reducing emissions from deforestation and forest degradation in developing
countries
tCER temporary Certified Emission Reduction
UNEP United Nations Environment Programme
UNFCCC United Nations Framework Convention on Climate Change
Some Lighter Moments :
REFERENCES :
- International Carbon Market Mechanisms in a Post-2012 Climate Change Agreement
Deborah Murphy, John Drexhage and Peter Wooders -- May 2009.
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International Institute for Sustainable Development (IISD) IPCC, 2001. ―Global Warming Potentials.‖ Climate Change 2001: The Scientific Basis. Contribution of Working Group I to the Third Assessment Report of the Intergovernmental Panel on Climate Change. J.T. Houghton, Y. Ding, D.J. Griggs, M. Noguer, P.J. van der Linden, X. Dai, K. Maskell and C.A.Johnson (eds.). Cambridge: Cambridge University Press. Chapter 6, Section 12.
- IPCC, 2006. 2006 IPCC Guidelines for National Greenhouse Gas Inventories. Prepared by the National Greenhouse Gas Inventories Programme. Hayama, Japan: Institute for Global Environmental Strategies.
- International Emissions Trading Association (IETA), 2008. Carbon Dioxide Capture and Geological Storage as a Clean Development Mechanism Project Activity. Submission to the UNFCCC Secretariat by IETA.
