Carbon Trading

Carbon trading essentially puts a price on a country's carbon emissions as a means of encouraging a reduction in greenhouse gases. Emerging countries such as China, Brazil and India are proving to be big players in the global carbon trading marketplace.

Author Anna Rees, 07.15.12

Carbon trading essentially puts a price on a country’s carbon emissions as a means of encouraging a reduction in greenhouse gases. Emerging countries such as China, Brazil and India are proving to be big players in the global carbon trading marketplace.

Carbon Trading in a Nutshell

The 1997 Kyoto Protocol called for a united, international standard on reducing pollutant emissions so as to combat the global warming of the earth’s atmosphere. The direct response to this became what is known today carbon or emissions trading. Carbon trading takes a globalized, market-based approach to reducing CO2 levels in the atmosphere, offering economic incentives to industry in return for reducing polluted emissions.

An appointed authority, usually governmental such as the United Nations Framework Convention on Climate Change, is tasked with determining the limit or “cap” of any pollutant (methane, sulphur, carbon dioxide) a given industry or company is allowed to emit. The company must then buy the number of permits (called CERs-Certified Emissions Reductions) which equate to their cap (one CER is generally equal to emitting one metric ton of CO2 emissions) and must not exceed that emissions limit. If they do, they will need to purchase permits or credits from companies who have emitted below their limit and therefore have permits to spare. In a sense, companies who exceed their emissions limit have to pay for their practices, while more eco-conscious companies are financially rewarded for their ways. Like any market product the actual price of any permit is dictated by supply and demand.

The obvious objective here is to encourage businesses to, over time, employ eco-friendly practices and reduce their overall environmental impact.

Overview of the Global Carbon Market

The European Union was one of the first on the scene, making carbon trading a pillar of its policy portfolio and introducing the Emissions Trading System in 2005, which it made mandatory for organizations within the EU to comply with. In other developed regions, individual organizations nominally sign up with their respective governing body in order to take part in carbon trading.

Carbon trading has built momentum, particularly as climate change and global warming increasingly become prevalent issues in the media. The World Bank puts the current global value of the carbon-trading market at 176 billion USD, with the majority of CERs being sold by Asian countries to western countries.

The success of the carbon trade is widely debated. People backing the system point to obvious economic gains for developing countries, drops in the European Union’s CO2 emissions in the years following the introduction of its Emissions Trading System and a globalized approach to tackling climate change as proof of the strategy’s success. Those arguing the system’s failure underline the steadily dropping price of carbon and the initiative’s inability to re-shift focus towards investing in renewable energy sources. In 2011, Canada was the first country ever to renounce its ratification of the Kyoto Protocol while the world’s top two polluters, China and the USA (both of whom Kyoto doesn’t cover), continually struggle to meet emissions targets, despite both being big players in the carbon trading market.

Follow the Leader? A Closer Look at the EU Approach

Currently in effect in 31 countries, the Emissions Trading System (ETS) looks to apply a pricetag to pollution and is applied to 11,000 power and manufacturing plants, covering around 45 percent of total emissions coming out of the EU. Airline operators active in and between the 31 countries also fall under the system and the EU claims that the ETS comprises three quarters of the total international carbon trading market.

Under the ETS, companies must acquire a set amount of ‘Emissions Allowances’ (according to the regulated emissions ‘cap’ under which the company must operate) which they either purchase or receive from the government for free (although, not for much longer. In 2013, the EU introduced bidding on Emissions Allowances at auction with a view to reducing the number of carbon credits given away). Each Emission Allowance permits the company to emit one tonne of carbon dioxide or the equivalent amount of nitrous oxide and perfluorocarbons.

Companies who emit beyond their cap can draw upon any surplus Emissions Allowances that have been saved from previous years or, in some cases, buy a limited amount of CERs from emissions-saving or ‘offset’ projects around the world.

Businesses are checked once a year by a third party source to ensure compliance. Companies who have emitted more tonnes of CO2 than allowed must purchase extra credits and pay a fine (around 100 € per tonne of CO2).

In 2013, the ETS entered its third phase of operation with the EU requiring a 1.74 percent reduction per year in emissions from power stations as part of its goal to lower emissions from applicable industries by 21 percent (from 1990 levels) by 2020.

The video below also gives an overview of the EU’s ETS:

The ETS is generally held up as the marker when it comes to carbon trading and it has experienced some success, particularly early on. By the end of 2013, emissions levels had fallen to 19 percent below levels in 1990.

Despite being the world’s biggest and most visible carbon trading campaigns (or perhaps because of it), the ETS comes under a lot scrutiny, with people primarily arguing that the caps outlined under the system have been set too high to really be effective. A 2013 report outlined that the financial crash of 2008 led to a significant reduction in production in Europe’s manufacturing plants, leading inadvertently to these plants having an oversupply of credits. At the time, the report claimed these credits would be banked for future use, allowing effected companies to potentially exceed their emissions limits without repercussion. A proposition was put forward to take 900 million credits out of the market at the time to ease surplus. The current approach (called backloading) is to take out these credits over a three year period (400 million in 2014, 300 million in 2015 and 200 million in 2016) and postpone auctioning them until 2019 – 2020 (the end of the current ETS phase).

Another report issued in 2013 by a coalition of grassroots environmental groups argued that the ETS does not adapt easily to supply and demand changes in the market (this article from Spiegel Online outlines this in further detail) and is not an effective tool against climate change. According to the report, reductions in EU manufacturing emissions can be hard to qualify in any substantial way if it outsources more and more of its manufacturing to places like China, meaning the emissions have just been redirected and are just coming from someone else’s backyard.

One area where the ETS comes under fire has been, what detractors call, its inability to encourage industry to make the switch to renewable energy, with the aforementioned oversupply of credits allegedly making it cheaper for business to stick to fossil fuels than to start using alternative forms of energy.

Are Others Following Suit?

China recently announced plans to set up its own national carbon trading scheme. The goal to have the world’s biggest polluter start paying for its emissions is undoubtedly a positive sign yet the country risks making some of the mistakes that the ETS is derided for, namely that it is flooding its market with credits in order to get companies to sign up to the system. Chinese officials have publicly stated that they would learn from the oversupply mistakes the ETS has made however, a 2014 article by Reuters pointed out that issuing a surplus of credits had led to carbon stock prices dropping by a third in a matter of weeks in some parts of the country.

Should We Trade in the Trade?

There is no sizable alternative to carbon trading right now and getting a system off the ground that tackles climate change by requiring large emitters to reduce emissions or pay has proven tricky in the past (the fate of the much-maligned carbon tax in Australia springs to mind). Despite all of this, there are continued calls for new approaches to (or at least a refining of) the system. In some parts of the world, alternative or complementary initiatives have been set up that employ a more tailored method of emissions reduction and/or adoption of renewable energy. We take a look at few below:

The Renewable Energy Certificate Trading Programme (India)

Already in progress, the renewable energy certificate trading program (REC) was established for wind, solar and biomass power plants. Renewable power distributors are eligible to obtain one certificate for every MWh (one million watts of energy per hour) they generate. Renewable energy sources currently contribute to about 8 percent of energy production in India, compared to coal’s 60 percent.

Companies who sign up to take part in the REC program must source up to 14 percent of their energy from renewable sources or buy RECs to make up for the difference. If they don’t, state energy regulators will purchase the certificates and invoice the companies for the amount.

One of the touted benefits of RECs is investment opportunities. The government-set minimum price of 1.5 rupees (0.03USD) per kilowatt-hour for the RECs delivers almost three times higher returns than developers earn from UN-regulated carbon trading credits and is in place to guarantee a certain return for investors.

Trading of RECs is building steam as the government rolls out mandates stipulating organisations and individuals must source a certain percentage of their overall energy from renewable sources, as part of the government’s plan to increase solar power output to 20 gigawatts by 2020.

Reforestation and Forest Carbon Stocks (various locations)

Globally, deforestation accounts for between 12 and 20 percent of CO2 emissions, much of this coming from the the carbon that is stored in trees being released when the trees are chopped down. Projects, such as REDD+, look to kill two birds with one stone by rebuilding and maintaining biodiversity and tackling climate change. The basic idea is to create a financial value for the carbon stored in forests, as well as a means to leverage this, thus offering an incentive to developing countries to reduce emissions caused by deforestation however, the scheme has been criticised by some as doing exactly what carbon trading does – turning our natural resources (trees; pollution-free air) into commodities.

Carbon Tax (Ireland)

Unlike in Australia, government-imposed taxes on the use of fossil fuel (whether for use in the household, at work or for transport) have been successful in some parts of the world. Ireland introduced a carbon tax in 2009 as means of tackling climate change and creating a stream of revenue for its ailing economy. The country’s emissions have decreased by about 15 percent since 2008 and while much of this would be tied to the recession in Ireland, emissions still dropped even when the economy experienced slight period of growth. Although criticised by some members of the public, the revenue from the tax helped the country avoid increasing income tax rates back in 2012. British Columbia in Canada has also had success imposing a carbon tax.

A report prepared by Friends of the Earth in 2010 outlined further ideas for reducing emissions without relying on carbon trading schemes. Some of their suggestions included: a global feed-in tariff of 1 billion USD to help make renewable energies as affordable as possible; establishing global standards for industry so as to avoid scenarios whereby companies can claim a reduction in domestic manufacturing emissions when manufacturing has been sent offshore; placing a tax on carbon emissions.

A study conducted by researchers at Duke University in the US noted the troublesome aspect of having a truly global carbon trading system, stating that political and regional concerns alongside differences in how stringent or relaxed programmes are country to country inhibits the development of a global carbon playing field. What they did find however, was that new players (like California and Quebec) were able to learn from past mistakes conducted in global carbon trading and turn these lessons into new strategic approaches to develop more robust schemes before linking up with other schemes nationally or internationally.

Carbon trading schemes as they currently exist have drawn ire from some who say that the emissions caps set are too unambitious and that there are too many credits circulating in the market. However, as the EU makes new promises and tries to adapt its flagship carbon trading scheme and new markets continue to emerge in key regions, it is clear that carbon trading will stick around for the time being. Applying the lessons from past mistakes to new carbon trading schemes as well as adopting programmes that encourage a switch to renewable energies and place personal onus on carbon emissions could be key to making significant, meaningful reductions in greenhouse gas emissions.

Sources and links:

Author: Anna Rees/ RESET editorial. Last update: February 2015.

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