Emission Trading and Business Term Paper – This is one of the best term papers on ‘Emission Trading and Business’ especially written for school and college students.
Term Paper # 1. Introduction to Emission Trading and Business:
Emission trading is trading of carbon credit permits. Emitters that need to increase their emission allowance can buy credits for the offset amount from those who pollute less or savers. The transfer of set allowances through buying and selling is referred to as a trade. Thus those who can reduce emissions below the allowed limit are financially benefited by selling the carbon units to the defaulters. Emission trading or its popular version ‘cap-and-trade’ is similar to a tax, i.e., for every cap placed, there exists a tax that has identical economic effects.
Business transactions on emission allowances are carried out in between an emitter and saver or through open market. Markets can be mandatory (for Kyoto Protocol signatory countries, e.g., EU) and voluntary markets (for non-signatories of Kyoto Protocol, e.g., USA). Transaction mechanisms are covered in Kyoto Protocol. The emission trading market is vast. List of emitters include fossil fuel based power plants, transportation, cement & steel industries.
The savers list include green constructions, forest preservation, and power generation using alternative energy sources, such as solar, wind and hydro. Business for the savers is growing fast thus providing an opportunity to control the emission rate despite the ever increasing presence of polluters. In addition to industrial sectors, there has been a spurt of green activities in different fronts, such as, real estate, green cities and in service sector.
Emission Trading or Cap and Trade of Emissions:
The emission trading, also known as cap and trade, basically refers to the trading of emissions allowances (carbon credit permits), as follows:
(i) Between one regulated entity and a less pollutive entity;
(ii) Through an intermediate company that sells carbon credits to commercial and individual customer to reduce the carbon footprint on a voluntary basis;
(iii) Carbon off setters purchasing the credits from an investment fund or a carbon development company that has aggregated the credits from individual projects; and
(iv) From open market.
Term Paper # 2. Kyoto Protocol and Emission Trading:
Emissions trading, as set out in Article 17 of the Kyoto Protocol, allows countries that have emission units to spare (i.e. units saved through less emission than the permitted limit) to sell the excess units to countries that are over their targets. Thus, a new commodity has been created in the form of emission reductions or removals.
Since the global warming potential (GWP) is expressed in terms of carbon dioxide equivalent, the emission unit is simply referred to as carbon unit and the trading as carbon trading. Carbon is now tracked and traded like any other commodity. The big carbon market across the globe has grown several folds.
Emission Certificates/Units for Trading:
More than actual emissions units can be traded and sold under the Kyoto Protocol’s emissions trading scheme.
The units which may be transferred under the scheme, each equal to one tonne of CO2, may be in the form of:
i. Certified Emission Reduction (CER)- a certified emission reduction (CER) generated from a clean development mechanism project activity,
ii. Emission Reduction Unit (ERU)- an emission reduction unit (ERU) generated by a joint implementation project,
iii. A removal unit (RMU) on the basis of land use, land use change and forestry (LULUCF) activities such as reforestation,
iv. Verified Emission Reduction (VER), and
v. EU has a unified certified emission management and reduction scheme, known as, Certified Emissions Measurement and Reduction Scheme (CEMERS).
In order to do trading on carbon credits, either in mandatory or in voluntary markets it is essential to get the carbon reduction units duly certified and validated by appropriate authorities. Although both markets trade with same emission certificates, but the certificates provided in voluntary markets are not registered by the governments of the host countries or the Executive Board of the UNO.
Transfer and Acquisition Registries and International Transaction Log:
Emission targets for industrialized country (Parties to the Kyoto Protocol) are expressed as levels of allowed emissions, or “assigned amounts”, over the 2008-2012 commitment periods. Such assigned amounts are denominated in tonnes (of CO2 equivalent emissions) known informally as “Kyoto units”.
The ability of Parties to add to their holdings of Kyoto units (e.g. through credits for CDM or LULUCF activities) or move units from one country to another (e.g. through emissions trading or JI projects) requires registry systems for tracking and recording of the transfers and acquisitions of the Kyoto units.
Two types of registry are being implemented:
Governments of the 38 Annex B Parties are implementing national registries, containing accounts within which units are held in the name of the government or in the name of legal entities authorized by the government to hold and trade units.
The UNFCCC secretariat, under the authority of the CDM Executive Board, has implemented the CDM registry for issuing CDM credits and distributing them to national registries. Accounts in the CDM registry are held only by CDM project participants, as the registry does not accept emissions trading between accounts.
In addition to recording the holdings of Kyoto units, these registries “settle” emissions trades by delivering units from the accounts of sellers to those of buyers, thus forming the backbone infrastructure for the carbon market.
Registry Operation Mechanism:
Each registry will operate through a link established with the international transaction log put in place and administered by the UNFCCC secretariat. The ITL verifies registry transactions, in real time, to ensure they are consistent with rules agreed under the Kyoto Protocol. The ITL requires registries to terminate transactions they propose that are found to infringe upon the Kyoto rules.
An international transaction log ensures secure transfer of emission reduction units between countries. In order to address the concern that Parties could “oversell” units, and subsequently be unable to meet their own emissions targets, each Party is required to hold a minimum level of ERUs, CERs, AAUs and RMUs in its national registry. This is known as the “commitment period reserve”.
The quality of the credits depends on the validation process and sophistication of the fund or development company that acted as the sponsor to the carbon project. This is reflected in their price; voluntary units typically have less value than the units sold through the rigorously-validated Clean Development Mechanism.
Term Paper # 3. Emission Reduction Unit (ERU):
The ERU refers to the reduction of GHGs particularly under Joint Implementation, where one unit represents one tonne of CO2 equivalent reduced. Regarding emission reduction units, one example is the production of biogas by landfill sites. These gases consist of mainly methane which escapes to the atmosphere if it is not collected. The main reason for dealing with methane is that it’s global warming potential (GWP) has a multiplier of 21 compared to carbon dioxide.
Collection of methane is usually accompanied by its combustion. Although burning methane produces carbon dioxide, its greenhouse effect is reduced by 18 ERU. One tonne of methane, with 21 tonnes carbon dioxide equivalent produces nearly 3 tonnes of carbon dioxide on burning, thus making a net saving of 18 tons of carbon dioxide or ERU.
Certified Emission Reductions (CERs):
These are issued in accordance with stipulations in the Clean Development Mechanism (CDM). Emission reductions achieved by CDM projects are to be verified by a DOE under the rules of the Kyoto Protocol.
CERs can be used by:
(a) Annex 1 countries in order to comply with their emission limitation targets or,
(b) By operators of installations covered by the European Union Emission Trading Scheme (EU ETS) in order to comply with their obligations to surrender EU Allowances of CERs or,
(c) Emission Reduction Units (ERUs) for the CO2 emissions of their installations.
CERs can be held by governmental and private entities on electronic accounts. CERs are split into long-term (1CER) or temporary (tCER), depending on the likely duration of their benefit. At present, most of the approved CERs are recorded in CDM Registry accounts only. It is only when the CER is actually sitting in an operator’s trading account that its value can be monetized through being traded.
The UNFCCC’s International Transaction Log has already validated and transferred CERs into the accounts of some national climate register. European .operators are waiting for the European Commission to facilitate the transfer of their units into the registries of their Member States. Under CDM, several ultra-mega thermal power projects are in the process of installation in India.
Verified Emission Reductions (VERs):
A unit of greenhouse gas emission reduction that has been verified by an independent auditor, but that has not yet undergone the procedures and may not yet have met the requirements for verification, certification and issuance of CERs (in the case of the CDM) or ERUs (in the case of JI) under the Kyoto Protocol. Buyers of VERs assume all carbon-specific policy and regulatory risks (i.e. the risk that the VERs are not ultimately registered as CERs or ERUs). Buyers therefore tend to pay a discounted price for VERs, which takes the inherent regulatory risks into account. VER cannot be used in mandatory markets.
Term Paper # 4. Types of Markets for Emission Trading:
There are two types of markets for emission trading as follows:
(i) Mandatory market for those trading on mandatory carbon offsets as required by Kyoto Protocol; and
(ii) Voluntary market which provides various options for off setters outside the Kyoto regime.
(a) Mandatory Market:
To reach the goals defined in the Kyoto Protocol with least economical costs the following flexible mechanisms were introduced for the mandatory market:
i. Emissions trading.
ii. Clean Development (CDM).
iii. Joint Implementation (JI).
i. Emission Trading:
The Kyoto Protocol defines legally binding targets and timetables for cutting the greenhouse-gas emissions of industrialized countries (excepting USA, not ratified KP) that ratified the Kyoto Protocol. Under the treaty, for the 5-year compliance period from 2008 until 2012, nations that emit less than their quota will be able to sell emission credits to others that exceed their quota. Emission quotas were agreed by each participating country, with the intention of reducing their overall emissions by-5.0% of their 1990 levels by the end of 2012.
For trading purposes, one allowance or CER is considered equivalent to one metric tonne of CO2 emissions. These allowances can be sold privately or in the international market at the prevailing market price. Also allowances can 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.
ii & iii. Clean Development and Joint Implementation:
It is also possible for developed countries within the trading scheme to sponsor carbon projects that provide a reduction in greenhouse gas emissions in other countries, as a way of generating tradable carbon credits. The Protocol allows this scheme through Clean Development Mechanism (CDM) and Joint Implementation (JI) projects, in order to provide flexible mechanisms to aid regulated entities in meeting their compliance with their caps. The UNFCCC validates all CDM projects to ensure they create genuine additional savings and that there is no leakage.
(b) Voluntary Market:
In contrast to the strict rules set out for the mandatory market, the voluntary market provides companies with different options to acquire emissions reductions. An emission reduction scheme, comparable with those developed for the mandatory market, has been developed for the voluntary market, and known as the Verified Emission Reductions (VER).
This measure has the great advantage that the projects/activities are managed according to the quality standards set out for CDM/JI projects but the certificates provided are not registered by the governments of the host countries or the Executive Board of the UNO. As such, high quality VERs can be acquired at lower costs for the same project quality. However, at present VERs cannot be used in the mandatory market.
Voluntary Market in USA:
USA not being a signatory to Kyoto Protocol has voluntary markets for emission trading. In 2003, U.S. corporations were able to trade CO2 emission allowances on the Chicago Climate Exchange under a voluntary scheme.
The voluntary market in North America is divided between:
(i) Chicago Climate Exchange, and
(ii) Over the Counter (OTC) market.
The Chicago Climate Exchange is a voluntary yet legally binding cap-and-trade emission scheme, whereby members commit to the capped emission reductions and must purchase allowances from other members or offset excess emissions. The OTC market does not involve a legally binding scheme and a wide array of buyers from the public and private spheres, as well as special events that want to go carbon neutral.
In 2007, the California passed the California Global Warming Solutions Act, AB-32, providing flexible mechanisms in the form of project based offsets for five main project types. A carbon project would create offsets by showing that it has reduced carbon dioxide and equivalent gases.
The project types include:
a. Manure management,
b. Forestry,
c. Building energy,
d. SF6, and
e. Landfill gas capture.
California is also one of seven states and three Canadian provinces that have joined together to create the Western Climate Initiative, which has recommended the creation of a regional greenhouse gas control and offset trading environment.
There are project developers, wholesalers, brokers, and retailers, as well as carbon funds, in the voluntary market. Some businesses and nonprofits in the voluntary market encompass more than just one of the activities listed above. A report by Ecosystem Marketplace shows that carbon offset prices increase as it moves along the supply chain i.e., from project developer to retailer.
While some mandatory emission reduction schemes exclude forest projects, these projects flourish in the voluntary markets. A major criticism concerns the imprecise nature of GHG sequestration quantification methodologies for forestry projects.
However, others note the community co-benefits that forestry projects foster. Project types in the voluntary market include avoided deforestation, afforestation/reforestation, industrial gas sequestration, increased energy efficiency, fuel switching, methane capture from coal plants and livestock, and even renewable energy.
Renewable Energy Certificates:
Renewable energy certificates (RECs), also known as green certificates, green tags, or tradable renewable certificates, represent the environmental attributes of the power produced from renewable energy projects. RECs can be traded through retailers, wholesalers and certificate brokers/exchanges. Several agencies for consumer protection and the REC tracking systems are also available. Renewable Energy Certificates (RECs) sold on the voluntary market are quite controversial due to additional concerns. Industrial Gas projects receive criticism because such projects only apply to large industrial plants that already have high fixed costs.
The size and activity of the voluntary carbon market is difficult to measure but projected to be $4 billion by 2010.
Credits Versus Taxes:
Credits were chosen by the signatories to the Kyoto Protocol as an alternative to Carbon taxes. A criticism of tax-raising schemes is that they are frequently not hypothecated, and so some or all of the taxation raised by a government may be applied inefficiently or not used to benefit the environment. By treating emissions as a market commodity it becomes easier for business to understand and manage their activities, while economists and traders can attempt to predict future pricing using well understood market theories.
Thus the main advantages of a tradable carbon credit over a carbon tax are:
i. Fair price of carbon, as set by the market, and investors in credits have more control over their own costs.
ii. Investment goes into genuine sustainable carbon reduction schemes through accepted validation process in the flexible mechanisms of Kyoto Protocol.
Market Price for Carbon:
The energy use and hence emission levels are going to increase with time. With increasing demand and less credit availability would push up the market price following the rules of supply and demand. Higher price of credits shall encourage more groups to initiate measures to curb emissions which would create carbon credits to sell.
An individual allowance, such as a Kyoto Allocation Allowance Unit (AAU) or its near-equivalent European Union Allowance (EUA), may have a different market value to an offset such as a CER. The offsets generated by a carbon project under the Clean Development Mechanism are potentially limited in value because operators in the EU- ETS are restricted as to what-percentage of their allowance can be met through these flexible mechanisms.
Market Trend:
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 European market as Euros per tonne 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 (GWP).
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 at least four exchanges trading in carbon allowances, such as, Chicago Climate Exchange, European Climate Exchange, Nord Pool, and Power Next.
The last one has a contract to trade offsets generated by a CDM carbon project called Certified Emission Reductions (CERs). Many companies engaged in emissions abatement, offsetting, and sequestration programs to generate credits operate through these exchanges.
Market Size:
Managing emissions is one of the fastest-growing segments in financial services, especially in the City of London. With the creation of a market for mandatory trading of carbon dioxide emissions within the Kyoto Protocol, the London financial marketplace has established itself as the center of the carbon finance market. The market is now worth about $60 billion (€30 billion) in 2007, expected to grow into a market of $0.5 trillion (€1 trillion) within a decade.
The voluntary offset market, by comparison, is projected to grow to about $4bn by 2010. Louis Redshaw, head of environmental markets at Barclays Capital predicts that “Carbon will be the world’s biggest commodity market, and it could become the world’s biggest market overall”.
The quantum of Carbon emissions trading has been steadily increasing in recent years. According to the World Bank’s Carbon Finance Unit, 374 million metric tonnes of carbon dioxide equivalent (tCO2e) were exchanged through projects in 2005, a 240% increase relative to 2004 (110 mtCO2e) which was itself a 41% increase relative to 2003 (78 mtCO2e).
In terms of dollars, the World Bank has estimated that the size of the carbon market was 11 billion USD in 2005, 30 billion USD in 2006, and 64 billion in 2007. In near future, the price of carbon will be the most pressing question.
In America, the new president has pledged to cut emissions by instituting a cap-and-trade scheme. EU is fine tuning the next phase of carbon trading scheme. Next updating of Kyoto Protocol by 2012, would decide the modalities of carbon trading practices, based on global accord.
Business Reaction:
Twenty three multinational corporations came together in the G8 Climate Change Roundtable, a business group formed at the January 2005 World Economic Forum. The group included Ford, Toyota, British Airways, BP and Uniliver. The group has published a statement stating that there was a need to act on climate change and stressing the importance of market-based solutions. It called on governments to establish “clear, transparent, and consistent price signals” through “creation of a long-term policy framework” that would include all major producers of greenhouse gases. By December 2007 this had grown to encompass 150 global businesses.
Businesses in the UK have come out strongly in support of emissions trading as a key tool to mitigate climate change, supported by Green NGOs.
Other Activities:
Carbon Footprints:
The carbon footprint is a measure of the exclusive global amount of GHGs greenhouse gases, emitted by a human activity or accumulated over the full life cycle of a product or service and expressed as a carbon dioxide equivalent (usually in kilograms or tonnes). The carbon footprints can be assessed for a product, corporate or an event (like X’ mas when carbon footprint found to increase substantially in UK).
A carbon label, which shows the carbon footprint embodied in a product in bringing it to the shelf, was introduced in the UK in March 2007 by the Carbon Trust. Examples of products featuring their carbon footprint are Walkers Crisps, Innocent Drinks, and Boots shampoos. A conceptual tool in response to carbon footprints are carbon offsets, or the mitigation of carbon emissions through the development of alternative projects such as solar or wind energy or reforestation.
Carbon Trust:
The Carbon Trust is non – profit company(trust) to help businesses and public organizations to reduce their emissions, by funding development of low carbon technology, such as, development of alternate renewable energy. Unusual for a government sponsored organization it operates venture capital and loan funds as well. It is partly funded from the Climate Change Levy, a tax on electricity, gas, and coal. The Trust’s annual report for 2008 indicates an estimated savings for UK business of £1 million a day through the cost savings by reducing carbon emissions.
Carbon Banking:
Several forms of “carbon banking” accounting are being developed. Carbon banking is a service that itemizes carbon reductions and storages, and provides some form of economic compensation as the global warming issue heats up.
Some of the carbon banking is as follows:
GAIA Carbon Bank, trying to purchase existing forests in the northern hemisphere and to manage these as a future ecologically sounds resource. Carbon Bank USA, in their environmental outreach program, provides an opportunity to reduce carbon emissions by planting trees and reforestation.
Morgan Stanley has recently announced the creation of the Morgan Stanley Carbon Bank to assist clients seeking to become carbon neutral. Offsetting capabilities based on the highest recognized international standards. Britain has recently urged for the creation of an independent European carbon bank to improve the functioning of the EU’s.
The World Bank Carbon Finance Unit’s (CFU) are part of the larger global effort to combat climate change, along with the World Bank and its Environment Department. The CFU uses money contributed by governments and companies in OECD countries to purchase project-based greenhouse gas emission reductions in developing countries and countries with economies in transition.
The emission reductions are purchased through one of the CFU’s carbon funds on behalf of the contributor, and within the framework of the Kyoto Protocol’s Clean Development Mechanism (CDM) or Joint Implementation (JI). Unlike other World Bank development products, the CFU does not lend or grant resources to projects, but rather contracts to purchase emission reductions similar to a commercial transaction, paying for them annually or periodically once they have been verified by a third party auditor.
The selling of emission reductions – or carbon finance – has been shown to increase the bankability of projects, by adding an additional revenue stream in hard currency, which reduces the risks of commercial lending or grant finance. Thus, carbon finance provides a means of leveraging new private and public investment into projects that reduce greenhouse gas emissions, thereby mitigating climate change while contributing to sustainable development.
Term Paper # 5. Emission Trading Scheme to Help Farmers:
In USA, Farmers Union’s Carbon Credit Program allows agriculture producers and landowners to earn income by storing carbon in their soil through non-till crop production and long-term grass seeding practice. For example, the Farmers Union has earned approval from Exchange, like Chicago Exchange, to aggregate carbon credits. Farmers Union will enroll producers’ acreage of carbon into blocks of credits that will be traded in the Exchange, much like other agricultural commodities that are traded.
Green Buildings:
California has adopted first statewide green building code. Approved by state’s Building Standards Commission in July, 2008, the new standards are designed to encourage construction of new buildings to use at least 15% less energy, conserve water, and reduce the use of products containing toxic substances. Building more energy efficient buildings and homes is the state’s strategy to comply with its mandate to cut greenhouse gases to 20% below 2005 levels by 2020, or by about 30%.
Initially voluntary, the new standards become mandatory with the state’s 2010 according to building code, California may only credit efforts that produce GHG reductions that are real, quantifiable, permanent, verifiable, enforceable and additional beyond those that would otherwise occur under business as usual. The same general requirements govern offsets in other GHG programs throughout the world.
These are the threshold design issues a Green Building Credit must satisfy. In some systems, a customized process is used for each project, such as in the Clean Development Mechanism under the Kyoto Protocol. But such project-by-project analysis creates high transaction costs that undermine the financial viability of offset projects. The preferred and more effective method is to use standardized measurement and verification protocols.
Green Cities:
Based on the:
(i) Source of electricity such as wind, solar, biomass and hydroelectric power, residents using their own power sources, like roof-mounted solar panels,
(ii) Type of transportation such as public transportation or carpool,
(iii) Green living such as number of buildings certified by the U.S. Green Building Council, as well as for devoting area to green space, such as public parks and nature preserves, and
(iv) Recycling and green perspective based on a measure of how comprehensive is city’s recycling programme and citizen’s participations, 50 cities in USA have been rated as green cities.
Green Sports:
NBA’s New Jersey Nets has bought ‘carbon credits’ that support 4-hydro-power stations in China, as part of programme to offset its own carbon emissions in America. The Nets claim to be first major professional sports team to achieve carbon neutral status.
Indian Scenario in Carbon Trading:
The government is betting big on two market-based trading schemes to encourage energy efficiency and green power across the country sidestepping widely used cap & trading emissions schemes. The trading scheme is called as Perform, Achieve and Trade (PAT). India is starting a mandatory scheme that sets benchmark efficiency levels for 563 big polluting from power plants to steel mills and cement plants that account for 54 percent of the country’s energy consumption.
The scheme allows businesses using more energy than stipulated to buy tradable energy saving certificates, or Escerts, from those using less energy, creating a market estimated by the government to be worth about $16 billion in 2014 when trading starts. The number of Escerts depends on the amount of energy saved in a target year.