Understanding Carbon Markets

Moustadam #4

 

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The 1992 Kyoto Protocol produced the United Nations Framework Convention on Climate Change, which is an international treaty that set binding obligations on industrialized countries to reduce emissions of greenhouse gases. The United Nations accordingly created the Clean Development Mechanism (CDM) as a regulatory authority to trade and sell carbon dioxide emissions or its equivalent in a regulated market in industrialized countries that signed the Kyoto protocol. The main purpose for carbon trading is to lower greenhouse gas emissions and encourage investment in green technologies. The pricing of carbon credits is supposed to be carefully designed, but prices remain unpredictable and it is not very clear how they are determined.

Carbon markets are the medium through which carbon dioxide emissions or other greenhouse gas equivalents (Co2e) are traded as a credit or an offset. A country/region/city can regulate pollution caused by greenhouse gas emissions through a market-based approach known as cap-and-trade. Accordingly, authorities would regulate maximum allowable emissions caps for industries. Industries that produce a smaller amount of emissions than their allowable cap would sell the difference as carbon credits or offsets; and industries that produce more emissions than their allowable cap have to buy the difference. In other words, those who produce less greenhouse gas emissions than the allowable caps make money, and those who produce more have to pay money. Through regulating maximum allowable emissions caps for industries, the United States, for example, has managed since 1980 to effectively reduce the greenhouse gases responsible for acid rain pollution.

Emissions may also be regulated through a carbon tax. The tax or fee is a cost for pollution, and the money collected from this tax would be used to finance green technologies that enhance green economic development. This can be an easy and quick instrument to price pollution in comparison to the complex process of developing a cap-and-trade approach. However, it can have negative economic consequences if it ends up being only about paying taxes and no action is taken to reduce emissions and to invest in green technologies. Sweden has implemented a carbon tax system since 1990, and has managed to reduce greenhouse gas emissions by 17%. The tax rate there today reaches $150/ton of Co2e (tCo2e), and the collected taxes have been invested in financing green technologies and in successfully phasing out fossil fuels for heating.

To return to cap-and-trade, organizations that produce lower emissions than the allowable cap can sell the difference as carbon offsets (each offset is equal to one tCo2e). Offset projects in lower-income countries can sell the offsets resulting from implementing green technology projects like renewable energy and biomass projects. The CDM unit issues Certified Emission Reduction (CER) credits, giving each carbon offset project a serial number that allows it to trade and sell in regulated markets. This allows CDM to improve the bankability of energy, waste, and infrastructure projects. An example of this is the Ghabawi Landfill in Jordan. Here, the Greater Amman Municipality (GAM) acquired a loan from the World Bank to build a solid waste landfill and to capture the resulting methane gas that the landfill produces to generate electricity, thus avoiding emissions amounting to more than 200,000 tCo2e per year. The World Bank Carbon Fund will buy the expected emissions offsets and sell them in the European market through the CDM process, thus generating income to GAM.

Carbon credits issued outside the regulation of the United Nations framework are traded in voluntary markets. For example, airlines may buy offsets in the voluntary carbon market from individuals or offset projects to improve their reputation as environmentally conscious entities and as part of their Corporate Social Responsibility (CSR) efforts.

Regulated and voluntary carbon markets have emerged in Europe, the United States, and Canada. Carbon trading transactions reached 10.3 billion tCo2e in 2011, and are valued at $176 billion. Although global growth of the carbon trading industry has been very small over the past few years, it is expected that the participation of new countries in carbon markets in the coming years will again encourage its growth. The Kyoto Protocol ended in 2012, and existing carbon markets have proved to be successful, particularly in Europe. The shape of new carbon market systems is still being determined, and additional countries are being welcomed in existing markets or encouraged to create their own markets. There also is considerable debate taking place regarding the future role of the United Nations in designing carbon markets, particularly since it has not effectively addressed issues relating to regulations and pricing.

The price of carbon credits varies today from $20 to $35/tCo2e, but is expected to reach $65 by 2050. Although these remain modest prices compared to the carbon tax rate per tCo2e in Sweden, the expected growth of existing markets and the resulting growth in supply and demand for credits may result in significant price increases, which will greatly contribute to increasing the financing available for green technologies.

Scientists state that the increasing quantities of greenhouse gases in the atmosphere are the direct cause of climate change and the disastrous environmental consequences that have accompanied it. In spite of this, some still argue that addressing increasing greenhouse gas emissions is not a priority and is not as important an environmental problem as the depletion of resources such as fresh water. Further development of carbon markets may give societies around the world an important financial incentive to become actively involved in reducing greenhouse gas emissions and to give it the attention it deserves.

 

Nourhan Al Kurdi
March 28, 2013

 

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