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Toni Johnson, Staff Writer
September 20, 2007
A new round of international talks is getting under way on what policy should follow the Kyoto Protocol, a treaty set to expire in 2012 that established binding greenhouse-gas emissions reductions for thirty-six countries. U.S. lawmakers—who had in the past supported Bush administration refusals to ratify the treaty over economic concerns—also will begin work on legislation that would establish binding emissions targets for U.S. industries. A central feature of Kyoto and any new global policy is expected to be a greenhouse gas cap-and-trade program. Problems with some current trading markets offer lessons for crafting new cap-and-trade policies.
The Kyoto Protocol established a market-based mechanism to allow developed countries with binding emissions targets to reduce greenhouse gases such as carbon dioxide, methane, carbon tetrafluoride, trifluoromethane, and nitrous oxide. Under the cap-and-trade system, industries would be allocated allowances limiting them to a certain amount of greenhouse gas emissions each year. Most trading schemes use one ton carbon-dioxide units for sale or convert non-CO2 gases into CO2-equivalent units for the purposes of trading. Industries are also allowed to purchase credits that offset their carbon output above those caps. The goal of the cap is to prevent increases in net emissions. Some facilities may find it more economical to reduce their emissions and then sell their surplus emission allowances as credits, while others may find it cheaper to buy credits to offset their emissions rather than make direct reductions. Greenhouse-gas emission credits can be purchased or sold from either a carbon market or a project certified by the United Nations. In August 2007, Kyoto participants with binding targets submitted reports showing whether they were able to track emissions and results of trading before Kyoto’s enforcement period begins in 2008.
Cap-and-trade systems have been utilized in the past to successfully reduce other types of emissions. The cap-and-trade system instituted under the 1990 Clean Air Act amendments in the United States is credited with achieving significant reductions in acid-rain-causing sulfur-dioxide emissions by power plants.
According to the World Bank’s 2007 report (PDF) on trading systems, a total of $30 billion in allowances was traded in 2006. Of that total, nearly $25 billion was traded on the EU market, about $5 billion was for UN projects, $225 million was on the New South Wales exchange, and $38 million was on the Chicago Climate Exchange.
CDM “hasn’t been as effective or cost effective as many people had hoped,” says Chandler.
The report shows the EU system traded more than 1.1 billion metric tons of carbon allowances in 2006 while UN projects accounted for about 500 million metric tons. New South Wales traded about 20 million tons and the Chicago Climate Exchange about 10 million tons. A UNFCCC background paper (PDF) on financial flows for climate change predicts the global demand for carbon offsets for countries obligated under the Kyoto enforcement period of 2008 through 2012 to be somewhere between 500 tons and 850 million tons per year.
Experts say the CDM has achieved mixed results. William Chandler, senior policy analyst for energy and climate at the Carnegie Endowment for International Peace, says in an interview; “In some cases they are resulting in real investment being made, particularly [in reducing] carbon dioxide from energy use. On the other hand it hasn’t been as effective or cost effective as many people had hoped.” According to UNFCCC, the majority of projects in the Clean Development Mechanism pipeline focus on sustainable energy production, including biomass, wind power, and hydropower. The bulk of the projects are located in relatively wealthy developing nations such as China and India. China alone accounts for more than half of the certified emissions reductions being generated by the CDM. Raymond J. Kopp, director of the climate and technology program at the environmental think tank Resources for the Future, asserts that smaller countries will only start to benefit from the CDM if the program is widened to include deforestation, not just reforestation as it does now. Carbon that escapes during deforestation accounts for 20 percent (FT) of the world’s carbon dioxide emissions.
“Without the proper caps we simply don’t have an increase in carbon prices to bring an incentive to boost investment,” says Davies.
CFR Senior Fellow Sebastian Mallaby says that the intention to turn emissions trading into a development mechanism (PDF) has failed, noting that almost no money goes to the least developed countries. “The reasons are partly understandable,” Mallaby argues. “It’s easier to trade bulky industrial offsets than to collect small tokens of progress from dozens of remote villages. But even with that caveat, the Kyoto mechanism works badly.” Michael Wara, research fellow at Stanford University’s Program on Energy and Sustainable Development, says that even though developing nations, such as China and India, are benefiting from the CDM, the mechanism has not achieved its intended goals. He points to the billions spent to abate chemicals such as nitrous oxide and trifluoromethane, also known as HFC-23, instead of to construct large-scale power projects (PDF), which he argues would be a better development outcome and abate greenhouse gases over the long term.
The first round of trading was intended (PDF) to work out kinks in the system and did not have goals for meeting Kyoto targets. Prices for credits started fairly high, but quickly devalued when it was learned that the European Union handed out too many emissions allowances. The surplus meant industries had little need to make emissions reductions or buy credits to meet their targets. Instead, emissions from large European polluters rose slightly from 2005 to 2006. Chris Davies, environment spokesman for the EU Parliament’s Liberal Democrats, told Britain’s Independent: “Getting the emissions trading system up and running has been a major achievement but without the proper caps we simply don’t have an increase in carbon prices to bring an incentive to boost investment.”
China alone accounts for more than half of the certified emissions reductions generated by the CDM.
Some experts say despite flaws in the initial rollout, the EU trading system has broken new ground by creating an emissions-trading regime across multiple jurisdictions and has “provided new evidence on how different approaches to enforcement and monitoring, allocation, and even effort and stringency can be encompassed in a single trading program,” said a February 2007 Resources for the Future discussion paper (PDF) on the EU trading scheme. Kopp notes that EU emissions futures trading—where people buy credit contracts set at a certain price for the future—is strong, which he says implies investor confidence in the stability of the market.
The European Union is working on emissions allocations for the upcoming 2008 to 2012 enforcement period. Phase two is set to begin at the onset of the Kyoto enforcement period for binding targets in 2008. The World Bank says the inability to carry over surplus allowances into the next phase was a “design flaw.” Linking the allowances from the two phases might have prevented the collapse of the market, the bank says. The Economist argues some companies see EU market participation as a regulatory hassle, failing to realize the money to be made from the market. It suggests firms pay more attention to emissions trading.
Lawmakers in the United States, still debating federal global-warming regulations, are proposing auctioning initial allowances rather than giving them away as Europe has done. CFR’s David Victor and Stanford researcher Danny Cullenward expressed disappointment in “how quickly many U.S. policy makers have settled on the cap-and-trade approach without permitting a proper debate to occur on the use of taxes.”
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