The market for trading allowances relating to the right to emit carbon dioxide or the Emissions Trading Market has expanded dramatically in the last few years and promises to continue to do so in the near future. It has an extremely high profile as it is intrinsically linked to worldwide efforts to address climate change. The key differences between the emissions market and the commodities markets are that it is a politically-generated and managed market and that the underlying is a dematerialized allowance certificate, as opposed to a physical commodity. Global warming is a high priority topic in any political index across the globe. Considerable efforts are being made in this direction, some of which include UN Framework Convention on Climate Change (UNFCCC) - 1992, the Kyoto Protocol - 1997 and the Bonn Agreement - 2001. The New Oxford American Dictionary even chose ‘carbon neutral’ as word of the year for 2006. Many liken the practice of buying carbon credits to buying pardons from the Catholic Church in 16th century Europe. We believe that it is easier to assess our progress and achieve our goals if we attach a value to something. It was found that economists too think the same and they jumped at the opportunity to attach a monetary value to the environment issue at hand. The paper attempts to advise these nations so that they may design an innovative mechanism which enables them to benefit from their carbon offset potential and not just rely on the good will of other nations. The paper does a Case Study on Africa and its huge potential to take the initiative in designing such a market.
Tradable carbon units are one of the most effective instruments in the battle for a better environment. What is a carbon unit you ask? A carbon unit is a permit to emit one tone of carbon dioxide (CO2).
The Emission Trading Scheme (ETS)
169 industrialized nations agreed to reduce greenhouse gas emissions to a level of 5.4% by 2012 keeping 1990 as the base. Thus, the Kyoto Protocol gave birth to the carbon trading market. The UN distributes carbon units to those industrialized countries who have signed the treaty, who set a limit on the level of emissions. This limit is equivalent to the total amount of emissions that they are allowed to emit. Countries may buy and sell units. The price of tradable units will be determined by the volume of units in circulation, similar to a stock exchange.
Kyoto Protocol’s flexibility mechanism
When a country to unable to reduce its emissions to the cap set by the Protocol, the market dynamics of ‘cap and trade’ come into play. The Kyoto protocol allows for reduction projects to be carried out in other countries. The Protocol assumes that emissions of greenhouse gases contribute equally to global warming wherever they are emitted, meaning that companies can choose to reduce emissions where it is cheapest for them. When projects are carried out in countries without Kyoto target (non-Annex I or developing countries) they operate under the 'Clean Development Mechanism' or CDM. When they are carried out in countries with a target (Annex I countries), they operate under a process known as 'Joint Implementation' or JI. The ETS is based on units which must be obtained to cover emissions. They can be bought or sold.
The CDM and JI are project based mechanisms and are together known as ‘carbon offsets’. CDMs generate Certified Emission Reductions or CERs which can be used to achieve regulatory platforms or be traded on the international carbon market using the ETS.
With the most recent data released in February 2012, the CDM project share of China, India, Brazil, and Mexico combined has dropped to 65 per cent (http://www.cdmpipeline.org/).
CDM accounted for 91%...