Carbon Trading

Carbon trading means an idea presented in response to the Kyoto Protocol that involves the trading of greenhouse gas (GHG) emission rights between nations. For example, if Country A exceeds its capacity of GHG and Country B has a surplus of capacity, a monetary agreement could be made that would see Country A pay Country B for the right to use its surplus capacity.

The Kyoto Protocol presents nations with the challenge of reducing greenhouse gases and storing more carbon. A nation that finds it hard to meet its target of reducing GHG could pay another nation to reduce emissions by an appropriate quantity.  
The carbon trade came about in response to the Kyoto Protocol. Signed in Kyoto, Japan, by some 180 countries in December 1997, the Kyoto Protocol calls for 38 industrialized countries to reduce their greenhouse gas emissions between the years 2008 to 2012 to levels that are 5.2% lower than those of 1990.

Carbon is an element stored in fossil fuels such as coal and oil. When these fuels are burned, carbon dioxide is released and acts as what we term a "greenhouse gas".

The idea behind carbon trading is quite similar to the trading of securities or commodities in a marketplace. Carbon would be given an economic value, allowing people, companies or nations to trade it. If a nation bought carbon, it would be buying the rights to burn it, and a nation selling carbon would be giving up its rights to burn it. The value of the carbon would be based on the ability of the country owning the carbon to store it or to prevent it from being released into the atmosphere. (The better you are at storing it, the more you can charge for it.)

A market would be created to facilitate the buying and selling of the rights to emit greenhouse gases. The industrialized nations for which reducing emissions is a daunting task could buy the emission rights from another nation whose industries do not produce as much of these gases. The market for carbon is possible because the goal of the Kyoto Protocol is to reduce emissions as a collective.

On the one hand, carbon trading seems like a win-win situation: greenhouse gas emissions may be reduced while some countries reap economic benefit. On the other hand, critics of the idea suspect that some countries will exploit the trading system and the consequences will be negative. While carbon trading may have its merits, debate over this type of market is inevitable, since it involves finding a compromise between profit, equality and ecological concerns.

http://www.investopedia.com/ask/answers/04/060404.asp

Kyoto Protocol

How does it work?

There are four mechanisms through which the Kyoto Protocol attempts to meet these goals:

1) International Emissions Trading

This system allows countries that cannot meet their own emissions goals to purchase additional credits (called Assigned Amount Units or AAUs) from other countries that have been able to exceed their own goals. Systems have emerged among countries to facilitate this type of trading, the largest of which is the European Emissions Trading System   (EU ETS). The EU ETS began on January 1, 2005 and has a two-phased system. The first phase, which ends December 31, 2007, has come under fire   for providing too many credits to its members. As a result, prices for credits have been exceedingly low and the targeted emissions reductions have not been reached. Phase two will run from 2008-2012 with new allocations of credits and more stringent caps on emissions. For more information on current carbon prices under EU ETS as well as the latest news on carbon markets, I highly recommend Point Carbon.

2) Domestic Emissions Trading

A number of countries have either implemented   or considered   introducing their own regional cap-and-trade schemes. These systems allow states, regions, or businesses within a country to trade emissions credits with each other in order to achieve the country-wide emissions goal. A major problem with these schemes is that they often introduce their own units for carbon credits, with their own elements and requirements. As such, there is often little coherence between international trading schemes and domestic trading schemes. There needs to be a single standard and unit for carbon credits. A global market would allow for more gains from trade and would lead to better success for the Kyoto Protocol.

3) Clean Development Mechanism (CDM)

As I explained in Part one of this post series, the goal of a cap-and-trade scheme is to reduce global emissions with little regard for their origin. Based on this concept, the Kyoto Protocol allows developed countries to offset their excess emissions by reducing emissions in developing countries, where such projects may be more cost-effective (read: inexpensive). Rather than, or in addition to, trading credits with other developed nations, some countries elect to finance emission reduction projects in developing countries through the CDM. Projects in the CDM must go through a complicated and relatively expensive approval process   before being accepted as a qualified emissions reduction projects. There are currently 55 countries participating   in the CDM with hundreds of project types.

4) Joint Implementation (JI)

The Joint Implementation mechanism is often grouped with CDM because it is a very similar system. The major difference is that the countries in which projects can be built under the JI are primarily in the Eastern Bloc  . This is separate from the CDM because these countries are generally considered developed, but fit within their own category.

Has it been successful?

There is a lot of debate over the effectiveness thus far of the Kyoto Protocol. Detractors have a number of complaints. Their strongest complaint, in my opinion, is that the EU ETS handed out far too many   allowances (called EU Allocations or EUAs), and in doing so flooded the market with credits and drastically reduced the need to reduce emissions. In addition, critics   note that Kyoto extends only through 2012, not nearly long enough to achieve the sustained reductions necessary for mitigating the climate change crisis. Finally, it is widely believed that many countries will not meet   their stated emissions targets by the end of the 2008-2012 cycle. Most proponents of Kyoto acknowledge these flaws, but view the Protocol as a stepping stone   to a better, more effective international cap-and-trade scheme.

Personally, I am inclined to believe that despite Kyoto's (significant) flaws, it is a major step in the right direction. It is important to keep in mind that the Kyoto Protocol introduced by far the largest cap-and-trade scheme ever, and we are still in the very beginning stages of its implementation. I am hopeful that it will extend beyond 2012, and as regulators, countries, and industry alike become comfortable under the system, carbon prices will stabilize and significant emissions reductions will take place. However, without the United States as a signatory and with significant barriers to other countries emissions reductions, we should not rely on the Kyoto Protocol as a panacea to climate change.

http://www.celsias.com/article/carbon-trading-the-basics-part-2-kyoto-protocol/