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A growing market for carbon dioxide

February 28, 2005

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With the Kyoto Protocol on environment having come into force from February 16, a newer kind of commodity which one cannot see and possess is poised to become one of the largest markets in the world. It is carbon dioxide. Already, trading is taking place and climate exchanges on the pattern of stock exchanges have come up.

It is essentially a rich-poor or North-South transaction. The rich (in the North) will release carbon into the atmosphere, the poor (in the South) will save it on the former's behalf and get money in return.

However, so far, the trading has taken place in the western countries where awareness of environment is quite high. Carbon trading is, in fact, an umbrella term that includes the trading of greenhouse gas reduction credits that were defined in the 1997 Kyoto Protocol, first drawn up in 1992.

There are two major systems of trade that were agreed upon - Joint Implementation (JI) and Clean Development Mechanisms (CDM). JI allows emissions credits to be traded between two different countries. CDM allows companies to earn credits by paying for emissions-reducing and clean energy projects in developing countries.

Under the 1992 UN Framework Convention on Climate Change (UNFCCC), countries are permitted to use a trading system to help meet their emissions targets. In principle, a country may allocate permits to individual companies for the emission of a certain quantity of greenhouse gases to a level equal to or below the assigned amount.

The Kyoto treaty could not come into force for long because it required ratification by 55 countries, of which developed countries account for 55 per cent of total emissions of 1990 levels.

Although President Clinton signed the protocol in 1998, President Bush had insisted that the emission targets for developing countries such as China and India must be fixed. And in 2001, he withdrew his country from the treaty under the industry lobby's pressure.

Hence, Kyoto could come into force only when either the US or Russia ratified it as their respective emission targets of 36 per cent and 17 per cent were enough to achieve the required participation of developed countries affecting at least 55 per cent of the world's total emissions.

It was 44 per cent before Russia ratified the treaty three months ago and earned the title of "ecological saviour". Now developed world's share is 61 per cent. Interestingly, Russia did so in exchange for EU support for its admission to the WTO.

However, both absolute and relative targets to cut greenhouse gas emissions as part of a regime, under the new situation, to tackle climate change post-2012 are yet to be agreed and an international conference is scheduled to be held in May this year in this connection.

The first "carbon trade" took place in March 2003 between Shell, the global oil company, and Nuon, a Dutch multinational, that also supplies power to users in Belgium and Germany, in which Nuon bought a significant volume of allowances from Shell for 2005.

For every tonne of CO2 (carbon dioxide) that goes over their target, companies are liable to a fine of 40 euros during a three-year transitional period. From 2008 to 2012, the punishment will increase, to 100 euros per tonne of CO2.

In 2004 alone, nine million tonnes of carbon changed hands, a fraction of the 2.2 billion tonnes annually that can be potentially traded within the European Union starting this year. Trading costs, charged by the brokers, have fallen from 16 cents per tonne down to as low as 2.5 cents.

The predictions are that the business could be worth tens of billions of Euros in just a few years and that Russia alone could earn as much as $10 billion, because its Kyoto targets were set at levels that peaked just after the collapse of the Soviet Union.

Now Russia's power production has fallen some 30 per cent, making it the world's largest owner of carbon credits, which also allows it to drive prices up by restricting supply.

Countries set greenhouse gas limits for emitting companies, giving those companies what the Kyoto Protocol calls "Assigned Amount Units" (AAUs). If a company produces less than its limit, it can trade remaining allotments to companies that have exceeded their limit.

Each country has to decide how to divide up its carbon allocation - for example Denmark announced last week that its 235 electricity and heat producers will be allocated 65.1 million tonnes, while 120 industry and offshore producers will be allocated 27.6 million tonnes. In addition, it set aside a reserve of 0.9 million tonnes for new entrants and significant growth.

If a country is incapable of meeting its target, it could conceivably buy permits from countries that are under their targets. Similarly, companies within a country that prove more able to reduce their emissions would be allowed to 'trade' excess permits to other, more polluting, enterprises.

The trading system could involve the issuing of carbon credits for affore station and reforestation activities. It would probably require an independent assessment to answer questions such as: Was the forest established after 1990? How quickly is it growing? How much carbon is it sequestering? Credits would be issued, probably by a government, to the individual or the company growing the forests. These credits could then be sold to a carbon emitter such as a power company, which could use them to 'offset' its excessive carbon emissions.

According to the Kyoto Protocol, the UN would distribute pollution rights to 38 industrialized nations. Under the Clean Development Mechanism (CDM), one way to earn carbon credits involves funding "carbon dioxide saving" projects in the global South. These projects are designed to keep greenhouse gases out of the atmosphere either by preventing their release or by sequestering them.

Forests and tree plantations are one of the preferred forms - and are often called "carbon sinks", since trees remove carbon from the atmosphere and sequester it in their wood. Renewable energy projects are also admissible as sinks since they produce energy without burning fossil fuels.

It is worth recalling that the burning of fossil fuels like coal, oil and natural gas - in which carbon has been stored for millions of years - combined with accelerated land clearance has led to unprecedented levels of greenhouse gas emissions.

Carbon sinks can't keep up, and concentrations of greenhouse gases in the atmosphere have risen dramatically leading to an enhanced greenhouse effect. Scientists say that if concentrations of these gases continued to rise, there will be a general and very rapid warming of the world's climate.

No one is sure what effect this warming will have on human health, but predictions include widespread ecological damage, dramatic changes in agricultural production, and rising sea levels.

Meanwhile, among those set to profit from carbon trading is the World Bank as well. It is also a major financier of fossil fuel developments. Eight years ago, leaked confidential documents from within the World Bank revealed debates about its plans to get involved in carbon trading.

According to Corp Watch website, one such document says the bank plans to profit handsomely by charging a five percent commission on carbon transactions by acting as a self-appointed broker between Northern and Southern governments and industries. With a potential market in carbon touching $2 billion by the end of 2005, the World Bank noted in this memo, it could quickly earn $100 million in one year.

To facilitate smooth carbon trading, climate exchanges are being set up. These include Chicago Climate Exchange (which also owns Amsterdam-based European Climate Exchange), Climex and Sendeco2, as well as three existing electric power trading companies - Nord Pool, EEX and Power next.

An American company is not legally required to trade in "carbon credits" because the United States has not signed the Climate Change Convention, but in Europe, most major power plants and factories, have become part of a legally binding scheme to reduce greenhouse gas emissions.

The European Union has evolved the first multi- national emissions trade system in the world that covers all its 25 member-states. Canada and Japan are also planning their own carbon markets soon, which will likely be linked to the European Union scheme.

Some 13,000 companies in Europe are required to take part in the scheme, such as electricity and heat generators that exceed 20 megawatts, cement, ceramics, ferrous metal, glass, pulp and paper producers, which are the largest emitters of green house gases.

The biggest emitters of carbon dioxide registered under the EU scheme are respectively; the German energy groups RWE AG and E.ON, Swedish power company Vatten fall, Endesa from Spain, followed by Anglo-Dutch steel and aluminium company Corus Group, Royal Dutch Shell Group, Thyssen Krupp, Estonian power group Eesti Energia and Britain's Drax Power.

Meanwhile, the European Bank for Reconstruction and Development (EBRD) is in the final stages of setting up the Multilateral Carbon Credit Fund (MCCF) which will cover 27 countries in Central and Eastern Europe and the former Soviet countries in Central Asia. The fund will purchase emission projects and might even purchase allowances in the EU ETS, should the investors want it to do so.

Critics say carbon trading is a smokescreen. At best, it is designed to attain "carbon neutrality" - representing no net growth in emissions for a country or industry.

Even in economic terms, carbon-saving projects are likely to fail because one cannot verify whether a power plant's emissions are being compensated by a tree or other project. And investors may later lose confidence in the credits they buy from such projects.