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Global Carbon Markets

Global carbon markets continue to exhibit strong growth.

The global carbon markets have seen explosive growth in the last three years, driven largely by the Kyoto Protocol and the European Union Emissions Trading Scheme (EU ETS). Transactions topped $30 billion in 2006, representing a threefold increase over 2005¹, and the first half of 2007 has already seen $21.9 billion in trades ².

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Kyoto Protocol
EU ETS
Japan
Australia

Kyoto Protocol

The objective of the Kyoto Protocol is the “stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system³.” The protocol covers six global warming gases (CO₂, SF₆, HCF, NOx, PFCs, and CH₄) and assigns GHG emissions targets to its signatory countries.

As of June 2007, 172 countries have signed the document. Of these, 35 countries have agreed to reduce GHGs collectively to 5% below 1990 GHG levels by 2012 through a country-based cap-and-trade scheme. The United States and Australia have thus far refused to sign the Kyoto Protocol because large emitters in the developing world (China, India, and Brazil) do not need to commit to reductions.

Kyoto is implemented in a phased approach: Phase I covers 2005-2007. Phase II will begin in 2008 and will end in 2012. Post-2012 discussions for the protocol will commence formally at the UN Convention on Climate Change in Bali, Indonesia, set for later this year.

EU ETS

The EU ETS, a regional cap and trade scheme for Europe, commenced on January 1, 2005. It provides a framework for the EU to comply with the Kyoto Protocol via domestic emissions reduction programs, emissions allowance trading between EU ETS countries, and a linkage mechanism that enables importing of emissions reductions from projects in developing and emerging Eastern European countries.

Covering all six greenhouse gases recognized by the Kyoto Protocol, the EU ETS grants countries allowances based on their target reductions and their 1990 emissions. An allowance (AAU) is the GHG equivalent of one ton of CO2. The countries then distribute these allowances to large stationary emitters based on their National Allocation Plans. Large emitters regulated by the EU ETS generally fall into the power, minerals, metals, or pulp/paper sectors, covering roughly 40% of the EU’s GHG emissions. Like Kyoto, the EU ETS also trades in two Phases, 2005-2007 and 2008-2012.

In harmony with the Kyoto Protocol, the ETS allows the importation of emissions reductions in the EU via Joint Implementation (JI) and Clean Development Mechanism (CDM) projects. CDM and JI projects allow developing countries or Eastern European countries, respectively, to develop projects that reduce GHG emissions and then transfer those reductions into an EU country in a limited capacity. Currently, the UN has approved over 800 CDM and JI projects of various types, such as the destruction of industrial gases such as N2O and HFC23; construction of renewable generation; capture and destruction of methane; fuel switching; and energy efficiency.

Phase I of the EU ETS is generally considered over-allocated, and as a result, carbon prices have dropped sharply. Phase II is expected to fare better, since the European Commission has been far less lenient in how many allowances are granted to the individual countries. The EU has also raised the potential of including emissions from aviation and shipping into the scheme during Phase II. Post-2012, although Kyoto is set to expire, the EU by its own initiative has pledged to reduce its overall emissions 20 percent by 2020.

Japan

Aside from Europe, Japan is a major signatory to the Kyoto Protocol, and has pledged to reduce its emissions 7 percent below 1990 levels by 2012. Domestically, the government has instituted a voluntary GHG trading scheme for large industrials. Additionally, it has also dedicated government funds to purchase Kyoto credits as a way to mitigate its carbon footprint. There is some doubt as to whether Japan will be able to meet its Kyoto commitments, given that their emissions are currently higher than 1990 levels.

Australia

While eschewing the Kyoto Protocol, Australia has set forth a federal proposal to institute a domestic carbon cap and trade system for large stationary emitters. The plan recommends allowing the usage of CDM credits to reduce emissions. The introduction of this scheme should further spur global carbon markets.