What is Carbon Trading

Posted on June 19, 2009 | What at mybiginfo.com | What is Carbon Trading | | View all What | |

Carbon emissions trading (or carbon trading) is an administrative approach used to control pollution by providing economic incentives for achieving reductions in the emission of carbon. Carbon trading is basically a commercialised activity that originates from protecting the earth from harmful emission of gases from industries. The concept of carbon credit is that of incentivising the units which pollute less and disincentivising the units that pollute more. The most dangerous gases thrown out by the industrial units are six in number – carbon dioxide, methane, nitrous oxide, hydroflourocarbons, perflurocarbons and sulphur hexafluoride. The group of such gases, which are responsible for removing greenery from our planet, are called greenhouse gases.

On the initiative of UNO (United Nations Organisation), Kyoto protocol was signed in 11 December 1997 and it came into force from 16 December 2005. The Kyoto protocol aims to tackle global warming by setting target levels for nations to reduce greenhouse gas emission worldwide. The Kyoto protocol is an agreement by which the ratifying countries have agreed to reduce their emission of greenhouse gases. Under the protocol, initial target is to reduce greenhouse gas emission to 5.2 per cent below 1990 base level. 172 countries have signed the Kyoto Protocol. Australia has also recently ratified the protocol. These countries and their companies are the only ones allowed to engage in carbon trading.

A central authority (usually a government or international body) sets a limit or cap on the amount of a pollutant that can be emitted. Companies or other groups are issued emission permits and are required to hold an equivalent number of allowances (or credits) which represent the right to emit a specific amount. The total amount of allowances and credits cannot exceed the cap, limiting total emissions to that level. Companies that need to increase their emission allowance must buy credits from those who pollute less. The transfer of allowances is referred to as a trade. In effect, the buyer is paying a charge for polluting, while the seller is being rewarded for having reduced emissions by more than was needed. Thus, in theory, those who can easily reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest possible cost to society.

How Carbon Trading works

A central authority fixes the limit of the amount of a pollutant that can be emitted into the environment. Now this limit becomes the permit of pollutants allowed into the environment. This permit is devised into several smaller units and distributed to several companies in the form of permit or credit or allowance. This permit or credit or allowances gives licenses to emit a fix amount of pollutant into the environment.

Now if a company, say SRF, is able to emit only eight units of greenhouse gases out of 10 units allotted to it, then SRF will be having two units of emission as ‘credit outstanding’ in its ‘pollution’ account. On the other side, if a company say MRF emits 12 units instead of 10 units allotted to it then MRF will be having two units of ‘debit balance’ in its pollution account. Now SRF will be able to transfer its two ‘credit balance’ to two debit balance account of MRF. So both the companies’ pollution account will be matched and the environment also is able to digest a certain scientifically fixed amount of pollutants. This transfer from SRF to MRF will be for some monetary consideration and hence it is referred as carbon trading.

Carbon credit, as defined by Kyoto protocol, is one metric tonne of carbon emitted by burning of fossil fuels. The GWP (Global Warming Potential) factors are used to convert each of the five gases (like methane, for example) that are not CO2 into tonnes of CO2 equivalent (CO2E), which is the standard of trading. To bring the buyers and sellers of carbon trading on one platform and to augment the process of carbon trading, carbon credits are traded at CO2E exchange in Britain, CDM (Clean Development Mechanism) exchange in Europe. In India recently, MCE (Multi Commodity Exchange) has announced carbon trading exchange with license agreement from Chicago climate exchange. Like the usual stock exchange, carbon credits have all spot transactions, forward settlement and options of trading.
Prices of credit trading vary and some time back was in the range of Euro six to Euro 12 per tonne of CO2. An estimate suggests that in 2004, 107 million tonnes of CO2 were exchanged through carbon trading worldwide. There is a steep penalty to the tune of Euro 40 per tonne to the companies emitting more than their quota. So companies that are having huge carbon credit can sell these to companies that are deficient in carbon credit or that have exhausted their quota for huge prices.

Recent Growth

Growth of Carbon Emissions

Carbon emissions trading has been steadily increasing in recent years. According to the World Bank’s Carbon Finance Unit, 374 million metric tonnes of carbon dioxide equivalent (tCO2e) were exchanged through projects in 2005, a 240% increase relative to 2004 (110 mtCO2e) which was itself a 41% increase relative to 2003 (78 mtCO2e).[52]

In terms of dollars, the World Bank has estimated that the size of the carbon market was 11 billion USD in 2005, 30 billion USD in 2006,and 64 billion in 2007.

The Marrakesh Accords of the Kyoto protocol defined the international trading mechanisms and registries needed to support trading between countries, with allowance trading now occurring between European countries and Asian countries. However, while the USA as a nation did not ratify the Protocol, many of its states are now developing cap-and-trade systems and are looking at ways to link their emissions trading systems together, nationally and internationally, to seek out the lowest costs and improve liquidity of the market. However, these states also wish to preserve their individual integrity and unique features. For example, in contrast to the other Kyoto-compliant systems, some states propose other types of greenhouse gas sources, different measurement methods, setting a maximum on the price of allowances, or restricting access to CDM projects. Creating instruments that are not truly fungible would introduce instability and make pricing difficult. Various proposals are being investigated to see how these systems might be linked across markets, with the International Carbon Action Partnership (ICAP) as an international body to help co-ordinate this.

Apart from the fact that “Carbon” will become the single most biggest commodity ever traded, another aspect of it which makes it important is the solution it offers to a common problem which we all have just started to realize and probably talk about more, “Global Warming” I’ve tried to cover in basic terminology, what carbon trading is, in this post. Problem: Carbon emissions into the earth’s atmosphere have resulted in drastic climatic changes. Though, we have both, firm believers who blame Industries outright for polluting the atmosphere resulting in some of natures shocking disasters and some, who believe it’s difficult to blame carbon emissions for these climatic changes as its hard to find a pattern over the past billion years or so, how climate has changed.

The scientific perspective

Part of the reason for global warming is excessive land clearing, so is restoring vegetation cover part of the solution? Vegetation, largely forest, is already absorbing about one-third of human-induced emissions, planting more forests could increase absorption.

Some caution is required when offsetting carbon dioxide emissions with forest plantations. Forests can have other impacts such as drying soils, absorbing heat, removing people in poorer communities from their land and releasing methane (another greenhouse gas). Accounting for the carbon contained in forests is difficult; the amount of carbon in forest soils, forest litter and the trees themselves needs to be measured. Different types of trees store different amounts of carbon when growing on different types of soils in different climates. In addition, we might expect natural year-to-year variations in carbon stored, related to climate variations. And there is the added difficulty of monitoring the long-term fate of carbon – will the sink become a source?

Consider what happens in a plantation harvested for pulp. Much of the carbon stored in the roots, leaves, bark and branches of trees is released into the atmosphere as the dead vegetation rots. The stems are turned into pulp, which is manufactured into a range of paper and wood fibre products. Many of these are used once and then discarded – they will also rot or be incinerated, returning their carbon to the atmosphere. Even trees harvested for long-term uses such as furniture and house frames will lose a large proportion of their stored carbon to the atmosphere through waste during processing.

Planting trees for conservation purposes – where they are unlikely to ever be harvested – will be of more long-term benefit to the global carbon cycle than will plantings for some commercial harvesting (eg, trees for pulping). But even trees for conservation purposes may be lost in a forest fire – and most of the stored carbon would return to the atmosphere. Furthermore, a new forest acts as a sink only until it reaches maturity, at which time new growth is compensated by death and decay.

To help account for carbon flow, the Australian Government Department of Climate Change, the CSIRO and the Australian National University have developed methods to reliably measure greenhouse gas emissions. The methods calculate emissions resulting from variables such as soil cultivation, fire management, fertiliser application, climate, different plant species and land management systems. Methods for measuring emissions are evolving and improving as a result of new research.

» Filed Under What