Flexible Mechanisms
Encyclopedia
Flexible mechanisms, also sometimes known as Flexibility Mechanisms or Kyoto Mechanisms), refers to Emissions Trading, the Clean Development Mechanism
and Joint Implementation
. These are mechanisms defined under the Kyoto Protocol
intended to lower the overall costs of achieving its emissions targets. These mechanisms enable Parties to achieve emission reductions or to remove carbon from the atmosphere cost-effectively in other countries. While the cost of limiting emissions varies considerably from region to region, the benefit for the atmosphere is in principle the same, wherever the action is taken.
Much of the negotiations on the mechanisms has been concerned with ensuring their integrity. There was concern that the mechanisms do not confer a "right to emit" on Annex 1 Parties or lead to exchanges of fictitious credits which would undermine the Protocol’s environmental goals. The negotiators of the Protocol and the Marrakesh Accords therefore sought to design a system that fulfilled the cost-effectiveness promise of the mechanisms, while addressing concerns about environmental integrity and equity.
To participate in the mechanisms, Annex 1 Parties must meet the following eligibility requirements:
) from other countries to help meet their domestic emission reduction targets.
." The credits are acquired by an Annex I country financing projects that reduce emissions in non-Annex I countries or other Annex I countries, or by purchasing credits from Annex I countries with excess credits. The project-based mechanisms are the Clean Development Mechanism (CDM) and Joint Implementation (JI).
The project-based mechanisms allow Annex I countries with efficient, low GHG-emitting industries, and high prevailing environmental standard
s to purchase carbon credits on the world market instead of reducing greenhouse gas emissions domestically. Annex I countries typically will want to acquire carbon credits as cheaply as possible, while non-Annex I countries want to maximize the value of carbon credits generated from their domestic greenhouse gas reducing projects.
(mostly developing countries). Non-Annex I countries have no GHG emission restrictions, but have financial incentives to develop GHG emission reduction projects to receive Certified Emission Reduction
s that can then be sold to Annex I countries, encouraging sustainable development
.
The ultimate buyers of credits
are often individual companies that expect emissions to exceed their quota, their assigned allocation units, AAUs or 'allowances' for short. Typically, they will purchase credits directly from another party with excess allowances, from a broker, from a JI/CDM developer, or on an exchange.
National governments, some of whom may not have devolved responsibility for meeting Kyoto obligations to industry, and that have a net deficit of allowances, will buy credits for their own account, mainly from JI/CDM developers. These deals are occasionally done directly through a national fund or agency, as in the case of the Dutch government's ERUPT programme, or via collective funds such as the World Bank’s Prototype Carbon Fund (PCF). The PCF, for example, represents a consortium of six governments and 17 major utility and energy companies on whose behalf it purchases credits.
Since allowances and carbon credits are tradeable instruments with a transparent price, financial investors can buy them on the spot market
for speculation purposes, or link them to futures contracts. A high volume of trading in this secondary market helps price discovery and liquidity, and in this way helps to keep down costs and set a clear price signal in CO2 which helps businesses to plan investments. This market has grown substantially, with banks, brokers, funds, arbitrageurs and private traders now participating in a market valued at about $60 billion in 2007. Emissions Trading PLC, for example, was floated on the London Stock Exchange
's AIM market in 2005 with the specific remit of investing in emissions instruments.
Although Kyoto created a framework and a set of rules for a global carbon market, there are in practice several distinct schemes or markets in operation today, with varying degrees of linkages among them.
Kyoto enables a group of several annex I countries to create a market-within-a-market together. The EU elected to be treated as such a group, and created the EU Emissions Trading Scheme (ETS). The EU ETS uses EAUs (EU Allowance Units), each equivalent to a Kyoto AAU. The scheme went into operation on 1 January 2005, although a forward market has existed since 2003.
The UK established its own learning-by-doing voluntary scheme, the UK ETS, which ran from 2002 through 2006. This market existed alongside the EU's scheme, and participants in the UK scheme have the option of applying to opt out of the first phase of the EU ETS, which lasts through 2007.
The sources of Kyoto credits are the Clean Development Mechanism
(CDM) and Joint Implementation
(JI) projects. The CDM allows the creation of new carbon credits by developing emission reduction projects in non-annex I countries, while JI allows project-specific credits to be converted from existing credits within annex I countries. CDM projects produce Certified Emission Reductions (CERs), and JI projects produce Emission Reduction Units (ERUs), each equivalent to one AAU. Kyoto CERs are also accepted for meeting EU ETS obligations, and ERUs will become similarly valid from 2008 for meeting ETS obligations (although individual countries may choose to limit the number and source of CER/JIs they will allow for compliance purposes starting from 2008). CERs/ERUs are overwhelmingly bought from project developers by funds or individual entities, rather than being exchange-traded like allowances.
Since the creation of Kyoto is subject to a lengthy process of registration and certification by the UNFCCC, and the projects themselves require several years to develop, this market is at this point largely a forward market where purchases are made at a discount to their equivalent currency, the EUA, and are almost always subject to certification and delivery (although up-front payments are sometimes made). According to IETA, the market value of CDM/JI credits transacted in 2004 was EUR 245 m; it is estimated that more than EUR 620 m worth of credits were transacted in 2005.
Several non-Kyoto carbon markets are in existence or being planned, and these are likely to grow in importance and numbers in the coming years. These include the New South Wales Greenhouse Gas Abatement Scheme
, the Regional Greenhouse Gas Initiative
and Western Climate Initiative
in the United States and Canada, the Chicago Climate Exchange
and the State of California’s recent initiative
to reduce emissions.
These initiatives taken together may create a series of partly linked markets, rather than a single carbon market. The common theme is the adoption of market-based mechanisms centered on carbon credits that represent a reduction of CO2 emissions. The fact that some of these initiatives have similar approaches to certifying their credits makes it possible that carbon credits in one market may in the long run be tradeable in other schemes. The scheme would broaden the current carbon market far more than the current focus on the CDM/JI and EU ETS domains. An obvious precondition, however, is a realignment of penalties and fines to similar levels,since these create an effective ceiling for each market.
Clean Development Mechanism
The Clean Development Mechanism is one of the "flexibility" mechanisms defined in the Kyoto Protocol . It is defined in Article 12 of the Protocol, and is intended to meet two objectives: to assist parties not included in Annex I in achieving sustainable development and in contributing to the...
and Joint Implementation
Joint Implementation
Joint implementation is one of three flexibility mechanisms set forth in the Kyoto Protocol to help countries with binding greenhouse gas emissions targets meet their obligations. JI is set forth in Article 6 of the Kyoto Protocol...
. These are mechanisms defined under the Kyoto Protocol
Kyoto Protocol
The Kyoto Protocol is a protocol to the United Nations Framework Convention on Climate Change , aimed at fighting global warming...
intended to lower the overall costs of achieving its emissions targets. These mechanisms enable Parties to achieve emission reductions or to remove carbon from the atmosphere cost-effectively in other countries. While the cost of limiting emissions varies considerably from region to region, the benefit for the atmosphere is in principle the same, wherever the action is taken.
Much of the negotiations on the mechanisms has been concerned with ensuring their integrity. There was concern that the mechanisms do not confer a "right to emit" on Annex 1 Parties or lead to exchanges of fictitious credits which would undermine the Protocol’s environmental goals. The negotiators of the Protocol and the Marrakesh Accords therefore sought to design a system that fulfilled the cost-effectiveness promise of the mechanisms, while addressing concerns about environmental integrity and equity.
To participate in the mechanisms, Annex 1 Parties must meet the following eligibility requirements:
- They must have ratified the Kyoto ProtocolKyoto ProtocolThe Kyoto Protocol is a protocol to the United Nations Framework Convention on Climate Change , aimed at fighting global warming...
. - They must have calculated their assigned amount, as referred to in Articles 3.7 and 3.8 and Annex B of the Protocol in terms of tonnes of CO2-equivalent emissions.
- They must have in place a national system for estimating emissions and removals of greenhouse gasGreenhouse gasA greenhouse gas is a gas in an atmosphere that absorbs and emits radiation within the thermal infrared range. This process is the fundamental cause of the greenhouse effect. The primary greenhouse gases in the Earth's atmosphere are water vapor, carbon dioxide, methane, nitrous oxide, and ozone...
es within their territory. - They must have in place a national registry to record and track the creation and movement of Emission Reduction UnitEmission Reduction UnitThe Emission reduction unit is a trading unit under the Kyoto Protocol representing a reduction of greenhouse gases under the Joint Implementation mechanism, where it represents one tonne of equivalent reduced....
s, Certified Emission ReductionCertified Emission ReductionCertified Emission Reductions are a type of emissions unit issued by the Clean Development Mechanism Executive Board for emission reductions achieved by CDM projects and verified by a DOE under the rules of the Kyoto Protocol...
s, Assigned amount unitsAssigned amount unitsAn Assigned Amount Unit is a tradable 'Kyoto unit' or 'carbon credit' representing an allowance to emit greenhouse gases comprising one metric tonne of carbon dioxide equivalents calculated using their Global Warming Potential....
and Removal UnitsRemoval UnitsA Removal Unit is a tradable carbon credit or 'Kyoto unit' representing an allowance to emit one metric tonne of greenhouse gases absorbed by a removal or Carbon sink activity in an Annex I country....
(RMU)s and must annually report such information to the secretariat. - They must annually report information on emissions and removals to the secretariat.
Emissions trading (ET)
The Emissions Trading-mechanism allows parties to the Kyoto Protocol to buy 'Kyoto units'(emission permits for greenhouse gasGreenhouse gas
A greenhouse gas is a gas in an atmosphere that absorbs and emits radiation within the thermal infrared range. This process is the fundamental cause of the greenhouse effect. The primary greenhouse gases in the Earth's atmosphere are water vapor, carbon dioxide, methane, nitrous oxide, and ozone...
) from other countries to help meet their domestic emission reduction targets.
Project-based mechanisms
The Protocol defines two project-based mechanisms that allow Annex I countries to meet their GHG emission reduction commitments by acquiring GHG emission reductions "creditsCarbon credit
A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent equivalent to one tonne of carbon dioxide....
." The credits are acquired by an Annex I country financing projects that reduce emissions in non-Annex I countries or other Annex I countries, or by purchasing credits from Annex I countries with excess credits. The project-based mechanisms are the Clean Development Mechanism (CDM) and Joint Implementation (JI).
The project-based mechanisms allow Annex I countries with efficient, low GHG-emitting industries, and high prevailing environmental standard
Environmental standard
An environmental standard is a policy guideline that regulates the effect of human activity upon the environment. Standards may specify a desired state or limit alterations An environmental standard is a policy guideline that regulates the effect of human activity upon the environment. Standards...
s to purchase carbon credits on the world market instead of reducing greenhouse gas emissions domestically. Annex I countries typically will want to acquire carbon credits as cheaply as possible, while non-Annex I countries want to maximize the value of carbon credits generated from their domestic greenhouse gas reducing projects.
Joint Implementation (JI)
Through the Joint Implementation, any Annex I country can invest in emission reduction projects (referred to as "Joint Implementation Projects") in any other Annex I country as an alternative to reducing emissions domestically.Clean Development Mechanism (CDM)
Through the CDM, countries can meet their domestic emission reduction targets by buying greenhouse gas reduction units from (projects in) non Annex I countries to the Kyoto protocolKyoto Protocol
The Kyoto Protocol is a protocol to the United Nations Framework Convention on Climate Change , aimed at fighting global warming...
(mostly developing countries). Non-Annex I countries have no GHG emission restrictions, but have financial incentives to develop GHG emission reduction projects to receive Certified Emission Reduction
Certified Emission Reduction
Certified Emission Reductions are a type of emissions unit issued by the Clean Development Mechanism Executive Board for emission reductions achieved by CDM projects and verified by a DOE under the rules of the Kyoto Protocol...
s that can then be sold to Annex I countries, encouraging sustainable development
Sustainable development
Sustainable development is a pattern of resource use, that aims to meet human needs while preserving the environment so that these needs can be met not only in the present, but also for generations to come...
.
Carbon market
Kyoto provides for a 'cap and trade' system which imposes national caps on the emissions of annex I countries. On average, this cap requires countries to reduce their emissions by 5.2% below their 1990 baseline over the 2008 to 2012 period. Although these caps are national-level commitments, in practice, most countries will devolve their emissions targets to individual industrial entities, such as a power plant or paper factory. One example of a 'cap and trade' system is the 'EU ETS'. Other schemes may follow suit in time.The ultimate buyers of credits
Carbon credit
A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent equivalent to one tonne of carbon dioxide....
are often individual companies that expect emissions to exceed their quota, their assigned allocation units, AAUs or 'allowances' for short. Typically, they will purchase credits directly from another party with excess allowances, from a broker, from a JI/CDM developer, or on an exchange.
National governments, some of whom may not have devolved responsibility for meeting Kyoto obligations to industry, and that have a net deficit of allowances, will buy credits for their own account, mainly from JI/CDM developers. These deals are occasionally done directly through a national fund or agency, as in the case of the Dutch government's ERUPT programme, or via collective funds such as the World Bank’s Prototype Carbon Fund (PCF). The PCF, for example, represents a consortium of six governments and 17 major utility and energy companies on whose behalf it purchases credits.
Since allowances and carbon credits are tradeable instruments with a transparent price, financial investors can buy them on the spot market
Spot market
The spot market or cash market is a public financial market, in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market in which delivery is due at a later date...
for speculation purposes, or link them to futures contracts. A high volume of trading in this secondary market helps price discovery and liquidity, and in this way helps to keep down costs and set a clear price signal in CO2 which helps businesses to plan investments. This market has grown substantially, with banks, brokers, funds, arbitrageurs and private traders now participating in a market valued at about $60 billion in 2007. Emissions Trading PLC, for example, was floated on the London Stock Exchange
London Stock Exchange
The London Stock Exchange is a stock exchange located in the City of London within the United Kingdom. , the Exchange had a market capitalisation of US$3.7495 trillion, making it the fourth-largest stock exchange in the world by this measurement...
's AIM market in 2005 with the specific remit of investing in emissions instruments.
Although Kyoto created a framework and a set of rules for a global carbon market, there are in practice several distinct schemes or markets in operation today, with varying degrees of linkages among them.
Kyoto enables a group of several annex I countries to create a market-within-a-market together. The EU elected to be treated as such a group, and created the EU Emissions Trading Scheme (ETS). The EU ETS uses EAUs (EU Allowance Units), each equivalent to a Kyoto AAU. The scheme went into operation on 1 January 2005, although a forward market has existed since 2003.
The UK established its own learning-by-doing voluntary scheme, the UK ETS, which ran from 2002 through 2006. This market existed alongside the EU's scheme, and participants in the UK scheme have the option of applying to opt out of the first phase of the EU ETS, which lasts through 2007.
The sources of Kyoto credits are the Clean Development Mechanism
Clean Development Mechanism
The Clean Development Mechanism is one of the "flexibility" mechanisms defined in the Kyoto Protocol . It is defined in Article 12 of the Protocol, and is intended to meet two objectives: to assist parties not included in Annex I in achieving sustainable development and in contributing to the...
(CDM) and Joint Implementation
Joint Implementation
Joint implementation is one of three flexibility mechanisms set forth in the Kyoto Protocol to help countries with binding greenhouse gas emissions targets meet their obligations. JI is set forth in Article 6 of the Kyoto Protocol...
(JI) projects. The CDM allows the creation of new carbon credits by developing emission reduction projects in non-annex I countries, while JI allows project-specific credits to be converted from existing credits within annex I countries. CDM projects produce Certified Emission Reductions (CERs), and JI projects produce Emission Reduction Units (ERUs), each equivalent to one AAU. Kyoto CERs are also accepted for meeting EU ETS obligations, and ERUs will become similarly valid from 2008 for meeting ETS obligations (although individual countries may choose to limit the number and source of CER/JIs they will allow for compliance purposes starting from 2008). CERs/ERUs are overwhelmingly bought from project developers by funds or individual entities, rather than being exchange-traded like allowances.
Since the creation of Kyoto is subject to a lengthy process of registration and certification by the UNFCCC, and the projects themselves require several years to develop, this market is at this point largely a forward market where purchases are made at a discount to their equivalent currency, the EUA, and are almost always subject to certification and delivery (although up-front payments are sometimes made). According to IETA, the market value of CDM/JI credits transacted in 2004 was EUR 245 m; it is estimated that more than EUR 620 m worth of credits were transacted in 2005.
Several non-Kyoto carbon markets are in existence or being planned, and these are likely to grow in importance and numbers in the coming years. These include the New South Wales Greenhouse Gas Abatement Scheme
New South Wales Greenhouse Gas Abatement Scheme
The New South Wales Greenhouse Gas Abatement Scheme , which commenced on 1 January 2003, is a mandatory greenhouse gas emissions trading scheme that aims to lower greenhouse gas emissions to 7.27 tonnes of carbon dioxide per capita by the year 2007.-External links:*...
, the Regional Greenhouse Gas Initiative
Regional Greenhouse Gas Initiative
Regional Greenhouse Gas Initiative is a regional initiative by states and provinces in the Northeastern United States and Eastern Canada regions to reduce greenhouse gas emissions...
and Western Climate Initiative
Western Climate Initiative
The Western Climate Initiative, or WCI, is an initiative—started by states and provinces along the western rim of North America—to combat climate change caused by global warming, independent of their national governments....
in the United States and Canada, the Chicago Climate Exchange
Chicago Climate Exchange
The now defunct Chicago Climate Exchange was North America’s only voluntary, legally binding greenhouse gas reduction and trading system for emission sources and offset projects in North America and Brazil....
and the State of California’s recent initiative
Global Warming Solutions Act of 2006
The Global Warming Solutions Act of 2006, or Assembly Bill 32, is a California State Law that fights climate change by establishing a comprehensive program to reduce greenhouse gas emissions from all sources throughout the state...
to reduce emissions.
These initiatives taken together may create a series of partly linked markets, rather than a single carbon market. The common theme is the adoption of market-based mechanisms centered on carbon credits that represent a reduction of CO2 emissions. The fact that some of these initiatives have similar approaches to certifying their credits makes it possible that carbon credits in one market may in the long run be tradeable in other schemes. The scheme would broaden the current carbon market far more than the current focus on the CDM/JI and EU ETS domains. An obvious precondition, however, is a realignment of penalties and fines to similar levels,since these create an effective ceiling for each market.
See also
- Carbon accountingCarbon accountingCarbon accounting is the accounting process undertaken to measure the amount of carbon dioxide equivalents that will not be released into the atmosphere as a result of Flexible Mechanisms projects under the Kyoto Protocol. These projects thus include renewable energy projects and biomass, forage...
- Clean Development MechanismClean Development MechanismThe Clean Development Mechanism is one of the "flexibility" mechanisms defined in the Kyoto Protocol . It is defined in Article 12 of the Protocol, and is intended to meet two objectives: to assist parties not included in Annex I in achieving sustainable development and in contributing to the...
- Joint ImplementationJoint ImplementationJoint implementation is one of three flexibility mechanisms set forth in the Kyoto Protocol to help countries with binding greenhouse gas emissions targets meet their obligations. JI is set forth in Article 6 of the Kyoto Protocol...
- Kyoto ProtocolKyoto ProtocolThe Kyoto Protocol is a protocol to the United Nations Framework Convention on Climate Change , aimed at fighting global warming...
External links
- Emissions Trading UNFCCC pages on ET
- Joint Implementation UNFCCC pages on JI
- Clean Development Mechanism UNFCCC pages on CDM