Kyoto provides for a ‘cap and trade’ system which imposes national caps on the emissions of annex I countries. Although these caps are national-level commitments, in practice, most countries are required to devolve their emissions targets to individual industrial entities, such as a power plant.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 account, mainly from Joint implementation/ Clean development Mechanisms developers. These deals are occasionally done directly through a national fund of agency. World Bank’s Prototype Carbon Fund is prime example of this. The PCF represents a consortium of six governments and 17 major utility and energy companies on whose behalf it purchases credits. As 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 future contracts. This market has grown substantially, with banks, brokers, funds, arbitrageurs and private traders now participating in a market valued at about $100 billion in 2009. 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 marketwithin- a-market together. The European Union elected to be treated as such a group and created the EU Emissions Trading Schemes.
Clean development mechanism
The sources of Kyoto credits are the Clean Development Mechanism and Joint Implementation 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).
What is a carbon credit?
Carbon credits are a key component of national and international attempts to mitigate the growth in concentrations of greenhouse gase. One Carbon Credit is equal to one tonne of Carbon dioxide or in some markets Carbon dioxide equivalent gases.
There are two distinct types of Carbon Credits: Carbon Offset Credits and Carbon Reduction Credits. Carbon Reduction Credits consists of energy production, wind, solar, hydro and biofuels. Carbon Reduction Credits consists of all collection and storage of Carbon from our atmosphere through bioequestration(reforestation, forestation), ocean and soil collection and storage efforts. For trading purposes, one allowance or CER is considered equivalent to one metric tonne of carbon dioxide emissions. Climate exchanges have been established to provide a spot market in allowances, as well as futures and options market to help discover a market price and maintain liquidity. Carbon prices are usually quoted in Euros per tonne of carbon dioxide. Currently, there are five exchanges trading in carbon allowances- the Chicago Climate Exchange, European Climate Exchange, Nord Pool, PowerNext and the European Energy Exchange.
How carbon credits can cut emissions?
Carbon credits create a market for reducing greenhouse emissions by giving a monetary value to the cost of polluting the air. For example, consider the case of a business that has a factory which emits 100,000 tonnes of greenhouse gas emissions in a year. Its belongs to a country which is in Annex I that enacts a law to limit the emissions that the business can produce. So the factory is given a quota of say 80,000 tonnes per year. The factory reduces its emissions to 80,000 tonnes or is required to purchase carbon credits to offset the excess. It may choose to buy carbon credits on the open market.