Carbon Credit Trading

Introduction​​: With the increase in Greenhouse Gas (GHG), Carbon dioxide, Methane, Nitrous oxide, Sulfur
hexafluoride, Hydro fluorocarbons and Perfluorocarbons emissions in the atmosphere, the global temperatures have
been on a constant rise, this has led to a global phenomenon called the Greenhouse Effect. In the last 65 years the
amount of anthropogenic (induced by humans) carbon dioxide has risen from 280 to 380 parts per million (ppm)
and with the current energy mix favoring the use of fossil fuels, this level is expected to increase at a rapid pace.
Consequently, the United Nations Framework Convention on Climate Change (UNFCCC) felt an immediate need to
decrease the emission of GHG. Hence the ​Kyoto Protocol- ​A legally binding agreement under which industrialized
nations will reduce their collective emissions of GHG by 5.2% compared to the year 1990 (but note that, compared
to the emission levels that would be expected by 2010 without the Protocol, this target represents a 29% cut) ​was
negotiated in Kyoto, Japan in December 1997. It was opened for signature on March 16, 1998, and closed on
March 15, 1999 and came into force on February 16, 2005 following ratification by Russia on November 18, 2004.
As of August 2005, a total of 153 countries have ratified the agreement (including 35 Parties that account for
61.6% of the total carbon dioxide emissions subject to reduction targets representing over 61% of global
emissions). Notable exceptions include the United States and Australia. The protocol has a commitment period of 5
years, from 2008-2012 and its goal is to lower overall emission for 6 GHG by 2.5bn tones by 2012. In the first
phase of the protocol, emission targets have been enforced on 37 countries.
The protocol provides 3 mechanisms to achieve the required emission reduction:
●

Joint Implementation ​(JI​​)- Developed countries implement projects that reduce emissions, or remove
carbon from the atmosphere in other developed countries in lieu of Emission Reduction Units (ERUs), used
to meet the emission reduction targets.​Clean Development Mechanism (CDM) Project​​: Developed
countries implement project activities that reduce emissions in developing countries in return for Certified
Emission Reductions (CERs). These project ​s range from cement, steel, biomass power, bagasse
co-generation and municipal solid waste to energy, municipal water pumping and natural gas power. The
CERs generated through such project activities can be used by developed countries to help meet their
emission targets under the Protocol. The protocol also stresses that such project activities are to assist the
 developing country host parties in achieving sustainable development.

Emission Trading​​: Developed countries can acquire units from other developing parties and use them
towards meeting their emissions t​ arget. This enables developed countries to make use of low cost
opportunities to r​ educe emissions. Only developed countries in specified in Annexure I to the Kyoto P
​ rotocol
with emission limitation and reduction commitments inscribed in Annex B to t​ he Protocol may participate in
such trading.

Approval: ​For a project to be recognized and credits issued against it, it has to go through a lengthy and complex
process of approval. There are four stages of CDM approval. The first stage is at the domestic level, where the
project gets approved by National CDM Authority (NCM). In India, this process takes approx 60 days. After NCA’s
approval, the project is sent to the United Nations Framework Convention on Climate Changes. After this, the
project is reviewed by the executive board of UNFCCC. The project gets evaluated on every front and is then
registered under UNFCCC only if it meets all the norms. Thereafter, certification is done for the reduction in
emission and credits are issued.

CER Trading: ​It ​is difficult for developed nation to meet their target as, reducing a tonne of Co2 is estimated to
cost around $300-500 in developed countries as compared with only $10-25 in developing countries; this is where
trading comes into the picture. Developed participants (Companies, Government, etc) who cannot fulfill the
protocol norms buy ​contractual commitments or certificates that represent specified amounts of carbon-related
emissions from other countries. Thus, the stage is set for Credit Emission Reduction (CER) trade to flourish. Other
countries earn these certificates or credits through the following means:
● Achieving allowed emission levels- Countries that have surplus credits, collected by overshooting the
emission reduction target can be sold in the global market; or
● Through use of new technology, energy efficiency, renewable energy, etc- Credits are available for
companies engaged in developing renewable energy projects that offset the use of fossil fuels, under CDM
and JI; or
●

Offsets against emissions, through carbon sink and sequestration for capture of carbon in biomass and not
allowing in the atmosphere also qualifies for earning credits. ​CO2 sink is a carbon reservoir that is
increasing in size, and is the opposite of a carbon "source". The main sinks are the oceans and growing
vegetation. ​Carbon sequestration is the term describing processes that removes carbon from the
 biosphere.
Thus this is a process of penalizing the developed countries for their wild ways and rewarding countries who can
prove efficient in carbon emission reduction. For trading purposes, one credit is considered equivalent to 1 tonne of
CO2 emission reduced. Under the Kyoto Protocol, global warming potential (GWP) is an index that allows
comparison of greenhouse gases with each other in the context of their relative potential to contribute to global
warming, for e.g., methane and nitrous oxide in terms of CO​2​ equivalent are 21 and 310, respectively.
Apart from the project based emission reduction credits, there are market specific credits available to buyers, for
e.g., EU ETS provides its players European Emission Trading Allowances (EAUs).

Exchanges: ​At present trading in carbon credits takes place in three stock exchanges — the Chicago Climate
Exchange (CCX), the European Climate Exchange (ECX) and the Multi Commodity Exchange (MCX). To facilitate the
trading of Carbon credits trading systems are being set up and gaining importance. The UK Emission Trading
System (ETS), EU ETS and the New South Wales TS a ​ re examples of such exchanges/ trading systems. Carbon
credits trading also take place in the open market.

In 2004 107mn tones of Carbon Credits were traded (+38% from the 78mn tones traded in 2003). The weighted
average price of each credit was $4.22. European countries and Japan are the major buyers of carbon credit
accounting for 60% and 21% respectively and the Asians dominate the selling side, their share being 45% for
Jan-Apr 2005. These aggregate figures, however, are strongly influenced by the dynamics of HFC23 (1 ton of HFC
23 = 11700 tons of CO2) destruction projects, which are few in number but very large in volume, and are primarily
located in Asia. A secondary market for these carbon credits has also emerged. There are several funds which buy
credits at a lower price to be able to trade at a higher price later. Such mechanisms can be availed of by project
developers, who need the funds to develop the projects.

Price​​: The prices for Kyoto-compliant project based credits were

dominated by the World Bank and Dutch Government carbon procurement programmes; however, an increasing
number of options for sale of credits are now available as both government and private buyers are emerging. There
is not one single price for CERs or ERU’s, but prices depend on the preference of buyers for a specific project type
and quality. The quality of CDM and JI projects is predominantly defined by the project risks, the additionality and
the contribution to sustainable development. Price information on the forward transactions is sparse, and is based
on transactions of small quantities of allowances. ​During the period of January to April 2005 the prices of CER
forward contracts ranged from $3 to $7.15 per ton of CO2 equivalent (substantially higher yoy). The weighted
average price has increased 21% for CERs over the period. Prices of CO2 allowances rose to a record of Euro 29.5
a ton on July, 7th, up from a low of Euro 6.2 on Jan 10​th and trading at Euro 22 today in ECX. This was mainly
because EU formed EU ETS, the largest multi-national, greenhouse gas emissions trading scheme in the world in
January 2005 and all 25-member states of the European Union participated in the scheme. This resulted in an
increased demand as EU is the 3​rd ​largest emittor of CO2, thereby increasing the prices. This could would rise
further if US becomes a signatory to the protocol as it is the world’s largest emitter of CO2 accounting for more
than a third of the GHG emitted in the world. ​During Nov 28 to Dec 9’05 in Montreal, industrialized countries have
to report what they have done in their respective countries to achieve their emission reduction targets and an
​ he prices in India have increased from
increase of demand around that period could lead to further rise in prices. T
Euro 5 to the current rate of Euro ​8-15 for various projects. The first CERs are to be issued by the UNFCCC to two
projects in Honduras and one project in India on 21st Oct’2005.

​ rading in Caron credits has the following benefits to the general community of carbon trading:
Benefits: ​ T
● Reduction in overall cost of meeting emission reduction targets;
● Progressively improved definition of a "price" for carbon, particularly as the market becomes more liquid
and active, and assuming that all carbon certificate products are fungible, meaning that they are equivalent
ways of addressing emission reduction;
● An opportunity to generate income from activities that previously attracted no additional revenue, such as
investment in emission reduction, renewable energy generation, greenhouse friendly fuels and carbon
sequestration;
● Ability to use revenue from carbon sequestration to help fund additional planting of trees and other
vegetation, for benefits such as salinity amelioration, biodiversity enhancement, conversion to greenhouse
gas friendly fuels and energy, and employment and wealth creation in rural areas.

Global Market: ​The Global Carbon Market has evolved into an active market, which is estimated to be between
€4.6 to €200 billion by 2010 with the former estimate based on purchases of carbon credits limited to compliance
only, and the latter estimate subject to international political developments (e.g. expansion of the EU ETS or linking
with other schemes in Japan or North America). ​The global traded total units are expected to be 2.5 ​billion units by
2012. In July 2005 about 2 million CER are estimated to have been traded at a total value of around $68.5 million.
The emerging carbon market is not yet liquid and transparent, and contains various submarkets. The carbon credit
market can be roughly divided in the following market segments:
1. Project-based emission reductions​​- The most active sector in the current market is for project-based
emission reductions. intended for registration under either JI or the CDM and the emission reductions from
these projects are called Emission Reduction Units (ERUs) for JI projects and Certified Emission reductions
(CERs) for CDM projects
2. Market for emission allowances - This market involves the trading of emission allowances allocated
under a cap-and-trade regime. For example, Assigned Amount Units (AAUs) defined by the Kyoto Protocol
or emissions allowances under the domestic UK emissions trading regime and EU ETS.
3. Non​​-​project based or Voluntary emission reductions- N ​ on-Kyoto compliant emission reductions are
mostly bought to meet voluntary targets. These include the reduction in emission levels by countries such
as the US and Australia.

The market between 2005- 2007, is expected to have relatively low initial traded volumes ​but is gradually
increasing and prices will fluctuate considerably with factors like weather and fuel prices having some affect. The
First phase of the Kyoto Protocol from 2008-2012 may see a larger market with more Kyoto compliance buyers –
governments and companies – entering the market.
India’s role: ​India i​ s the Worlds 6th largest emitter of CO2 with its present share in the global emission estimated
at 6%, but being a developing country i​ t does not qualify for JI and Emission trading, but qualifies to be a host
​ s it is cheaper for developing countries to reduce emissions than developed
country for the CDM projects. A
​ uyers
countries- In developed countries, reducing a tonne of CER is $400 in Japan, $200 in USA and $25 in India; b
are coming to developing countries like India. In India, no target has been set for GHG emission by Kyoto

Protocol and so, they are excluded from reduction of GHG emission. On the contrary, they are entitled to sell
surplus credits to developed countries. India is considered as the largest beneficiary, claiming about 31% of the
total world carbon trade through the Clean Development Mechanism (CDM), which is expected to rake in at least
​ illion over a period of time by generating 500-600 m
$5-10 b ​ illion CERs (approximately 25% of the expected global
traded CERs of 2.5 ​billion units by 2012). China and Brazil are emerging as two of India’s strong competitors. ​India
has the largest portfolio of CDM projects, with more than 112 Indian companies all set to trade in carbon credits
and there a total of 300 projects in the pipeline. These companies are ready with clean technologies to bring down
the emission levels of greenhouse gases and sell certified emission reductions (CERs) to developed countries. The
projects range from cement, steel, biomass power, bagasse co-generation and municipal solid waste to energy,
municipal water pumping and natural gas power. The National CDM Authority, Ministry of Environment, has
approved 91 projects that can seek investments under the CDM. However, these companies need to get the
UNFCCC clearance to trade their CERs. So far the UNFCCC have approved 15 projects worldwide of which 5 are
Indian: These five are: Gujarat Flurochemicals, Kalpataru Power Transmission Ltd, the Clarion power project in
Rajasthan, Shree Renuka Sugars in Karnataka and the Dehar power project in Himachal Pradesh.
According to World Bank estimates, India is expected to rake in around $100-600 million annually by trading in
carbon credits and Indian companies are expected to corner at least 10% of the global market in the initial years.
​ illion at the rate of
According to Industry estimates Indian companies are expected to generate at least $8.5 b
$10/tonne of CER. ​The World Bank has reportedly bought the entire potential carbon emission savings for the next
10 years of a remote Andhra Pradesh village, Powerguda, which abounds in Pongamia pinnata trees, whose seed
produces a natural oil to replace diesel. An officially sponsored “climate technology bazaar” held in New Delhi in
CY04 had led to finalization of deals with foreign companies worth $325 million, for collaborative
environment-friendly projects. Tata Steel, HLL, Jindal Vijaynagar Steel, Essar Power and Gujarat Fluorochemicals
Ltd have specially designed projects to take advantage of this opportunity and Bharat Heavy Electricals Ltd is the
only public sector firm which is planning to approach the ministry for approval.
Twenty more Indian projects from the sugar, cement and paper and pulp sectors, seeking to trade carbon, are
likely to be registered soon at the UNFCCC with the CDM Executive Board recently approving methodologies for
fly-ash mixing during the cement manufacturing process, and power generation from industrial bio-residues. These
include companies like Balrampur Chini, Triveni, Ugar, Mawana in the sugar sector, ACC, Birla, Gujarat Ambuja,
​ 1st Oct’2005 first CER to be issued by the UNFCCC
Lafarge in the cement sector and ITC in the paper sector.​ 2
Limitations- T ​ hough Carbon Credits and its trading is fast gaining importance in the International markets there
are still a few issues and threats that surround the development of Carbon trading:
● Most significant threat to development of global market in Co2 is resistance to Kyoto protocol by the US.
● Measurement and verification of carbon storage is still a problem. This includes the duration of time over
which carbon is stored, whether or not it is in addition to baseline storage, and the amount of leakage. i.e.,
carbon emitted elsewhere through displaced forest activities;
● Adjusting for uncertainty and for risks that carbon will be released sooner than the contractual period,
either intentionally or by accident or neglect, and assignment of liability when this occurs;
● Development of compatible regulatory frameworks at local, national and international levels that include
agreement on what activities are eligible for credits, and who will receive the credits;
● Establishment of institutional arrangements that reduce transaction costs; and
● There is no clarity as to what will happen after 2012.
Protocol/ Agreement before the Kyoto Protocol​​:
● Montreal Protocol​​: It was signed on Sept 16, 1987 and currently it has 183 nations as its members. It set
limits on the production of CFC, Halons, and related substances that release chlorine or bromine to the
ozone layer of the atmosphere. For each country, the protocol provides a deadline by which the production
of the ozone-depleting substances (ODS) must be phased out and eventually eliminated. To effect a change
over to substitutes, the parties to Montreal Protocol set up a Multilateral Fund in 1990. Montreal Protocol
Multilateral Fund (MPMF) was set up for cessation of production of ozone depleting substances.
Contributions to the fund are made by developed countries to assist developing country users to
changeover to substitutes. Further producers in developing countries are compensated for ‘costs arriving
from premature retirement’ of their production facilities or ‘for establishing new production facilities for
substitutes.’ This compensation is thus paid to bear the incremental costs to manufacture CFC alternatives.
● Convention on Long-Range Transboundary Air Pollution- ​48 parties signed agreement to protect the
human environment against air pollution and to gradually reduce and prevent air pollution, including
long-range transboundary air pollution
● Nitrogen Oxide Protocol - Protocol to the 1979 Convention on Long-Range Transboundary Air Pollution
Concerning the Control of Emissions of Nitrogen Oxides or Their Transboundary Fluxes ​was to provide for
the control or reduction of nitrogen oxides and their transboundary fluxes. 28 parties signed the protocol.
● Sulphur Emissions Reduction Protocol​​- Protocol to the 1979 Convention on Long-Range Transboundary
Air Pollution on the Reduction of Sulphur Emissions or Their Transboundary Fluxes by at Least 30%.
Sources​​:​ ​www.unfccc.int​, ​www.envfor.nic.in​, ​www.wikipedia.org​, ​www.co2e.com​, ​www.businessworldindia.com​,
www.indiainfoline.com​, ​www.sharekhan.com​, ​www.business-standard.com​, ​www.hindubusinessline.com​,
www.economictimnes.com