Carbon Trading - The Basics: Part 2, Kyoto Protocol

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This is part two in a four-part series on the basics of carbon trading. Part one described the basic idea behind cap-and-trade. This post gives an overview of the Kyoto Protocol, the biggest, and most important, case study of an international cap-and-trade scheme.

What is the Kyoto Protocol?

The Kyoto Protocol is an international agreement that arose from the United Nations Framework Convention on Climate Change (UNFCCC). Negotiations for the treaty ended in December 1997 in Kyoto, Japan. Currently, the Kyoto Protocol has 172 signatories (PDF) which include all developed nations except the United States and Australia. The overall objective of the treaty is to reduce Greenhouse Gas emissions in developed countries 5.2% relative to 1990 levels by 2012. However, individual countries have different goals, ranging from an 8% decrease in emissions in the European Union to a 10% increase in Iceland. These goals are designed to be implemented through a major multinational cap-and-trade scheme that includes all signatory nations.

How does it work?

There are four mechanisms through which the Kyoto Protocol attempts to meet these goals:

1) International Emissions Trading

This system allows countries that cannot meet their own emissions goals to purchase additional credits (called Assigned Amount Units or AAUs) from other countries that have been able to exceed their own goals. Systems have emerged among countries to facilitate this type of trading, the largest of which is the European Emissions Trading System (EU ETS). The EU ETS began on January 1, 2005 and has a two-phased system. The first phase, which ends December 31, 2007, has come under fire for providing too many credits to its members. As a result, prices for credits have been exceedingly low and the targeted emissions reductions have not been reached. Phase two will run from 2008-2012 with new allocations of credits and more stringent caps on emissions. For more information on current carbon prices under EU ETS as well as the latest news on carbon markets, I highly recommend Point Carbon.

2) Domestic Emissions Trading

A number of countries have either implemented or considered introducing their own regional cap-and-trade schemes. These systems allow states, regions, or businesses within a country to trade emissions credits with each other in order to achieve the country-wide emissions goal. A major problem with these schemes is that they often introduce their own units for carbon credits, with their own elements and requirements. As such, there is often little coherence between international trading schemes and domestic trading schemes. There needs to be a single standard and unit for carbon credits. A global market would allow for more gains from trade and would lead to better success for the Kyoto Protocol.

3) Clean Development Mechanism (CDM)

As I explained in Part one of this post series, the goal of a cap-and-trade scheme is to reduce global emissions with little regard for their origin. Based on this concept, the Kyoto Protocol allows developed countries to offset their excess emissions by reducing emissions in developing countries, where such projects may be more cost-effective (read: inexpensive). Rather than, or in addition to, trading credits with other developed nations, some countries elect to finance emission reduction projects in developing countries through the CDM. Projects in the CDM must go through a complicated and relatively expensive approval process before being accepted as a qualified emissions reduction projects. There are currently 55 countries participating in the CDM with hundreds of project types.

4) Joint Implementation (JI)

The Joint Implementation mechanism is often grouped with CDM because it is a very similar system. The major difference is that the countries in which projects can be built under the JI are primarily in the Eastern Bloc. This is separate from the CDM because these countries are generally considered developed, but fit within their own category.

Has it been successful?

There is a lot of debate over the effectiveness thus far of the Kyoto Protocol. Detractors have a number of complaints. Their strongest complaint, in my opinion, is that the EU ETS handed out far too many allowances (called EU Allocations or EUAs), and in doing so flooded the market with credits and drastically reduced the need to reduce emissions. In addition, critics note that Kyoto extends only through 2012, not nearly long enough to achieve the sustained reductions necessary for mitigating the climate change crisis. Finally, it is widely believed that many countries will not meet their stated emissions targets by the end of the 2008-2012 cycle. Most proponents of Kyoto acknowledge these flaws, but view the Protocol as a stepping stone to a better, more effective international cap-and-trade scheme.

Personally, I am inclined to believe that despite Kyoto's (significant) flaws, it is a major step in the right direction. It is important to keep in mind that the Kyoto Protocol introduced by far the largest cap-and-trade scheme ever, and we are still in the very beginning stages of its implementation. I am hopeful that it will extend beyond 2012, and as regulators, countries, and industry alike become comfortable under the system, carbon prices will stabilize and significant emissions reductions will take place. However, without the United States as a signatory and with significant barriers to other countries' emissions reductions, we should not rely on the Kyoto Protocol as a panacea to climate change.

But I want to hear your opinions. Based on what you know about the Kyoto Protocol, what do you think? Is it worth pursuing as a long-term strategy, or should it be scrapped as a failed policy after 2012?

For more detail on the Kyoto Protocol:

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The Kyoto protocol is indeed a starting step towards cutting down the emissions. It has to be borne by each one of us that we live in the same world whether we are part of Kyoto protocol or not. Considering the status of the climate change as of today it has become all the more obvious to enter into something more stringent protocol than Kyoto and make part each and every nation to be a part of it.

Written in February 2010

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  • Posted on Aug. 13, 2007. Listed in:

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