Trading the right to pollute

2008 sees the launch of the international system for trading in emission rights as laid down in the Kyoto Protocol. Since 2005, it is Europe that has taken the lead. But how exactly does this market operate and, most importantly, can it prove effective?

© Shutterstock
© Shutterstock

Kyoto commits the Member States to reducing their greenhouse gas (GHG) emissions by adopting the appropriate measures. To ensure that the policy does not to compromise economic development, three ’flexibility‘ mechanisms have been introduced. The International emissions trading market tackles greenhouse gases emitted in industrialised countries and the two other mechanisms (1) – emissions in the developing and transition countries.

These mechanisms take their inspiration from tried and tested solutions, such as in the United States for SO2 emissions. The best known is the cap and trade system that sets a limit or cap on the emission entitlement of each ’polluter‘ who therefore has to reduce emissions and bear the related cost. If the operation proves too costly for company A, that company can then purchase ’emission rights‘ from company B for which the cost is lower, thus effectively financing the latter’s emission reductions. Hence the notion of trading in emission rights. Everybody benefits, including the atmosphere.

A and B do not interact directly, however, but negotiate emission rights through access to a regulated exchange or market. The starting limits must also be realistic and then subsequently lowered to make emission rights an increasingly scarce commodity and thus increasingly costly. “The threshold price from which the system permits emission reductions varies depending on the field of activity,” explains Claire Dufour, Product Manager at BlueNext, the French exchange market. “The main aim of cap and trade systems is to allow for variations in the costs linked to emission reductions from one sector to another.”

A bad start

For the International emissions trading market, it is the Kyoto Protocol that sets the limits (expressed as quotas) of the signatory states while the United Nations Framework Convention on Climate Change (UNFCCC) must ensure that the system works effectively.

For its part, the European Union has taken the lead by introducing, between 2005 and 2007, Phase 1 of its own market, the EU Emission Trading Scheme (EU ETS). It is here that emission rights known as the European Union Allowance (EUA) are traded. For the ceilings, each country submits a “national quota allocation plan” for the European Commission’s approval, this providing a breakdown of its quota per sector. (3).

But of the 2.2 billion tonnes of CO2 allocated for the EU, “only” 2 billion were rejected. The ceiling set was too high and consequently met without effort, the phase 1 EUA rate plummeting from around €25 to €0.03. The issuing right proved much too cheap to motivate companies to reduce their emissions.

Should we leave it to the Member States to draw up allocation plans? Claire Dufour seeks to be optimistic: “The Commission is becoming stricter. Nearly all the Member States had to revise the thresholds they proposed for Phase 2 of the EU ETS (2008–13). The EU’s global threshold, although widened overall, was cut for C02 to 2.082 billion tonnes – 1.974 billion for the Phase 1 country installations – which has already increased the price by between €20 and €25 for Phase 2. The Commission’s right of consultation will certainly guarantee the system’s viability.”

Delphine d’Hoop

  1. The Clean Development Mechanism (CDM) enables industrialised countries and their businesses to achieve their goals by financing projects to reduce emissions in the developing countries. Joint Implementation ( JI) is a similar device for investments in countries in transition such as those of Eastern Europe and Russia.
  2. The terms “permits”, “credits”, “quotas”, “units”, etc. are all found depending on the systems. For GHGs these represent the equivalent of one tonne of CO2..
  3. The EU ETS is for energy, ferrous metals, non-metallic minerals, pulp and paper only.