Carbon Credits Trading

Carbon credits trading arose as a result of the Kyoto Protocol – an international agreement to reduce carbon emissions to the atmosphere.

Participating countries for the Kyoto Treaty decided to give a value to the carbon dioxide (or carbon dioxide equivalent gases) released into the atmosphere as these green house gasses contribute to global warming. One carbon credit is equivalent to one ton of carbon dioxide emitted into the atmosphere, and the carbon credits serve as licenses for their owners to emit the corresponding amounts of carbon dioxide into the atmosphere. Subsequently, each country with the Kyoto Protocol is assigned with a specific number of credits, called the Assigned Amount Units. These units are then in turn distributed by countries to their selected companies (known as operators) as license for the emissions.

And to allow countries to benefit from lower emissions, and to make countries that are emitting more carbon into the atmosphere pay for the additional pollution, carbon credits trading is allowed by the Kyoto Treaty. This trade allows countries and operators who are reaching their yearly carbon emission quota to buy credits from other countries and operators who have yet to meet their carbon quotas limits. By buying carbon credits, emitters can continue emitting carbon (up to the specific licensed levels) into the atmosphere by paying a penalty, while those who sell them are rewarded for lower levels of emission.

This provision for carbon credits trading led to the creation of big international markets where carbon credits are sold and bought. Most of the carbon credits trading takes place in international markets with each transfer being validated by the United Nations Framework Convention on Climate Change (UNFCCC). Currently, there are six international exchanges for trading carbon credits: the European Climate Exchange, the European Energy Exchange, the NASDAQ OMX Commodities Europe, the Commodity Exchange Bratislava, PowerNext and the Chicago Climate Exchange. The latter is the only United States carbon credits trading system; all the other exchanges are European.

Carbon credits are important in the fight against global warming. First of all, it quantifies carbon emissions and forces companies, businesses and industries to take them into account when planning and implementing their business operations. Before the start of carbon credits, carbon emissions weren’t quantified, so every company could pollute the air as much as they wanted, without fear of any penalty or any need to take responsibility.

With carbon credits, the business equation changed. Now companies see pollution as a cost, and hence would be more motivated to invest in reducing pollution. In addition, companies that manage their pollution well could well seek to earn by selling their unused carbon credits. So it means that companies now have incentives to emit as little carbon as possible. The impetus for developing greener technologies is created.

The carbon credits trading allows businesses flexibility in their planning and operations, provides the incentive for reducing pollution, as well as help ensure that the quotas for carbon emission reduction are achieved.

But the carbon credits trading system isn’t without its criticism.

Critics have pointed out the instances where the issuing of free credits to companies could be abused. For example, highly polluting companies that are given sufficient free credits (based on historic emission levels, or for some other reasons are given favorable conditions by the regulatory body) would have no incentive to reduce their pollution. At the same time, companies that strive to reduce their carbon emissions might be given less credits the following year, subsequently penalizing them for their green efforts. As such, critics have called for alternative systems of credit distribution like auctioning.

Less developed countries have often been found to sell off their carbon credits at low prices, at the expense of the local communities, but to the benefit of the more developed countries that no longer have the incentive to reduce their emissions since there is a cheaper source of carbon credits available.

Annie Leonard, creator of The Story of Stuff, pointed out that the carbon credits trading system was actually a distraction from the search for more effective solutions of carbon emission reductions and global warming.

There is a problem of carbon leakage, where reduced emissions in one country or sector with a stricter carbon policy leads to increased emissions in another country or sector with a less stringent carbon policy. This problem arises because not all countries are subjected to the quotas on carbon emission in the Kyoto Protocol. Hence, enforcing the carbon limits on these countries (eg. non-Annex I countries in the Kyoto Protocol) is difficult. Moreover, enforcing international rules on sovereign states could be difficult. The operations of the carbon market would be dependent on negotiation and consensus building within the international community.

The effectiveness of the carbon market in cutting carbon emissions is also dependent on the management of the reporting system (i.e. system that reports on breeches). A corrupt reporting system or one that does not report accurate situations could undermine the intended purpose of the carbon quotas, as such allowing more carbon emissions than was originally planned.

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