ENVIRONMENTAL MARKETS

Climate change - The Causes

On the broadest scale, the rate at which energy is received from the sun and the rate at which it is lost to space determine the equilibrium temperature and climate of Earth. This energy is distributed around the globe by winds, ocean currents, and other mechanisms to affect the climates of different regions. Factors that can shape climate are called climate forcings or forcing mechanisms.These include processes such as variations in solar radiation, variations in the Earths orbit, mountain-building and continental drift and changes in greenhouse gas concentrations. There are a variety of climate change feedbacks that can either amplify or diminish the initial forcing. Some parts of the climate system, such as the oceans and ice caps, respond slowly in reaction to climate forcings, while others respond more quickly. Forcing mechanisms can be either internal or external. Internal forcing mechanisms are natural processes within the climate system itself (e.g., the thermohaline circulation). External forcing mechanisms can be either natural (e.g., changes in solar output) or anthropogenic (e.g., increased emissions of greenhouse gases). Whether the initial forcing mechanism is internal or external, the response of the climate system might be fast (e.g., a sudden cooling due to airborne volcanic ash reflecting sunlight), slow (e.g. thermal expansion of warming ocean water), or a combination (e.g., sudden loss of albedo in the arctic ocean as sea ice melts, followed by more gradual thermal expansion of the water). Therefore, the climate system can respond abruptly, but the full response to forcing mechanisms might not be fully developed for centuries or even longer.

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Whats being done about it?

In 1997, with ever-stronger evidence for an enhanced greenhouse effect driven by human activities, and deepening concern over the impacts the resulting changes in climate might have, over 150 nations came together in Kyoto in Japan to agree the first binding agreement aimed at cutting global greenhouse gas emissions: The Kyoto Protocol. But in 2009 the United Nations Climate Change conference in Copenhagen failed to agree on a binding agreement for all nations on reducing emissions. The Kyoto Protocol was drawn up to set specific targets for reductions in greenhouse gas concentrations in the global atmosphere. Emission restrictions were agreed for the developed world nations. Targets ranged from a 28% cut for Luxembourg to a 27% increase for Portugal, depending on the individual country and its circumstances. The UK committed to a 12.5% cut. To become legally binding the protocol had to be ratified by at least 55 countries which between them accounted for at least 55% of the total 1990 greenhouse gas emissions of developed countries. This happened in February 2005, but without the US or Australia.

Cap and Trade

Emissions trading or cap-and-trade is a market-based approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants. A central authority (usually a governmental body) sets a limit or cap on the amount of a pollutant that may be emitted. The limit or cap is allocated or sold to firms in the form of emissions permits which represent the right to emit or discharge a specific volume of the specified pollutant. Firms are required to hold a number of permits (or allowances or carbon credits) equivalent to their emissions. The total number of permits cannot exceed the cap, limiting total emissions to that level. Firms that need to increase their volume of emissions must buy permits from those who require fewer permits.

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The transfer of permits is referred to as a trade. In effect, the buyer is paying a charge for polluting, while the seller is being rewarded for having reduced emissions. Thus, in theory, those who can reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest cost to society.

Trading systems - global

In 1997 the Kyoto Protocol was adopted. The Kyoto Protocol is a 1997 international treaty that came into force in 2005. In the treaty, most developed nations agreed to legally binding targets for their emissions of the six major greenhouse gases. Emission quotas (known as Assigned amounts) were agreed by each participating Annex I country, with the intention of reducing the overall emissions by 5.2% from their 1990 levels by the end of 2012. The United States is the only industrialized nation under Annex I that has not ratified the treaty, and is therefore not bound by it. The IPCC has projected that the financial effect of compliance through trading within the Kyoto commitment period will be limited at between 0.1-1.1% of GDP among trading countries.

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The Protocol defines several mechanisms (flexible mechanisms) that are designed to allow Annex I countries to meet their emission reduction commitments (caps) with reduced economic impact (IPCC, 2007). Under Article 3.3 of the Kyoto Protocol, Annex I Parties may use GHG removals, from afforestation and reforestation (forest sinks) and deforestation (sources) since 1990, to meet their emission reduction commitments. Annex I Parties may also use International Emissions Trading (IET). Under the treaty, for the 5-year compliance period from 2008 until 2012, nations that emit less than their quota will be able to sell assigned amount units to nations that exceed their quotas. It is also possible for Annex I countries to sponsor carbon projects that reduce greenhouse gas emissions in other countries. These projects generate tradable carbon credits that can be used by Annex I countries in meeting their caps. The project-based Kyoto Mechanisms are the Clean Development Mechanism (CDM) and Joint Implementation (JI). The CDM covers projects taking place in non-Annex I countries, while JI covers projects taking place in Annex I countries. CDM projects are supposed to contribute to sustainable development in developing countries, and also generate real and additional emission savings, i.e., savings that only occur thanks to the CDM project in question.

Trading systems - European

The European Union Emission Trading Scheme (or EU ETS) is the largest multi-national, greenhouse gas emissions trading scheme in the world. It is one of the EUs central policy instruments to meet their cap set in the Kyoto Protocol. After voluntary trials in the UK and Denmark, Phase I commenced operation in January 2005 with all 15 (now 25 of the 27) member states of the European Union participating. The program caps the amount of carbon dioxide that can be emitted from large installations with a net heat supply in excess of 20 MW, such as power plants and carbon intensive factories and covers almost half (46%) of the EUs Carbon Dioxide emissions.Phase I permits participants to trade amongst themselves

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and in validated credits from the developing world through Kyotos Clean Development Mechanism. During Phases I and II, allowances for emissions have typically been given free to firms, which has resulted in them getting windfall profits. Ellerman and Buchner (2008) suggested that during its first two years in operation, the EU ETS turned an expected increase in emissions of 1-2 percent per year into a small absolute decline. In the initial 2005-07 period, emission caps were not tight enough to drive a significant reduction in emissions. The total allocation of allowances turned out to exceed actual emissions. This drove the carbon price down to zero in 2007. This oversupply was caused because the allocation of allowances by the EU was based on emissions data from the European Environmental Agency in Copenhagen, which uses a horizontal activity based emissions definition similar to the United Nations, the EU ETS Transaction log in Brussels however uses a vertical installation based emissions measurement system. This caused an oversupply of 200 million tonnes (10% of market) in the EU ETS in the first phase and collapsing prices. Phase II saw some tightening, but the use of JI and CDM offsets was allowed, with the result that no reductions in the EU will be required to meet the Phase II cap. For Phase II, the cap is expected to result in an emissions reduction in 2010 of about 2.4% compared to expected emissions without the cap. For Phase III , the European Commission has proposed a number of changes, including: the setting of an overall EU cap, with allowances then allocated to EU members; tighter limits on the use of offsets; unlimited banking of allowances between Phases II and III; and a move from allowances to auctioning. In January 2008, Norway, Iceland, and Liechtenstein joined the European Union Emissions Trading System (EU ETS), according to a publication from the European Commission. The Norwegian Ministry of the Environment has also released its draft National Allocation Plan which provides a carbon cap-and-trade of 15 million metric tonnes of CO2, 8 million of which are set to be auctioned.

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According to the OECD Economic Survey of Norway 2010, the nation has announced a target for 2008-12 10% below its commitment under the Kyoto Protocol and a 30% cut compared with 1990 by 2020.

Trading systems - North American

The California Air Resources Board (CARB) adopted the states cap-and-trade rule on October 20, 2011, and will implement and enforce the program. The cap-and-trade rules will first apply to electric power plants and industrial plants that emit 25,000 metric tons of carbon dioxide equivalent (CO2e) per year or more. In 2015, the rules will also apply to fuel distributors (including distributors of heating and transportation fuels) that meet the 25,000 metric ton threshold, ultimately affecting a total of around 360 businesses throughout California. The program imposes a greenhouse gas emission limit that will decrease by two percent each year through 2015, and by three percent annually from 2015 through 2020. Emission allowances will be distributed by a mix of free allocation and quarterly auctions. The portion of emissions covered by free allowances will vary by industry, but initially will account for approximately 90 percent of a businesss overall emissions. The percentage of free allowances allocated to the businesses will decline over time. A business may also buy allowances from other entities that have reduced emissions below the amount of allowances held. The program imposes a greenhouse gas emission limit that will decrease by two percent each year through 2015, and by three percent annually from 2015 through 2020. Emission allowances will be distributed by a mix of free allocation and quarterly auctions. The portion of emissions covered by free allowances will vary by industry, but initially will account for approximately 90 percent of a businesss overall emissions. The percentage of free allowances allocated to the businesses will decline over time. A business may also buy allowances from other entities that have reduced emissions below the amount of allowances held.

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