INTRODUCTION

Carbon trading is a practice which is designed to reduce overall emissions of carbon dioxide,
along with other greenhouse gases, by providing a regulatory and economic incentive. In fact,
the term “carbon trading” is a bit misleading, as a number of greenhouse emissions can be
regulated under what are known as cap and trade systems. For this reason, some people prefer
the term “emission trading,” to emphasize the fact that far more than just carbon is being traded.

This practice is part of a system which is colloquially referred to as a “cap and trade.” Under a
cap and trade system, a government sets a national goal for total greenhouse gas emissions over a
set period of time, such as a quarter or a year, and then allocates “credits” to companies which
allow them to emit a certain amount of greenhouse gases. If a company is unable to use all of its
credits, it can sell or trade those credits with a company which is afraid of exceeding its
allowance.

Carbon trading provides a very obvious incentive for companies to improve their efficiency and
reduce their greenhouse gas emissions, by turning such reductions into a physical cash benefit. In
addition, it is a disincentive for being inefficient, as companies are effectively penalized for
failing to meet emissions goals. In this way, regulation is accomplished largely through
economic means, rather than through draconian government measures, encouraging people to
engage in carbon trading because it's potentially profitable.

As a general rule, carbon trading is paired with an overall attempt to reduce carbon emissions in
a country over an extended period of time, which means that each year; the number of available
credits will be reduced. By encouraging companies to become more efficient ahead of time, a
government can often more easily meet emissions reduction goals, as companies will not be
expected to change practices overnight, and the carbon trading system creates far more flexibility
than setting blanket baseline levels.

In some countries, carbon exchanges have opened up, operating much like stock exchanges.
These organizations facilitate the exchange of carbon, ensuring that they flow smoothly through
the market, and they provide standard set prices for credits, based on market demand and general
economic health. In some cases, individual citizens can also participate in carbon trading,
purchasing credits to offset their own greenhouse gas emissions, and some advocates have
suggested that carbon trading should be formally expanded to all citizens, encouraging global
and individual involvement in reduction of greenhouse gas emissions.

Participants in carbon trading buy and sell contractual commitments or certificates that represent
specified amounts of carbon-related emissions that either:

 are allowed to be emitted;

 comprise reductions in emissions (new technology, energy efficiency, renewable energy);
or
 comprise offsets against emissions, such as carbon sequestration (capture of carbon in
biomass).

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People buy and sell such products because it is the most cost-effective way to achieve an overall
reduction in the level of emissions, assuming that transaction costs involved in market
participation are kept at reasonable levels. It is cost-effective because the entities that have
achieved their own emission reduction target easily will be able to create emission reduction
certificates "surplus" to their own requirements. These entities can sell those surpluses to other
entities that would incur very high costs by seeking to achieve their emission reduction
requirement within their own business. Similarly, sellers of carbon sequestration provide entities
with another alternative, namely offsetting their emissions against carbon sequestered in
biomass.

How carbon trading came out

Many changes in how Greenhouse Gases (GHG's) are being treated are due to policies proposed
a UNFCCC conferences held at Rio de Janeiro, Kyoto, Buenos Aires, and other places. This
convention meets to address the growing suspicion that some gases are trapping heat in earth's
atmosphere, possibly altering normal climate behavior.

Emissions trading were introduced as means to lower the lower the global production of
greenhouse gases. Recent US proposals to build capacity for this new sector are the Climate
Stewardship act and other legislation.

An emission trading does not mean an exemption from reductions. Trading moves an emission
reduction from one place to another, while participants report their reduction schedule. A global
accounting system keeps track of what trades were made and whether participants are meeting
their reduction targets.

How emission trading is applied

Over 30 countries have agreed to reduce annual greenhouse gas emissions by an average of 7%.
These countries (so called Annex countries) can trade ERC's with each other to level out the cost
of achieving emission reductions. For example, a country where there is plenty wind can put up
turbines, generate large amounts of emissions free energy and sell the reduction credits to a
country where there is less wind and possibly higher costs to achieve reductions with similar
turbines.

Each country reports yearly to the IPCC its total emissions and emission reductions. If they are
on track with their reductions, they maintain trading privileges. If not, penalties or sanctions may
be imposed.

Not all countries have committed to emission reduction schedules. These countries are not sure
how to achieve reductions and still grow their economies without hurting themselves. To enable
reductions in this second group of countries, one-way trades are permitted. For example, a wind-
farm is placed in India, and the credits are automatically transferred to Denmark, where the
money for the project came from. So bi-lateral trading is OK between the group with emission
reduction commitments, and the second group without commitments.

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Rules and modalities

Key to emissions trading is keeping track of what is being traded. Rules defining reporting
measures, compliance standards etc., are being agreed upon, and soon there will be an
internationally recognized game plan.

The ICBE is anticipating this market and documenting RE systems and the emissions they
reduce. We expect that many RE producers will be able to claim benefits when domestic and
international trading schemes start up.

TYPES OF CARBON TRADING

There are two kinds of carbon trading.

1. Emissions trading.
2. Trading in project-based credits

Often the two categories are put together in hybrid trading systems.

Emissions Trading

Emissions’ trading is also sometimes called ‘cap-and-trade’. A cap and trade system is an
emissions trading system, where total emissions are limited or 'capped'. The Kyoto Protocol is a
cap and trade system in the sense that emissions from Annex B countries are capped and that
excess permits might be traded. However, normally cap and trade systems will not include
mechanisms such as the CDM, which will allow for more permits to enter the system, i.e. beyond
the cap (Point Carbon). Suppose there are two companies, A and B. Each emits 100,000 tones of
carbon dioxide a year. The government wants to cut their emissions by 5 per cent. It gives each
company rights, or ‘allowances’, to emit 95,000 tones this year. Each company must either
reduce its emissions by 5,000 tones or buy 5,000 tones of allowances from someone else. The
market price for these allowances is $ 10 per tonne. Company A can reduce its emissions for half
this cost per tonne. So it’s reasonable for it to cut its emissions by 10,000 tones: if it sells the
extra 5,000 tones (for $ 50,000) it will be able to recover its entire expenditure. So the company
saves $ 25,000. For company B, making reductions is more expensive. Cutting each tonne of
emissions costs it $ 15. So it decides not to reduce its emissions, but instead to buy the 5,000
tones of surplus allowances that company A is offering. If company B reduced its own
emissions, it would cost $ 75,000. But if it buys company A’s surplus allowances, the cost is
only $ 50,000. So company B also saves $ 25,000 on the deal. Both firms, in short, save $ 25,000
over what they would have had to spend without trading. If they are the only two companies in
the country, this means the country’s business sector winds up cutting emissions just as much as
it would have under ordinary regulation. But by distributing the reductions over the country’s
entire private sector, it costs the sector as a whole $ 50,000 less to do so. Some emissions trading
schemes allow companies to save any surplus allowances they have for their own use in future
years, rather than selling them.

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Trading in project-based credits

Suppose there are two companies, A and B, each emitting 100,000 tonnes of carbon dioxide a
year. And, the government wants to cut their emissions by 5 per cent, so it gives each company
allowances to emit only 95,000 tonnes. But now the government tells each company that if it
doesn’t want to cut its emissions by 5,000 tonnes each, it has another option. It can invest abroad
in projects that ‘reduce’ emissions of carbon dioxide 5,000 tonnes ‘below what would have
happened otherwise’. Such projects might include growing crops to produce biofuels that can be
used instead of oil; installing machinery at a chemical factory to destroy greenhouse gases;
burning methane seeping out of a coal mine or waste dump so that it doesn’t escape to the
atmosphere; or building a wind power generator. The price of credits from such projects is only
$ 4 per tone, due to low labour costs, a plethora of ‘dirty’ factories, and government and World
Bank subsidies covering part of the costs of building the projects and calculating how much
carbon dioxide equivalent* they save. In this situation, it makes sense for both company A and
company B to buy credits from abroad rather than make reductions themselves. Company A
saves $ 5,000 by buying credits from projects abroad rather than cutting its own emissions.
Company B meanwhile saves $ 55,000. The total saving for the domestic private sector is $
60,000.Other names for project-based credit trading include ‘baseline-and-credit’ trading and
‘off set’ trading.

Hybrid trading systems

Some pollution trading systems use emissions trading only. Hybrid systems use both emissions
trading and ‘off set’ trading, and try to make ‘allowances’ exchangeable for project-based
‘credits’. The US sulphur dioxide market uses emissions trading only. But both the Kyoto
Protocol and the EU Emissions Trading System mix ‘cap-and-trade’ allowances and project-
based credits, and try to make them mutually exchangeable. Such systems are enormously
complex. Not only is it difficult to try to create credible ‘credits’ and make them equivalent to
‘allowances’. Mixing the two also changes the economics. For example, imagine that company
A and company B above are allowed three options in any combination: cutting their own
emissions, trading allowances with each other, or buying credits from abroad. For company B,
the best option would be, again, to buy $ 20,000 worth of credits abroad rather than spend $
75,000 to reduce its own emissions. (CarbonTrading, 2006.’Made in USA’-A Short History Of
Carbon Trading) For company A, the best option would be to cut its own emissions by 10,000
tones – but only if it could find a buyer who would pay $ 10 per ton for the 5,000 allowances it
would have to spare. Instead of having to pay $ 20,000 for carbon credits from abroad, it
wouldn’t have to spend anything. Unfortunately for company A, it can’t find any such buyer. If
company B can save $ 5,000 by going abroad for credits, it won’t buy company A’s spare
allowances. But company B is the only other firm in the emissions trading scheme. So without
company B as a buyer, it’s not worthwhile for company A to make any cuts at all, and it too will
wind up buying credits overseas.

How big is the market today?

Exact figures are hard to come by because the market is still fairly new, since data is not easily
available and since several different schemes exist, not all directly comparable. The World Bank,

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one of the main players in carbon financing, estimates the value of carbon traded in 2005 to be
about $10bn. The Bank believes the carbon market has the potential to bring more than $25bn
(£14bn) in new financing for sustainable development to the poorest countries and the
developing world.

Benefits of carbon trading

The benefits to the general community of trading emission reduction/offset certificates in a

market include

1. the reduction in overall cost of meeting emission reduction targets, as mentioned above;
2. the 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;
3. the 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;
4. the 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.

World Bank study of the carbon market

The World Bank Study for the International Emission Trading Association (IETA) indicates the
project-based emissions traded are rapidly increasing, approaching 107 million tons in 2004, a 38
per cent increase over the preceding year. The share of volume of emission reductions purchased
by various countries from January 2004 to April 2005 confirming that most of the CDM demand
is from the EU and Japan. (United Nations Conference on Trade and Development, 2006).

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Carbon Buyers

European buyers now represent the bulk of the purchases of emission reductions with a
combined 60% of total volume purchased between January 2004 and April 2005. Within this
group, the Government of the Netherlands (through its various agencies and intermediaries
except the CFB (Senter, and programs established within Rabobank, the International Finance
Corporation, European Bank on Reconstruction and Development, and the Corporation Andina
de Fomento) is the largest single buyer with 16%, followed by private firms from the United
Kingdom (12%). All other European purchasers combined account for 32% of the total volume
purchased. The share of Japan (mostly private Japanese entities) has diminished from 29% (Jan.
2003 –Dec. 2004) to 21% (Jan. 2004 – April. 2005). Interestingly, two-thirds of the volume
purchased from Europe was purchased by private firms, against one-third by governments
(mostly The Netherlands, Denmark, Sweden, and Austria). We have only anecdotal evidence
about the motivations for the transactions by private European firms, but compliance with the
EU ETS, both within the pilot phase and during the first commitment period, appears to be a key
driver. And the same is true overall: private entities represent about two-thirds (69%) of total
purchases of emission reductions. Whether this trend will continue, however, is unclear as
demand from Governments (as expressed, for instance, in Government purchase tenders and
funds) is growing rapidly, while it is not clear that private demand is growing as fast. The share
of the volume purchased by Canadian private and public entities has remained small (5%
between January 2004 and April 2005). This figure can appear surprising since GHG emissions
of Canada were 20% higher than their 1990 levels in2002, while the target for the country under
the Kyoto Protocol is –6% relative to 1990 levels; hence suggesting that Canada might be
required to purchase large amounts of outside credits to meet its Kyoto commitment. The limited
involvement of the Canadian private sector in transactions so far can probably be attributed to
the fact that Canada’s climate change plan has only recently been announced, and that there is
yet no clarity on allowance allocations to individual firms. Another contributing factor might be
the fact that many private companies appear to believe that the non-compliance fee under this
plan will be no more than 15 Canadian dollar per tonne of CO2e (U.S.$12 at exchange rate
prevailing at time of writing); a figure sufficiently modest to raise questions as to whether the
transaction costs associated with CDM and JI are worth the effort. When purchases by the
various funds managed by the World Bank Carbon Finance Business (CFB) are attributed to the
CFB, and not to the funds’ participants, the picture is slightly not very different. Simply, shares
of purchases by all major groups diminish as part of their volume is now attributed to the CFB.
Precisely, European entities represent 44% of the purchases from January 2004 to May 2005,
before the CFB itself (22%) and Japanese entities (16%). (IETA, 2005)

Carbon Seller:

The largest seller of ERs is Asia (45% from January 2004 to April 2005). Latin America is
second with 35% of the volume supplied. Projects in OECD countries, which include both JI
projects in New Zealand and voluntary activities in the U.S., rank third with 14%, while
transition economies rank fourth at 6%. These aggregate figures, however, are strongly
influenced by the dynamics of HFC23 destruction projects, which are few in number but very
large in volume, and for the moment, to our knowledge at least, all located in Asia. In fact, Latin
America is by far the largest supplier of ERs from projects other than HFC23 destruction (46%).

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Asia’s share of non HFC-based ERs is stable (28% from Jan. 2004 to April 2005, against 28%
from Jan. 2003 to Dec. 2004), and is lower than Latin America’s. This result might come as a
surprise to observers of the carbon market, considering the very large flow of projects approved
by the Indian DNA, which is reflected, inter alia, in many of the methodologies submitted to the
CDM Executive Board. Most of these projects, however, are intended to be unilateral CDM, i.e.,
projects that are implemented without an Annex I participant. As long as no credit is sold,
unilateral CDM projects (60 to 70 at least in India) are not included in our database of
transactions, and thus not reflected in the above figures.

The three largest suppliers (again India, Brazil and Chile) account for 58% of the total volume
delivered over that period, and the top five (which include also Bulgaria and Romania) account
for nearly 70%. As can be seen in Figure 3, and unilateral CDM notwithstanding, India is by far
the single largest supplier of emission reductions. In terms of trends, the market seems to be
concentrating in large, middle-income countries. Most of the new volume is going to India and
Brazil. Emerging countries in the carbon market are China, where projects are now being
accepted by the DNA, and Mexico, which has also seen large volumes transacted in the past 12
months. This concentration of CDM flows towards large middle-income countries is consistent
with the current direction of Foreign Direct Investment. (IETA, 2005).

CRABON TRADING IN INDIA

India signed and ratified the Protocol in August, 2002. Since India is exempted from the
framework of the treaty, it is expected to gain from the protocol in terms of transfer of
technology and related foreign investments. At the G-8 meeting in June 2005, Indian Prime
Minister Manmohan Singh pointed out that the per-capita emission rates of the developing
countries are a tiny fraction of those in the developed world. Following the principle of common
but differentiated responsibility, India maintains that the major responsibility of curbing emission
rests with the developed countries, which have accumulated emissions over a long period of
time.

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Carbon trading allows industries in developed countries to offset their emissions of carbon
dioxide by investing in reforestation and clean energy projects in developing countries. Carbon
projects could potentially recover habitat on millions of hectares of heavily populated forest and
farmlands. "This would bring social, economic, and local environmental benefits to hundreds of
thousands, and potentially millions, of poor rural people in the developing world," (David
Kaimowitz, Director General of CIFOR, 2002).

The deals between industry and community tree growers may be one of the least expensive ways
for companies to off-set their carbon emissions. (Sara Scherr et al, Senior Policy Analyst at the
Washington, D.C.-based Forest Trends). "Healthy forests bring all kinds of other benefits
too,"(Scherr). "In this situation, they would help to protect endangered floras and faunas.
"Community tree planting efforts have always been thought of as too costly and risky for
businesses,"(Joyotee Smith). "However, many community-based projects can sell carbon credits
at the expected global market price of US$15 to $20 per ton of sequestered carbon."
"Problems with forest carbon arise when trees are being grown solely for their carbon. If there
are other economic uses of the reforested land, such as producing fuel wood, rubber, fruits, and
food crops, then the cost of carbon sequestration is lower. "Communities can use carbon
payments to finance sustainable tree-growing investments that produce these non-carbon
benefits,"(Scherr, 2002).

India is expected to capture between 20 and 30 per cent of the CDM market, bringing in up to
$300 million in revenue. Several favorable enabling factors have contributed to India’s pre-
eminent position in the CDM market such as a good technical base and a pro-active National
CDM authority, which includes secretaries from ministries such as finance, non-conventional
energy sources and power. The Ministry of Environment and Forests deals with the climate
change and CDM issues in India. Over the eighteen-month period from January 2004 to June
2005, 80 projects were approved by the National CDM Authority, far more than in any other
country during the same period. Of these 80 projects, 44 are in renewable energy, 25 in energy
efficiency, 5 each in fuel switching and industrial processes, and 1 in municipal solid waste.
These projects are then submitted to the UNFCCC’s Executive Board for validation and
registration.

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 BIBILOGRAPHY

 www.investopedia.com/ask/answers/04/060404.asp

 www.google.com

 www.wikipedia.com

 www.carbontrading.com

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