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Carbon credits

Amidst growing concern and increasing awareness on the need for pollution control , the concept of carbon credit came into vogue as part of an international agreement, popularly known as the Kyoto Protocol .

Carbon credits are certificates issued to countries that reduce their emission of GHG (greenhouse gases) which causes global warming.

It is estimated that 60-70% of GHG emission is through fuel combustion in industries like cement, steel, textiles and fertilisers. Some GHG gases like hydro fluorocarbons, methane and nitrous oxide are released as by-products of certain industrial process. These adversely affect the ozone layer, leading to global warming .

Kyoto Protocol

Kyoto Protocol is a voluntary treaty signed by 141 countries, including the European Union, Japan and Canada for reducing GHG emission by 5.2% below 1990 levels by 12. However, the US, which accounts for one-third of the total GHG emission, is yet to sign this treaty. The preliminary phase of the Kyoto Protocol is to start in 07 while the second phase starts from 08. The penalty for non-compliance in the first phase is E40 per tonne of carbon dioxide (CO2) equivalent. In the second phase, the penalty will be hiked to E100 per tonne of CO2.

The concept of carbon credit trading seeks to encourage countries to reduce their GHG emissions, as it rewards those countries which meet their targets and provides financial incentives to others to do so as quickly as possible. Surplus credits (collected by overshooting the emission reduction target) can be sold in the global market. One credit is equivalent to one tonne of CO2 emission reduced. CC are available for companies engaged in developing renewable energy projects that offset the use of fossil fuels.

Developed countries have to spend nearly $300500 for every tonne reduction in CO2, against $10-$25 to be spent by developing countries. In countries like India, GHG emission is much below the target fixed by Kyoto Protocol and so, they are excluded from reduction of GHG emission. On the contrary, they are entitled to sell surplus credits to developed countries.

It is here that trading takes place. Foreign companies who cannot fulfill the protocol norms can buy the surplus credit from companies in other countries through trading. Thus, the stage is set for Credit Emission Reduction (CER) trade to flourish. India is considered as the largest beneficiary, claiming about 31% of the total world carbon trade through the Clean Development Mechanism (CDM), which is expected to rake in at least $5-10bn over a period of time.

Trading Exchanges
The trading takes place on two stock exchanges, the chicago Climate Exchange and the European Climate Exchange. CC trading can also take place in the open market. European countries and Japan are the major buyers of carbon credit. Under the Kyoto Protocol, global warming potential (GWP) is an index that allows comparison of greenhouse gases with each other in the context of their relative potential to contribute to global warming. For trading purposes, one credit is considered equivalent to one tonne of CO2 emission reduced.

As weather patterns become more obviously disruptive, the need to counter CO2 emissions will increase and the demand for Carbon Credits will become greater. Essentially the Carbon Credit market will be about buying credits to ensure against extreme weather events. Since the Carbon Credit is so inextricably connected to CO2 and we need something to actually value, CO2 should be considered to be the currency, it has to be. But how much is CO2 worth and ultimately what do we have to buy to actually reduce our CO2 levels?

Lets look at trees. The tree is the only known thing we can control that absorbs CO2.

The oceans absorb a lot of CO2 (there are lots of shells) but we have no control over this constant. Our farming methods and the way we handle our waste affect levels of CO2 but if you try to imagine what one Credit looks like, a tree or number of trees is a great way to give it context. So what is the market value of a tree and how much CO2 does it absorb?

Well that ultimately varies from tree to tree. An Oak in the UK is not the same as a Eucalyptus in Australia. Each tree has a different ability to absorb CO2. In practice, if the lumber price of a tree is less than its value for CO2 absorption, then foresters will naturally leave the tree to stand.

So far, the unit for one Carbon Credit is given as 1 Tonne of CO2. So how many trees does it take to absorb 1 Tonne of CO2? And which particular trees do we choose?

Since the terms of the Kyoto agreement are that trees should be left to stand for 25 years before being felled, lets take an example to calculate how many 25 year old maple and pine trees are needed to absorb 1 Tonne of CO2.

an average 25 year old maple tree absorbs 2.52lbs (1.1kg) of CO2 per year. Over 25 years thats 27.5 kgs. It means that 36 trees are needed to absorb one Tonne (1000kg) of CO2 and with each tree costing $50, each Carbon Credit should cost at least 50 x 36 trees = US $1800. Otherwise there is more value in felling the trees. Using these trees to give estimates to their carbon value gives very expensive Carbon Credit prices. Clearly these particular trees are not very good at absorbing high levels of CO2.

an average 25 year old pine absorbs 15lbs (6.82kgs) of CO2 per year

This means that the cost of a Carbon Credit when measured with this tree is approximately 6 times cheaper at US$300. In other words it takes $300 dollars (6 trees) worth of lumber of this type of tree to absorb 1 Tonne of CO2.

If these trees are used as a benchmark for prices the Credit would cost $300.