The opportunity to trade carbon credits was created by the United Nations’ Kyoto Protocol, a legally binding document committing countries to efforts for the reduction of greenhouse gases (GHGs).
The treaty created a number of emission reduction targets that nations needed to meet to safeguard the environment. Collectively, industrial nations agreed to reduce their GHGs by 5.2% from 1990 levels. On an individual country basis, this ranges from an 8% reduction in the European Union to 6% for Japan, 0% for Russia, and an increase permitted of 8% for Australia and 10% for Iceland. These countries are now responsible for ensuring that companies, and the governments themselves, are reducing GHGs.
To facilitate this, the Kyoto Protocol gave GHGs a value, known as a carbon credit. Each carbon credit is equivalent to one tonne of CO2. If a company has emissions over its allowance, then this entails a cost. Conversely, companies able to stay under this allowance receive credits which can be traded on exchanges for their value. Thirdly, projects in developing countries which actively reduce GHG emissions become eligible for these carbon credits, and by selling on an exchange can raise funds.
There are three main types of carbon offsets.
CERs
Certified Emission Reductions (CERs) were created under the Kyoto Protocol’s Clean Development Mechanism (CDM) to allow industrialised countries to invest in emission reducing projects in developing nations. The CDM projects generate CERs, credits which can then be used to offset emissions on the EU ETS. Once a CER has been issued it carries the same compliance value as an EUA.
CER credits are highly regulated and must meet a number of criteria as defined by the CDM and the Kyoto Protocol. The emissions reductions must be real, measurable, permanent, additional to what is already being done, and independently verified.
EUAs
These are the emission allowances given to participants in the EU ETS and are traded in a secondary market on the European Climate Exchange (ECX). One EUA gives the holder the right to emit one tonne of CO2. Approximately 2.3bn EUAs have been issued annually to industries covered under the EU ETS.
VERs VERs are generated by projects verified by a third party, but without the costs associated with CERs, which are a type of carbon credit subject to much more stringent regulation, pushing up the price. This means that individuals and companies can reduce their emissions in a more efficient and cost effective way. Despite there being less regulation, VERs are still subject to a standard, and emissions reductions must be real, measurable, permanent, additional to what is already being done, and independently verified.
VERs trade over the counter and on some exchanges such as the Chicago Climate Exchange (CCX). This is giving structure to the market, and helping it grow.
The VER market is growing. In 2008, 123.4 million metric tones of CO2 were transacted, a near doubling of the 2007 volume. VER prices then increased by 20% in 2009, and the market was valued at US$705 million, with annual growth of 15% projected. General market opinion is that the wider scope of the voluntary market, and growth led by the private sector, not public policy, means that it has a strong potential to outstrip the mature market size of the compliance regime.
By the end of 2013, the total value transacted in the carbon markets is projected to reach US$669 billion, making it one of the biggest growth stories in investment (Carbon Emissions Trading Markets Worldwide, 2010).
360investgroup
