FLEXIBILITY MECHANISMS
EMISSIONS TRADING
Kyoto Protocol Article 17

"The Conference of the Parties shall define the relevant principles, modalities, rules and guidelines, in particular for verification, reporting and accountability for emissions trading. The Parties included in Annex B may participate in emissions trading for the purpose of fulfilling their commitments under Article 3. Any such trading shall be supplemental to domestic actions for the purpose of meeting quantified emission limitation and reduction commitments under that Article."

 

KEY ORGANIZATIONS

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WORLD BANK GLOBAL CARBON INITIATIVE

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UNCTAD
Contact: Frank Joshua

Ding2.gif (586 bytes) INTERNATIONAL ENERGY AGENCY (IEA)
Ding2.gif (586 bytes) OECD
Ding2.gif (586 bytes) TREXLER AND ASSOCIATES
Ding2.gif (586 bytes) FIELD
Ding2.gif (586 bytes) ENVIRONMENTAL FINANCIAL PRODUCTS LIMITED
Ding2.gif (586 bytes) EMISSIONS MARKETING ASSOCIATION (EMA)
Ding2.gif (586 bytes) ENVIRONMENTAL DEFENSE FUND
Ding2.gif (586 bytes) COLUMBIA UNIVERSITY
Ding2.gif (586 bytes) BRITISH PETROLEUM
Ding2.gif (586 bytes) CENTER FOR CLEAN AIR POLICY
Emissions Trading allows an Annex I country with an excess of emission units, presumably from reducing emissions below commitment levels, to sell its credits to another Annex I country unable to meet its commitments. Trading is probably the most contentious of all the flexibility mechanisms mentioned in the Protocol. The actual principals, rules and guidelines for trading are to be decided at an undetermined future COP.

The concern that trading will allow some developed countries to avoid domestic actions has fueled a dispute over a "cap" on the amount countries are allowed to trade. The debate centers on a phrase in Article 17 stating that trading should be "supplemental" to domestic actions to meet emission reduction requirements. A successful emissions trading regime requires a system of verification so countries may engage in trading without the fear that they are purchasing worthless credits. However, such a system presents difficulties because of the inherent uncertainty in verifying GHG emissions. Even the best scientific methods do not eliminate the uncertainty in the measurements. Several suggestions have been made on how to account for this uncertainty. One would establish a discounting system where credits based on uncertain activities will have their value discounted to reflect the uncertainty. Another solution may be to require insurance for every trade thereby spreading the risk of liability. Finally, some argue for a minimum level of credits to be banked before countries are allowed to engage in trading. The banked credits can be used to balance any counterfeit credits.

Given the uncertainty in verification, a liability system to deal with "bad trades" must be developed. In the US sulfur dioxide trading system, the seller is liable if they oversell their credits or the credits are worthless. Under a carbon trading system it has been suggested that the buyer and the seller should share liability. They argue that in many cases the buyer may be in a better position to scrutinize the integrity of the carbon credit. Opponents to a shared liability system argue that the buyer is in less of a position to ensure the integrity of the credit and should not be liable for the seller’s irresponsibility.

In order for developing countries to participate in the trading regime they will likely have to assume emission limitations. However, no decision was reached in Kyoto on voluntary commitments by developing countries. Critics of the trading system argue that as developing countries take on voluntary commitments there will be an incentive for both developing and developed countries to set unrealistically high targets. Some Parties support a standardized system for setting targets. Some NGOs and developing countries argue that the targets should be based on a set per capita emissions level, arguing that this is the most equitable and enduring system because all citizens of the world would have the same "right" to emit. Others criticize the per capita system as being politically unrealistic.

The US will continue to champion emissions trading. They favor a simple set of trading rules to minimize confusion and oppose regulations that would limit the amount that can be traded. In Bonn, the JUSCANZ countries (Australia, Canada, Iceland, Japan, New Zealand, Norway, Russia and the US) submitted a paper proposing rules for a trading system.

The EU also supports trading in principle but wants to ensure that there is an adequate compliance regime in place before trading occurs. Several G-77 countries remain skeptical of a trading system and want to ensure a verification and compliance system before trading is allowed. These countries are concerned that trading will be used by developed countries to avoid domestic actions. They argue that countries such as Russia and the Ukraine who have experienced an economic decline since 1990 will have a huge surplus of credits to trade. This surplus or "hot air" would then flood the market and create an inexpensive means for countries such as the US to avoid domestic action. The US, which is somewhat dependent on the successful development of a trading regime, opposes a "cap" on trading.

Ding2.gif (586 bytes)Emissions trading proposal   pdficon.gif (224 bytes)
Australia, Canada, Iceland, Japan, New Zealand, Norway, Russia and the US
 

Under this proposal, the tradable unit would be Assigned Amount Units (AAUs). AAUs would be denominated in "CO2 equivalent" and would express one metric tonne of CO2 equivalent emissions. Each Annex B Party could issue serialized AAUs from its "assigned amounts." AAUs would be valid until used to offset emissions for the purposes of contributing to compliance.

Parties could trade directly and/or authorize legal entities to acquire and or transfer AAUs. Each Annex B Party would need to comply with Protocol Article 5 (national emission estimation  systems) and Protocol Article 7 (emissions inventories). They must also establish and maintain a national system for recording their "assigned amounts" and tracking AAUs held, transferred or acquired. Each Party would also be required to report annually on activities and be assessed on compliance at the end of the commitment period.

Ding2.gif (586 bytes) Emissions trading proposal from the EU

The EU proposal on international emissions trading takes an approach different from the proposal of Canada and others in addressing: supplementarity; environmental effectiveness, compliance mechanisms, market transparency, risk and liability rules, reporting requirements, and eligibility.

The EU, along with Switzerland, also submitted a preliminary response to the initial list of issues raised by the G-77-China on the flexibility mechanisms, which is contained in document FCCC/SB/1998/Misc.1/Add.6

Ding2.gif (586 bytes)The G-77/China position on trading
in document FCCC/SB/1998/Misc.1/Add.3, (submitted 4 June) contains the Group's initial position. FCCC/SB/1998/Misc.1/Add.5 contains the Group's Proposed Work Programme on Mechanisms of the Kyoto Protocol. 

The Group was guided by the following positions:

(a) that we have to proceed on a step-by-step basis on mechanisms in a protocol that has yet to enter into force and that a common understanding has to be reached on the nature of these mechanisms. The study of methodological issues is a first step to be taken.

(b) that the above must be accomplished under the sole authority of the Conference of the Parties with the assistance of its subsidiary bodies, and other relevant bodies which have defined relationships with the Convention, such as the IPCC, working through its subsidiary bodies. In this regard, there must be a clear delineation of functions between the two subsidiary bodies, consistent with the mandate given to them by Articles 9 (SBSTA) and Article 10 (SBI) of the Convention.

(c) that these two first items are what is expected of us at this session, in preparation for COP4, namely, guidance to the Secretariat for preparatory work, and allocation of work. Timing of this work comes at a later stage, and also depends upon the other Articles of the Protocol. Timing and scheduling should be dealt with by SBI/SBSTA at their 9th Session.


CLEAN DEVELOPMENT MECHANISM
Article 12.2
"The purpose of the clean development mechanism shall be to assist Parties not included in Annex I in achieving sustainable development and in contributing to the ultimate objective of the Convention, and to assist Parties included in Annex I in achieving compliance with their quantified emission limitation and reduction commitments under Article 3."

KEY ORGANIZATIONS

Ding2.gif (586 bytes) UN Development
Programme (UNDP)
Ding2.gif (586 bytes) US Initiative on Joint Implementation (USIJI)
Ding2.gif (586 bytes) Deutsche Gesellschaft f�r Technische Zusammenarbeit (GTZ)
Ding2.gif (586 bytes) Environmental Development Action in the Third World (ENDA)
Ding2.gif (586 bytes) Nature Conservancy (TNC)
Ding2.gif (586 bytes) Business Council for Sustainable Energy
Ding2.gif (586 bytes) World Resources Institute
Ding2.gif (586 bytes) United Nations University

 

The Clean Development Mechanism (CDM) allows governments or private entities in industrialized countries to implement emission reduction projects in developing countries in order to meet their emission objectives. The industrialized nations receive credit for these projects in the form of "certified emission reductions" (CERs). The purpose of the CDM is to promote "sustainable development" while contributing to the objective of the FCCC. In contrast, the purpose of JI, according to the Protocol, is simply to help Annex I countries meet their emission commitments.

There are several discrepancies in the construction of the article on CDM compared to the other flexibility mechanisms. There is no requirement that CDM activities be "supplemental" to domestic actions. Therefore, an Annex I country could forego domestic measures completely and use credits obtained through the CDM to meet its obligations. Article 12 does not include a provision for carbon sinks. Nevertheless, most observers agree that the use of carbon sinks will eventually be included under the CDM. The article on CDM differs because Parties can begin accruing CER credits in 2000 as opposed to JI projects that do not begin accruing until the start of the first commitment period in 2008.

Few issues regarding the CDM have been resolved. The Protocol calls for the CDM to be "supervised by an executive board." Although there has been little discussion about the composition of this board, it will likely be a sub-group of Parties to the Protocol. There are currently several models being discussed on how to organize the CDM. One idea is for investing countries or companies wanting to engage in multilateral projects to invest in a central independent fund. The organization managing the fund would use its expertise to decide which projects to implement and would be responsible for the administration of the projects. If the project produces emissions reductions each investor would receive credit for their proportional contribution to the project.

Reduction in emissions from CDM projects must be "additional" to what would have otherwise occurred. Therefore, baseline emission levels must be developed. Nevertheless, determining which baseline system should be used remains unresolved. As noted before, a top-down baseline approach may be the most appropriate for JI projects. However, for the CDM a project-by-project setting of baselines is probably necessary to ensure verifiability. Since developing countries have no emission targets a project specific baseline must be determined to eliminate the exportation of counterfeit emission reduction units. In a project-by-project approach each project will receive its own baseline "tailored" to the specific facts of the project.

Article 12 states that emission reductions must be certified and "real." In both JI and CDM projects there is an incentive for both participants in the project to exaggerate the emission reductions. Therefore, a system of certifying and verifying the ERUs must be developed to maintain credibility. Article 12 also states that verification of the project activities should be conducted by an "independent auditor." Finally, Article 12 requires that CDM projects have "long-term" benefits. Scientists and policymakers have suggested several different alternatives for measuring "long-term." One approach is a "ton-year" accounting system that examines the residency life of carbon in the atmosphere and multiplies this by the amount of tons emitted. Assuming that the residency life of carbon in the atmosphere is 200 years, one ton emitted would equal 200 "ton-years." Theoretically, this amount is offset by a project that sequesters an equal amount of "ton-years" even if it does not exist for 200 years. A second approach has been referred to as "real-time" accounting. This approach considers the residency life of carbon and the polluting activity for which it was meant to offset. For instance, if there is a manufacturing plant that has an operating life for forty years and assuming carbon has a residency life of 200 years than the project would have to be maintained for 240 years.

Ding2.gif (586 bytes)The G-77/China's proposed work programme on mechanisms, contained in FCCC/SB/1998/Misc.1/Add.5, addresses the CDM. The proposed programme of work, along with the proposals made by other papers were distributed in FCCC/SB/1998/CRP.2

The G-77 stressed that the primary issues include methodological and technical work on: the purpose of CDM projects; supplementarity to domestic action; part of Annex I commitments; additionality criteria in funding; criteria for real, measurable and long-term benefits related to climate change; and compatibility with sustainable development priorities/strategies.

Another problem associated with JI and CDM is "leakage," which occurs when a project does not decrease overall emissions but simply shifts emissions to another locale. As a general rule, projects that displace economic activity will most likely resurface elsewhere. For example, if one tract of forest is protected, it is possible that loggers will simply cut down trees on another tract. In the end, protecting the original tract has not decreased overall GHG emissions. Delegates have not begun to discuss the issue of leakage but it must be addressed at some stage.

The Protocol calls for a percentage of the proceeds from CDM projects to be used to cover CDM administrative costs and to assist developing countries in meeting the costs of "adaptation." How "adaptation" will be defined is unclear, however, the funds will most likely be dispersed to developing countries to conduct self-assessments and produce strategic plans on how best to adapt to their changing climate.

The US views the CDM it as an economically efficient means of achieving their emissions target. They argue that there should not be a limit to the CDM projects as a means to achieve emission requirements. In contrast, the EU is less supportive by the CDM and would like to limit its use especially with regard to land use measures. Developing countries and environmental NGOs have many of the same reservations with the CDM that they have with JI. Specifically, that the CDM will be used to avoid domestic emission reductions. Nevertheless, most developing countries recognize that the CDM could create a tremendous flow of capital to their countries.

 

 


JOINT IMPLEMENTATION - ACTIVITIES IMPLEMENTED JOINTLY

Portions of this page were drawn from "The Kyoto Protocol: Major Themes, Current Activities and Future Initiatives," by Ben Simmons, currently with the Center for International Environmental Law. The report was prepared for the International Institute for Sustainable Development (IISD).

Please direct all comments or questions to Chad Carpenter, IISD