The problem of climate change led to subscribe the Kyoto Protocol, which falls within the UN Framework Convention on Climate Change. This document implies that industrialized countries reduce their emissions of greenhouse gases (GHGs). Global commitment is to reach an emission level for the period 2008 - 2012 which is on average 5.2% below 1990 levels. Then, the overall objective is precised for each country (for example for 15 European Union countries the reduction target is 8%).

The carbon market has been created to allow countries and companies from industrialized countries to meet in an easier way their objectives of emission reductions according to the Kyoto Protocol. This consists of a purchase and sale space of emission quotas & certified GHG emission reductions, also called carbon credits. Each carbon credit equals to one ton of certified CO2e (GHG amount is equivalent to one CO2 ton) that is not emitted into the atmosphere.

This market allows entities of developing countries, following certain certification processes, to generate carbon credits for reducing GHG emissions and thus achieve an additional financial resource to promote investment projects in clean technologies.

 

Emision Reduction Mechanism

Countries committed to the Kyoto Protocol to reduce GHG emissions must reach their targets through national measures. As additional means to achieve these goals, the protocol introduced three flexible mechanisms based on the market, creating what is now known as the carbon market. These mechanisms are international emissions trading, clean development mechanisms and joint implementation.

These mechanisms provide financial incentives to private companies that contribute positively to the environment and that regulate or reduce their emissions. Thus benefiting to companies that do not emit or emit less than their objective, and making pay companies that emit more than their objective.

Recall that:

 

Flexibility Mechanism

  • Joint Implementation Mechanism (JI)

    Joint Implementation is a program under the Kyoto Protocol that allows industrialized countries to meet part of their obligations to cut emissions of greenhouse gases paying for projects that reduce emissions in other industrialized countries. The operation of the joint implementation mechanism is similar to the CDM. This mechanism generates Emissions Reduction Units (ERU).

    Learn more: JI UNFCCC

  • International Emissions Trading (IET):

    Emission trading is a buy-and-sale scheme of greenhouse gases emissions between countries with targets set under the Kyoto Protocol. That is to say, between industrialized countries belonging to Annex I of the Kyoto Protocol. Thus, those which reduce their emissions more than committed can sell surplus emission certificates to countries that have not entirely fulfilled their commitment.

    Learn more: ET UNFCCC

  • Clean Development Mechanism (CDM):

    The Clean Development Mechanism (CDM) is an agreement on the Kyoto Protocol, Article 12, which allows industrialized country governments and businesses (natural or legal persons, public or private entities) to enter into agreements in order to meeting targets for reducing greenhouse gas (GHG) in the first commitment period between the years 2008 to 2012. This is done by investing in emissions reduction projects in developing countries (so called countries non-Annex I) as an alternative to acquire certified emission reductions (CER) to lower costs.

    Learn more: CDM UNFCCC

    • How does it work?

      The clean development mechanism (CDM) allows projects of greenhouse gas emission reductions in countries without emission targets under the UN Framework Convention on Climate Change (UNFCCC) and Kyoto Protocol. In theory, the CDM allows a drastic reduction in costs for industrialized countries, though they generate the same emission reduction that would have occurred without the CDM. The CDM also generates a transfer of clean technologies to developing countries. Governments or companies when investing in these CDM projects receive certificates of emission reductions CERs (one of the three types of carbon credits), which can be purchased at a lower cost than in their markets and simultaneously achieve complete reduction targets.

    • Development of the CDM project

      A CDM project must comply with the terms of additionality, baseline determination and contribution to sustainable development of the country, as provided by Article 12 of the Kyoto Protocol. A project that participates in the CDM must comply with the cycle established by the Board of the CDM prior to receiving the economic benefits resulting from such participation. This cycle is summarized in the following chart:


 

Carbon markets linked to the Kyoto Protocol

  • European market

    The European Union (EU) has been a leader in global carbon markets. The EU has implemented a “cap and trade” mechanism called “emissions trading scheme” (EU ETS) implemented in 2005, which has been a driving force behind the Kyoto Protocol. This system was designed to transfer emission reduction obligations by engaging the private sector, mainly domestic and multinational corporations. Such emissions are based on income (“allowance based”), some other are based on projects (“project based”). The cap and trade system is the mechanism of intra-European market established by European Directive on Emissions Trading to encourage the reduction of CO2 emissions at minimum cost production in certain sectors (electricity generation, cement, etc.). The operation of this system is based on two key concepts: (a) setting a cap on emissions without penalty for each Member State of the European Union and (b) the transfer of emission rights between agents.