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Carbon trading impacting business climate

Nobel laureate IPCC has highlighted the severity of manmade effects of climate change through its recent report. This comes ahead of the UN Framework Convention on Climate Change conference in Bali.

The IPCC report sets the tone for what the UN expects from participating nations, as they discuss options on a treaty to replace the Kyoto Protocol. If the review process is anything to go by, one can only expect that the US, China and India may once again raise objections to the measures proposed to reduce emissions.

But what will become immediately relevant are the steps proposed to bring about substantial reduction in the greenhouse gas emissions and their impact on the ‘Carbon Market’, the name derived since carbon dioxide is the most widely produced GHG.

Let us have a look at the objective of the Protocol and then examine the clean development mechanism (CDM) and system for emission trading under it. It is relevant to discuss the obligations of the developed and developing countries under the Kyoto Protocol, and consider whether carbon trading is being exploited by emitters in developed nations, and the present state of carbon trading in India.

The Protocol is a multi-state, legally-binding agreement which came into force on February 16, 2005. The primary objective of the Protocol is to stabilise GHG concentration in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system. The Protocol requires signatory countries to meet targets to limit or reduce GHGs and sets mandatory emissions targets that individual industrialised countries must meet.

The Protocol recognises that developed nations have the highest level of emissions and because of the shared atmosphere the effects of their emissions are felt all over the world. But the Protocol equally recognises that emission reduction in any one part of world is good for overall atmosphere and thus UNFCC sets down a ‘common but differentiated responsibility’.

The Protocol recognises that not all countries will be able to meet their emission targets and allows countries that have permitted emissions, but not used them, to be sold to those countries that have exceeded their mandatory emission targets. Article 17 of the Protocol permits emissions trading between signatories to the Protocol.

Even within this system, Annex I countries (which includes Germany, Japan and Canada) can only buy from other Annex I or non-Annex I countries (which includes India, China, Brazil and Korea).

The current carbon trading model centres around CDM. CDM projects involve developed nations’ funding activities in developing nations that reduce GHG emissions and such activities result in the creation of new carbon credits by assisting emission reduction projects in these developing countries.

These projects create carbon emission reductions (CERs), where one CER is equivalent to one tonne of CO2 reduction and the credits earned from such activities are what are eventually sold as carbon credits.

Carbon trading impacting business climate

The creation of CER is subject to a lengthy process of registration, certification and monitoring by the UN or a local designated authority and it is necessary to demonstrate that the ‘greener project’ would not have been possible or had not been contemplated without the CDM funding.This mechanism facilitates economic advancement in developing countries and allows these countries to use their natural resources cleanly. Large GHG emitting nations can offset their emissions through such projects.The question therefore is what is the actual ecological and economic impact of this trading since these trades allow large emitters, without undertaking any alterations to their behaviour, to meet their mandatory emission limits simply by buying credits from elsewhere. One view is that reductions should in fact be at the source of pollution and that one needs greater community-based policies.

Recently, the Detroit Lions (a major US football team) announced that their customary thanksgiving day game will be a carbon neutral event and they will set off the emissions generated from the game by investing in rain forests in Ecuador. The Asia Society, America’s leading not-for-profit organisation, recently announced that its annual corporate conference, scheduled for May 2008 in Tianjin, China, will be carbon-neutral.

These are in addition to British Airways ongoing voluntary carbon trading schemes, allowing passengers to offset their carbon emissions by paying for their carbon liability.

All these projects fund initiatives in developing regions and carbon trading is economically benefiting developing nations. But, at present, there are no factors to indicate whether the upcoming UNFCC convention in Bali will be carbon neutral and what steps if any are contemplated to set-off the emission!

State of Carbon Trade in India

India (like China) is a signatory to the Kyoto Protocol but is currently not required to reduce any carbon emissions. Although, India is one of the larger emitters of GHG, it argues that developing nations have played little part in creating the problem and thus should not be required to take on any GHG reduction commitments.

India recognises that any reduction measures would require high levels of efficiency from the manufacturing and power sector, something that could adversely affect the Indian economy. A recent government study said it could have cost India $2.53 trillion if it were required to reduce its GHG emission to the 1990 emission levels under the Protocol.

The UN recently recommended to the Indian government that it take measures to reduce its GHG emissions. The recommendations, part of the UNDP — Human Development Report 2007, urge India (and China) to look beyond the distinctions of developed and developing countries and institute target-based commitments to facilitate GHG emission reduction. These recommendations can’t help but force one to think whether it is not in India’s long-term interest to undertake emission cuts.

One does question why similar recommendations have not been made to the US, which accounts for almost 70% of all the GHG in today’s atmosphere. Is it that the UN feels that it may be easier to push India to adopt efficient standards and the UN recognises that it can get severe resistance from the US which may undermine the legitimacy of UN’s other recommendations.

Carbon trading impacting business climate

Anyway, India now has the largest number of registered CDM projects and contributes to 22% of the global carbon trading market. For an Indian project to register as a CDM project it has to enroll both with the environment ministry and UNFCC. Despite the government being unsure on whether to treat carbon credits as a commodity or a financial instrument, the government is proactive in approving and registering CDM projects. Some speculate India could be the largest player in the carbon emission market, worth $100 billion.Companies in India are already exploring opportunities to generate CERs and most projects are in the energy sector. Recently, DMRC used fly-ash in its concrete structures, the Delhi Electricity Relay Corporation is generating electricity using methane and waste and Hindustan UniLever is earning carbon credits from the use of a new soap making technology.But with UNFCC recently having rejected nine projects submitted by Indian companies for carbon reduction, the carbon trading market must proceed with caution. Given that India currently has no carbon trading exchange, most emission reduction purchase agreements are long-term contracts, with the promise of a certain number of credits to be purchased at a later date, all of which are subject to various things, apart from and the CDM risk. It needs to be ensured that the ERPAs are structured to avoid massive defaults by Indian companies.

Eventually, as UNFCC prepares for the Bali negotiations starting December 3 and nations discuss options on measures to be adopted upon expiry of the Protocol in 2012, it is becoming imperative to look beyond coal and other fossil fuels.

China and India need to accept that they can no longer ignore rapidly increasing fuel costs and the pressing need for energy security. The US has to recognise that it can’t continue to oppose the Protocol since legislative bills are receiving cross-party support in the US Congress and winning favour with fortune 500 companies, all of whom support a federal regulation to restrict GHG.

With Australia’s recent change of guard and the labour party leaders resounding support to ratify the Protocol, one hopes for renewed support towards the Kyoto Protocol. What remains to be seen is whether the participating nations can be as innovative in devising conclusive arrangements for when the Protocol expires similar to the originality displayed with CDM projects.

First Published in the Economic Times on November 30, 2007
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