CARBON MARKETS

OVERVIEW

There are several types of carbon markets operating throughout the world, and the differences may be confusing. The markets can be divided into two basic types:

1. Compliance markets (associated with countries that have ratified the Kyoto treaty), and

2. Voluntary markets (operating in countries that have not ratified the Kyoto treaty, such as the U.S.).

There are significant differences in these markets, both in terms of how they operate and market prices for carbon credits. Agricultural producers and others in the U.S. who hope to sell carbon credits someday, or already are selling credits, should have a basic knowledge of these markets so they know what to expect. The following is a brief summary of the two basic types of carbon markets in operation today in the U.S. and abroad.

1. The Compliance Carbon Market (outside the U.S.)

This is also sometimes called the “regulated” carbon market, and came about as a direct consequence of the Kyoto Protocol. Most developed countries in the world, except for the U.S. and Australia, ratified the Kyoto Protocol, which established legally binding targets for greenhouse gas (GHG) reductions. These countries have been termed “Annex I” countries. Industries and governments in these countries had to meet specific targets for reductions. Those that could not meet their mandated reductions were allowed to enter the marketplace to buy carbon credits or emission reduction units.

To enable compliance the Protocol established Flexible Mechanisms to allow these countries to meet their targets by trading carbon credits or emission reduction units. These mechanisms are: the Clean Development Mechanism (CDM); Joint Implementation (JI); and Emissions Trading. In addition to this, several nations and groups of nations have developed their own trading mechanisms to help them meet their targets; the biggest of these is the European Emissions Trading Scheme (EU ETS).

* The Clean Development Mechanism (CDM). This mechanism allows Annex I countries to buy carbon credits from emissions-reducing and emissions-saving projects in developing countries. These projects generate emissions credits called Certified Emissions Reductions (CERs) which can then be bought and traded. One CER is equal to one tonne of carbon dioxide equivalent gases. To be recognized, CDM projects have to demonstrate that they create savings which are additional to anything that might have happened anyway — a concept known as “additionality.” An authorized third party called the Designated Operational Entity is responsible for the verification and certification of the project. Verification involves on-site inspection and review. The certification procedure provides written assurance that the project has achieved the claimed emissions reductions. A CDM “Gold Standard” has been developed by a group of NGOs led by the World Wildlife Federation-UK. CDM projects are restricted to renewable energy and end-use energy efficiency projects, and are also assessed via a scoring system on their environmental, social and economic impacts on sustainable development. The standards for acceptance as a certified CDM project are costly and have often proven to be difficult to achieve.

* Joint Implementation (JI). This mechanism is similar to the CDM mechanism, except that the emissions-reducing projects are in other developed countries, rather than developing countries. These projects generate tradable credits which are called Emission Reduction Units (ERUs). As under the CDM, projects must demonstrate additionality and go through a similar verification and certification process.

* Emissions Trading. The Kyoto emissions trading scheme is a cap-and-trade scheme. In a cap-and-trade system parties are given an emissions allowance based on an emissions reduction target. A limited number of allowances are issued equal to the “global” GHG emissions reduction target. In the Kyoto scheme each allowance is called an Assigned Amount Unit (AAU), which is equivalent to one tonne of carbon dioxide. The implementation of this process can seem a little complicated. At the end of a period each party must hold enough AAUs to equal the amount of greenhouse gas it emitted. This allows parties to decide whether to reduce their emissions internally, or to buy credits from other parties.

* The EU Emissions Trading Scheme (EU ETS) began in January 2005 and is the largest emissions trading scheme, covering 12,000 installations in 25 countries. The trading units in this scheme are called EU Allowances (EUAs). Parties in this scheme can buy and sell EUAs, or they can purchase—within certain limits—CERs from the Clean Development Mechanism or ERUs under Joint Implementation. The EU ETS has become a significant factor in reducing emissions across Europe.

2. The Voluntary Carbon Market (within the U.S. and elsewhere)

This is also sometimes called the “unregulated” carbon market. Those in the U.S. may look at the carbon trading activity in Europe, and especially at the prices that carbon credits are bringing overseas, and see that prices for carbon credits are much higher than on the voluntary market in the U.S., through the Chicago Climate Exchange (CCX). That’s one difference between a compliance and a voluntary carbon market. Not only is the basic rationale for carbon trading different in a voluntary system, but there is no agreement yet on what standards should be used to verify these voluntary carbon credits.

The Voluntary Carbon Market includes more than just business and organizations in the U.S. Both within and outside the U.S., individual consumers and others not included in the Compliance Carbon Market can also buy credits in the Voluntary Carbon Market. One advantage of the Voluntary Carbon Market is that participants can buy both credits which originate from the compliance market and credits which originate from the voluntary market. It is not always very clear to buyers exactly which type of credit they are buying.

Carbon credits generated within the Voluntary Carbon Market are recognized only within the particular trading scheme with which they are associated, unlike credits generated within the Compliance Carbon Market. In other words, the Voluntary Carbon Market credits are not universally recognized credits that can be marketed on any trading scheme in the world. The most widely used Voluntary Carbon Market in the U.S. is the Chicago Climate Exchange. The CCX trading scheme is a legally-binding market where parties can set self-imposed, GHG emissions reductions targets.

In any Voluntary Carbon Market trading scheme, those who invest in emissions reductions do so for a variety of reasons, such as helping to address climate change, or helping to reduce the impact of their carbon footprint. Some credits in this market are verified according to certain standards, others do not meet any identifiable verification standards. Unlike in the Compliance Carbon Market, in the Voluntary Carbon Market there are no uniform standards for creating credits. There are, however, a number of voluntary standards emerging. Two of the biggest of these are the Voluntary Gold Standard and the Voluntary Carbon Standard. Another standard is being developed by Duke University’s Nicholas Institute for Environmental Policy Solutions. There are also standards which have been created for other types of offset projects. An example is “Plan Vivo” which is created for projects in rural communities which promote sustainable livelihoods. Here is a brief summary of the various voluntary carbon credit standards:

* The Voluntary Gold Standard (VGS). Launched by World Wildlife Federation-UK in May 2006, the Voluntary Gold Standard is a simplified version of the CDM Gold Standard (mentioned above). The methodology creates Voluntary Emissions Reduction Units (VERs). The VGS is only available for projects in developing countries.

* The Voluntary Carbon Standard (VCS). The Voluntary Carbon Standard has been developed by The Climate Group and the International Emissions Trading Association. Version 1 of the VCS was released for consultation in March 2006. Version 2 is in development. The VCS has creates a unit called the Voluntary Carbon Unit (VCU). The Voluntary Carbon Standard aims to ensure that all voluntary emission reductions projects are independently verified. The VCS will provide protocols and criteria to certification entities and project developers. The VCS has created a registry managed by the Bank of New York.

* The Climate, Community and Biodiversity Standards (CBB). These standards were developed by the Climate, Community and Biodiversity Alliance. They are for "land-based projects that can simultaneously deliver compelling climate, biodiversity and community benefits." There are three levels of CBB validation: approved, silver, and gold. An independent third party evaluates whether the project merits approval, and if so, at what level. The standard uses the methodologies of the Intergovernmental Panel on Climate Change Good Practice Guidance (IPCC GPG), but can also used approved CDM methodologies for calculating carbon reductions/ savings.

* Nicholas Institute for Environmental Policy Solutions. A new “how-to” manual for reducing U.S. greenhouse gas emissions through land-use sequestration in farmlands and forests, and turning those reductions into verifiable credits for trading in carbon markets, is about to be released. Duke University Press will publish Harnessing Farms and Forests in the Low-Carbon Economy: How to Create and Verify Greenhouse Gas Offsets, a technical guide for farmers, foresters, traders and investors, in June. A preview of the guide is available online at http://www.nicholas.duke.edu/institute/ghgoffsetsguide/ Duke’s Nicholas Institute for Environmental Policy Solutions developed the guide in collaboration with the nonprofit advocacy group Environmental Defense, and scientists from Kansas State University, Texas A&M University, Colorado State University, Rice University, Princeton University, and Brown University, as well as other experts. The guide explains how farmers and foresters can convert their land’s carbon dioxide storage capacity into revenue-generating “offsets” that can be bought and sold in future carbon markets. Providing recommendations for specific land-use practices and formulas for calculating sequestered carbon, the book provides technical information needed by quantifiers, verifiers, and traders of the offset credits.

* The Plan Vivo System. This system offers a standard for "managing the supply of verifiable emission reductions from rural communities in a way that promotes sustainable livelihoods." The Plan Vivo System is managed by BioClimate Research and Development, a not-for-profit organization. Projects are usually monitored using local experts, and credits are registered on a database.

* Verified Emission Reductions. To add confusion to the matter, voluntary offset retailers have developed their own standards to create credits with the generic term of Verified Emission Reductions (VERs). This is not to be confused with Voluntary Emission Reductions used in the “Gold Standard” system. In the Gold Standard system, the emissions reduction or saving uses a single set of standards. In the Verified Emission Reductions system, the standards vary widely in many respects including how the project baselines are calculated, how additionality is tested, and how verification is carried out. For some projects, this is not done at all, which reflects the cheaper cost of some of these credits in the voluntary market. It is up to the buyer of credits to determine what standards they want their credits to meet. Consequently these sorts of credits are neither comparable nor tradable.

* Proposed Government Code in the UK. In January 2007 the UK’s Department for Environment, Food and Rural Affairs (DEFRA), launched its consultation on establishing a voluntary code of best practice for the provision of carbon offsetting the UK customers. Its purpose in establishing the code is to "ensure consumer confidence in an emerging market and continued growth of that market through that confidence." The code would apply only to compliance market credits being traded in the voluntary market, principally, CERs.

Note: This article is based in part on the Environmental Audit – Sixth Report from the UK House of Commons, issued in July 2007. For the complete report, see:

http://www.publications.parliament.uk/pa/cm200607/cmselect/cmenvaud/331/33102.htm

-- Steve Watson, CASMGS Communications

Kansas State University

swatson@ksu.edu