Traders probe Europe’s CO2 frontiers

The EU’s emissions trading scheme may be the largest greenhouse gas market in the world, but it is not alone and it does not operate in isolation. As well as its connections to other nations through the ‘project trading’ mechanisms of the Kyoto Protocol, it may soon find itself linked to emissions trading systems in other countries, whether it likes it or not.

The Kyoto Protocol provides the context for the creation of the EU ETS, and, like other signatories, the EU states can take advantage of the protocol’s trading mechanisms. Countries can directly trade their emission allocations under the protocol, for instance if an economic downturn or other factors leave them with a surplus. Russia, the Ukraine and countries in central and eastern Europe are considered prime candidates for this approach, with Romania and Slovakia already trading part of their allocation.

More common is the trade in emission reduction projects, where countries able to make reductions cheaply solicit sponsorship for such projects in exchange for emission reduction credits. The Kyoto Protocol provides two mechanisms for doing this: the Clean Development Mechanism (CDM) covers emission reduction projects in countries without Kyoto commitments, sponsored by commitment countries, while Joint Implementation (JI) allows for projects between countries with Kyoto commitments.

CDM in particular has been taken up with enthusiasm, with several thousand projects planned or under way. India, China, and Brazil are particularly active in hosting projects, while the EU member states together account for more than half of the scheme’s customers. Japan is also a significant participant.

While these mechanisms are aimed at governments trying to meet their Kyoto targets, it is also expected that CDM and JI credits can be used by participants in the EU ETS to meet their commitments, although so far this has not taken place: it is too early for JI projects and the international transaction log necessary for recognition of CDM credits has been delayed. The existing greenhouse gas trading system in Japan also recognises CDM, as do present and planned systems in Australia and the US, (the irony being that neither country has ratified the Kyoto protocol).

This means that CDM will become a point of contact between trading systems, indirectly linking them together and providing a point of comparison for prices. Analysts are already predicting that the CDM mechanism will strengthen and endure beyond the end of the Kyoto protocol, regardless of its successor. There has also been some secondary trading in CDM credits, which could grow as the scheme matures.

A more involved question is whether the different trading systems will form direct links. For credits to be traded between systems requires a degree of harmonisation that may be prohibitive given the differences between how existing and planned schemes operate. Where this is expected to happen, for instance the planned link between the EU ETS and the Norwegian trading system, it is thanks to parallel development.

A simpler approach is for one system unilaterally to recognise the credits generated by another, as has already happen between the Chicago Climate Exchange and the EU ETS. In May 2006 Baxter Healthcare surrendered EU allowances for 100 tonnes of greenhouse gas, allotted to its facility in Castlebar, Ireland, in return for 100 tonnes of credit to the company’s account with Chicago. This was despite the price per tonne being significantly higher in the EU than in the US.

The possibility of such unilateral links with the EU ETS are also foreseen, under certain circumstances, in the plans for the US RGGI scheme and the Australian national scheme. How far such links would be used remains in doubt. Analysts tend to think that, regardless of how far EU carbon prices fall, CDM projects will represent a better buy. And given the size of the EU ETS, the impact of a small number of transactions to other schemes is expected to be negligible.

• Ian Mundell is a freelance journalist based in Brussels.

Other markets

• Australia

The New South Wales Greenhouse Gas Abatement Scheme has operated a mandatory trading system for the electricity sector since 2003. Consultation on a national scheme closed in December 2006

• US

The voluntary Chicago Climate Exchange has operated since the end of 2003, and several regional schemes are under development. Nine north-eastern and mid-Atlantic states are working on a mandatory Regional Greenhouse Gas Initiative (RGGI) trading CO2 for the electricity sector, due to start in 2009. Caps on greenhouse gas emissions in California and Oregon are expected to be backed up with trading systems

• Japan

Japan began a voluntary CO2 trading scheme in 2005

• United Kingdom

A voluntary greenhouse gas trading scheme ran from March 2002 to December 2006. A mandatory replacement scheme is now being considered

• Norway

Norway established its own CO2 emission trading scheme in 2005. It is similar to the EU ETS, and Norway set itself the political target of making trading between the two systems possible from 2008

The EU’s emissions trading scheme may be the largest greenhouse gas market in the world, but it is not alone and it does not operate in isolation. As well as its connections to other nations through the ‘project trading’ mechanisms of the Kyoto Protocol, it may soon find itself linked to emissions trading systems in other countries, whether it likes it or not.