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20/11 Reading Casestudy 1?

Carbon credits: How they help reduce GHG

Publication:The Business Times 24/03/2008
No. of words:596

What are carbon credits? Each carbon credit allows the holder to emit one tonne ofcarbon dioxide equivalent.

Carbon credits have no physical underlying product – unlike derivative contracts like oil or grain futures, which are written on the actual commodities.

Rather, credits are created in two ways. The first type of credits are allowances, which are handed out to developed countries and effectively set a quota on their pollution.

The second type are project-based. They are created when an entity in a developing country completes a project that permanently reduces its greenhouse gas emissions. The project is verified by the UN, which issues credits to the entity. The entity can then sell the credits to developed country buyers.

The market exists because of the Kyoto Protocol, under which some developed countries, mainly in Europe and North America, agreed to cut their GHG (greenhouse gas) emissions by an average of 5 per cent from 1990 levels by 2012.

Who buys carbon credits? End demand comes from two sources. The first and largest consists of compliance buyers, located mainly in Europe, such as power generators. They must buy credits to offset their emissions, if they are exceeding their allowances.

The second, far smaller, source comes from voluntary buyers – both companies and individuals - from the US, Japan, Australia or elsewhere, who want to help fight global warming (or give the impression they are doing so).

Some 23.7 million tonnes worth of voluntary credits were bought in 2006, compared to nearly 1.64 billion tonnes worth of UN-issued credits.

Where do credits come from? The largest source is the European Union Allowances (EUAs), which are handed out to European countries based on the pollution quotas each state is allowed. 1.13 billion tonnes, or US$24.6 billion worth, of EUAs were traded in 2006.

The second source are project-based, such as under the Joint Implementation (JI) programme or the Clean Development Mechanism (CDM). About 500 million tonnes of project-based credits, worth US$5.5 billion, were traded in 2006.

How are credits traded? Trading takes place on exchanges, like the European Climate Exchange, or the Chicago Climate Exchange.

They are also traded through hedge funds, banks, or other intemediaries, which aggregate credits from projects all over the world, structure them into portfolios, then sell them on to end-buyers.

Many funds also invest directly in projects that cut emissions, with plans to hold or sell the generated credits.

Further, buyers can purchase directly from sellers, though this may again be arranged through a broker, or an online auction platform, like Singapore's own Asia CarbonExchange.

How does carbon trading help the environment? The carbon markets are essential to setting a price for carbon. This is important because companies then recognise there is a monetary benefit from reducing their pollution, because they either need to purchase fewer credits, or can sell off excess credits.

The market exists because of the commitments from countries to cut emissions and the political will to follow through with these promises. While the market enables countries to meet commitments by buying credits from others, any efforts to fight climate change must begin with commitments from governments, companies and individuals.

Some say that a carbon tax would be more efficient to administer, and less vulnerable to lobbying by industry groups than a cap-and-trade system. Industry players counter that atrading system allows the free market to discover the price for emissions.