Carbon Market and the Kyoto Protocol
Carbon markets are trading systems in which carbon credits are sold and bought. The emergence of carbon market can be traced back to the adoption of the Kyoto Protocol in 1997. The Kyoto Protocol was an international agreement to reduce greenhouse gas emissions in industrialized countries. The goal was to save mankind from the threat of climate warming by stabilizing the amount of greenhouse gases in the atmosphere at an appropriate level.
The Kyoto Protocol established three market mechanisms aimed at reducing emissions: the Clean Development Mechanism, International Emissions Trading and Joint Implementation. These mechanisms allow developed countries to flexibly complete emission reduction tasks through carbon trading markets, while developing countries can obtain relevant technologies and funds.
How do the 3 market mechanisms work?
Clean Development Mechanism
The Clean Development Mechanism (CDM) is a way for countries with emission-reduction or emission-limitation commitments under the Kyoto Protocol to implement emission-reduction projects in developing countries. These projects can earn saleable certified emission reduction (CER) credits, which are like points, each equivalent to one tonne of CO2. These points can be used to help the investing country meet its Kyoto targets.
International Emissions Trading
The Kyoto Protocol is an international agreement in which countries with commitments to limit or reduce their greenhouse gas emissions have agreed on specific targets for reducing their emissions. These targets are expressed as levels of allowed emissions over a certain period.
To help achieve these targets, the Kyoto Protocol allows countries with emissions units to spare to sell this excess capacity to countries that are over their targets. This has created a new commodity in the form of emission reductions or removals, commonly referred to as “carbon credit“. Carbon credit is now tracked and traded like any other commodity, which has given rise to the “carbon market.”
In addition to actual emissions units, other trading units can also be bought and sold in the carbon market under the Kyoto Protocol’s emissions trading scheme.
Joint Implementation
Joint Implementation is a mechanism established under Article 6 of the Kyoto Protocol that enables countries with emission reduction or limitation commitments under the Protocol (known as Participating Parties) to invest in emission-reduction or emission removal projects in other Participating Parties. The idea is that by investing in such projects, the investor country can earn emission reduction units (ERUs) equivalent to one tonne of CO2, which can be counted towards meeting its Kyoto target.
The benefit of Joint Implementation is that it provides Participating Parties with a flexible and cost-efficient means of fulfilling a part of their Kyoto commitments, as they can invest in emission-reduction projects in other countries that may be more cost-effective than reducing emissions domestically. Additionally, the host country benefits from foreign investment and technology transfer, which can help to support sustainable development and reduce emissions.
What is Carbon Trading?
Carbon trading is the buying and selling of carbon credits. The two main types of carbon credits are Certified Emission Reductions (CERs) and Verified Emission Reductions (VERs). CERs are issued under the Clean Development Mechanism (CDM) of the Kyoto Protocol, while VERs are issued under voluntary emissions reduction programs.
The price of carbon credits is determined by supply and demand. As emissions reduction targets become more stringent, the demand for carbon credits increases, and their price rises. Vice Versa.
The Global Carbon Market Continues to Grow
According to the World Bank report, despite the global economic downturn in 2020, the carbon market continues to grow. The carbon market provides a way for companies and countries to meet their emissions reduction targets in a cost-effective manner and has become an important tool in the fight against climate change. At present, many countries and regions, including China and the European Union, are implementing carbon trading markets.
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References:
Articles from HKEX: https://www.hkexgroup.com/media-centre/insight/insight/2022/hkex/carbon-markets-explained?sc_lang=en
Video from The Economics: How do carbon markets work?
Articles from Worldbank: https://www.worldbank.org/en/news/press-release/2022/05/24/global-carbon-pricing-generates-record-84-billion-in-revenue