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Emission Trading

Emission Trading

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55
Emission Trading under the Kyoto Protocol
ISSN 02357208. Energetika. 2003. Nr.4
Emission Trading under the Kyoto Protocol
 Arvydas Galinis,Skirmantas Pileckas
 Laboratory of Complex Energy Research, Lithuanian Institute of Energy, Breslaujos 3, LT-3035 Kaunas, Lithuania
Lithuania is on the integration way to the various world organisations andunions,
 e.g 
., NATO and EU. In parallel, Lithuania should ratify the maininternational treaties, charters and protocols, the Kyoto Protocol
inter alia
.It is not enough just to ratify the Protocol, all the obligations should betaken into account as well. It is an essential question for Lithuania  howto reach the Kyoto targets? The purpose of the article is to overview thepossibility of the implementation of the Kyoto Protocols mechanisms, suchas Emission Trading and Joint Implementation, in Lithuania.
Key words:
Kyoto Protocol, Emission Trading and Joint Implementation
1. INTRODUCTION AND KEY POINTS
The
Kyoto Protocol
is an agreement among thecountries of the world, negotiated in 1997. The worldhas decided to reduce its emissions of greenhousegases by 5% by 2012. The Protocol must be signedby at least 55 countries representing 55% of theWorlds emissions before its provisions can enterinto force. The status is presently that the EU, Ja-pan and most part of the world, but not the UnitedStates, are ready to ratify the protocol. Lithuania isplanning to join the team, which will be subjectedby the Kyoto Protocol and consequentially by therelated mechanisms. Already from 1997, the EU andin parallel all accession countries started the inte-gration of the Kyoto Protocol requirements in theirlegislation. In 2000, there was drafted the GreenPaper on Greenhouse Gasses Emission Trading within the European Union [1]. The above-men-tioned document was drafted with the intention tolaunch a discussion on greenhouse gas emission trad-ing within the European Union and on the rela-tionship between emission trading and other poli-cies and measures to address climate change. According to the Kyoto Protocol, there is givenan assigned amount for all the countries, which isreally its limit to pollute. Lithuanias assignedamount is 92% of its 1990 level [2]. If one country wishes to sell Emission Reduction Units (ERUs) toanother country, the assigned amount will be regu-lated accordingly. This means that Lithuania in prin-ciple can exploit the difference between its presentlevel of emissions and the 92%.In general,
Emission trading
(ET) is a market-based instrument related to the issue how to reduceclimate change. Kyoto Protocol has foreseen ET asa possibility to reduce the compliance cost of re-ducing CO
2
emissions. ET as an instrument is mainlysuitable for the rich industrialised countries, theClean Development Mechanism (CDM) is intendedfor the third world and Joint Implementation main-ly for the Central and Eastern European (CEE)part of the industrialised world. However, there isonly one active system in place in the EU, which issimilar to the ET systems, namely the Danish sys-tem for CO
2
quotas in the power sector. Also, thepower plants in the USA have a cap-and-trade sys-tem for reduction of SO
2
emissions. American com-panies in the power sector were given a limit onSO
2
emissions and were invited to trade pollutioncredits among them. The companies with the high-est SO
2
reduction costs bought permissions for com-panies with low reduction costs. For these latter, it was more profitable to reduce emissions and sellthe credits. The limited practical experiences withJoint Implementation have been made mainly bySweden, the Netherlands [8] and the World Bank.Conclusions here point to a value of an ERU inthe range of 59 EUR/t CO
2
equivalent. There are,however, reasons to believe that the value of theERU is not the only important factor when an EUcompany decides whether to invest in a JI projector not. The project may be part of a larger expan-sion plan by this company.The main players in the ET on the one side willbe the companies that consider to buy so-calledERUs or credits, instead of carrying out reductionof emissions themselves. Sometimes it is even im-possible to perform the reduction,
 e.g 
., in nonflexib-le industries, such as construction, chemical, steel
 
56
 Arvydas Galinis, Skirmantas Pileckas
and iron. On the other side, the energy sector willbe the main seller of credits, because the sectorgenerally can reduce its emissions at a rather lowcost. Moreover, it should be mentioned that ETshould go hand in hand with electricity trading. As regards the
 Joint Implementation
(JI), it wasintroduced as a tool for reducing emissions (mainlyCO
2
) by the technology transfer. JI is a market-based concept. Western EU countries generally havehigh CO
2
reduction costs, while Central and East-ern Europe (CEE) generally has low reduction costs.EU investors may invest in the CEE project, there-by reducing emissions there. The achieved reduc-tions are credited on the CO
2
account of the hostcountry and debited on the CO
2
account of the in- vestors home country. The resulting Emission Re-duction Units (ERUs) are sold at a market price,and the investor keeps the profit. On the other hand,the host country benefits from increased investmentsin its technological base, and from positive effectsof CO
2
reducing technologies locally: less damagesto the general health and cleaner air.The energy is the best sector for JI, becausesignificant reductions can be achieved by relativelysimple methods, and the result is relatively easy tomonitor and verify. The Baltic area is likely to bethe main area to benefit from JI. The EU countriesaround the Baltic Sea and some others face diffi-culties in reducing their emissions, and the candi-date countries own a significant amount of poten-tial projects.JI as a concept will most likely be competing with ET. The relation between Joint Implementa-tion and Emissions Trading is that ET is essentiallytrading in ERUs, the same unit as JI projects resultin. However, ERUs from JI projects should be pro-duced, while ERUs for emissions trading can beimmediately available. In accession countries, manyERUs are available. All the emission reductions thatresulted from the industrial decline and reorganisa-tion are in principle a resource for ERUs. How-ever, if all CEE countries can sell these unusedemissions, the value of the ERU will be close tozero, especially if Russia is included. In that case,Joint Implementation projects will not be profitablefor EU investors.Moreover, it could be mentioned that a directiveon emissions trading is under preparation by theEuropean Commission. Its tentative date for thestart of emissions trading in the EU is 2005 [6].The international ET, as regulated by the Kyoto Pro-tocol, will enter into force in 2008. However, theWorld Bank has estimated that about one billiontonnes of CO
2
need to be removed each year in theso-called commitment period 20082012. If half thatreduction happens through trade-based mechanisms,and the price of reductions is 5.5 EUR/t CO
2
, thenthe trade volume could reach EUR 1020 billionper year.
2. THE PRINCIPLES OF THE RELEVANTMECHANISMS
 Emissions trading (ET)
ET was never used in real life. However, a numberof experiments have been run. Nowadays, the Euro-pean Commission is drafting the directive for ET[6]. Therefore, it could be strongly assumed thatthe main efforts will be centered around that par-ticular document. On the other hand, the UnitedStates as a country having one of the biggest CO
2
emissions in the world has not introduced any simi-lar trading arrangements.The cheapest and easiest possibility to reduceCO
2
emissions is found in the energy sector. There-fore, the main sellers of CO
2
credits will typicallybe energy companies, even if there will be trade just among the companies. The highest reductioncosts are found in the transport sector, and theyare rapidly increasing. As one can see in the sche-me, the main element of the electricity and CO
2
trading system is the electricity sector, which playsa significant role. The liberalised electricity market where the power companies can buy and sell elec-tricity is already functioning in many EU MemberSates and takes the first steps in Accession Coun-tries including Lithuania. On the top of the electri-city market the elements of the CO
2
market couldbe placed. However, it should be politically estab-lished. CO
2
Emission Reduction Units (ERUs) arethe main commodity in this market.One of the most important conditions for hav-ing CO
2
market is that companies have a limit onthe amounts of CO
2
emission. If the limit, or cap,is not in place, there is no incentive to buy, andconsequently not to sell either. This cap is basedon the total emission cap of a country, distributed
Fig. 1. CO
2
and electricity market functioning scheme
ElectricitycompaniesERU
Electricitymarket
Energyconsumers
CO
2
market
 
Sales &purchaseSales &purchasesPurchasesSales &purchases
 
57
Emission Trading under the Kyoto Protocol
among the sectors allowed to participate in tradingby a particular country or region. The cap has notbeen settled yet in the EU or any of the membercountries. Only Denmark has already set a CO
2
emission cap for its power industry.ET as a mechanism should have a clear allo-cation of emission credits. There are several possib-le explanations of the principles of allocation of ERUs [1]:
Grandfathering.
Historical data are used to de-termine the amount of credits allocated to each com-pany. The more they have polluted in the past, themore they will get;
 Benchmarking 
. Allocations are made as if plants were using the most efficient technology and pro-cesses available, giving incentives for participants toimprove on existing standards;
 Auction
. Pollution credits are auctioned to themarket actors. Companies with high CO
2
reductioncost will be willing to pay more for allowances thancompanies with low reduction costs.The European Commission has decided in itsdraft directive [6] that pollution allowances shouldbe allocated for free in all Member States. Thisessentially excludes the
 auctioning 
principle, butcould include the
 grandfathering 
principle, especiallyif combined with the
 benchmarking 
principle. It would give pollution reduction to sectors, based ona reasonable standard level of pollution per unit of output from that sector. This would mean that somepower stations would receive pollution reduction, andsome would not. The member states are howeverfree to decide exactly which principles should beapplied.Why is the energy sector very attractive in viewof ET and JI? The reason is that the technology isready and available for increasing the efficiency andusing non/low polluting fuels (
 e.g 
., installation of gasturbines). One of the most attractive means when asufficient heat load is available (such as district heat-ing networks) would be installation of CombinedHeat and Power Plants, which instantly increase theefficiency and reduce primary energy use by some2030%.It is still unclear who will be the formal buyerof emissions. It may be the government itself, whichbuys the emission credits and then distributes themlater. On the other hand, there may also be directtrade between companies, like in the liberalized elec-tricity market.
 Joint Implementation (JI)
 According to the Kyoto Protocol, JI does not allowto sell unspent emissions directly, even if the totalemission limit is far below the limit for 2010. Theemission credits can only be achieved by investing intechnology that will further reduce emissions from arelevant CEE country. The Kyoto Protocol statesthat projects are eligible if they provide a reductionin emissions by sources, or an enhancement of re-movals by sinks, which is additional to any that wouldotherwise occur (article 6) [2]. The above statementstresses that the main target for JI projects could bethe energy sector. JI projects can be carried out inother sectors too, but the energy sector has specialcharacteristics that make it suitable for this type of project;
 e.g 
., large-scale reductions can be achievedby fuel conversion in power plants, or heat boilers. Also, a high energy efficiency could be achieved byconverting heat boilers to Combined Heat and Powerunits. That kind of projects could significantly bene-fit for CO
2
reduction. In other sectors the projectsprobably can be smaller and more different. There-fore, such cases will increase the transaction costs of doing the project. The situation will be the same with minor energy producers. Additionally, it shouldbe stressed that nuclear power cannot qualify as aproject under the Kyoto Protocol, even if it nowa-days saves for EU around 300 mill. t of CO
2
emis-sion per year [3]. It was decided under the UnitedNations Framework Convention on the Climate Chan-ge (UNFCCC) on the Conference of Parties (Sixthsession, part two), which took place in Bonn on 1627 July 2001. The Parties have agreed that nuclearpower plants will not be used to generate carboncredits, and as a result there will be no JI or CDMnuclear projects [13].
3. GROUND FOR EMISSION TRADING
The Kyoto Protocol sets the overall demand for CO
2
credits. The Western countries decided to cut off 5% of CO
2
emission compared to 1990 levels andthe EU to 8%. As Lithuania is planning to becomea member of the EU, the 8% reduction of emissionagainst the 1990 level is foreseen.
Fig. 2. Total EU greenhouse gas emissions in relation to theKyoto target [10]

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