At present, certified emission reductions (CERs) are not the only one type of carbon credit participating in the world’s carbon market. In fact, CERs forms only a small fraction of the credits being traded and exchanged globally. The Kyoto Protocol originates different types of carbon credits, such as assigned amount of units (AAUs), removal units (RMUs), emission reduction units (ERUs) and certified emission reductions (CERs). The following gives a broad overview how Annex I and non-Annex I Parties may involve in an exchange or purchase of different categories of carbon credits.
Annex I Parties1
The key target of the Kyoto Protocol is for all Annex I Parties reduce their GHG emissions by 5% from 1990 levels over the 2008-2012 commitment period. The total cut in GHG reductions is divided up so that each Annex I Party has its own individual emissions target.
Based on these individual targets, each Annex I Party is assigned a total emissions amount that it may emit over the commitment period and still meet its emissions target. These are known as “assigned amount units”, or AAUs, acting as legally-binding constraints on a Party’s greenhouse gas emissions. To comply with these limits, a Party may offset its emissions by increasing the amount of greenhouse gases removed from the atmosphere by using carbon sinks or conducting greenhouse gas reduction activities.
1At present, all Annex I Parties to the UNFCCC have signed and adopted the Kyoto Protocol, except for the US.
Figure 1 Example of GHG emissions reduction targets assigned for an Annex I country
Example: Figure 1 illustrates a schematic diagram showing assigned amount units for an Annex I Party (country A) over the commitment period, and the amount of necessary carbon credits required to meet its compliance level. Country A in this example is subject to a 6% reduction of GHG emissions from its 1990 level, shown by the bar furthest left . Since the commitment period covers 5 years time, the target is multiplied by 5. This becomes the assigned amount unit for country A, as shown by the barsecond from the left.
To the right is a comparison of the greenhouse gases expected to be emitted by country A over the same period of time. If the total emissions exceed the allowable assigned amount units, country A is required to offset these emissions by acquiring “carbon credits” from locally implemented carbon sink activities. Some activities in the Land-Use, Land-Use Change and Forestry (LULUCF) sector, such as afforestation and reforestation, are also covered. These emit or absorb carbon dioxide from the atmosphere. The credits resulting from eligible sink activities are known as “removal units”, or RMUs.
Country A may find it relatively difficult to meet its emissions target locally. Under the Kyoto Protocol, country A can adopt three cooperative mechanisms to earn additional credits elsewhere, in other words, from different countries. These mechanisms include International Emission Trading (ET), Joint Implementation (JI) and the Clean Development Mechanism (CDM). These mechanisms give countries and private sector companies the opportunity to reduce the costs of meeting their emissions targets by achieving emission reductions in other countries at lower costs than they could reach domestically. These emission reductions can then count towards their own reduction targets.
In brief, country A may acquire additional credits through the transfer of assigned amount units (AAUs) from other Annex I countries under the ET mechanism. Alternatively, by the JI scheme, it may implement a project that reduces emissions (e.g. an energy efficiency scheme) or increases removal more sinks (e.g. a reforestration project) in the territory of another Annex I Party. The credits earned are counted as emission reduction units (ERUs). Also, country A may implement projects in non-Annex I Parties that reduce emissions through the CDM scheme and use the resulting certified emission reductions (CERs) to help meet its own target. Nevertheless, the overall costs that country A bears to comply with its commitment depends on the total amount of the carbon credits necessary to count against its emission reduction target.
Non-annex I Parties
Unlike the Annex I Parties, developing countries, including Thailand, do not have any obligatory emissions reduction targets. Instead, Non-annex I Parties are only requested to submit National Inventories and to report their actions taken to address climate change and adapt to its effects. These are the general commitments under the UNFCCC that place a fundamental obligation on both industrialized and developing countries.
Since developing countries do not have emissions reduction targets, the AAUs carbon credits are not assigned to these countries. Also, as the Clean Development Mechanism is the only mechanism under the Kyoto Protocol that allows for the participation of developing countries, a non-Annex I Party may be able to participate in a trade or purchase of carbon credits only in the form of certified emission reductions (CERs).
In general, carbon credits can be classified into two main groups according to their origin: the credits originated from Annex I Parties' allowed emissions, and the credits resulting from project activities.
1. Carbon credits derived from Annex I Parties' allowed emissions:
Annex I Parties are industrialized countries that are required to fulfill mandatory emissions reduction commitments. They must commit to limiting GHG emissions and enhancing their sequestration. The emissions reduction target is for all Annex I Parties to reduce their GHG emissions by 5% from 1990 levels over the 2008-2012 commitment period. To meet their targets, each member of the Annex I Party is assigned its own individual targets. This in turn sets the limit of its ‘allowed emissions’ over the commitment period, called the “assigned amount units.” Under the Kyoto Protocol, International Emission Trading (ET) permits countries to transfer parts of their “assigned amount units” in order to meet their targets.
2. Carbon credits originating from project activity:
Clean Development Mechanism (CDM) is one of the three flexible mechanisms that allow Annex I Parties to implement projects that reduce emissions, or increase removals by sinks, in the territories of non-Annex I Parties. The carbon credits generated by CDM projects are “certified emission reductions” that can be claimed by the project investor. The CDM encourages the transfer of technology between Annex I and non-Annex I Parties and promotes sustainable development in the host countries.
Joint Implementation (JI) allows Annex I Parties to implement projects that reduce emissions, or increase removals by sinks, in the territories of other Annex I Parties. The JI mechanism allows countries to claim credits for emission reductions that arise from investment in other industrialized countries. This in turn results in a transfer of equivalent “emission reduction units” between the countries.
It can be observed that through the three cooperative mechanisms of the Kyoto Protocol, carbon credits become more like commodities, and they are tradable or exchangeable in a market known as the “carbon market.” Carbon credits are not tangible; instead, they are traded under a purchasing contract by a transfer of proprietary documents showing the rights on claimable credits. These credits can be counted against the emission reduction targets of the buying country.2 Also, the purchasing contract normally sets out the terms and conditions of payment between the seller and buyer.
Nevertheless, the driver of market prices for the carbon credits largely depends on their ‘quality.’ CERs are generally lower in price compared to AAUs. This is because the origin of CERs is project-based, and CER prices can be largely concerned with investment costs, risks and uncertainties associated with project performance. Meanwhile, AAUs are virtually available from the allowed emissions granted according to the Protocol. As a result, AAUs have no associated cost, they are risk-free, and they are mostly viewed as premium credits.
2At present, there are a number of active carbon markets. A high trading volume is found in the EU and US markets. However, as the US has not yet ratified the Kyoto Protocol, the cap and trade system in US markets is rather limited to industries at the state level using their own independently-developed mechanisms.
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