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Climate science tells that the earth is warming due to human activities. But considerable uncertainty regarding the precise nature and extent of the risks remains. Climate change happens slowly and has a global impact on the physical environment, whereas financial markets react to news in fraction of a second and are almost liberated from specific physical locations. The low energy intensity of financial sector means that reductions in greenhouse gases (GHGs) emissions would have little impact on physical operations of financial markets and institutions unlike for instance their effect on electricity production and transport. Nevertheless, financial markets potentially play two important roles in the policy response to climate change. They foster mitigation strategies, that is, the steps taken to reduce GHGs emissions for a given level of economic activity by improving the efficiency of the schemes to price and reduce emissions and the allocation of capital to cleaner technologies and producers.
Furthermore,
financial markets can cut the costs of adaptation by reallocating
capital to newly productive sectors and regions and hedging weather
related risks. In recent years, markets in carbon trading, weather
derivatives and catastrophe (CAT) bonds have seen sharp increases in
activity and innovations, which bodes well for the future. Hence
recognizing how financial markets will react to climate change
initiative and how they can best promote mitigation and adaptation will
become crucial to shaping the future policy and minimizing its costs.
Failure in reflection of basic understanding of finance can cause major
setbacks to climate change policy.
GHGs Emissions:
Burning
of fossil fuels is a major source of industrial GHGs emissions,
especially for power, cement, steel, textile and fertilizer industries. The major greenhouse gases (GHGs) emitted by these industries are carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydro fluorocarbons (HFCs), Per fluorocarbons (PFCs) and Sulphur hexafluoride (SF6) which will increase the atmosphere’s ability to trap infrared energy and thus affect the climate.
Carbon Credits:
The concept of carbon credits came into existence as a result of increasing awareness of the need for controlling emissions. The IPCC has observed that:
Policies
that provide a real or implicit price of carbon could create incentives
for producers and consumers to significantly invest in low GHGs
products, technologies and processes. Such policies could include
economic instruments, government funding and regulation (IPCC 2000).
This
tradable permit system is one of the policy instruments that have shown
to be environmentally effective in the industrial sector, as long as
there are reasonable levels of predictability over the initial
allocation mechanism and long term price. Every Annex-I country had
been assigned the amount of emission which is to be reduced by the
concerned country. It also implies that a country is permitted to emit
the remaining amount. This emission amount of allowance is actually one kind of carbon credit. The total amount is then subdivided into certain units expressed in terms of carbon equivalent. Each
unit gives the owner the right to emit one metric tones of carbon
dioxide or other equivalent GHGs. There is, however, another variant of
carbon credit. This variant of carbon credit is
to be earned by a country by investing some amount of money in such
projects known as carbon projects which will emit lesser amount of
GHGs. This exchange may take place within the economy or may take the
form of international transactions. Accordingly there are two types of carbon trading, namely, emission trading or cap-and-trade and offset trading or base-line-and credit trading.
Credit cards are generated by enterprises in the developing world that
shift to cleaner technologies and thereby save on energy consumption,
consequently reducing their GHGs emissions.
Carbon
trading is the name given to the exchange of emission permits,
alternatively known as carbon credit. It is an emission allowance which
was originally allocated or auctioned by the national administrators of
a cap-and-trade program or it can offset of emission. Such
offsetting and mitigating activities can occur in any developing county
which has ratified the Kyoto Protocol and has a national agreement in
place to validate its carbon project through one of the UNFCCC’s
approved mechanisms. Once approved, these units are termed as Certified Emission Reductions (CERs). The Protocol allows these projects to be constructed and credited in advance of the
·
Under Joint Implementation
a developed country with relatively high costs of domestic GHGs reduction would set up a project in another developed country.
·
Under the Clean Development Mechanism
(CDM) a developed country can sponsor a GHGs reduction project in a
developing country where the cost of GHGs reduction project activities
is usually much lower, but the atmospheric effect is globally
equivalent. The developed country would be given
credits for meeting its emission reduction targets, while the
developing countries would receive the capital investment and clean
technology or beneficial change in land use.
·
Under International Emissions Trading
(IET) countries can trade in the international carbon credit market to
cover their short fall in allowances. Countries with surplus credit can
sell them to countries with capped emission commitments under the Kyoto
Protocol.
The
Clean Development Mechanism (CDM), defined in Article 12 of the
Protocol, allows a country with an emission-reduction or
emission-limitation commitment under the Kyoto Protocol (Annex B Party)
to implement an emission-reduction project in developing countries.
Such projects can earn saleable certified emission reduction (CER)
credits, each equivalent to one tonne of CO2, which can be counted
towards meeting
These
carbon projects can be created by a national government or by an
operator within the country. In reality, most of the transactions are
not performed by national governments directly but by the operators who
have been set quotas by their country. For trading purpose, one
allowance of CER is considered equivalent to one metric tonne of CO2 emissions. These allowances can be sold privately or in the international market at the prevailing market rates. These trades were settled internationally and hence allow allowance to be transferred between countries. Each internationally transfer is validated by the UNFCCC. Each transfer within the European Union is additionally validated by the European Commission.
Climate Exchanges:
Climate
exchanges have been established to provide spot market in allowances,
as well as futures and options market to help discover a market price
and maintain liquidity. Carbon prices are generally quoted in Euros per tonne of carbon dioxide or its equivalent (CO2e). Other GHGs can also be traded, but are quoted as standard multiples of CO2 with
respect to their global warming potential. Currently there are six
exchanges trading in carbon allowances, namely, European Climate
Exchange; Nord Pool; Power Next; Multi Commodity Exchange and National
Commodity and Derivative Exchange. NCDEX is the first exchange in any
of the developing countries of the world to launch a futures contract
for carbon credit issued under United Nations Framework Convention on
Climate Change on its Exchange Platform. CER prices on NCDEX will be in
tandem with the international markets. Physical delivery of CERs will
also be facilitated where specific delivery requirements of the buyers
and sellers will be matched for guaranteed deliverable CERs. Recently, Nord Pool listed a contract to trade offsets generated by a CDM carbon project. Many
companies now engage in emissions abatement, offsetting and
sequestration programs to generate credits that can be sold on. MCX has
futures trading in Carbon Emission Allowances. The allowances for
carbon emissions allocated to developed countries up to their target
level under the Kyoto Protocol. These allowances are tradable under
Carbon
trading is becoming popular day by day. The volume of carbon trade is
increasing at a faster rate. A recently released World Bank report, State and Trends of the Carbon Market 2008,
points out that the value of carbon credits had doubled from $32
billion in 2006 to $64 billion in 2007. Amidst this burgeoning trade,
the record on carbon emission cuts is rather dismal. Emissions
increased by 1.1 per cent annually in the 1990s, and 3 per cent
annually between 2000 and 2004. This is despite the Kyoto Protocol
mandating a 5 per cent cut in 1990 emission levels by 2008-2012. This
is bound to grow even further as participation increases from other
countries that have not so far ratified to the Kyoto Protocol. As per
World Bank estimates, Carbon Finance unit, volume of carbon trade only
through Emission trading route had shown a 240 per cent increase in
2005 over the previous year. Barclays Capital predicts that “Carbon
will be the world’s biggest commodity market and it could become the
world’s biggest market overall”. As the deadline for meeting the Kyoto
Protocol draws nearer, prices can be expected to rise as
countries/companies save credits to meet strict targets in the future.
The rapid growth of
Carbon Taxes:
But this is not a good sign. Kyoto Protocol was signed to reduce GHGs emission. But
this flexibility mechanism allows, especially the main culprits, to
skip their reduction by spending some money. Moreover funds are
invested in carbon projects which are meaningless from the view of
emission reduction. Such projects only create a
false sense of emission reduction and thereby jeopardize the ultimate
objectives of the entire exercise. The time is now to fight climate
change. We have to level with the public that there has to be a price
on carbon emissions. Apparently, there should be a tax on carbon
emissions. The belief is that by starting a carbon emissions tax, it
would help reduce emissions and encourage companies and others to use
renewable energy sources. These people in the fossil fuel industry
should be prosecuted. Ecological Internet supports a global carbon
market that is well regulated, but not as a replacement for carbon
taxes, which will address the issue of pricing carbon more quickly,
effectively and simply. While short-term politics favour markets, taxes
would be better in the long term because industry needs certainty for
investments... A government committing to painful taxes signals the
seriousness of its intentions.
What we need therefore is: A much bigger
CDM which essentially incentivise green investments with reduced transaction costs by penalizing the polluters and a
separate
mechanism
for financing technology development and technology transfer.
This mechanism should be based on historic emissions of developed
countries on cumulative basis. In the next two years, when the UNFCCC
process would agree on the targets and processes that would constitute
the second commitment period of the Kyoto Protocol, it is the right
time for
The
Kyoto Protocol brings into focus the callousness with which humans have
polluted the earth’s atmosphere. The negative impact of this industrial
growth is being felt more by the less developed countries such as
Indian Scenario:
Other
than Industries and transportation, the major sources of GHGs emission
are the paddy fields, enteric fermentation from cattle and buffaloes
and municipal solid waste. The emission from
paddy fields can be reduced through special irrigation strategy and
appropriate choice of cultivars; whereas enteric fermentation emission
can also be reduced through proper feed management. In recent days the
third source of emission, that is, Municipal Solid Waste (MSW) dumping
grounds are emerging as a potential CDM activity despite being provided
least attention till date. At present there are no Sanitary Landfill
sites in
World
over, major companies are spotting "green spots" for investment and
pouring in their resources to devise products that are at once
revenue-generators of the future as well as accolade earners. With
global warming becoming real threat, big corporate players of the world
are developing environmentally conservative technologies which will see
huge demand in future to cash in on million-dollar future demands. The
carbon market, growing at a fast pace in
Currently,
Low CER rates, non-enforcement of rich nations' renewable energy investment commitments
in poor nations, lack of transparency in the CDM quantification process
and several other irregularities are cited in the CDM market.
The
CDM, one of three mechanisms of the Kyoto Protocol, allows Annex-I or
industrialized nations to buy emissions reduction units, called CERs,
from non- Annex developing countries. Annex I rich nations can then
count these credits towards their GHGs emissions targets. The principle
is to help rich nations reduce the costs of meeting their reduction
targets by 2012 whilst mitigating climate change and helping developing
nations. There are six greenhouse gases (GHGs), carbon dioxide,
methane, nitrous oxide, hydro fluorocarbons, per fluorocarbons and
sulphur hexafluoride. One tonne of carbon dioxide or its equivalent of
the other five gases makes one CER.
As per the CDM rules, the
emissions reduction should benefit sustainable development, help
alleviate poverty, create clean technology in a carbon-less economy and
produce local benefits among others. But not a single one of
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Each
of the eight panels will have an institutional structure consisting of
government departments, industry experts, academics and citizen
representatives, the government said. Each so-called mission will
devise a state-funded plan and have authority to carry it out. The
missions include developing efficient building technologies and better
managing waste, conserving water, and sustaining the environment of the
Dr Gursharan Singh Kainth
is the Director GAD Institute of Development Studies, 14-Preet Avenue,
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