Climate Change Part 2: What is carbon trading?

The world is currently trying to formulate an agreement to stop the planet getting warmer (see part 1). And as the planet heats up, so does the pressure on governments to find a replacement system for the Kyoto Protocol (which expires in 2012).

In all likelihood, it will be a global set of rules surrounding the buying and selling of carbon credits.

What is carbon trading?

Each business is allocated a certain amount of credits, depending on its industry. The credits equal the number of tonnes of emissions the business is allowed to release into the atmosphere every year.

If a business releases fewer emissions, then it can sell its unused credits on a market, much like the share market. If it releases more, then it must buy enough credits to meet its emissions, or face heavy financial penalties.

Businesses can also offset their emissions by reducing the carbon they produce, or donating to various environmental groups.

This provides a financial incentive for businesses to produce fewer carbon emissions – they will either make money by selling credits, or lose money by spending more on offsetting their extra emissions.

This system is called ‘Cap and Trade.’ The caps are the limits that governments decide each industry will get. A coal power station will be allocated more credits than an accounting firm, for example, but the power station’s limits will still be strict enough to encourage it to find ways to emit less carbon.

Major criticisms of carbon trading to date are that caps under the Kyoto Protocol are too high, and that the lack of global participation creates “carbon leakage” (i.e. businesses can avoid the scheme by manufacturing in non-capped countries).

Who judges how much each business actually emits is up to individual countries, but could include government organisations, specialist private companies or accountants.

Why don’t developing countries want carbon caps?

Developing nations rely on carbon-heavy industries for their livelihood, but also for development (that is, their ability to raise the standard of living through trade and industry).

For example, deforestation is one of the leading causes of global warming, but countries such as Brazil, Indonesia, and the Democratic Republic of Congo depend on the logging trade for survival.

Although China and India are two of the world’s biggest polluters, the amount of greenhouse gas they produce per person is low. Their emissions come from development (such as the two new coal power stations opened every week in China) rather than cars, aeroplanes or other modern conveniences.

On top of this, low-carbon technology is expensive. Given that richer countries have profited from their earlier industrialisation, developing countries want richer countries to commit to financing low carbon technology for everyone.

In the meantime, non binding and less expensive domestic initiatives (such as converting methane emissions to electricity) are a more appealing way for developing countries to reduce their carbon footprint.

Rich countries

In addition to paying for low-carbon technology on a global level, industrialised countries must also manage their own domestic carbon costs.

Sectors such as transport, energy and manufacturing are necessary, but they are heavy carbon emitters. Implementing carbon caps will mean those businesses will have to buy excess credits, or find low-carbon alternatives to their current practices.

As mentioned, businesses that don’t comply with their emissions allowance will face penalties.

Governments have therefore considered measures to sustain such key industries. In Australia for example, the proposed emissions trading scheme (which was semi-confirmed yesterday) temporarily exempts farmers from paying any penalties for excess carbon emissions.

The American problem

Although Obama has been optimistically vocal about the US commitment to setting viable carbon targets, strict caps will have a significant effect on America’s economy.

For starters, the US is a farming nation – and not only is farming a key source of carbon emissions, farmers will also face higher costs for necessary tools such as fertiliser, fuel and electricity. On the other hand, farmers stand to profit if they curb their emission outputs and adopt greener technology.

Strict carbon caps will also hurt the energy and automobile industries as they will have to spend money to offset their likely excess emissions.

And when global competitors such as China, India and Brazil will not pledge reductions in their emissions, it becomes particularly difficult for Obama to justify emissions rules that decreases these industries’ profitability.

The climate change bill currently in front of the Senate proposes a 17% reduction from 1995 levels by 2020, moving to 83% by 2050.

On Monday, the White House said it would still announce target goals at Copenhagen. But with actual laws still to be finalised at home, it remains to be seen what impact big business will have on the final target numbers, not only for America, but for the whole world.

By Natalya King