Carbon Market
The Clean Development Mechanism (CDM)
What is the Clean Development Mechanism? The Clean Development Mechanism (CDM) is an emission reduction mechanism established in Article 12 of the Kyoto Protocol. Under this mechanism Annex I countries can participate in the implementation of projects that reduce GHG emissions and that are physically located in non-Annex I countries. Provided certain conditions are met, they can use these emission reductions to comply with their emission reduction commitment targets under the Kyoto Protocol.
CDM offers Annex 1 countries a flexible and cost-efficient means of fulfilling a part of their Kyoto commitments, while the non-Annex 1 party benefits from foreign investment and technology transfer.
The CDM cycle consists of the following steps:
- Project Design Document development
- National approval
- Validation of the project by an accredited auditor ("Designated Operational Entity - DOE")
- Registration of the project by the CDM Executive Board of the UNFCCC
- Monitoring of the emission reductions
- Verification and certification of the emission reductions by a DOE
- Issuance of the Certified Emission Reductions (CERs) by the CDM Executive Board
What has CDM achieved?
- More than 1600 CDM project activities registered
- About 1.5 billion CERs expected from registered projects up to 2012
- Over 280 million CERs already issued
In order to qualify under the CDM, emission reductions resulting from the implementation of registered projects need to be real, measurable, and long term. Furthermore, each tonne reduction of carbon-dioxide-equivalent-emissions, once verified and certified, results in the issuance of a CER (Certified Emissions Reduction). The purchase and sale of CERs constitutes a CDM transaction.
The EU ETS
Launched January 1 2005, the European Union Emission Trading Scheme (EU ETS) is the world's first international company-level 'cap-and trade' system of allowances for emitting carbon dioxide (CO2) and other greenhouse gases (GHGs).
The EU ETS is based on the recognition that creating a price for carbon offers the most cost-effective way to achieve the deep reductions in global GHG emissions that are needed to prevent climate change from reaching dangerous levels and for the EU to achieve the reduction targets it committed to under the Kyoto Protocol.
At present some 11,000 installations from the 27 Member States of the EU and neighbor countries including Iceland, Liechtenstein and Norway participate in the ETS. These installations belong to the power and heat generation industry and selected energy-intensive industrial sectors such as: combustion plants, oil refineries, coke ovens, iron and steel plants and factories making cement, glass, lime, bricks, ceramics and pulp and paper. These sectors account for 50% of the EU's total CO2 emissions and 40% of its overall GHG emissions. Starting 2012 the aviation sector will be included, adding to the system airlines operating within, to and from the EU zone.
The EU ETS is based on four fundamental principles:
- It is a 'cap-and-trade' system
- Participation is mandatory for businesses in the sectors covered
- It contains a strong compliance framework
- The market is EU-wide but taps into emission reduction opportunities in the rest of the world by accepting credits from projects carried out under the Kyoto Protocol's CDM and JI
The EU ETS is being implemented in distinct phases or 'trading periods':
- Phase 1, 2005-2007 was a three-year pilot phase of 'learning by doing' in preparation for the crucial phase 2. The generation of verified annual emissions data filled an important information gap and created a solid basis for setting the caps on national allocations of allowances for phase 2.
- Phase 2, 2008-2012 coincides with the 'first commitment period' of the Kyoto Protocol - the European Commission has cut the volume of emission allowances permitted in phase 2 to 6.5% below the 2005 level, thus ensuring that real emission reductions will take place.
- The European Commission proposes that Phase 3 should run for eight years, from 1 January 2013 to 31 December 2020. This longer trading period will contribute to the greater predictability necessary for encouraging long-term investment in emission reductions.
- One EU emission allowance (EUA) gives the right to emit one tonne of CO2. Member States are currently required to draw up national allocation plans for each trading period setting out how many allowances each installation will receive each year. Decisions on the allocations are made public.
The limit or 'cap' on the total number of allowances allocated creates the scarcity needed for trading. Companies that keep their emissions below the level of their allowances can sell their excess allowances at a price determined by supply and demand at that time. Those facing difficulty in remaining within their allowances limit have a choice between several options ensuring that emissions are reduced in the most cost-effective way.
- Take measures to reduce their emissions (such as investing in more efficient technology or using a less carbon-intensive energy source)
- Buy extra allowances and or CDM/JI credits on the market
- Use a combination of the two