Carbon Trading: A Review of the Kyoto Mechanismscourses.washington.edu/pbaf595/Readings/6b - Carbon Markets I/He… · 2These are carbon dioxide (CO 2), methane (CH 4), nitrous oxide

ANRV325-EG32-13 ARI 2 October 2007 13:14

Carbon Trading: A Reviewof the Kyoto MechanismsCameron HepburnSt. Hugh’s College and the Environmental Change Institute, Oxford University,Oxford OX2 6LE, United Kingdom; email: [email protected]

Annu. Rev. Environ. Resour. 2007. 32:375–93

The Annual Review of Environment and Resourcesis online at http://environ.annualreviews.org

This article’s doi:10.1146/annurev.energy.32.053006.141203

Copyright c© 2007 by Annual Reviews.All rights reserved

1543-5938/07/1121-0375$20.00

Key Words

CDM, climate change, emissions trading, flexible mechanisms, JI,Kyoto Protocol, voluntary carbon market

AbstractThe three Kyoto flexible mechanisms—emissions trading, the cleandevelopment mechanism (CDM), and Joint Implementation ( JI)—have always been controversial. Proponents saw the mechanisms asclever tools to ensure environmental outcomes were achieved at leastcost. Reducing the costs of compliance, they argued, would maketighter environmental targets possible, and certainly more politi-cally feasible. Detractors have argued that the flexible mechanismscommoditize Earth’s atmosphere in a manner that will allow du-bious projects and the exchange of “hot air” to substitute for seri-ous engagement on climate change. This chapter reviews the Kyotoflexible mechanisms, which will become fully operative during theperiod 2008 to 2012. The review assesses their progress and successto date, examines the problems that have emerged, and considerssuggestions for future developments in climate policy.

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ETS: EmissionsTrading Scheme

Contents

1. INTRODUCTION . . . . . . . . . . . . . . 3762. CLIMATE ECONOMICS: THE

BIG PICTURE . . . . . . . . . . . . . . . . . . 3773. CARBON TRADING AND THE

KYOTO FLEXIBLEMECHANISMS . . . . . . . . . . . . . . . . . 3793.1. Conceptual Underpinnings . . . 3793.2. International Emissions

Trading and the CarbonMarkets . . . . . . . . . . . . . . . . . . . . . . . 380

3.3. The European EmissionsTrading Scheme . . . . . . . . . . . . . . . 380

3.4. The Clean DevelopmentMechanism . . . . . . . . . . . . . . . . . . . 381

3.5. Joint Implementation . . . . . . . . . 3823.6. Other Carbon Markets . . . . . . . 382

4. ASSESSMENT OF THE EUETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3834.1. Achievements . . . . . . . . . . . . . . . . 3834.2. Problems . . . . . . . . . . . . . . . . . . . . 383

5. ASSESSMENT OF THE CLEANDEVELOPMENTMECHANISM . . . . . . . . . . . . . . . . . . 3855.1. Achievements . . . . . . . . . . . . . . . . 3855.2. Problems . . . . . . . . . . . . . . . . . . . . 385

6. FUTURE DIRECTIONS . . . . . . . . 3876.1. Geographical Expansion . . . . . . 3876.2. Sectoral Expansion . . . . . . . . . . . 3886.3. Temporal Expansion. . . . . . . . . . 3886.4. Caps and Allocations . . . . . . . . . 389

7. CONCLUSIONS . . . . . . . . . . . . . . . . 389

1. INTRODUCTION

Over the past few years, climate change eco-nomics and carbon trading have moved fromthe academic arena to front page headlinesin mainstream newspapers. This is partlybecause climate change has itself moved upthe political agenda, promoted by weatherevents such as the European heat wave in2003, Hurricane Katrina in the United Statesin 2005, and the droughts, bushfires, and

snow (almost simultaneously) in Australiain 2006. Not only has climate change beenplaced at the top of the Group of Eight (G8)nations (Canada, France, Germany, Italy,Japan, Russia, the United Kingdom, and theUnited States) and the European Union (EU)agendas, carbon offsetting has captured theinterest of individuals and businesses whowant to “do their bit” for the atmosphere.Media interest has been heightened byintroduction of the pan-European EmissionsTrading Scheme (EU ETS) in 2005 andthe publication of the Stern Review on theEconomics of Climate Change (1).

All this recent activity and publicity mightgive the impression that carbon trading is aradically new idea. However, the conceptualunderpinnings for carbon trading began within 1920 with Pigou (2), who pointed out thesocial benefits of forcing companies to pay forthe costs of their pollution, and were devel-oped by Coase (3), who showed that allocatingproperty rights and allowing trade can yieldefficient results.1 The first explicit applica-tion of these ideas to pollution was proposedin 1968 by Dales (5). In a typical “cap andtrade” scheme, the government issues a to-tal number of permits, or allowances, whichgive firms the right to emit pollution. Be-cause fewer allowances are issued than firmsneed, allowances are valuable and trade with apositive price. The price provides firms withan incentive to reduce their emissions whenthis is cheaper than purchasing allowances.In short, the basic theory of emissions trad-ing has been established for almost fourdecades.

Nor is the practice of emissions tradingparticularly novel. Trading of sulfur dioxide(SO2) and nitrogen oxides (NOx) began inthe United States in the 1990s (6). It wasgreeted with skepticism but is now viewedby many as a success. Carbon trading, which

1Pearce (4) provides a valuable intellectual history of envi-ronmental economics.

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refers to the trading of emissions of six majorgreenhouse gases,2 is more recent. The EUETS is the largest scheme to date, althoughit is by no means the first, and it only capsEurope’s carbon dioxide emissions from fixedindustrial installations, leaving the other fivemajor greenhouse gases, and the other sec-tors, to be addressed through other policymeasures. Before the EU ETS, several gov-ernments had implemented carbon tradingschemes, including the United Kingdom in2002 and the Australian state of New SouthWales in 2003. The 1997 Kyoto Protocol tothe United Nations Framework Conventionon Climate Change (UNFCCC) provided forcarbon trading through three “flexible mecha-nisms,” over its first commitment period from2008 to 2012. Even though the first commit-ment period has not yet commenced, the firstforward carbon trades occurred many yearsearlier, long before the Protocol came intoforce on February 16, 2005, and the very firstvoluntary trades (by parties not subject to reg-ulatory requirements) occurred almost twodecades ago, in the late 1980s.

What is new, however, is the sheer scaleof the enterprise. The Kyoto Protocol hasprompted the emergence of major interna-tional markets in carbon, the largest of whichby far is the EU ETS. In 2006 alone, theinternational carbon markets were estimatedto have turned over $30 billion, and the ag-gregate annual value of the permits to emitcarbon dioxide on the EU ETS, called EUAllowances (EUAs), were worth more still.Any analysis of the bigger picture (see Sec-tion 2 below) suggests that this is just thetip of the iceberg if humanity is going toachieve the emission reductions necessary toavoid dangerous anthropogenic interferencewith the climate, which is also economicallysensible (1).

A great deal rides on the success or fail-ure of this global socioeconomic experiment

2These are carbon dioxide (CO2), methane (CH4), nitrousoxide (N2O), hydrofluorocarbons (HFCs), perfluorocar-bons (PFCs) and sulfur hexafluoride (SF6).

UNFCCC: UnitedNations FrameworkConvention onClimate Change

EUA: EuropeanAllowance

in commoditizing and trading carbon. Thischapter provides an overview and an assess-ment of carbon trading and the Kyoto flexi-ble mechanisms. What has been achieved sofar? What are the crucial problems? What fu-ture developments are likely? Finally, what arethe directions for future policy-relevant re-search? Section 2 provides a brief overviewof the bigger picture, outlining the scale andnature of challenge that carbon trading isintended to address. Section 3 reviews thethree Kyoto mechanisms. Section 4 exam-ines how these mechanisms have facilitated orstimulated carbon trading around the world.Section 5 attempts an assessment of the re-sults so far of this grand experiment. Section 6considers future directions, and Section 7concludes.

2. CLIMATE ECONOMICS:THE BIG PICTURE

Any examination of carbon trading must beinformed by the magnitude of the problemit is being asked to address. The size of thechallenge is apparent from some simple arith-metic in the Third and Fourth AssessmentReports of the Intergovernmental Panel onClimate Change (IPCC) (7, 8). Since theonset of the Industrial Revolution, almost300 gigatonnes of carbon (GtC) have beenreleased into the atmosphere. Stabilizationof the atmospheric concentration of carbondioxide at around 450 parts per million byvolume (ppmv), which may involve an ∼50%probability of exceeding 2◦C warming (1),requires cumulative emissions since the In-dustrial Revolution to be below 670 GtC (7,§3.8.3).

Extremely roughly, then, a 450 ppmv tar-get leaves us with an “atmospheric reserve”of around 370 GtC. However, consumingproven conventional oil and gas reserveswould add another 200 GtC to the atmo-sphere, and there are likely to be substantialoil and gas reserves beyond 200 GtC that arenot currently considered “proven” or are “un-conventional.” Moreover, there is more than

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1000 GtC available in proven coal reserves (7,§3.8.3). The IPCC Fourth Assessment Report(8) estimates that in 2004, annual global emis-sions of all greenhouse gases weighted by theirglobal warming potentials totaled 49 GlCO2e(approximately 13 GtC) of which fossil CO2eemissions (including from cement and naturalgas flaring) constituted −30 GtCO2e (ap-proximately 8.2 GtC). These numbers haveoften been translated into a call for reductionsof between 60% to 80% on 1990 emissionsby 2050, which has led to the adoption of2050 targets by the United Kingdom (60%),France (75%–80%), and California (80%).3

By way of comparison, the emission re-ductions generated by the multibillion dollarmarket created by the EU ETS will almostcertainly represent less than 1% of globalemissions.4 For carbon trading to make asignificant contribution to achieving globalemission reductions of 60% to 80% by2050, the carbon markets will need to ex-pand extremely rapidly over the comingdecades. Net flows of up to US$40 bil-lion per year could be required, assum-ing that developed countries take responsi-bility for reductions of 90% by 2050 andassuming that 50% of their financial effort isdirected to developing countries (1). Ideally,the lessons from our experience to date wouldbe learned and applied before any such expan-sion occurs.

The significance and nature of the climatechange challenge implies that other policy in-struments will have to be employed in addi-

3A more complete list of government targets on climatechange and clean energy is provided by Stern et al. (1,Chapter 21).4It has been suggested that in 2005 the EU ETS deliveredemission reductions of between 50 megatonnes of CO2

(MtCO2) and 200 MtCO2, corresponding to reductions ofbetween 0.1% and 0.4% of global emissions (9). Over the2008 to 2012 period, the annual EU ETS cap is just over2000 megatonnes of CO2 equivalent (MtCO2e) per annum(10), and the EU ETS is extremely unlikely to stimulatenet emission reductions of 300 MtCO2e per annum, whichis 1% of global fossil CO2e emissions, let alone achievereductions of 490 MtCO2e per annum, which is 1% of thetotal greenhouse gas emissions.

tion to carbon trading. Taxes and subsidies canalso create an explicit price for carbon, andregulation creates an implicit carbon price.Information provision and other explicit pro-grams focused on behavioral change also havean important role to play. However, in part be-cause of its central place under the Kyoto Pro-tocol, carbon trading is currently the most sig-nificant instrument within global climate pol-icy. Although taxes are more efficient underuncertainty for climate change over short pol-icy horizons such as 5–10 years (11), there areat least seven reasons why trading is dominant:

1. International harmonized taxes are dif-ficult for countries to approve.

2. Unlike trading, taxes do not automat-ically support the international wealthtransfers necessary to decarbonize thedeveloping world’s economies.

3. Unlike trading, taxes do not create aprivate-sector lobby in favor of tightertargets.

4. Industry lobby groups are often stri-dently against taxes.

5. Environmental lobby groups are oftenagainst taxes because taxes do not placea quantity restriction on emissions.

6. Unless a system of tax credits wasconstructed, carbon taxes would be lesseffective at promoting the creation ofspecialized firms with specific expertiseand a core business in reducing carbonemissions.

7. Trading may increase management at-tention on carbon owing to the “carrot”of profit opportunities, whereas taxesoperate only by the “stick” of additionalbusiness costs.

Furthermore, even though trading is clearlyless efficient under uncertainty than taxesover short time horizons, careful design oftrading schemes to make them more “pricelike” (12) would reduce the efficiency differ-ence between carbon taxes and trading, aswould longer trading periods. So although itis not impossible that governments could shiftthe focus to coordinated global carbon taxes,these reasons suggest that trading should and

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will continue to play a central role in provid-ing carbon price signals after the first com-mitment period ends in 2012.

3. CARBON TRADING ANDTHE KYOTO FLEXIBLEMECHANISMS

After examining the conceptual underpin-nings of the Kyoto flexible mechanisms, thissection reviews carbon trading on the in-ternational level, under the European ETS,through the clean development mechanism(CDM), through Joint Implementation ( JI),and through other carbon markets.

3.1. Conceptual Underpinnings

The three Kyoto Protocol “flexibility mecha-nisms” are designed to enable emission reduc-tions to occur in the cheapest locations acrossthe globe. The first mechanism, emissionstrading, can occur between countries withbinding targets, so that countries can meettheir domestic targets by purchasing creditsfrom other countries that have exceeded theirtargets. The largest implementation of emis-sions trading to date has been the EU ETS.Second, the CDM is a project-based mecha-nism that allows credits from emission reduc-tion projects in poorer countries to be usedby rich countries to meet their own commit-ments under the Kyoto Protocol. Third, JI isalso a project-based mechanism that enablescountries with binding targets to get creditfrom projects carried out in other countrieswith binding targets.5

All three mechanisms rest on the Coasiansolution for the tragedy of the commons—privatize the commons and trade the result-ing property rights. It is clear from eco-nomic theory, if not also common sense, that

5Joint Implementation ( JI) is different than emissions trad-ing in that more industry sectors are included and jointparticipation is expected. At a practical level in Europe, JIallows credit for reducing any of the six major greenhousegases, whereas the EU ETS only covers carbon dioxide.

CDM: cleandevelopmentmechanism

JI: JointImplementation

well-informed trade between two consentingparties is likely to improve the lot of bothparties.6 Every time you go to your localstore to purchase some bread you are en-gaging in mutually welfare-enhancing trade.Similarly, with environmental assets, undersome relatively straightforward conditions,economic theory implies that an ETS willdeliver emission reductions at least cost tosociety. There is evidence to support thisassertion from experience in other environ-mental and nonenvironmental contexts (14,15).

Nevertheless, many people consider thatthe creation of markets in environmentalassets is ethically dubious at best, if not ob-noxious (16; see also 17). Some conceptualizethe emerging carbon markets as neoliberal“accumulation by decarbonisation” (18).Noting with concern that the Kyoto flexiblemechanisms were “made in the USA” (19),Lohmann (20) argues against carbon tradingon the grounds that it “reduces the politicalspace available for education, movement-building and planning around the neededfair transition away from fossil fuels.” Andsome environmentalists have denouncedcarbon trading by comparison with the saleof indulgences by the Catholic church in theearly sixteenth century (21).

In addition to these (more fundamen-tal) ethical disagreements, mainstream eco-nomic theory also stresses that an efficientoutcome—where it is impossible to makesomeone better off without making someoneworse off—is not necessarily fair, equitable, ordesirable (4). In environmental markets, fair-ness depends in large measure (but not en-tirely) on the initial allocation of the prop-erty rights. Some have argued that these newproperty rights will be acquired by “those whohave the most power to appropriate them andthe most financial interest in doing so” (20).This review examines equity issues involved in

6This proposition is probably more robust for develop-ments in behavioral economics, unlike other propositionssuch as “more choice increases welfare” (13).


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CER: certifiedemission reduction

ERU: emissionreduction unit

carbon trading and addresses its shortcomingsin practical implementation without enteringany further into deeper debates about the le-gitimacy of the market system in which mostof us operate.

3.2. International Emissions Tradingand the Carbon Markets

Article 17 of the Kyoto Protocol allows AnnexB7 countries to “participate in emissions trad-ing for the purposes of fulfilling their commit-ments,” provided that trading is supplementalto domestic action. This allows nation stateswho would not otherwise meet their commit-ments to purchase units from other states inthe form of

� Assigned amount units (AAUs), the unitassigned directly to nation states underthe Kyoto Protocol

� Certified emission reductions (CERs)from project activities under the CDM(see Section 3.4, below)

� Emission reduction units (ERUs) fromJI projects (see Section 3.5, below)

� Removal units on the basis of landuse, land-use change and forestry(LULUCF) activities.

The merit and likelihood of any directtrade of AAUs between nation states is cur-rently controversial. Targets for the KyotoProtocol commitment period of 2008 to 2012are referenced to the emissions baseline in1990, and the recession following the collapseof the Soviet Union has left Russia and theUkraine with a significant surplus of AAUs,which might exceed the net demand for AAUs

7There are essentially the Organisation for EconomicCo-operation and Development (OECD) countries alongwith countries undergoing transition to a market econ-omy. In total, there are 38 countries (39 entities in-cluding the European Community) listed in Annex Bof the Kyoto Protocol. This is almost identical tothe list of countries in Annex I of the FrameworkConvention on Climate Change. The differences are(a) Belarus and Turkey are not in Annex B becausethey were not Parties to the Convention when theProtocol was adopted, and (b) Croatia, Liechtenstein,Monaco, and Slovenia are in Annex B but are not inAnnex I.

from other nation states.8 Because this sur-plus has not resulted from efforts to transi-tion to a low-carbon economy, it is widelyreferred to as hot air, and countries such asAustria, Germany, and The Netherlands havestated that they will not buy Russian or East-ern European hot air unless the paymentsare “greened” by being directed to produc-ing other environmental benefits through a“Green Investment Scheme” (22).

In contrast to AAU trades, trading throughthe major subsidiary scheme of the Kyoto Pro-tocol, the EU ETS, is vigorous. Carbon trad-ing on the EU ETS in 2006 comprised 67%of the global carbon markets by volume, and81% by value, as shown in Figure 1 (23). Be-cause of the importance of the EU ETS, it isexamined in more detail in Section 3.3 below.The CDM (Section 3.4) comprises the vastmajority of the remaining volume of trades,with very small quantities traded thorough JI(Section 3.5) and other carbon markets (Sec-tion 3.6).

3.3. The European EmissionsTrading Scheme

The EU ETS was launched by the 25 coun-tries of the European Union on January 1,2005, and was intended to be the primarymechanism for achieving compliance with theEU-15 target of an 8% reduction in emissionsunder the Kyoto Protocol.9 The first commit-ment period of the Protocol runs from January2008 to December 2012, so this initial phaseof the EU ETS (Phase 1), which concludes inDecember 2007, was designed to familiarizeEuropean firms with emissions trading and topromote learning by doing.

8Russia and Ukraine would be expected to engage in tacitcollusion, restricting the AAU sales to maximize revenue.Hence, a theoretical excess supply would not be expectedto yield zero prices.9Fifteen EU countries agreed to a so-called “bubble” targetunder the Kyoto Protocol, so that the EU-wide target isan 8% reduction. Internal “burden sharing” arrangementsreflect a much wider range of targets from a 28% reduction(Luxembourg) to a 27% increase (Portugal) in emissions.

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The scheme covers over 11,000 instal-lations, including combustion plants, oilrefineries, coke ovens, iron and steel plants,and factories making cement, glass, lime,brick, ceramics, pulp, and paper. However,land and air transport are notably absent, andthe EU ETS only covers the most importantgreenhouse gas, CO2. Nevertheless, becauseit covers almost half of the total EuropeanCO2 emissions, it is the most importantEuropean climate policy instrument. AsFigure 1 illustrates, it is the largest carbonmarket in the world by a substantial margin,both by value and by volume. Moreover, theEU ETS is driving much of the activity inthe CDM, and these two markets combinedcomprise over 96% by volume and over 98%by value of the world’s carbon markets.

The tradable instrument is termed an EUAand is distributed to firms according to Na-tional Allocation Plans (NAPs). The NAPsare determined by discussion and negotiationbetween member states and the participatingfirms, and the NAPs are then submitted tothe European Commission for approval. TheNAP development process is not particularlytransparent, but well over 90% of the EUAsin both phases 1 and 2 are given to firms forfree (rather than being sold at auction) andare primarily based upon historical emissions(24). In phase 2, member states can increasethe share of auctioning up to 10% “withoutprior acceptance by the Commission,” and nomember state has proposed auctioning a pro-portion greater than 10%.

The EU ETS has become the hubof the global carbon markets through theimplementation of the “Linking Direc-tive” (2004/101/EC), which came into forceNovember 13, 2004, and allows for the use ofcredits from CDM and JI projects by firms inthe EU ETS.

3.4. The Clean DevelopmentMechanism

Under Article 12 of the Kyoto Protocol, theCDM was established to help non-Annex I

countries in “achieving sustainable develop-ment” and to provide Annex I countries withan alternative mechanism for complying withtheir targets. The CDM does this by allow-ing Annex I governments or private entitiesto accrue CERs from project activities in non-Annex I countries from the year 2000. CERsare only created if all parties give their volun-tary approval and if the emissions reductionsare real, measurable, and additional.

The process for putting together a projectunder the CDM requires the project de-veloper to satisfy a number of proceduralstages. These hurdles can involve relativelyhigh transaction costs, although there are sim-plified procedures for small-scale projects.Projects are proposed in a formal Project De-sign Document, which presents detailed in-formation, including a study of what wouldhave occurred without the project (the “base-line”), a monitoring and verification plan todetermine the quantity of emissions reducedthat are “additional” to the status quo, cou-pled with an estimate of expected emissionreductions. Projects are assessed against ap-proved methodologies for determining thebaseline and monitoring process. If the projectis novel and employs a methodology that hasnot yet been approved by the CDM ExecutiveBoard (CDM EB), further cost and delay areinvolved in submitting the methodology forapproval.

The Project Design Document must thenbe validated by a Designated Operational En-tity, which assesses whether the project passesthe relevant criteria, most crucially the addi-tionality criteria. After validation, formal ac-ceptance of the CDM project occurs once itis registered by the CDM EB. After registra-tion, the project’s monitored emission reduc-tions are periodically verified and certified bya Designated Operational Entity. On the ba-sis of a certification report, the CDM EB is-sues CERs via the CDM registry and forwardsthem into the account(s) specified by projectparticipants.

Typical projects to date have included re-newable energy projects (wind, smaller-scale


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hydro, renewable biomass) and the captureof destruction of damaging greenhouse gasessuch as methane, nitrous oxide, and hydroflu-orocarbons (see Section 5.2, below). AlthoughCERs produced by a CDM project will, indue course, be effectively fungible with EUAsby virtue of the Linking Directive, they cur-rently trade at a variety of price discounts asa function of the various risks that may beapplicable. These include the risk that theproject will deliver fewer emission reductionsthan planned, that problems or delays willarise in the UNFCCC administrative process(such as problems with the project method-ology, project registration, or verification ofCERs), that national caps will restrict the abil-ity CERs, and some residual risks relating toUNFCCC “International Transaction Log”and the European “Community IndependentTransaction Log,” the technology that linksregistries together and allows CERs to be em-ployed within the EU ETS.

Despite these various hurdles, in June2006, the UNFCCC announced the mile-stone that projects conducted under the CDMwould reduce emissions by the equivalent of1 billion tonnes of CO2 by 2012, and by May2007, there were over 1800 CDM projects inthe pipeline. At the time of publication of thisarticle (i.e., late 2007), this figure is expectedto have doubled. A more detailed assessmentof the CDM is contained in Section 5.

3.5. Joint Implementation

JI under article 6.1 of the Protocol allowsthe transfer or acquisition of ERUs betweenAnnex I states, which are also engaged inemissions trading. These ERUs can resultfrom projects in any sector of the economy(not just the sectors covered by the EU ETS),and they have to be approved by the relevantparties and be considered supplemental to do-mestic actions. JI processes have similar pro-cesses and institutions to the CDM. Sellersof ERUs are primarily from Russia and East-ern Europe, whereas the buyers are primar-ily Western European countries with tighter

Kyoto targets. More background informationon JI is presented in References 25 and 26.

3.6. Other Carbon Markets

The remaining carbon markets form a tinyfraction of the total volumes and do not comeunder the umbrella of the Kyoto Protocol.The largest of the remaining markets in termsof physical volume (66%) and financial value(90%) is a scheme in New South Wales, Aus-tralia, which results from a mandatory cap onpower suppliers (27). Like the EU ETS, thismarket allows offset projects, but at present,only Australian projects are permitted. An-other peripheral market is a voluntary schemerun by the Chicago Climate Exchange.

In addition to these markets, there hasbeen an explosion of interest in voluntaryoffsetting by individuals and corporationsover recent years, especially to cover emis-sions from air travel. A thriving consumer-ledmarket, which has not arisen in response togovernment regulation, is developing. Oneconsequence of this is that standards havebeen patchy, although more recently offsetretailers and nongovernmental organizations(NGOs) have collaborated to develop stan-dards and procedures that are similar to theprocedural requirements of the CDM but aremore closely tuned to consumer demands.Being closer to consumer needs, this marketis also the subject of more probing criticismby journalists (21, 28, 29) and NGOs. Nev-ertheless, because voluntary markets enablemore direct finance of small communityprojects, they may be better than the CDMfor encouraging sustainable development(18). Some commentators forecast that asindividuals come to understand climatechange and want to take personal action,voluntary markets will increase rapidly in vol-ume, potentially to several hundred milliontonnes of CO2e per annum by 2009–2010(30, 31). Although there is speculation thatthe voluntary markets could eventuallyovertake compliance markets (32), it seemsunlikely that altruistic sentiment alone could

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form the main driver of global emissionreductions. (See Reference 33 for morediscussion of voluntary markets.) However,both the Carbon Trust (http://www.carbon-label.co.uk/) and the Climate Group(http://theclimategroup.org/assets/carbonstewardship council discussion paper.pdf)are supporting carbon labeling of consumerproducts, which, among other things, maystimulate the market for goods and serviceswith bundled voluntary offsets.

4. ASSESSMENT OF THE EU ETS

Assessment of the performance of currentcarbon trading arrangements requires twopreliminary stages, namely the specificationof a plausible counterfactual and the speci-fication of criteria of assessment. Differentcounterfactuals are responsible for a greatdeal of debate about the merits of carbontrading. If the counterfactual is “no action,and no prospect of future action, on climatechange,” then carbon trading inevitablyreceives a positive report card. In contrast,if the counterfactual is an idealized state(e.g., rigorous carbon reduction policiesthat would be put in place by an omniscientglobal government), then carbon trading as itcurrently exists is an unambiguous failure. Amore realistic counterfactual might consist ofa patchwork of different carbon taxes in dif-ferent countries, with some attempt at globalharmonization and with some (probablylimited) side payments designed to encourageparticipation.

The criteria employed here include effec-tiveness (in delivering emission reductions),efficiency (at least cost), and equity (withacceptable distributional consequences).Dynamic issues and political factors are keptin mind.

4.1. Achievements

Perhaps the most remarkable feature of theEU ETS is that it exists at all, given that its cre-ation involved extraordinary challenges of co-

ordination between European bodies, mem-ber states, and a variety of different privateentities—each with different interests. Themost important single feature of the EU ETSso far is that Europe now has a coordinatedand explicit carbon price that is being re-ported across the continent in mainstreamnewspapers. The carbon markets have stim-ulated private-sector interest and finance andhave contributed to the shift in the attention ofEuropean board rooms toward climate changeas a pressing problem.

Although the spot carbon price has beenextremely volatile and is currently (in June2007) at an all-time low, there is some evi-dence that it has prompted some abatementefforts from European firms. Ellerman &Buchner (9) attempt to determine the ex-tent to which the current low prices in theEU ETS are the result of overallocation orabatement. Their results are very tentative,but their analysis suggests that CO2 emissionswere reduced by “an amount that was proba-bly larger than 50 million tons and less than200 million tons.” Interestingly, a 2006 surveyof European firms found that the EU ETS hadprompted 15% of respondents to take abate-ment measures, and the same survey, repeatedin 2007, found that 65% of respondents hadtaken some abatement measures (27).

4.2. Problems

These achievements, however, are simply toomodest when compared with the magnitudeof the challenge. Moreover, there are a sub-stantial number of problems with the designof first Phase of the EU ETS, which do notappear to have been corrected for Phase 2.

Perhaps the most egregious problem is thefact that EUAs are distributed for free, as arough function of past emissions. As is wellknown within economics, this leads to per-verse dynamic effects where firms have anincentive to emit more now in order to re-ceive a larger free allocation in the future. Fur-thermore, allocating EUAs for free inevitablyresults in rent-seeking behavior by firms as


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they invest valuable resources in lobbying toobtain a higher allocation.

Hepburn et al. (34) note that these prob-lems can be resolved by auctioning the EUAs.As well as resolving the above flaws, auc-tioning brings three additional benefits. First,auctions induce the private sector to revealtheir expected abatement costs to govern-ment, reducing problems of asymmetric infor-mation. Second, auctioning allowances pro-motes greater managerial focus on emissionstrading, which is likely to increase (cost-effective) abatement effort. Third, free alloca-tion is a regressive transfer of wealth from (rel-atively poor) citizens to (relatively wealthy)shareholders. Hepburn et al. (35) estimate theproportion of allowances that should be givento firms if policy makers are to leave firm prof-its unchanged before and after the introduc-tion of the scheme. They find that in manyindustries more than 50% of the allowancescould be auctioned without damaging firmprofits. It is not surprising, therefore, that util-ities in the United Kingdom are estimated tohave made 800 million in “windfall profits”(36). Policy makers elsewhere are taking heedof these lessons from the EU ETS, and cur-rent policy proposals in the United States andAustralia contemplate auctioning at least a sig-nificant proportion of allowances (generallyabove 50% and often 100%). Strangely it iswithin the Europe that these lessons appearto be being ignored: No member state is con-templating auctioning any more than 10% ofallowances in Phase 2 of the EU ETS.

Another important problem with the EUETS is that the determination of the NAPs in-volves asymmetric information and lobbying.Government is relying upon firms to revealtheir abatement cost curve in order to deter-mine an appropriate NAP. Yet firms have anincentive to bias their cost estimates upwardin order to obtain a more generous allowanceand a looser cap. Uncertainty is importantin this context (37), and although Ellerman& Buchner (9) do find some evidence ofabatement, they also conclude that overallo-cation of EUAs has been partly to blame for

the extremely low market prices. Althoughthe European Commission has acknowledgedthese lessons and cut allocations for the 2008to 2012 period, uncertainty in future eco-nomic conditions and emissions implies thateven these cutbacks cannot guarantee that themarket in phase 2 will not show a similar over-allocation with prices close to zero.

One of the most crucial tests of whether aclimate policy is “fit for purpose” is whetherit provides appropriate long-term incentives.Investment in energy generation assets, inparticular, is forward looking over severaldecades, so the expected carbon prices from2012 to 2030 are more important than the spotprice today. Unfortunately, both the KyotoProtocol, with its five-year commitment pe-riod, and the EU ETS, with five-year phases,provide little or no incentive for long-termlow-carbon investment today. Firms makingsuch investments have to gamble that gov-ernments will be able to agree on tight tar-gets and that the regime in place in a decadeor more is one that will provide them withan adequate return on low-carbon assets tomake investment worthwhile. And stimulat-ing low-carbon investment is important ifemission reductions of 60% or greater areto be achieved by 2050. Under such circum-stances, designing policy instruments to fo-cus on the least-cost emission reductions inthe short term may be suboptimal in the longterm if these reductions result in locked-in useof carbon-intensive technologies for the nextdecade.10

A final problem arises with the way infor-mation has been revealed to the market. Inlate April and early May 2006, installation-level data for verified emissions and allowanceallocations were released, indicating that themarket was oversupplied with allowances byaround 80 million tonnes (9). Prices fell by

10Additionally, achieving the lowest global cost for a near-term emissions target may not be particularly important at atime where the focus should be on institutions, experience,trust, and ensuring that structures are in place to supportdeveloping countries (38).

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70% in just three weeks, from 30 to 9,reflecting an overestimate by the market ofcounterfactual emissions (owing to rising realoutput, adverse weather, and higher gas pricesrelative to coal) and an underestimate ofabatement. In either case, it is arguable thatmarket-sensitive information should be re-leased as gradually as possible to reduce pricevolatility.

5. ASSESSMENT OF THE CLEANDEVELOPMENT MECHANISM

This section considers the achievements andproblems of the CDM. The most importantachievement has been substantial emission re-ductions at relatively low cost, accomplishedthrough international carbon finance trans-fers. However, the Mechanism has come un-der attack for a variety of reasons.

5.1. Achievements

In some respects, the CDM has been thesuccess story of carbon trading to date.The UNFCCC announced in late 2006 thatthe CDM was expected to generate 1 billiontCO2e in CERs. This number is predicted toincrease, and the CDM is projected to deliverover 275 MtCO2e annually of emission reduc-tions over the first commitment period from2008 to 2012 (39, 40). It has provided a plat-form for engaging the developing world in ef-forts to mitigate climate change and has, alongwith the EU ETS, played an important rolein driving private-sector interest in projects toreduce emission reductions.

As a market, the CDM is functioninglargely as one would expect it to. Despite thecosts and barriers described in Section 3.4,the private sector has developed a wide rangeof methodologies to reduce emissions, whichhave been submitted for approval to the CDMEB, and efforts have focused on the “lowhanging fruit,” or the cheapest emission re-ductions. In short, the CDM market has di-rected private-sector efforts to the short-termefficient outcome.

5.2. Problems

The short-term efficient outcome, however,involves emission reduction projects beingconcentrated in relatively few countries,particularly China and India, and furtherbeing focused on non-CO2 gases in rela-tively few industry sectors, in particular onHFC-23 from refrigerant manufacturing, asshown in Figure 2, which is derived fromthe data from the UNEP CDM pipelineof 1885 projects (as of May 1, 2007) (seehttp://cdmpipeline.org/). The preponder-ance of CERs from HFC-23 projects reflectsthe fact that HFC-23 has a very high globalwarming potential: Reducing one tonne ofHFC-23 emissions has the same impact onatmosphere as reducing 11,700 tonnes ofcarbon dioxide emissions. As such, it is easy togenerate large amounts of CERs from HFCcapture and destruction. So although theCDM is functioning as it would be expectedto, its design is failing to achieve two impor-tant objectives. First, as with the EU ETS, theCDM is doing relatively little to address thecrucial long-term need to reduce CO2 emis-sions from the energy sector at a time whenhigh-carbon capital assets are being locked in.For instance, the CDM has done very littleto stop China from rapidly adding coal-firedpower-generating capacity, most of which islikely to still be operating in several decades,and most of which will be expensive to retrofitwith carbon capture and sequestration tech-nology (41).11 The relatively slow and cau-tious approach of the UNFCCC has, to date,failed to produce any clear signal to these de-veloping economies about the technologies,programs, and policies that may be of centralimportance—carbon capture and sequestra-tion and energy efficiency being good exam-ples. Second, it is contributing very little to

11China is estimated to add 546 GW of coal-fired powercapacity (net of requirements) between 2003 and 2030 (39),corresponding to an average of 20 GW a year, or 400 MWa week. A large proportion of all coal-fired power plantscurrently under construction are in China: The proportionof global orders from China was 77.7%, 85.8%, and 90.5%,respectively, in the years 2001, 2002, and 2003 (42).


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sustainable development in the poorest coun-tries, which was one of the original objectivesof the mechanism.12 In particular, projectsin Africa constitute a tiny percentage of thetotal.

The CDM can also be viewed as a sub-sidy (44), rather than a market, because it isa mechanism by which the nations with Ky-oto targets fund less-developed countries toreduce their emissions. A well-designed sub-sidy would achieve the desired objective ofreducing emissions at the lowest cost to thepublic purse. Although the CDM seeks outand finds the cheapest projects, it performsrather poorly as a subsidy because buyers inWestern Europe are paying high prices thatare set primarily by the balance of supply anddemand in the EU ETS. Indeed, in some in-stances, the price paid is approximately 10times the marginal cost of abatement forHFC-23 projects in China. So, although theCDM is efficient as a market mechanism—itseeks out the cheapest projects, it is not a verycost-effective subsidy because it allows largetransfers of rents to project developers in theless-developed world.

As the CDM market is an artificial onedesigned to achieve social goals, there is noreason the government should not work toimprove its design to better achieve thosegoals. One approach would be to restrictthe CDM to carbon dioxide (and perhapsmethane) and rely on financial inducementsto encourage China (and others) to ban theemission of gases such as HFC-23 with a highglobal warming potential (GWP) (44). A com-plicated and unappealing alternative wouldbe to retain one market for all gases, butto adjust the exchange rate between gases.For instance, gases could be valued accord-ing to their maginal cost of abatement, insteadof their GWP (which reflects the marginaldamage of emissions). However, agreeing to

12Boyd et al. (43) highlight the tension between sustain-ability and emissions reduction criteria and critically assesshow the sustainable development criterion is currently be-ing implemented.

standardized marginal abatement costs wouldbe a scientific, economic, and political night-mare. A third alternative would be to orga-nize a buyers’ cartel, so that the buyers couldpay around the marginal cost for emissionreductions, thereby achieving far greater re-ductions for the same amount of (WesternEuropean) money. Similar questions are aris-ing in the forestry sector, which may havemuch lower marginal abatement costs thanthe energy generation sector.

The CDM has also created some per-verse incentives (1, p. 505). Both privateparticipants and governments of developingcountries face issues of moral hazard. Gov-ernments have an incentive not to imposeregulations on emissions if this means that lu-crative CDM projects are incorporated intothe baseline. In other words, the CDM re-duces the incentives of developing countrygovernments to enact policies reducing emis-sions. Project participants have an incentive todesign their projects so that they just, at themargin, fail to be economically sensible with-out the support of carbon finance through theCDM.

As alluded to above, transaction costs ofthe CDM can be rather high because of therequirement to demonstrate project addition-ality on a case-by-case basis. This requiresshowing that the project will reduce emissionsabove and beyond the business-as-usual orbaseline scenario. Although this might soundfairly straightforward, in practice additional-ity is an extremely subtle and complex con-cept, largely because it inevitably involvesspeculation about what would have happenedin the absence of the project obtaining car-bon finance.13 Stern et al. (1, p. 505) note thatit has proved difficult to establish method-ologies to demonstrate project additionalityfor transport and energy efficiency in sectorsdominated by small- and medium-sized

13The UNFCCC helpfully provides an additionalitytool to guide the assessment of whether a project isadditional (see http://cdm.unfccc.int/methodologies/PAmethodologies/AdditionalityTools/Additionalitytool.pdf ).

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enterprises because transaction costs are moredifficult to overcome.

Criticisms have been leveled at the UnitedNations bureaucracy running the CDM, in-cluding the assertions that the CDM EB hasbeen too weak or too onerous and certainlytoo slow. Until extra funding was provided atthe Conference of the Parties (COP) 11 atMontreal in 2005, there was broad agreementthat the CDM EB and methodology panelwere seriously underresourced (45). More re-cently, industry participants were expressingthe view that the CDM EB should be “pro-fessionalized” such that its members are paidfor their services.

Finally, almost by definition, the CDMcan only ever serve as a transitional mech-anism because it does not generate emis-sion reductions above and beyond those re-quired by developed country targets (1).Indeed, one might even argue that the CDMis responsible for a net increase in emissions(46). The conclusion rests upon the assump-tions that (a) the targets agreed to in Ky-oto would have been identical without theCDM; (b) those targets would have been metentirely through domestic emission reduc-tions in the absence of the CDM; and (c) aproportion of the emissions reductions un-der the CDM are not actually real and ad-ditional. If these assumptions hold, then itfollows that incorporating the CDM actuallyincreases net global emissions. The conclu-sion, of course, is only as good as its assump-tions, which may be debated. Irrespective, likethe EU ETS, it is clear that at present thescale of the problem (the need to decarbonizegrowing developing economies) and the scaleof the response (the CDM) are clearlymismatched.

6. FUTURE DIRECTIONS

Carbon trading is likely to expand to covermore countries, more sectors, and longer timeperiods. This section considers some of theissues arising from the expansion of carbontrading.

6.1. Geographical Expansion

The Linking Directive of the European Com-mission integrated the EU ETS with theCDM and JI markets. Now other fledglingmarkets are considering the possibility of po-tential linking with the EU ETS. These in-clude the U.S. Regional Greenhouse Gas Ini-tiative (RGGI), which covers emissions fromthe power sector in the northeastern UnitedStates,14 various initiatives on the West Coastof the United States,15 and the schemes un-der development in Australia at both the Stateand Commonwealth levels.16 Although par-ticipants within the EU ETS cannot use cred-its from other markets for compliance withKyoto targets, the converse may well end upbeing possible, and it seems likely that one-way links will be devised where CERs areused for compliance on other emissions trad-ing markets.

Indeed, a survey by Point Carbon, aprovider of news about the carbon markets,revealed that ∼50% of responding subscribersthought that a Canadian and U.S. federalETS would be linked with the EU ETS post-2012.17 A major advantage of linking marketsis that this establishes related (or identical)

14In May 2007, the RGGI included Connecticut,Delaware, Maine, Maryland, Massachusetts, NewHampshire, New Jersey, New York, Rhode Island, andVermont. It is scheduled to begin in 2009, will stabilizeCO2 emissions from power plants by 2014, and reduceemissions by 10% by 2019.15The Western Regional Climate Action Initiative wasestablished in February 2007 and comprises Arizona,California, New Mexico, Oregon, and Washington as wellas the Canadian province of British Columbia, and its over-all emissions target is scheduled to be fixed by August 2007.16A coalition of the Australian states created a NationalEmissions Trading Taskforce, which has details of a verysensible proposal (http://www.emissionstrading.nsw.gov.au/), and at the federal level, the Australian Prime Min-ister has established a Task Group on Emissions Trading(http://www.dpmc.gov.au/emissionstrading/index.cfm).17Although subscribers to Point Carbon are likely to berelatively well informed about the carbon markets, theyare also likely to have a strong interest in the continuationand expansion of the carbon markets as well as an optimismbias (47), which suggests that their views are not necessarilya reliable predictor of future events.


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carbon prices in different geographies. Fur-thermore, deepening the carbon markets islikely to reduce transaction costs and increaseefficiency.

Nevertheless, at present, the emissionscovered by the EU ETS and the CDMamount to a very small fraction of the globaltotal. Extending the EU ETS such that it cov-ers the power and industrial sectors in Aus-tralia, Canada, the European Union, Japan,and the United States would correspond to a2.5-fold increase in the scale of the scheme (1).Extending the scheme to cover all fossil emis-sions from the top 20 global emitters wouldexpand the ETS by a factor of almost five, sothat 80% of global CO2 emissions would becovered with annual allowances worth up toUS$350 billion (at an assumed carbon price of$40/tCO2e).

6.2. Sectoral Expansion

As the commencement of the first commit-ment period of the Kyoto Protocol drawsnearer, calls to expand the sectoral cover-age of carbon trading have grown louder,particularly with regard to aviation and alsoto the reversing current trends in deforesta-tion. Other developments, motivated in partby the logic of broader investments in en-ergy efficiency, have concerned the introduc-tion of “programmatic” and “policy”-basedCDM.

Proposals to include the aviation sectorwithin the EU ETS have been advanced byboth the EU Commission and the EU Par-liament.18 This now seems a likely outcome,because on December 20, 2006, the EU Com-mission adopted a proposal for legislation(http://ec.europa.eu/environment/climat/aviation en.htm) that would include flightsboth departing and arriving within Europe in

18Muller & Hepburn (48) proposed a global levy, whichreflects both responsibility for emissions and capability topay, as a way of providing finances for adaptations to climatechange.

the EU ETS as of 2011 and that would extendcoverage to all flights to or from Europe in2012.

Despite the disproportionate focus ofthe popular press on forestry-based vol-untary offsets, projects within LULUCFhave not yet been a significant feature ofthe Kyoto flexible mechanisms. To startwith, the scope of forestry activities eligi-ble for the CDM is limited to afforestationand reforestation projects, thereby excludingprojects that prevent deforestation. More-over, it was not until relatively recently thatinitial baseline and monitoring methodolo-gies for CDM LULUCF projects were ap-proved. Finally, unlike other CDM projects,LULUCF projects carry a risk of fire orconversion of forests back to pasture. Assuch, CERs from LULUCF projects havea limited duration and have to be re-placed upon expiry. Various proposals arenow under consideration to provide eco-nomic incentives for avoided deforestation(49).

Finally, at the Montreal COP 11 in 2005,the UNFCCC approved the concept of pro-grammatic CDM, which allows for develop-ing world countries to gain credits from pro-grams that aggregate up many smaller emis-sion reductions (such as those from house-holds, small businesses, and transport). Thiswill likely allow broader inclusion of sectorsthat have diffuse, rather than point, emis-sion sources and that simply would not makeprofitable projects without the economies ofscale accessible through a larger program.Further extensions to yet more sectors mightinvolve policy-based CDM, which would pro-vide developing country governments withCERs for the introduction of broader poli-cies that reduce emissions (50). This wouldreduce some of the perverse incentives notedabove.

6.3. Temporal Expansion

As discussed, a central problem facing in-vestors in low-carbon technologies is that

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there is no carbon market over the rele-vant investment period. In its current form,the EU ETS runs until 2012 (coincidentwith the Kyoto commitment period), afterwhich there are no binding targets, only areassurance from the EU commission thatthe market will continue. This imposes po-litical risk on investors, who are left to predictwhat governments will do after 2012 when theduration of their project may be 30–40 years.Uncertainty about future carbon markets ef-fectively transfers political risk from the gov-ernment to the private sector, which is an in-efficient risk allocation.

The problem is not resolved by long-termaspirational carbon targets of the sort an-nounced by the United Kingdom, France,and California because the party making thepromise is unlikely to be in power for the next30 to 40 years and may not have to abide bythe promise. A clear signal from governmentsabout the likely acceptability of different typesof projects would reduce private-sector risk.So, for instance, the private sector would beinterested now in the types of large-scale pro-grams that could become eligible for accel-erated recognition. For example, a signal onwhether and how carbon capture and storagemay be eligible for crediting under the CDMcould provide important incentives. However,the question remains as to whether govern-ment is subject to any penalty for breaking itsword.

What is needed is a policy structure thathas predictability and credibility, which mightbe designed by building a respected institutionby analogy to the Monetary Policy Commit-tee of the Bank of England (51) or by usinglegal means to contractually bind the govern-ment to its promise (52). At the time of writ-ing (i.e., May 2007), the U.K. government istaking the former idea seriously through theestablishment of a “Committee on ClimateChange,” which will advise the governmenton reaching its 2050 target and will report an-nually on progress toward this goal (53). In theabsence of these stronger mechanisms, agree-

ment on commitment periods longer than fiveyears (as under the Kyoto Protocol) is desir-able to provide clearer long-term carbon pricesignals (1, p. 332).

6.4. Caps and Allocations

As noted above, tighter caps would increasethe carbon price and ratchet up the incentivesfor low-carbon investment. Moreover, a verystrong conclusion from the economic litera-ture is that a large proportion of the cap shouldbe auctioned (35).

7. CONCLUSIONS

Climate change is a market failure withoutparallel, on the “greatest scale the world hasseen” (1), so it is not surprising that the ETScreated to address it should eventually be seenas representing the world’s greatest ever pri-vatization of a natural asset. Despite this, cur-rent carbon markets represent a very small andhighly imperfect step. Indeed, one of the mostpressing challenges in climate policy over thenext decade, once the manifest and seriousflaws in the current system are corrected, isto increase the scope of emissions trading tocover more countries, more sectors, and overlonger time periods. Ultimately, caps mustbe tightened to improve environmental ef-fectiveness, and allowances must auctioned toaddress serious inefficiencies in allocation andimportant issues of fairness.

Other climate policies are, of course, avail-able and well understood, including regula-tion, carbon taxes, and information provi-sion. These approaches will continue to playan important role. But extraordinary human,social, and negotiating capital has been in-vested in the institutions of the flexible mech-anisms under the Kyoto Protocol. Althoughthe flexible mechanisms currently have someserious problems, they nevertheless providea very important basis on which to constructa more sensible and effective global climatepolicy.


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SUMMARY POINTS

1. Carbon markets are expanding rapidly: A new global commodity has been created.

2. Carbon trading directs financial flows to the cheapest emission reductions.

3. Carbon trading has created a lobby for tighter targets and clearer long-term policies.

4. Trading has prompted a shift in climate discourse from the negative (intractable, highcosts) to the positive (new business opportunities).

5. Current allocation procedures are regressive and unfair, and more allowances shouldbe auctioned in future.

6. The CDM has not achieved its goals of sustainable development, and financial flowsare concentrated in relatively few sectors and countries.

7. Although the CDM is probably efficient in the short term, it is probably inefficientin the long term.

8. Linking of regional carbon markets is sensible and is likely to continue.

FUTURE ISSUES

1. The expansion of carbon trading to new countries and sectors will create challengesrelated to how schemes are designed and linked.

2. Permits will be increasingly allocated by auction, so important questions of auctiondesign will arise.

3. Improved incentives for long-term low-carbon investment are urgently required.

4. Policy risks associated with carbon trading will gradually be shifted from the privateto the public sector.

5. As carbon trading expands, concerns about the commoditization of the atmospherewill intensify.

6. Voluntary carbon markets are growing rapidly but may falter if existing standards arenot widely adopted.

DISCLOSURE STATEMENT

The author is a director of Vivid Economics Ltd, a consultancy working on climate changepolicy and private sector climate strategy, and is a director of Climate Bridge Ltd, an inter-national company reducing emissions in China through voluntary carbon markets. He is alsoon the Academic Panel of the United Kingdom Department of Environment, Food and RuralAffairs.

ACKNOWLEDGMENTS

I am grateful for useful comments from Ashok Gadgil, Elizabeth Garnsey, Dieter Helm, SilviaHepburn, Nate Hultman, Diana Liverman, Benito Mueller, Timmons Roberts, Alex Rau, andthe James Martin Fellows at the 21st Century School at the University of Oxford.

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www.annualreviews.org ● Carbon Trading C-1

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Carbon trading activity in different market segments in 2006. Abbreviations: CDM, clean developmentmechanism; EU ETS, a pan-European Emissions Trading Scheme; JI, Joint Implementation.

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AR325-FM ARI 21 September 2007 16:39

Annual Review ofEnvironmentand Resources

Volume 32, 2007Contents

I. Earth’s Life Support Systems

Feedbacks of Terrestrial Ecosystems to Climate ChangeChristopher B. Field, David B. Lobell, Halton A. Peters, and Nona R. Chiariello � � � � � �1

Carbon and Climate System Coupling on Timescales from thePrecambrian to the AnthropoceneScott C. Doney and David S. Schimel � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 31

The Nature and Value of Ecosystem Services: An OverviewHighlighting Hydrologic ServicesKate A. Brauman, Gretchen C. Daily, T. Ka’eo Duarte, and Harold A. Mooney � � � � � 67

Soils: A Contemporary PerspectiveCheryl Palm, Pedro Sanchez, Sonya Ahamed, and Alex Awiti � � � � � � � � � � � � � � � � � � � � � � � � � 99

II. Human Use of Environment and Resources

Bioenergy and Sustainable Development?Ambuj D. Sagar and Sivan Kartha � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �131

Models of Decision Making and Residential Energy UseCharlie Wilson and Hadi Dowlatabadi � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �169

Renewable Energy Futures: Targets, Scenarios, and PathwaysEric Martinot, Carmen Dienst, Liu Weiliang, and Chai Qimin � � � � � � � � � � � � � � � � � � � � � �205

Shared Waters: Conflict and CooperationAaron T. Wolf � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �241

The Role of Livestock Production in Carbon and Nitrogen CyclesHenning Steinfeld and Tom Wassenaar � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �271

Global Environmental Standards for IndustryDavid P. Angel, Trina Hamilton, and Matthew T. Huber � � � � � � � � � � � � � � � � � � � � � � � � � � � � �295

Industry, Environmental Policy, and Environmental OutcomesDaniel Press � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �317

vii

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AR325-FM ARI 21 September 2007 16:39

Population and EnvironmentAlex de Sherbinin, David Carr, Susan Cassels, and Leiwen Jiang � � � � � � � � � � � � � � � � � � � �345

III. Management, Guidance, and Governance of Resources and Environment

Carbon Trading: A Review of the Kyoto MechanismsCameron Hepburn � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �375

Adaptation to Environmental Change: Contributionsof a Resilience FrameworkDonald R. Nelson, W. Neil Adger, and Katrina Brown � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �395

IV. Integrative Themes

Women, Water, and DevelopmentIsha Ray � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �421

Indexes

Cumulative Index of Contributing Authors, Volumes 23–32 � � � � � � � � � � � � � � � � � � � � � � � �451

Cumulative Index of Chapter Titles, Volumes 23–32 � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �455

Errata

An online log of corrections to Annual Review of Environment and Resources articlesmay be found at http://environ.annualreviews.org

viii Contents

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Documents

Carbon Trading: A Review of the Kyoto Mechanismscourses.washington.edu/pbaf595/Readings/6b - Carbon Markets I/He… · 2These are carbon dioxide (CO 2), methane (CH 4), nitrous oxide