Industrial gas credits - banned from the EU ETS (Source: Isaac Mao)

Industrial gas credits - banned from the EU ETS (Source: Isaac Mao)

In the aftermath of the Durban conference analysts have been turning their attention to the continued role of Kyoto Protocol emissions credits in the EU ETS. To date this trading mechanism has provided the biggest market for Kyoto credits, but the position is set to change drastically from 2013 onwards due to significant restrictions on the type and number of permissible credits. It is hoped that this move will address some of the credibility issues that have been plaguing the EU ETS (notably the use of environmentally dubious credits). Moreover, EU emissions allowances (EUAs) will become firmly established as the tradable instrument of choice in the market.

The impact of Kyoto credits on the EU ETS

In addition to EUAs, regulated installations can use credits from two kinds of Kyoto mechanisms, namely Clean Development Mechanism (CDM) and Joint Implementation (JI) projects to fulfil their EU ETS obligations. Each EU Member State currently sets its own limits on the use of CDM and JI credits. Phase III of the EU ETS will see the introduction of a general cap on Kyoto credits of 50% of total, EU-wide emissions reductions.

The linkage between Kyoto mechanisms and the EU ETS has provided these credits with market value. In particular, the price of Certified Emission Reductions (CERs) resulting from CDM projects has to date closely followed that of EUAs, as the former type of credit has been extensively traded by EU ETS regulated entities.

Environmental credentials of Kyoto credits

The usability of Kyoto credits in the EU ETS has been progressively reduced over the years so as to address concerns regarding the effectiveness of the credit-generating projects in combating climate change.

A notable example of credits which will be banned from the EU ETS in Phase III (from 2013) are those generated from the destruction of HFC-23, a by-product of a highly noxious refrigerant which is itself a potent greenhouse gas. HFC-23 crediting has been particularly popular in India and China. It has been strongly criticised by environmental organisations on the basis that the additional HFC-23 may arguably not have been produced at all were it not translatable into Kyoto credits.

Cutting the Kyoto mechanisms short

Phase III of the EU ETS is set to entail considerable quantitative and qualitative restrictions on the applicability of Kyoto credits. These developments reflect the recently amended wording of the EU ETS Directive, which provides that credits must “represent real, verifiable, additional and permanent emission reductions and have clear sustainable development benefits and no significant negative environmental or social impacts”.

From the qualitative perspective, the current ban on the use of credits from nuclear energy or land use, land use change and forestry (LULUCF) activities will continue beyond 2013 alongside the new ban on industrial gas (HFC-23 and N2O) credits.

On the quantitative front, credits from CDM projects registered after 2012 can only be used in the EU ETS if they originate from a defined list of Least Developed Countries (LDCs), which does not include large emerging economies such as India and China. The exclusion of such countries is intended to motivate them to reduce emissions in ways other than the generation of CERs and thus step up their regulatory approaches to mitigating the effects of climate change.

Where does this leave international emissions credits?

As the demand for CDM and JI credits for use in the EU ETS will inevitably drop from 2013, the continued relevance of these mechanisms will depend on the level of interest that they can generate in other emissions trading schemes, such as the incipient Australian or New Zealand systems. The EU Commission has arguably taken the correct approach in placing clear limits on the usability of Kyoto credits, which has been made dependent on their environmental quality and provenance. In the short term at least it is envisaged that the market in EUAs will emerge as dominant, as it is unlikely that national trading schemes will be able to absorb levels of Kyoto credits on the same scale as the EU ETS.

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