A brief History of Carbon Credits
The very beginning of the carbon credit trading system and market started to be discussed at Eco 92, in Rio de Janeiro, when the United Nations on Climate Change Convention (UNFCCC) was established, as result of the first Intergovernmental Panel on Climate Change (IPCC). At that time, all countries in the world came together to discuss climate change, GHG emission and the environment. In 1997 the Kyoto Protocol was negotiated and signed, and a regulated market was implemented in 2005.
The first regulated carbon market was global and was organized by the UN. After signing the Kyoto Protocol, almost all countries in the world were regulated by entering the Kyoto Protocol, with the notable exception of the United States. The Kyoto Protocol, generically speaking, set targets for countries on a decreasing “ladder”. As an example, let’s say that the emission of a country was one billion tons in a year, considering the year 1990 as the basis for the calculation. In the following year, the target would be 950. In the next year, 900, and so on until reaching zero.
The Kyoto Treaty also led signatory countries to set country wide targets. In many regions, such as Europe, regional trading systems were created, such as the ETS (Emission trading system), with sectoral targets. The steel industry as an example has had its own goals from the outset. Let us illustratively set a target of 2 million tons per year. In the case of Europe, if a Steel Company A polluted 3 million (i.e. 1 million above the annual target of 2), the company would be forced by the European regulator to buy one million CO2 certificates, or “allowances” (or “permits” to emit GHG gases), in organized carbon exchanges in Europe. In other words, Steel Company A, because it emitted more than the target / limit, would have a financial cost due to its extra GHG emission. Since the “allowance” currently costs US$ 25, Steel Company A has a financial cost of US$ 25 million because it emitted 1 million tons more than the target.
In contrast, if another European company like Steel Company B emitted (polluted), in the same year, 1 million tons of CO2 (1 million less than the target), the company would have a financial benefit by certifying the issuance of one million “allowances” that it can sell in the market. Steel Company B would therefore be rewarded US$ 25 million for its greater efficiency. In other words, the system creates an incentive for the most carbon intensive companies to pollute less (because they have a higher cost for GHG emission above the target and it hurts their finances) and companies that pollute less have an incentive to continue researching and maintaining their best environmental practices. This is how current regulated markets work, such as the ETS (Emission Trading System) in Europe and the ETS in Chinese provinces.
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