Abstract
The Kyoto Protocol became effective on February 2004, after Russia ratified it. The importance of this step is huge because nations agreed on a method to fight climate change together. The aim is very complex and ambitious: no environmental ambition can be successful if there is no economic incentive or if it is financially negative. According to this, the Kyoto Protocol provides 3 flexible mechanisms in order to allow companies covered with binding limits to pursue emission reductions where and how they are cheaper: Emission Trade, Clean Development Mechanism and Joint Implementation.
As a consequence, a large market for Carbon Credits was born and a multitude of players crowds it: form single companies needing to achieve their emission limits, to professional operators providing solution to third companies, to governments financing bilateral and multilateral funds. The 3 flexible mechanism are connected among them by the underlying logic of achieving emissions reduction in a cost-effective way. The European Emission Trade Scheme provides a scheme where the 3 mechanisms are connected and can be used successfully both from the economic and environmental point of view.
Even if with problems and with important defections (USA, China, Australia…), the system is showing itself reliable and open to welcome more participants. Surely it s not enough to change the climate change trend, but it represents the first concrete step, proving with effective results that pursuing the Greenhouses Gases reduction with economic incentives is a viable (and up to now the only one) solution. Following the EU ETS, also in countries not covered by the Kyoto Protocol examples of voluntary schemes are spreading.
To provide solid and reliable structure able to attract capitals and to secure investments continuity a post-2012 agreement is needed: here is the next challenge for the international community.

Key words: Kyoto protocol, CDM, Emission Trade, Carbon market.
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1. The Kyoto Protocol

1.1 Kyoto Protocol and Flexible Mechanism
In the last 20 years climate changes become one of the most important parts in Industrialized and Developing countries’ agenda.
Intergovernmental Panel on Climate Change (IPCC) was created in 1988, formed by thousand of scientists and experts on “global warming”, with the aim to gather scientific information about climate changes from different research centres and institutions. In its first report, in 1990, IPCC confirmed the need to adopt policies and measures aimed to Green Houses Gases (GHG) reduction, in order to control Green House effect and the consequent growing warming of the earth surface.
To respond this new scientific trend, United Nations start to negotiate until the creation of the United Nation Framework Convention on Climate Change (UNFCCC) in 1992.
The purpose of the Convention is to stabilize the GHG concentration in the atmosphere.
It recognises the Conference of the Parties (COP) as its supreme organism responsible of the process to achieve the aim of the Convention.
Inside the Convention, nations are divided into two categories:

• Annex 1 Parties, that, in general principle, includes all the Industrialized Nations, who give the biggest contribute to GHG growth with their industrial systems, and Economies in Transaction¹;

• Non-Annex 1 Parties, including all the Developing Countries.

In the first Conference of the Parties (COP 1), which took place in Berlin (Germany), has been decided that the Annex 1 Parties, the main responsible for climate changes, will be the only ones to take binding limits for GHG reduction.
As a consequence, during the COP 3 in Kyoto (Japan), reduction goals have been established for 38 industrialized countries and for 11 countries located in Central and Eastern Europe. The overall target, for the Annex 1 Parties, is to cut down, in the period 2008-2012, GHG² emissions by an average of 5.2% below 1990 levels.

The protocol assumes that climate changes are a common problem. So, it is mandatory to achieve GHG emission, but it is not important where they can be achieved. GHG cause climate changes, but they are not directly harmful for human health. Because of this, localization of emitting sources is not significant and higher or lower gas concentration in different areas has no effect on the possibility to achieve overall reduction.
The Kyoto Protocol came in force in on February 2005 with the acceptance of Russia, reaching the amount of 55% of global GHG emissions. It was needed to make the Protocol operative.

The Protocol provides three “mechanisms” to achieve the emission reduction:
• Emission Trading (ET)
• Joint Implementation (JI)
• Clean Development Mechanism (CDM)

CDM allows actors (public and private) operating into the Annex I Parties to obtain emission reductions from implementing projects (CDM projects) in order to reduce GHG emission in Developing Countries. JI projects have almost the same structure, except for the hosting country that must be one of the Economies in Transition.

The 3 mechanisms have the same target: to provide Countries with tools able to minimize overall costs from emission reduction. Even if it is not important where the reductions are achieved, it has a big importance to reduce emissions with the lower possible cost, in order to keep the system working. Hence, the Protocol adopts a “market driven” approach, instead of a “command and control” one. This is an essential change in the Environmental Policies, which abandon the idea of pursuing aims with a “top down” imposition, leaving the market free to drive the parties involved in the GHG emission reduction. The underlying logic, common to all the three mechanisms, is to pursue emission reductions where and by whom the reduction costs are lower.
 

1.2 Italy and the Kyoto Protocol.

Italy, as part of the European Economic Community, signed the Protocol in 1998, and it has been ratified on May 2002. As said, it came in force only on February 2005 after Russia’s agreement on the Protocol. EU took a general task of reducing GHG emission about 8% to 1990 levels. The general target has been shared among the Community countries according to the “burden sharing agreement” which provides each country with a different emission limit: Italy has a target of –6.5% to 1990 level. The real situation is even harder than the one prospected: the reference scenario in 2010 is over the Kyoto target about 8.9%³ that in terms of Mtons means a gap of 78 to reach the goal.
According to the new Development minister the situation is even worst than before, and it is foreseen a cut by 14% of GHG emission in five years⁴. The new National Allocation Plan provides the figures of this worst situation.
The 6.5% reduction agreed by Italy to join the Kyoto Protocol, according to 1990 levels, means that in the period 2008-2012 the emission average cannot exceed 486.01 MtCO2eq/year. But the actual emission in the year 2004, collected in the national emission inventory, grew by 12% compared to 1990 levels: from 519.79 MtCO2eq to 583.33 MtCO2eq leaving a gap of 97.32 MtCO2eq.
Basing on this, the future allocation of permits will be lower than in the past period, 2005-2007, with a total amount of 200 MtCO2eq, including the reserve for the new comers. The total amount is 31.09 MtCO2/year lower than the past allocation.

The recent change of the Italian government is going to affect strongly the policy to achieve the reduction imposed by the Kyoto Protocol.
The previous government pushed on CDM as a strategy to achieve the target. The underlying reason lies in the peculiarity of the Italian situation: the Italian fuel-mix is characterized by the absence of nuclear power and the scarce coal penetration; moreover Italy has a low energy and carbon intensity⁵ compared with the European average mean that the marginal cost for emission reduction is higher than other European countries. In economical terms, the Italian commitment to meet Kyoto’s standard would be too expansive for the industrial sectors covered, causing reduction of competitiveness due to expansive investments required to cut down emissions. So, CDM and JI were seen as useful tools to reduce emissions, as confirmed by the massive investments of the Government in three different carbon funds at World Bank for about 115 million dollar⁶.
The new Government totally changed the approach: the new Environmental Minister stated that most of the emission reduction, around 80%, will be achieved through internal measures⁷, and it has been confirmed in the new National Allocation Plan where a limit to the use of credits generated by JI or CDM has been set. The operators can use Emission Reduction Unit and Certified Emission Reduction, generated respectively from JI and CDM, only up to the 25% of the total amount of CO₂ allocated to them.
 

1.3 Outside Kyoto. The Asia Pacific Partnership
One of the most common critic to the Kyoto architecture, is that it does not includes within its binding agreement countries such China and USA which account for a large part of GHG emissions in the world. The countries not joining the Kyoto Protocol produced one main reason: the costs related to the measure for reducing the emission would be too high and reduce the competitiveness of the national companies in the international markets.
Despite this objection, also these countries are moving the first steps forward a policy to cut down GHG emissions. With this purpose 3 domestic Emission Trade Scheme have been created in countries not covered with binding limitations by the Kyoto Protocol⁸. This trend could be explained by the following factor: even if at the national level there is no consensus on the participation to the Kyoto Protocol, inside the country (it is the case of California Climate Change Register in the USA) there are voluntary actions to control emissions. It can also be seen as an attempt to create market closer to the EU ETS, in order to develop expertise and familiarity with the new market before assuming the commitment to a binding agreement. Private companies and public entities can take advantage of this trial period to be ready when emission reduction will be compulsory.
Also among the countries not included in the Kyoto regulation, there is a large agreement on the need to stop the changes in the world climate. On 28^th July 2005, Japan, United States, South Korea, India and China created the Asia Pacific Partnership (APP). The APP represents 45% of the world population, 49% of the GDP, and 48% of energy consumption and of GHG emission. Among them, only Japan has binding limits within the Kyoto Protocol.
The purpose of the agreement is to develop, diffuse and deploy cost-effective and cleaner technologies and practices through the cooperation among the parties⁹; it is complementary to the Kyoto Protocol and tries to demonstrate that the real instrument to fight Climate Changes is the research of advanced technical solutions. Main aims of the partnership are to eradicate poverty, reduce pollution and GHG emission, including energy security. This Partnership can provide a great “push” for innovation and help to fight the Climate Change: APP will operate in several fields, from renewable energies to nuclear power, from forestry and land use, to transportation and buildings.
 

1.4 Beyond Kyoto: the post 2012
The structure provided by the Kyoto protocol, even through some expectable delay or problem, seems to be a suitable tool to speed up the GHG emission reduction in a cost-effective way. Companies and government are investing a growing amount of financial and human resources in order to achieve the targets without losing competitiveness in the international markets. Obviously the entire structure is perfectible and several improvements can be introduced, but the basic idea seems to be reliable.
Probably one of the biggest limits to the Kyoto Protocol is the uncertainty for the post 2012 scenario, when the current agreement will expire. This situation on the future continuation of the Protocol is causing lack of reliance on the whole system, most of all, the companies covered by the Protocol should be able to plan their industrial strategy well in advance, considering the size of the investments and the difference in planning the future strategy with or without constriction like the one provided by Kyoto Protocol. Most of the new cleaner technologies and the investments in renewable energies have a economic life of 15 to 30 years, far beyond the expiration date of the current agreement, discouraging investments in these fields because of the lack of a predictable scenario in the short term (post 2012).
The next step to be taken is to define a clear architecture for the post 2012; of course the new structure should solve the controversial points raised in these years.
For sure there is the need of including a larger number of countries in the future accord: nations such as USA, China, India and Australia should be included because of their weight on the global GHG emission. There should be some kind of differentiation among the countries, according to their economic situation, because both rich and developing countries are important to reach an effective result in fighting the climate changes. So the future regime should consider common but differentiated responsibilities. Different countries have different economic and social priorities, especially for the developing and poor countries but they all must be included in a common structure to solve the common problem of the global warming. In any case, a larger number of Developing countries must be involved, because their emission are raising rapidly following the economic growth, and they account for the biggest part of global population and are accounting for an increasing amount of global GDP, energy use and consumption and CO₂ emissions.
One of the positive points in the Kyoto Protocol, is the emphasis on the relation with the economy, because it is clear that no environmental ambition can be successful if there is no economic incentive or if it is financially negative. This is more important for the Developing countries, where economic issues normally exceed environmental issues. The Protocol with its flexible mechanism is walking in this direction, allowing the operators to choose the lowest cost option, mobilizing public and private capitals on international markets, promoting the technological research and transfer even among countries.
There are several proposals to improve the Kyoto Protocol, and considering that the first step of setting up a functional structure has already been done, a future wider Protocol is possible. Among the most common ideas, there is the inclusion of more sectors to be covered with binding limits, such as aviation and transportation, considering the number of polluting companies still not covered with limits, and also a wider number of gases could be included. Every nation involved in the future scheme should develop a clear and defined domestic policy on topics such as energy, investments on environment, promoting the technological research and pushing for energy efficiency¹⁰: covering a large number of sectors with a defined and shared regulation together with economic opportunity, would speed up the research towards more eco-efficient solutions and forcing the industries in reducing the environmental impact of their business.

For sure there will be disagreement among the negotiators on the real effectiveness of the GHG emission reduction to fight the climate change, and there will be discordance also on what would be the best structure to face global warming and growing pollution as well as for the prediction of the possible scenarios if the average temperature grows. Even if when there will be a common consent on the risks and damage coming from the rise of the temperatures, for sure there will be big difference on the best solutions and means to reach the goal of stabilizing the GHG concentration in the atmosphere. A wider number of sectors and actors participating imply a wider number of views and strategies that somehow will have to be bonded together and directed toward a common goal.
The next COP 12 and COP/MOP 2, to be held in Nairobi, Kenya, on November 6^th to 17^th, will be the first appointment where the Parties, both from developed and developing countries could start a serious and effective discussion on the possible future regime to fight the Climate Change.


2. European Emission Trade Scheme

2.1 Structure of the European Emission Trade Scheme
One of the flexible mechanisms provided to achieve target reductions is the EU-Emission Trade Scheme. It is independent of the Kyoto Protocol, even if it is obviously related and compatible with it. It is the world largest Cap and Trade System, covering around 12.000 sites in 25 countries, accounting for almost the 50% of the total emissions.
It started in January 2005, according to the Directive 2003/87/EC, and is based on the trading of Allowances, each equivalent to 1 tonne of CO₂: if one company’s emissions go beyond the limit set in the National Allocation Plan, they are allowed to buy credit form the companies who have a lower amount of emission and with a surplus of Allowances.
The function of the EU-ETS is to provide the EU member states with a low-cost tool to comply with the emission limits. It provides also a concrete example of a possible architecture for an International Emission Trade Scheme including a large number of countries. It represents the international attempt to relate environmental issues with economic solutions, assigning a real price for the pollution produced and creating a market for the rights to pollute. This right to pollute is represented by the Allowances: an allowance is the right to emit a tonne of CO2, issued by a member state and allocated to the single sites covered by the Kyoto limitations. The allocation of the allowances (in the first phases) is performed annually by the member states by sector and by single site: according to the verified emission data collected every year, each plant must surrender the amount of allowances corresponding with the actual emissions registered.
Up to now the covered sectors are:
1. Energy; combustion installation with more than 20MW of thermal input, refineries and coke ovens;

2. Production and processing of ferrous minerals;

3. Mineral industry; Cement, Glass and Ceramic;

4. Pulp and Paper industry.

2.1.1 Nature of allowances and the Registries
Allowances are issued by each Member State and allocated to the operators covered with limitations, giving the right to emit one tonne of CO₂. This title is freely tradable among persons and companies within the European Community but normally they are bankable across years, but not across the two Phases¹¹.
Every year before the end of February a new amount of allowances is allocated for the following year; further the verified emission must be collected and before April 30th Allowances must be surrender. Companies not complying with their limitations will pay a fine: in the first period it is 40 Euro/Co2 Ton, from 2008 it will be 100 Euro/Co2Ton.
The Allowances and their accounting must be held in a electronic registry¹²: every member state must create its own national registry, where operators can apply for an account, both companies and individuals. Every national registry records the transactions among the operators such as cancellation, surrender, acquisition, issue and transfer. Moreover, the registries can check the differences between allowances hold by an operator and its verified emissions. Every national registry is connected with the Community Independent Transaction Log (CITL), which is a supplementary transaction log, verifying every transaction or activity is performed according to the scheme’s rules and to which every transaction must be communicated before they are finalised.
The CITL is an independent transaction log form the one provided by the Kyoto Protocol: the International Transaction Log (ITL), which is in charge of monitoring all the movements related with Kyoto units. The two logs on a temporary base perform the reconciliation, to assure that all the records and actions are consistent. The ITL is established by the UNFCCC Secretariat, while also the CDM Executive Board must establish a CDM registry.
The CITL is obviously connected with the ITL, but it is independent and checks only the transactions and operations related with the EU ETS.
 

Currently, there are several Emission Trade Schemes both within and outside the Kyoto framework. If the Schemes inside the Kyoto scope was created to provide a cost effective tool to achieve the limits to the emissions, there are at least 3 markets outside this scope, born to encourage and support voluntary efforts to cut GHG emissions. Up to now the following schemes exist:
» United Kingdom Emission Trading Scheme (UK ETS)
» European Union Emission Trading Scheme (EU ETS)
» New South Wales Abatement Scheme (Australia)
» California Climate Change Register
» Chicago Climate Exchange (CCX).

2.2 A description of the National Allocation Plan. The linking Directive
In order to take part in the EU ETS, each country must produce a National Allocation Plan (NAP), containing a plan to allocate the allowances by sector and by single installation covered by the Kyoto Protocol on given periods.
The NAP must fulfill several criteria to be consistent with the EU judgment. The most important are:

• Be consistent with the Kyoto obligation.
• The total amount of allocation must be realistic and must take in account the potential development of technologies for the GHG abatement. Also an amount of allowances must be considered for new entrants.
• List of the installations covered with the quantities allocated to each.
• Information on the effects of the ETS on the competition inside and outside the European Community
• Describe the methodologies used for the allocation and to estimate rates of growth and forecasts.
• Mention explicitly the amount of CERs and ERUs each operator can use (as a percentage of the total allocation).

The allocation can be based on two different criteria: the first uses the “historic emissions” and it considers the actual and verified emission in a given period; the second method is the “benchmarking” system that uses standard performance rates to for sectors. Each plan must not create discrimination between companies or countries and not create distortion of the competition.
In the future, especially when if more countries will join the scheme, one problem to be solved will be the harmonization of the methodology and criteria for drawing the NAP in order to obtain more similar output from every country.
Normally, the annual trading cycle starts on the end of February, when new EUA are allocated for the next year, then in the end of March the verified emissions are declared and by April 30^th Allowances must be surrender.
 

2.2.1 Italian NAP
In Italy, the Ministries in charge to redact the NAP are the Ministry of Environment and Territory and Sea and the Ministry of Productive Activities, due to the implication both on the environment and, especially, on the economic and competitiveness aspects of the NAP for the covered sectors and companies.
The European Commission passed the Italian National Allocation Plan (NAP) for the first Phase after it has been accepted conditionally. It was due to the lack of some data considered necessary by the Commission and because the amount of permits allocated was overestimated.
Italian Government accepted the European Commission’s request to cut down by 9% the previous NAP rejected by the Commission and increased the number of the installations covered with the restriction: from 1170 to 1240.
According to the commitment Italy took within the Kyoto Protocol, the Inter-ministerial Commission for Economic Planning (CIPE) passed, in December 2002, The National Plan for GHG Reduction. It is a description of the current emission situation, analysed by sector, and providing a plan to reduce the GHG emission in the period 2003-2010, following the framework of the Kyoto Protocol, starting from the description of a reference scenario.
Moreover, the plan provides a detailed policy to reduce the emission in each sector¹³ through internal actions. According to the high cost the private and public companies would bear for the internal reduction, CIPE includes in the national plan the necessity of investing in project based reduction, operating in foreign countries within JI and CDM framework.
This decision assumes that the marginal cost for abatement is lower than internal reduction. In order to preserve the competitiveness of the sectors covered by the Kyoto Protocol, the CIPE encourage investments where the reduction cost is lower.

Still Italy must approve the second NAP for the Phase 2. The first drafts show a reduction of the annual average of the emission cap: in the previous period it was set at 224 M/Tons per year, while the new phases has a stricter cap, 200 M/Tons per year including the new entrants’ reserve for a total reduction of 24 M/tons form the previous draft.
The first one set also a limit to the use credit from CDM and JI: they could be used only up to the 10% of the total allocation but the new draft (that should be closer to the final version) the cap has been expanded to the 25%, after some utility protested against the low cap for the CERs and ERUs.
It seems that a part of the total allocation will be auctioned, so the income would be used to finance the costs of the reduction program and to achieve the Kyoto goal. It is expected that the final version will be submitted in few weeks to the European Community.

2.2.2 Linking Directive
In the year 2004 the European Community passed a directive¹⁴ aimed to create a direct link between links the EU emissions trading scheme (ETS) with the Kyoto international emissions trading mechanisms, so that European companies can use carbon credits from the Joint Implementation and Clean Development Mechanism to meet their emissions targets at home. The so called “Linking” directive, formally create the carbon market where it is possible to negotiate CERs and Emission Reduction Unit (ERU)¹⁵ as well as EUA. The only differentiation between the two titles is that CERs can be used in the EU ETS from 2005 while ERU can be used only starting from 2008. One CER or one ERU has the same value than an EU Allowance, representing 1 Tonne of CO₂e . It is allowed to bank ERU or CER between the two phases, while the EU Allowances are not bankable in the two phases. The Directive excludes clearly the Nuclear based projects (according to the Kyoto Protocol) and credits generated by “Sinks” (unlike what agreed in Bonn-COP 6).
Up to now, among the 25 countries forming the European Community only seven¹⁶ transposed the “Linking” directive into national law, while the remaining eighteen, among them also Italy, have missed the deadline of the 13 November 2005 and are still in the process of transposing the directive.
 

2.3 EU ETS: positive impacts and problems.
The introduction of a Trading Scheme is one of the most remarkable successes toward the fight to climate changes. As said before, every effort fort the environment must be economically viable and sustainable; otherwise it would not achieve substantial changes. Some impact of the existence of the EU ETS influenced positively the industry approach toward environment. First of all, a new market has been set and it has proved itself reliable, beside the high volatility, and capable of several million worth exchanges. Large financial institutions are participating in the market, increasing the credibility and the liquidity of the market itself.
One of the reason of the excess of allowances in the 2006 allocation is the result of an over allocation by the member states, but a part of this surplus is caused by a real emission reduction due to the company commitment in the previous year.
The EU ETS, joined with effective use of CDM and JI, is the key to reduce the risk of losing competitiveness on the international market, allowing companies to reach lower GHG emission without a too onerous commitment.
Moreover, the introduction of the EU ETS forced the companies to take in account environmental impacts of their business (even if only in terms of GHG emissions). It brought a change in corporate culture, with resources mobilized to fulfill the commitment and introducing a monetary reward for achieving a positive environmental performance.
Thank to the introduction of CDM and JI pushed technological exchange and innovation in developing countries. The opportunity of obtaining carbon credit moved several western countries to invest in renewable energy or in advanced technology based projects, quickening the technological exchange among rich and developing countries.
As well as every new policy involving economical tools, the EU ETS had to face some problem since it has started. On the theoretical level, some objection has been raised on the positive effects of introducing an Emission Scheme: the scheme was supposed to cause lower competitiveness for the countries covered with bidding limits; secondly it was supposed to cause “CO₂ leakage” with the CO₂ intensive activities relocated where no limits for the emission have been set. Still it is too early to evaluate deeply if these objections have sound reasons, even if it seems that no big changes are occurring in these direction.
Another limit, as said, is the short horizon of the scheme: the EU ETS, as well as the Kyoto Protocol, will last until 2012 leaving a big uncertainty to the players. The payback time for the introduction of new and cleaner technologies, as well as for renewable ones, is longer than the few years covered with the current agreement, so the system is missing the incentives for the introduction of less polluting solutions because of the impossibility of formulating an industrial strategy beyond the year 2012.
One problem rose with the allocation of the allowances: they have been allocated according to the “Grandfathering” process, giving them for free to the plants covered by the Kyoto Protocol¹⁷. The companies could have just passed the extra cost to the consumers, or, during the high peak of allowance’s price, they could have bought cheap credits (from CDM and JI whose prise was less than an half than an allowance) and cashing the allowances obtained for free, keeping the difference¹⁸.
The system showed another imperfection: when the verified data have been collected, it was clear that the emission level was, in general, lower than the expected one. This means that the allocation of EUA to the member states has been generous and the states were, apart from some exception, long, that means a surplus of Allowances to be used on the market. Among the 25 member states, only 5 were short: Great Britain (27.1 Mt), Spain (10.5 Mt), Italy (7.3 Mt), Ireland (1.5 Mt) and Austria (1.0 Mt)¹⁹.


3. Carbon Market: risks and opportunities

3.1 Financial implications
The development of the Carbon Market and the publication of the second NAP by the member states facilitated the development of the EU market for the Allowances. The more players are involved in the Kyoto commitment, the more they need different kind of tools to invest in the market. Different type of interests and position requires also a broad range of services to implement structured strategies to minimize the cost of the compliance: the brand new market of the Allowances is getting mature and can provide solutions to the player involved.
Also in the EU ETS, the industrial players don’t have such big expertise on the allowances market and sometime the resources that can be dedicated to the trading is limited, so it gives the room to high specialized companies providing the service needed.
As the market grows and more actors with different necessities and interests start to play, a more differentiated range of possible options is offered. Different kinds of approaches are possible in the EU ETS:

» Compliance, with few trades per years.
» Speculation, acting on the market only for pure financial reasons.
» Frequent Hedging, with frequent trade to reduce the risk trading against the natural position of the NAP.
» Project Based reduction, using CERs or ERU²⁰ using the “linking” directive.

The EUA price, as well as the Carbon price, is driven by several factors; some of them are related to prices on different markets, for instance oil and gas prices or the energy price, and some other related with political decisions and action, like NAP publications and results from the annual verification. Because of the several causes that influence the price, volatility is still high, as confirmed by the recent drop of Allowance’s price after the verification of the actual emissions: prices crashed from around 30 Euro to 12 Euro²¹. Up to now the most powerful driver for players seems to be the compliance, with a large number of companies acting on the market to make sure the Kyoto’s limits will be fulfilled.
 

3.2 Carbon Funds
The most important players in the Carbon Market are the numerous carbon Funds investing public and private financial resources.
The carbon funds provide and secure way for both companies and states needing to invest to achieve the emission reduction imposed by the Kyoto Protocol. This option is often more cost effective than implementing internal reduction measures.
The existence of several funds investing in the Carbon Market, provides a broaden range of services and opportunities for the investors. Actors, who need to comply with the Kyoto limits, have two options on the market: investing directly on the development of CDM (or JI) activities as a project partner, or investing through the Carbon Funds. The choice on how to operate depends on several aspects: first of all on weather the company has advanced technologies or know-how to participate direct in a project, then on the willingness to take or avoid risks, the capabilities to invest in the market and the industrial strategy to achieve the commitment.
Two different kinds of Carbon Funds can be identified: the ones returning pure cash yields and the ones returning carbon credits²². In the first case the Fund is more similar to a traditional Fund investing in commodities (such a coal or energy), and the investors simultaneously invest also in different Funds in other markets to diversify the risk. Also these funds returning pure money provide a large number or tools for the investments, due also to the correlation among the carbon price and other products as oil, and gas. Most of such investors are banks or hedge funds, looking to diversify their own portfolio or to make profit on the credits.
The main importance of the Funds is the creation of a reliable connection among investors (both financial and compliance) and project developers who implement the projects. The Funds provide a wide range of service that makes the investment profitable or more attractive:

• Reduction of the transaction costs, mostly facilitating the encounter between demand and supply of credits and the access to a large number of projects
• Reduction of delivery risk, assuring the delivering of the expected amounts of credits
• High specialization on different sectors or geographic area
• Providing a wide range of financial tool for investors²³
• Attracting private and public funding in the carbon market.

Compliance investors are those who need the credits to achieve the limit imposed by the Protocol. On a general basis, investing in a Carbon Fund is less risky than developing the project directly and less expansive that starting internal reduction action. This kind of investors look for reliable sources of credit all around the world, avoiding (or at least reducing by far) all the risks, difficulties and costs related to the direct involvement in a CDM project.
The most active Carbon Funs on the market are the seven managed by World Bank, which manage 4 specific funds²⁴ and 3 nationals funds²⁵, including the first fund launched in the year 2000; while among the private funds Natsource (GG-CAP), ICECAP, KfW Carbon Fund and Japan Carbon Fund (it has some public funding) have several million CERs/ERU in signed Early Reduction Purchase Agreement.
 

3.3 A general overview on CERs
Beyond the positive aspects for environment and for countries participating (both hosting and proponent ones) CDM projects have interesting economical and financial implication.
First, a CDM project has not to be economically positive itself. The Internal Rate of Return (IRR) of the project should become higher than 0% with the inclusion of the profit generated by CERs. In most of the CDM project it has been noticed that the CERs change the IRR of the project, even if there are differences due to the type and scale of the project²⁶. For example, fugitive methane capture projects impact heavily the IRR because of the amount of CERs obtained, given the higher global warming potential of methane compared with CO₂.

The CDM process to obtain CERs is quite long, and in some case could be expensive. Starting a CDM process implies to consider several costs impacting the profitability of the project itself, especially in the first phase. Project participants should estimate correctly the weight of cost for collecting data and for the feasibility studies, for the process of validation and verification, the fee that must be paid to the EB, which is proportional to the amount of CERs emitted. Those costs normally don’t affect so much the profitability of the project, but can be a barrier to start the whole process, which is in any case risky.

One important aspect of CERs is the price in the carbon market. First of all CERs must be differentiated from European Allocation Units (EAU), that are the emission permits ready to be negotiated on the market, provided by each government to the sites submitted to Kyoto restriction. They are not related to any project, but they represent the amount of emission that a company can trade meeting the Kyoto targets. Their price is about 16 euro/CO₂ton²⁷, and it is affected by the operation of the actors in the market, as well as other stock markets.
CERs are a completely different kind of title, and the difference is reflected in the spread between the prices of the two titles. CERs price is normally among 6-8 euros, even if is it possible to distinguish various prices on the market, as shown in the following chapter. As said, they are two different kinds of instruments: if the EAU is related to something certain and secure, with no risk but the price volatility on the market²⁸, while CERs are the consequence of a long and uncertain process because they depend on a project that has some kind of risks. CDM projects face two types of risk: conventional project risks and CDM related risks. The first type is common to every kind of project, and includes risks as legal, market, technology performance, political etc. that are common to every kind of business projects. CDM related risks are a type of risks strictly connected with the nature of the CDM. One of these is the policy risk, due to the possibility that host country would not accomplish his obligations, or that the project itself would no be approved because of baseline or verifying problems. Because of this, the price is significant different and lower than the EAU one.
CERs’ price is lower than an EUA’s, it is around 5-7 euro and so CDM projects spreading in several countries are a real chance to meet Kyoto’s goals with the lower possible costs. Until the price for a CER is lower than the price for a European Allowance and for the emission fine companies would be interested in participating CDM projects. Even if a project-based activity implies a higher risk, the potential for companies is high, and they will invest assuming the related risk.

Different factors affect the financial performance of a CDM project activity. Some of them are perceived as risk, such as uncertainties about technology performance, electricity tariffs, and additional revenues from CER. In addition, the level of transaction cost of the CDM project activity is quite high. These costs are:
• Adoption Fund, with is financed with the 2% of the CERs revenue²⁹
• EB administrative costs
• DOE charge
• Cost for the whole process including project searching and scouting, project design, validation and registration, monitoring/validation and registration, issuance.

Transaction costs can differ according to specific project. Obviously, the higher are these costs the lower is the potential for CDM. This market is new, so the actors involved, both governments and private company, don’t have a good expertise about the issues related to CDM and how to manage them. Beside this, forecasts are quite hard because of the uncertainty on the development of the market and also about the future international policies on climate change, involving the post 2012 structure of international agreements on this subject.

3.4 Current trends
Different prices are available on the market: non registered projects, with a low risk for the seller, the price is around 7-8 euros; for projects in which the buyers are involved from the initial stage, the price is lower, around 5-6 euros; for those projects in which the seller take an higher risk the price grows up to 11-12 euros and more³⁰.
At present, the current buyers of CERs are:
• Multilateral Government Funds
• Government Funds
• Commercial/Development banks
• Multilateral Institutions
• Bilateral transaction (with signed Memorandum of Understanding).
Two opportunities are available for companies interested in participating in this market:
» Implementing and participating directly in one or more projects
» Buying CERs generated by a CDM projects.
The first option allows a company to participate in a project transferring technology and knowledge necessary to make the project suitable with the CDM required standards. The proponent provides new and advanced technologies for the hosting counterpart, with a negotiated payment considering the particularity of the transaction and the following CERs emission in which the actors are involved. Interested companies are those who are looking to spread worldwide their own technologies and leader in sectors in which the CDM potential is high. As said, the lower marginal cost for emission cut down is another reason to act in this type of market
The second option consists in buying CERs generated by a project without participating directly in the development as a technical provider. In any case, the participation even as a mere buyer has to be clear for the initial phase on the project, having to sign the Emission Reduction Purchase Agreement.
The development of this market and its changing bring to the differentiation among projects. Western companies implement several of them s providing technology transfer, while a gowning number of project owner are starting to sell the CERs emitted to foreign companies, who participate as buyers.
A new problem rose in the Carbon Market. Despite the growing number of CERs emitted giving confidence in the quality system, a source of uncertainty is represented by the delay in creating the International Transaction Log (ITL). This Log is supposed to be the connection between temporary buyer’s account and the national account. After the payment has been done to the UNFCCC Secretariat to cover administrative costs, the CER is forwarded to the buyer’s account. Without the ITL is not possible to transfer the CER obtained to the National account. In practice until the ITL is operating the owner of the CER can not use it freely on the market or to meet his goals. It is estimated that the ITL will be ready before April 2007.



References

“Directive 2003/87/CE crating an emission exchange scheme for GHG in the European Community modifying Directive 96/61/CE of the Council”, Italian Ministry for Environment and Territory.

“Allocation scheme for CO2 shares for the period 2005-2007, formulated according to article 11, paragraph 1 directive 2003/87/CE”. Italian Ministry for Environment and Territory, November 2005.

“CDM Information and Guidebook”, UNDEP June 2004.

“Directive 2004/101/CE”, European Parliament, October 2004.

“National Plan for the GHG emission reduction –2003/2010”, Italian Ministry for Environment and Territory, Italian Ministry for Economy and Finance. December 2002.

http://www.minambiente.it
http://www.unfccc.com
http://www.sinoitaenvironment.org/
http://www.ieta.org
http://www.desair.org
http://www.pointcarbon.com/
http://www.euractiv.com
http:// www.italiancarbonfund.org.

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1 Most of them are the former Communist nations.
2 GHG included in the Kyoto protocol are: Carbon dioxide (Co2), Methane (CH4 - GWP= 21) Nitrous monoxide (N2O - GWP=310), Hydrofluorocarbons (HFCs - GWP=140-11.700), Sulphur hexafluoride (SF 6 - GWP=23.900), Perfluorocarbons (PFCs – GWP=6.500-9.200).
3 Source: National Allocation Plan.
4 Source: Point Carbon Web Site.
5 Energy intensity and carbon intensity are two indicators based on the ratio between energy consumption in industry (or coal) per unit of GDP.
6 105 million in the Italian Carbon Fund, 7.7 million in the Community Development Fund and 2.5 million in the Biocarbon Fund.
7 Italy, according to a GRTN official, is going to meet the 22% of total energy production from renewable energies by 2010.
8 Two different markets are located in the USA, while another one in Australia. See Paragraph 2.1.
9 Source: Vision Statement of the APP, during the inaugural meeting in Sydney, January 2006.
10 With regards to energy efficiency some countries are already walking this path, such as the EU with the Energy Efficiency Action Plan to save the 20% of total energy consumption by 2020, or China’s plan to cut by 20% the energy consumption by 2010.
11 France and Poland NAPs allow banking among Phases, even if with some limitation.
12 Allowances have only electronic form.
13 The sectors described are: energy production and transmission, private and public transportation, construction, land use, industry, and renewable energies.
14 The directive is: 2004/101/CE.
15 CERs are generated by CDM project, ERU are the results of the JI activity.
16 Denmark, France, Germany, the Netherlands, Spain, Ireland and the UK.
17 In the First Phase, a minimum of 95% of the total allowances has been allocated for free, while in the second Phase the minimum will be 90%.
18 According to The Economist, Britain Power Companies gained around Euro 1.2 billions.
19 Source: Point Carbon Web Site, taken from Community Independent Transaction Log, June 13th 2006.
20 CERs are generated by CDM projects, while ERUs by JI activities.
21 Source: Point Carbon Web Site
22 Although there are Carbon funds returning both money and credits.
23 For more details on the Financial Tools available see cap. 4.4.
24 Prototype Carbon Fund, Community Development Carbon Fund, Bio Carbon Fund, Umbrella Carbon Fund.
25 Italian, Danish and Spanish Carbon Fund.
26 As said in chapter 1.4 about Additionality, the CDM component has to make the project profitable.
27 Source: Point Carbon, 25/10/2006.
28 Main drivers for the Co2 price are: JI\CDM credits, Hot air, Sector targets, Bancability, Growth of GDP and electricity demand.
29 Decides in the Marrakech Accords.
30 Source: Point Carbon Web Site.


* dariobrex@yahoo.it.


 

Pubblicato su www.ambientediritto.it il 06/11/2006