Emission allowances

Emission allowances

Under the Kyoto Protocol, the 'caps' or quotas for Greenhouse gases for the developed Annex 1 countries are known as Assigned Amounts and are listed in Annex B.^[11] The quantity of the initial assigned amount is denominated in individual units, called Assigned amount units (AAUs), each of which represents an allowance to emit one tonne of carbon dioxide equivalent, and these are entered into the country's national registry.^[12]

In turn, these countries set quotas on the emissions of installations run by local business and other organizations, generically termed 'operators'. Countries manage this through their national registries, which are required to be validated and monitored for compliance by the UNFCCC.^[13] Each operator has an allowance of credits, where each unit gives the owner the right to emit one tonne of carbon dioxide or other equivalent greenhouse gas. Operators that have not used up their quotas can sell their unused allowances as carbon credits, while businesses that are about to exceed their quotas can buy the extra allowances as credits, privately or on the open market. As demand for energy grows over time, the total emissions must still stay within the cap, but it allows industry some flexibility and predictability in its planning to accommodate this.

Since 2005, the Kyoto mechanism has been adopted for CO₂ trading by all the countries within the European Union under its European Trading Scheme (EU ETS)^[14] with the European Commission as its validating authority.^[15] From 2008, EU participants must link with the other developed countries who ratified Annex I of the protocol, and trade the six most significant anthropogenic greenhouse gases. In the United States, which has not ratified Kyoto, and Australia, whose ratification came into force in March 2008, similar schemes are being considered.

By permitting allowances to be bought and sold, an operator can seek out the most cost-effective way of reducing its emissions, either by investing in 'cleaner' machinery and practices or by purchasing emissions from another operator who already has excess 'capacity'. Through ETSs, the price of carbon is driven by emissions limits and the number of carbon allowances in circulation. These markets create a price for the impact of carbon emissions. ETS markets are regulated by governmental organizations and trading in these markets is tracked by the IHS Markit's Global Carbon Index, which provides a benchmark that track carbon credits future contracts globally. Investors participate in these markets by buying shares in highly specialized funds that buy an assortment of contracts to track index like The KraneShares Global Carbon ETF (KRBN).

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