A conveyor belt moves underground mined coal to the surface. Carbon dioxide from burning coal, oil and other fossil fuels is the biggest of the greenhouse gases. (Seth Perlman/Associated Press)

The Kyoto Protocol allows countries to use a trading system to help meet the accord's goal of reducing the world's greenhouse gas emissions by an average 5.2 per cent relative to 1990 levels by 2012.

Any country struggling to meet its targets may buy "credits" — essentially the right to emit a certain amount of carbon dioxide — from countries exceeding their reduction targets. Global emissions trading won't start until 2008, but there are schemes in place to test the market system, including a continent-wide one started by Europe in January 2005.

Carbon credits

Carbon dioxide (CO2), which is mainly emitted by burning fossil fuels, is the most widely produced greenhouse gas. Each country that has signed on to Kyoto has its own target for slashing CO2 emissions.

Countries that cut their emission of greenhouse gases get credits for their efforts: one credit for each tonne of reduced CO2 emissions.

The concept of carbon trading rewards countries that meet their targets and provides financial incentives to others to do so as quickly as possible. Those who overshoot their emission reduction targets can sell surplus credits in the market.

It's like trying to get people to do more volunteer work, said Rodney White, University of Toronto professor and co-author of the book Carbon Finance: The Financial Implications of Climate Change.

"Set the target where they have to do 50 hours a year. Those who do more, get credits. Those who do less have to buy credits. That way you get targets at the lowest possible cost," said White.

Kyoto's three mechanisms

The Kyoto Protocol includes three so-called flexibility mechanisms.

The Kyoto protocol's clean development mechanism (CDM) allows developed countries to gain emissions credits for financing environmentally friendly projects based in developing countries.

QUICK FACTS:

• The European Climate Exchange calls carbon dioxide (C02) the new kid on the block in commodity trading.
• C02 is being bought and sold as if it were a commodity, like a barrel of oil.
• The difference between trading in CO2 and more traditional commodities: what people are selling is akin to a right to emit carbon dioxide.
• One EU allowance equals the right to emit one tonne of C02.

The European Union Emissions Trading Scheme began operation in January 2005

• It's the first international trading system for C02 emissions in the world.
• It covers over 11,500 energy-intensive installations across the EU, which represent close to half of Europe's emissions of C02.
• These installations include combustion plants, oil refineries, coke ovens, iron and steel plants, and factories making cement, glass, lime, brick, ceramics, pulp and paper.
• The EU ETS runs in two phases: 2005-2007 and 2008-2012, coinciding with the first commitment period of the Kyoto Protocol).

Source: European Climate Exchange

A country can also earn emissions credits through something called joint implementation (JI), which allows a country to benefit by carrying out something like a reforestation project in another industrialized country or "economy in transition."

Carbon trading is the third mechanism. Called emissions trading (ET) in the accord, it allows countries to buy emissions credits from countries that don't need them to stay below their emissions quotas.

The environmental group Sierra Club "cautiously supports" the trading of carbon dioxide emissions, according to its senior policy advisor for energy, John Bennett.

But he says credit should be based on real energy reductions based on real energy projects.

"When trading emissions, you should have permanent emissions.… We want someone in a factory to reduce emissions — that's good credit. But for a corporation to go to Guatemala and buy a forest and get that to count as a credit? We don't support [that]," said Bennett.

How carbon emissions can be traded

Europe has a cap-and-trade scheme where emissions can be traded, but there is a limit to them. A country — or group of countries — caps its carbon emissions at a certain level and then issues permits to firms and industries to emit specified amounts of carbon dioxide over a period of time.

Companies exceeding their targets would earn credits, while those falling below their targets would need to purchase credits to make up the shortfall. Any whose emissions exceed their credits would be fined.

The idea behind carbon trading is that it creates a system of supply and demand: a shortage of credits will drive up the price and give financial incentive for firms to cut their emissions.

The European vs. North American markets

The EU Emissions Trading Scheme (ETS) started on Jan.1 2005, creating the world's first multi-country emissions trading system. The EU ETS runs in two phases: 2005-2007 and 2008-2012, the latter timeframe coinciding with the first commitment period of the Kyoto Protocol.

The scheme involves the 25 European Union member states, is mandatory, and is the largest companies-based scheme around. Covering heavy industry and power generation, it includes non-European companies.

Each EU country has to submit national allocation programs to the EU commission. Each country must agree with the EU on an annual national "allocation" of emission levels which should be lower than the existing ones. The federal government is responsible for enforcement.

The system requires people to perform, but in a competitive and efficient way, said U of T's White.

"Companies that are smarter than others can get ahead," he said.

In North America, there are voluntary cap-and-trade schemes, such as the Chicago Climate Exchange (CCX) and the Montreal Climate Exchange.

Britain also has its own voluntary scheme, for which companies cut their emissions in return for incentive payments.

Though the U.S. government has decided not to ratifiy Kyoto, interest in carbon trading at the regional level is increasing, say experts. Members of the Chicago Climate Exchange include the cities of Aspen, Chicago, Oakland.

Experts say that in the absence of strict government regulations, this system will never become anything more than a pilot project.

Why would firms be involved in a voluntary process if their federal governments haven't imposed limits on them? Because those companies believe that, one day, it will be compulsory, and they want to be ready ahead of time, said White.

"Doing the prudent thing early is part of our philosophy," said Paul Vickers of TransAlta, in a news release. TransAlta, an Alberta-based electric energy company, is a member of the Greenhouse Emissions Consortium (GEMCo), a group of Canadian energy companies focusing on market-based ways of reducing greenhouse gas emissions.

"We think there's a significant chance that government will set regulations requiring reductions in greenhouse gas emissions.… We believe the best way is to help the government shape the regulations in the most practical way for the [energy] industry," said Vickers.

Bennett says the Chicago-Montreal exchanges are a good step, but the federal governments need to be involved. Otherwise, the voluntary systems are "tokenism."

The market system doesn't work unless there is a value on carbon, a cost to emitting it, said Bennett.

Canada's position

The Conservative government said Canada had no chance of meeting its targets under the Kyoto Protocol. The Clean Air Act introduced in October would see greenhouse gas emissions cut in half, but not until 2050.

According to the bill's notice of intent, "the government will not purchase credits or otherwise participate in the emissions trading market."

Bennett says our government should have imposed caps years ago.

"The first step is limit emission, but go one step further. They should not only put a cap but auction off permits," said Bennett.

In this way, Bennett said firms would buy permits to emit and then have to buy additional permits for emissions trading, and the number of permits available would be reduce over time. The government, he added, could use the money to ease transitions and aid essential industries.

Ross McKitrick of the University of Guelph says that if the government were to sell permits, money would be recycled by reducing taxes.

Effectiveness of carbon trading

Critics say carbon trading would only work if there are enough reductions to cut global warming: if trading is not comprehensive, the benefits would be limited. They point to the fact the United States, the world's largest carbon dioxide polluter, pulled out of Kyoto.

Two of the world's biggest and growing polluters, India and China, are considered developing countries and are outside the protocol's framework. They are not obligated to reduce emissions.

Without those big emitters included, carbon trading can't work, critics say.

But others say it's a good start.

McKitrick says people are missing the point about carbon credits when they claim that big business is buying its way out.

"True, by trading you're reallocating," he said. "But what brings the overall emission down is the cap…Someone has to reduce emission to get the credit in the end."

There's nothing wrong with big business buying credits, according to Bennett.

"You're going to have to buy your way out one way or another. If you're not buying credit, then you're investing in things that reduce your emissions. No company is going to buy credit if it's cheaper to reduce emission," said Bennett.

The principle of the polluter paying is paramount to the economy, according to Bennett.

"It puts value on carbon and puts cost on corporations that emit it. On their balance sheet, if it costs money, they'll figure out ways to cut costs," said Bennett.

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