International Emissions Trading Scheme Accounting Essay

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Human existence is dependent on the environment and its conditions determine how conducive or otherwise life will be for humans and other life forms on earth. Weather and climate are major environmental factors that affect human lives in countless ways such as affecting health, sources of food and others. A rise in net global temperatures triggered by anthropogenic emission of Greenhouse gases (GHG) would have devastating effects on humanity. There is the need to reduce GHG emissions (especially carbon dioxide, CO2) drastically to avoid any such occurrence. A number of measures are being implemented and several others under discussion and consideration aimed at averting such an occurrence. Significant among the measures being implemented to tackle the issue of climate change is the reduction of GHG emissions using market based instruments, namely emissions tax and tradable emissions permit. These instruments basically involve compelling firms to reduce their emissions directly or indirectly. These instruments are currently used in a number of countries but due to the global nature of climate change, mitigation can be most effective when countries worldwide take collective stands to address the problem.

This paper therefore aims to assess how an emissions trading scheme adopted by all nations can be effective in the fight to mitigate climate change as compared to other measures also aimed at promoting GHG emission reduction in climate change mitigation. In the subsequent chapters climate change and its mitigation will be reviewed briefly, as well as use of market based instruments in mitigation. Comparison of emissions trading schemes and emissions tax schemes will be made. Current implementation of emissions trading will be also reviewed and based on that factors that will facilitate the successful implementation of an international emissions trading scheme will be examined. Conclusions will be then be drawn as to whether widespread international emissions trading scheme will be effective in reducing GHG emissions significantly and ultimately mitigating climate change.

Climate change

Climate is the accumulated weather conditions of a particular location over a specified long period. Climate change can be said to be the net change in average weather patterns over a long period. The UNFCCC in Article 1 of its convention defines climate change "a change of climate which is attributed directly or indirectly to human activity that alters the composition of the global atmosphere and which is in addition to natural climate variability observed over comparable time periods". [1] 

The UNFCCC definition attributes the changes in climate to the direct or indirect effects of anthropogenic activities. These changes in climate are as a result of the net increases in the temperatures of the earth's surface known as global warming. Global warming is caused by the accumulated greenhouse gases in the atmosphere, which then trap heat. Greenhouse gas as per the definition of the UNFCCC is any gas that may either be naturally occurring or emitted by anthropogenic activities into the atmosphere, that has the potential to absorb and re-emit infrared radiations and include gases. [2] It includes gases such as water vapour, carbon dioxide, methane, ozone, nitrous oxide and halocarbons which constitute approximately 1% of the earth's atmosphere naturally. [3] This feature of greenhouse gases is very essential in the sustenance of life on earth include that of humans by regulating the earth's climate. For instance the absorption and subsequent re-emission of infra-red radiations by these gases helps keep the earth surface warm to sustain life. The increased emission of these gases into the atmosphere from anthropogenic activities, such as the burning of fossil fuels (oil, coal, etc.) and destruction of forests have the potential of eventually causing havoc for humankind and all life on earth.

Global temperature readings from the start of the century indicate a net increase of about 1.4 oF (0.8 oC) much of which has been observed to have occurred in the last 30 years and scientist attribute this mainly to human activities. There is strong evidence linking the increasing global temperatures to the effects of anthropogenic activities; measurements of the sun's output by satellites in the last 30 years does not indicate any significant changes that corresponds with the rising global temperatures over the years. [4] 

Climate change will have several impacts on humans and other life forms, these may either be beneficial or otherwise depending on the location and the organisms involved. These impacts include increase in occurrence of floods in flood prone areas as a result of intense rainfall and rise in sea levels due to the melting of the ice caps, severe droughts in dry areas, melting of permafrost in sub-arctic areas will make them habitable. It is likely to ease marine transportation in areas hitherto inaccessible, increase the incidence of diseases in vulnerable regions like Africa, increase incidence of extreme weather events like hurricanes, etc. [5] 

Climate change mitigation

With the glaring consequences of climate change, it is imperative that urgent measures are undertaken to drastically minimise the rate of change to avoid its deleterious effects on humanity and all life forms on earth. Mitigation primarily deals with eliminating the causes of the climate change, in this case reducing greenhouse gas emissions from anthropogenic activities. Several efforts are being made by the global community to address this issue

Kyoto protocol, article 3.3

The need for non-Annex I countries with increasing GHGs such as India and China to also commit to emission reductions have been raised.

CHAPTER TWO

Why use market instruments for mitigating climate change?

With the knowledge of the fact that CO2 emissions from anthropogenic activities contribute significantly to climate change, several measures tailored to reduce these emissions are employed. Thus from policy point of view, a number approaches are used namely;

Prescriptive (command-and-control) regulation

Market-based instruments

Hybrids. [6] 

Prescriptive regulation (Command-and-control)

Command-and-control regulation sets standards for the level of pollution permitted and prescribes the types of technology to be used in remedying the situation. [7] Thus regulatory agencies set up levels of CO2 emissions that are permitted and firms are then compelled to comply with the directive or face sanctions. Two forms of this approach are in use, the technology standards and the performance -based standards.

Under technology standards the regulatory agency prescribes the specific technology that must be utilised by firms to reduce emissions to reach targets. The performance based standards allows the polluter the freedom to choose the method it can utilise in meeting the prescribed standards, in some cases however criteria for selection of appropriate and affordable technology may be prescribed. [8] 

This approach used to be the most commonly used approach because of its enforceability and effectiveness in achieving targets some years back, however it raises some concerns such as;

It is less cost- effectiveness because it imposes regulation that have to be complied with without consideration for the varying marginal cost of abatement of the various firms being regulated.

It may lead to high cost of goods and services.

It does not provide any incentive for technological innovativeness on the part of firms when technology standards are prescribed.

It may not always cause emissions reductions, for instance firms with higher abatement cost would prefer to pollute and pay damages, which may be lower than their abatement cost. [9] 

Market-based Instruments

Market based instruments on the other hand are economic instruments that use price and other economic variables to provide incentives for firms to reduce their emissions (pollution). [10] These instruments are aimed at making firms and consumers account for the environmental impact of their activities by taking into account pollution abatement in their production and consumption decision. This also gives them the freedom to apply the least cost options for the maintenance and improvement of environmental quality. [11] There are numerous market-based instruments that can be considered for ensuring and improving environmental quality, the major ones to be considered for the purpose of this paper will be emission taxes, tradable permits and environmental subsidies.

Market-based instruments have a number of advantages over the traditional prescriptive regulation of command-and-control such as;

It takes into consideration the varying marginal abatement cost of each firm, thus ensuring cost-effectiveness.

Firms and consumers alike take responsibility for the impact of their activities on the environment and externality is reduced.

Firms and consumers have the freedom of choice in the technology or methodology which is cost-effective in ensuring environmental quality.

It generates revenue for government.

It also provides incentive for technological innovation to improve climate change mitigation and environmental quality in general.

Hybrids

This approach combines the features of the command-and control approach and market-based instruments. It is used because of its ability to ensure enforceability stemming from the command-and control and the flexibility and incentive for environmental quality improvement of the mainstream market-based approach. [12] 

In mitigating climate change market-based instruments are to preferred approach by regulators and firms alike because it is flexible, makes firms account for the environmental impact of their actions, cost-effective. It also gives incentive for technological innovations for emission reduction among other benefits and caters for the different responses of various firms to the emission reductions targets.

Emissions trading (tradable permit) scheme and Emissions tax scheme

The two main market-based instruments to be discussed in addressing climate change and improving environmental quality are emission trading schemes and emission taxes. Market based as discussed earlier give incentives for emissions reductions

Emissions trading schemes also known as tradable permit schemes involve the setting of pollution limits that should not be exceeded and the subsequent issuance of permits to cover those emissions and encourage trade among firms, where firms that pollute in excess of the set limit buy from smaller ones who pollute less than the set limits and do not require their excess permits. [13] With regards to climate change, CO2 emission limits are set for every sector and permits/ allowances auctioned or grandfathered [14] , these permits cover each firm's allowable emissions. Firms with emission levels higher than the permissible emission level are then compelled to cut down emissions by reducing outputs, investing in technology or purchasing permits from firms which have excess permits and do not require them. Thus under an emissions trading scheme, the quantity of emissions permitted is determined and price left undetermined to be determined by the ensuing market. Emission trading exists in various forms in dealing with CO2 emission reductions.

The basic underlying principle of emission tax is the polluter pays principle where the firms pay for damages done to the environment. [15] Under emissions tax schemes for climate change mitigation, regulatory agencies institute tax which firms pay for every unit of CO2 that is emitted. [16] Price under emission trading schemes is determined and quantity of emission left to be determined by the firms in the free market. Depending on the cost involved, abatement [17] may be preferred when the cost is less than the emission tax and the emission tax preferred when it is lower than the abatement cost.

CHAPTER THREE

International Emissions Trading Scheme

Emission trading schemes have been shown to be a more effective means of reducing atmospheric pollution as evidenced in the successful implementation of the Acid Rain Program in the United States, it is aimed at reducing sulphur dioxide emissions and from the results it has succeeded in achieving its goal. It therefore is by far the world's largest and most successful emission cap and allowance trade programme. [18] 

In addressing the issue of climate mitigation, the Kyoto protocol makes arrangement for reductions in GHG to be carried out through least cost measures such as emission trading systems [19] among others. Emission trading under the Kyoto Protocol allows countries with GHG emission limitations as in Annex B [20] trade emission permits amongst themselves, thus an Annex B country or its subnational entities in a bid to meet it emission targets can purchase emission permits from another Annex B country or its subnational entities that have been able to reduce its emissions below its assigned limit. [21] 

There are several GHG emissions trading schemes already up and running, whereas some are mandatory others are voluntary. Some of the mandatory schemes in operation now are; The European Union Emissions Trading System (EU ETS) in about 31 countries [22] , the Regional Greenhouse Gas Initiative in the USA, the New Zealand Emissions Trading Scheme, the Tokyo Metropolitan Trading Scheme in Tokyo Japan, and the New South Wales Greenhouse Gas Abatement Scheme in Australia. [23] 

The EU Emission Trading Scheme is so far the popular and biggest mandatory GHG emission trading schemes in operation currently. It serves as the cornerstone for EU's policy on climate change mitigation and key to reducing GHG emissions through cost effective means [24] . It is based on the "cap and trade" principle where emission caps are set and firms receive or buy allowances/permits to cover their emissions. Where emissions are in excess of the allowances/permits, strict fines are imposed and when a company's emissions are lower than its allowances, they may be kept to cover future emissions or sold to other companies that are emitting in excess of their allowed levels to make gains. This therefore creates an incentive for companies to reduce emission levels [25] where possible to avoid fines or make profit by selling unused allowance. With the success chalked so far with the EU ETS and other regional trading schemes, more credence is given to the need for a wide spread international implementation.

The establishment of emissions limitation on the national scale is key to facilitating the successful expansion of GHG emissions trading beyond the regional programs currently in operation to involve as many countries worldwide as possible in an international emissions system. Other factors that have a bearing on the success of such a program are; the scope of coverage, the forms/types to be implemented on international scale, monitoring schemes.

Scope of Coverage

The scope addresses the issues of which GHGs are to be covered under this "international emission trading scheme" as well as whether it should be economy wide or only certain sections of the economy should be covered.

How complicated or otherwise an "international emissions trading scheme" will be, one way or the other depends on the number of GHGs that are covered under the scheme. Incorporating all GHGs is likely to make the implementation and monitoring of the scheme quite complicated. If it is streamlined however to address the major GHGs of anthropogenic origin (for instance CO2), then it is likely to make implementation and monitoring less complicated and thus enhance effectiveness.

Various parties have raised concerns about how much of a country's emissions should be traded (sold or bought). [26] There are suggestions that limiting the amount of emissions that can be traded will ensure that the aim of emissions trading supplementing national/domestic measures to reduce emissions is achieved. In inter-source emissions trading [27] for instance, firms may prefer to buy permits once they are cheaper than their marginal abatement cost. Thus they will not engage in any activities to cut back on their GHGs emission, which would have defeated the aim of emission trading supplementing efforts to cut back emissions internally.

A limitation on the amount that is traded however has the potential of interfering in a free market operation and increasing operating cost. It gives less incentive for investment in technology and thus defeats the ultimate aim of emission reduction at the least cost possible. A possible solution to addressing this concern is the need for governments of Annex I [28] to ensure that emission reduction measures are undertaken on the national scale and that international emission trading only supplements national efforts.

The issue about whether it should be economy wide raises concerns about which sections of the economy when controlled have the highest potential for emission reductions. When carbon intensive upstream industries are regulated with a cap and trade, it leads to reductions in emissions at that source however it serves as no incentive for consumers to cut back on their consumption, waste and subsequent increase in GHG emission since they do not really feel the impact of their consumption behaviour. When regulation is limited to downstream side, the costs incurred in meeting emission targets are then passed on to consumers who then feel the rise in prices and thus adjust their consumption accordingly. This however leaves the upstream unregulated. A combined implementation of the two is a possible way of dealing with this issue such that both the upstream and downstream sections are regulated to cut down on GHG emissions.

What forms/types of emission trading schemes would be suitable for international implementation?

Various forms of emissions trading schemes are being discussed for implementation on international scale. These forms are basically based on the parties involved and the means of trade. Three basic forms have been discussed in literature, namely;

Inter-governmental trading [29] 

inter-source trading [30] 

credit trading [31] 

Inter-governmental trading as stated in Article 17 of the Kyoto Protocol to the UNFCCC basically involves the trading of emissions permits between Annex B countries of the Protocol amongst themselves. Countries that are not able to meet their emission reduction commitments can purchase emission permits/allowances from countries that have been able to cut their emission below their targets that they are committed to. Here an emission trading is between governments and no formal approval is needed as is the case with other measures such as Joint Implementation projects. [32] 

An inter-source emission trading is where governments allocate to their subnational entities or firms their assigned amounts of emissions reductions. These governments will then authorize the entities to trade on the international emissions market. This stimulates technological innovation in reducing emissions since firms or entities are free to carry out measures that will help them meet their assigned limits set nationally. It will also enable the firms benefit from their emissions trade directly. Increase in the number of players in the market, which is characteristic of inter-source trade will boost competition and in effect make the market efficient.

Governments' involvement is therefore limited to definition of criteria and rules for governing the firms involved in international emissions trade. [33] 

Another form of international emissions trading is credit trading, this is involves trade between individual entities or firms but unlike in the inter-source trading where emissions permits is traded, here emission credit is traded. [34] Entities that have undertaken projects to reduce GHG emissions either in their home countries or other countries can then sell the credit to other firms that require credits to cover their emission in order to meet their targets once the project has been approved adjudged to effect reduction in the GHG emissions.

Monitoring, regulation and administration

The success of an international implementation of emissions trading system to mitigate climate change to a large extent depends on the manner in which monitoring and the regulation are carried out. There is the need for monitoring and regulation in the individual countries by an independent international regulatory agency and national regulatory agencies to ensure successful implementation. Emission levels would have to be monitored regularly to ensure that firms or entities adhere to set targets or limits and those acting contrary fined or sanctioned accordingly to serve as deterrent. As is the case with the credit trading form of emissions, projects should be monitored to verify that they are indeed additional, that is to say that approved projects for which credits are to be traded are actually reducing GHG emissions in the atmosphere. If that is not the case, then such projects would be no more be approved to participate in emission trading.

How effective will an International Emissions Trading be in mitigating climate change?

The implementation of an international GHG emission trading schemes which is well structured and has in place a well -resourced monitoring and administering agency will go a long way together with other efforts to reduce GHG emissions and help mitigate climate change.

International implementation of GHG emissions trading will prevent leakage, where firms move out of markets with emission limitations to other markets with less or no restrictions on emissions. With an international implementation then firms will have no options out of emissions reductions, thus initiating measures to reduce emissions to meet set targets or purchase emission permits or allowances to cover up for their GHG emissions.

Firms will in most cases be keen to invest in efficient technology to cut down on emissions so as to reduce the cost involved in acquiring permits to cover emissions and also make some profits from the sale of unused allowances.

Economics

Conclusion

There is the need for the world to take stands on mitigating climate change, the longer the delay in doing something about it the less chance we have of reversing this phenomenon. Thus this paper examined the climate change phenomenon and the measures that able being put in place to deal with as whole it. It however narrowed down to the feasibility of an international implementation of GHG emissions trading as a major way of compelling firms, and countries as a whole to cut down on emissions to save the planet. It became apparent that for the success of any such program, there was the need for an appropriate design, implementation, administering and monitoring to ensure that all key principles are adhered to.

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