There are many hazardous consequences due to the presence of greenhouse gases in the earth’s atmosphere. Some of these are ozone layer depletion, climate change, global warming and a rise in sea levels. This has resulted in many global initiatives taking shape, in order to urge nations to cut down on their carbon emission levels.

Thanks to this, many industry-oriented economies are facing a dilemma, since curbing pollution levels would result in a reduction of industrial activities. This, in turn, would result in a reduction of income and output for the economy in question, thereby hampering economic growth, not exactly a popular stance to take when seeking to get reelected (see Clean Energy ETFs In Focus).

In order to mitigate some of these concerns while still attempting to control emissions, investors have witnessed the birth of the emission trading (ET) industry. With the increasing participation of nations in the guidelines of Kyoto Protocol (KP) and rising social accountability, the emission trading industry has the potential to emerge as a major global industry, despite non-ratification of the Kyoto Protocol by the U.S.

Overview of the Kyoto Protocol (KP)

In 1997, the Kyoto Protocol was adopted by a host of participating countries. However, these countries were divided into two broad categories:

1) The developed industry-oriented economies responsible for a majority of GHG (Greenhouse Gas) emission were categorized as Annexure 1 countries (developed European nations, Japan, Australia, New Zealand, etc.) and 2) Developing nations as Non-Annexure 1 nations (China, Brazil, India, etc.)

The basic premise of the KP was to reduce emission of GHGs with specific emission reduction targets being assigned to the countries by the year 2012 (with an average of 5% leeway).

In addition to conventional and scientific methods of reducing emissions, countries also welcomed market-based mechanisms for the compliant Annexure 1 nations in order to meet the specified targets, including:

1) Emission Trading (ET) i.e. countries that have emission units to spare, can sell their units to countries in need for those units.

2) Clean Development Mechanisms (CDMs) which facilitated Annexure 1 countries in setting up “green” projects in Non-Annexure 1 countries. These projects earn tradable Certified Emission Reduction Credits (CERs) issued by the United Nations Framework Convention on Climate Change (UNFCCC). One CRE equals one ton of carbon dioxide which would be counted towards meeting the targets.

3) Joint Implementation (JIs), which is an initiative by the Annexure 1 and Non-Annexure 1 nations, to set up emission reduction or removal projects in developing nations in order to earn Emission Reduction Units (ERUs) which also would be counted towards the target.

Source: Zacks ETF Research