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Kyoto Protocol Mechanisms

The Kyoto Protocol, finally agreed in 1997, set up trading mechanisms for carbon emission permits and binding emission reduction goals for the period 2008-12, under teh auspices of the UNFCCC. The protocol was supposed to provide incentives to promote emission reduction in both industrialised and developing countries. It divides the world into three groups:

• "Annex-I" countries (26 countries): the set of "developed" countries, notably not including the USA, which agreed to binding reduction goals, which were unfortunately different for each country and subject to political horse-trading
• Other Kyoto signatories (163 countries): mostly "developing" countries, but including China and India
• Other countries which have not ratified the Kyoto Protocol.

A key phrase in the UNFCCC treaty was "common but differentiated responsibility". This phrase is supposed to capture the fact that the industrialised countries undoubtedly bear more responsibility for the current state of CO2e in the atmosphere than the developing world. This also takes account of the fact that the developing world has to be able to progress economically as well. Unfortunately, the wording only led to an unproductive polarisation into countries with targets and countries without.

The Flexible mechanisms

There are three main trading mechanisms each having a specific permit unit covering the emission of 1 t CO2e:

• The International Emissions Trading (IET) scheme (Assigned Amount Units, AAU)

This is a cap-and-trade mechanism which links actual emissions to the agreed mandatory emission caps and is supposed to allow trading to reduce the gap

• The Clean Development Mechanism (CDM) scheme (Certified Emission Reduction, CER)

This mechanism allows units to be credited to Annex-I countries for certifiable emission reduction in non Annex-I countries

• The Joint Implementation (JI) scheme (Emission Reduction Unit, ERU)

This mechanism is similar to the CDM, but covers projects between Annex-I countries

The so-called Marrakesh Accords (2001) extended the set of schemes to include CO2e "sinks" for specific land-use and forestry programs (and introduced another unit, the Removal Unit, RMU).

But do they work?

World Carbon Currency — WOC

The Basic Idea

The World Carbon Currency is new type of global currency: an extension of the cap & trade idea. The basic idea is that 1 unit of this money (WOC 1) has to be spent whenever 1 kg CO2e is emitted at source. By controlling the amount of this money that is in circulation, the level of emission can be influenced. By charging a negative rate of interest on WOC holdings, the World Carbon Central Bank — WCCB encourages circulation of the currency and discourages hoarding. Also, it is forbidden for commercial banks to issue WOCs that they do not have (unlike normal currency). Apart from these basic rules, the WOC currency can be traded like any other currency and will float to find its own value, driven by supply and demand.

The set of countries that have the legislation and facilities in place to collect and distribute WOCs form the World Carbon System — WCS. Countries outside the WCS have to pay a levy in WOCs to compensate for the embedded CO2e emissions in their exports to the WCS. Similar arrangements apply for air and sea travel and cargo emissions to and from WCS countries.

The various carbon units currently in circulation within the Kyoto flexible mechanisms and the ECTS can be converted into WOCs. Although one EUA (for example) is a permit to emit one tonne of CO2e, and so is notionally worth WOC 1000, it is likely that the market rate will not be exactly 1000 because of the lower liquidity of the Kyoto and ECTS units.

The WOC is book money that can only be held on bank accounts: modern charge, credit and debit cards should be able to handle such a new currency, even as a dual currency, without much adjustment being necessary. It would also be possible to use mobile phone based charging mechanisms, as is common in parts of the Third World.

WOCs are withdrawn from circulation as near as possible to points of primary CO2e emission, by collecting them from primary emitters, like electricity companies. How many WOCs have to be paid to the WCCB depends on the nature of the emission and its level. The rules are determined by independent scientists and are applied in an identical way by all countries in the WCS. Initially, the same industries covered by Kyoto and the European Carbon Trading Scheme (including international airline and sea travel) are covered so as to take advantage of existing auditing and measurement mechanisms. Over time, other emission points can be included. Governments (and voters) in countries in the WCC System would need to agree to police these mechanisms.

For example, if you want to pay petrol for your car, or oil for your heating, or an air trip to Guadeloupe, you would notionally have to pay the required number of WOCs, or their current market value in home currency.

The idea of collecting the WOCs as near to the primary emission point as possible, is to keep the number of players that have to collect WOCs at a reasonable level. This also means that the cost of policing can be kept to a managable level, and the number of objective measures needed (eg, how many WOCs is 1 kWh of this particular electricity worth) not too onerous. If the policing is adequate and importantly the WCCB's monetary policy is sufficiently restrictive, then WOCs will attract a reasonably high market value in developed countries (after all, people want to drive their cars and fly to Guadeloupe).

The next issue is how to allocate WOCs. Suppose that a simple country-based scheme can be found based on current emission levels, and population and GDP (perhaps 50:50), with a penalty scheme for countries not collecting sufficient WOCs to "pay" for their actual emissions (independent measurement of overall emissions will probably need a further intergovernmental watchdog). If this is set up right, there could be an incentive for WOCs to flow from developing to developed countries which would have part of the effect we wanted to achieve. It could become an "aid" reserve currency, also used for paying for adaptation projects.

The private person will get involved in this scheme, since he will need WOCs to do those nasty polluting things that he really wants to do. Either individuals would have to buy WOCs (effectively from less polluting countries and individuals) or they would have to be allocated in some equitable way, perhaps through taxes. This is a social issue that politics would have to solve, maybe differently in different countries.

If over time, the total number of WOCs in circulation is continuously reduced, then economic theory indicates that their value would increase. The "power of the market" could be harnessed to drive things in a positive direction, and at least in the West, individuals would still retain a degree of personal choice. For example, if I choose to use public transport and local holidays, or am a poor person (low number of WOCs needed), then I can sell my excess WOCs to others who want/need to drive cars and fly to Guadeloupe).

This whole scheme needs a lot of political will and leadership to get started, but might really be a credible alternative to the use of force/threat of war, and requires less administration than today's Kyoto mechanisms. Because the "market" is involved, it could be an attractive system for conservative and liberal politicians, and socialists will like the reallocation aspect. Also, because it would be a world currency, it would bind rich and poor in a new way, encouraging the pursuit of a common goal of emission reduction.

The private sector would get involved in maximising "profits" in WOCs, just like with any other currency. "Micro" carbon accounting will take place only where the cost of doing it is justifiable: otherwise the WOCs will just be treated as just another "cash expense".