Carbon Market Prepares for Ukraine Deal

12 June 2009

The Ukraine government recently announced its intention to sell US$3.5 billion worth of carbon credits, known as Assigned Amount Units (AAUs), to buyers in Japan, Switzerland, and New Zealand. If completed, the sales would represent the biggest such transactions to date.

AAUs are one of three measurements established by the Kyoto Protocol (KP) for quantifying greenhouse gas (GHG) emissions reductions - the other two mechanisms being Emission Reduction Units (ERU) and Certified Emission Reductions (CER). AAU is a cap and trade mechanism, and the latter two mechanisms deal with actual project based reduction.

Under the KP, countries have specific targets, based on the past year, that set a ‘cap' on future emissions. If countries emit less than their cap, they may sell their surplus carbon allowances in an Emissions Trading System (ETS). This ‘cap-and-trade' system has generated a multi-billion dollar market in emissions credits.

Kyoto set relatively easy targets for economies in transition by selecting base years for GHG emissions from their pre-transition period (1985-1990). The Ukraine agreed to cap its GHG emissions at 1990 levels through the first Kyoto commitment period (2008 - 2012).

Surplus of ‘hot air' in Eastern Europe

The country's most recent GHG inventory showed that in 2004 the GHG emissions made up only 45 percent of their 1990 level, and basic forecasts indicate that in 2012 emissions will not exceed 1990 levels. Current estimates calculate that the Ukraine has over 1 billion AAUs that could be sold in the Kyoto Protocol's first commitment period. The scale of the overall AAU market is many times this number, especially if number one supplier Russia sells its stores.

AAUs are often referred to as ‘hot air'. From the vantage point of international carbon markets, this hot air represents an excess supply of AAUs. If excess is traded with no restrictions, Russia's and Ukraine's hot air could be purchased by other countries, allowing Kyoto targets to be met without anyone actually reducing their GHG emissions.

Most AAUs result from restructuring in Eastern Europe in the 1990s (when polluting industries in ex-communist countries were shutting anyway), rather than by new investment in clean energy as intended under the emissions reductions schemes. This reality raises questions of whether carbon trading achieves its purported goal of overall emissions reductions and whether it contributes to the broader global goal of sustainable development.

Because of this, some buyers insist that AAU deals should be ‘greened', meaning their proceeds go to investments in clean energy or energy efficiency, under Green Investment Schemes (GIS). Buyers have taken similar approaches to Joint Implementation and the Clean Development Mechanism trading, and some countries have regulated such a requirement.

Re-investment into green initiatives unlikely

The Ukraine could use the transaction revenues from the multi-billion dollar sale to co-finance climate friendly projects, but is not required to do so under KP rules. The decision would be voluntary or stated in the purchase contract.  Analysts from the region observe that the extra income gained from the over-allocation of AAUs is unlikely to be invested in new low-carbon technologies or energy-efficiency schemes. "It is instead more likely to be treated as a windfall, to be used to subsidize polluting firms, and thereby enhance carbon lock-in," says Gábor Takács of the Budapest Business School.

The shaping and preparation for sale of the Ukrainian AAUs was made possible, in part, by technical assistance from the European Bank for Reconstruction and Development (EBRD). A one million dollar consultancy set up to evaluate GHG emissions and reduction potential, develop a framework for emissions, and increase local capacity, both amongst government representatives and local consultancies, to address carbon market matters. Notably, the project included the development of a pilot Green Investment Scheme (GIS) with the EBRD's Multilateral Carbon Credit Fund.

Sale will impact global carbon prices

The carbon markets trading in AAUs and Kyoto's other emissions reductions mechanisms constitute billions of dollars of potential profits for participating countries. The market, however, is volatile and although the number of units traded has increased by over 20 percent in the past year, the value of those units has dropped by 32 percent for the AAUs. The vast sale of AAUs is considered problematic because it affects the value of carbon within the carbon market, since the other units that have more stringent requisites.

CDM and Joint Implementation projects have greater difficulties securing financing, in part because of this greater stringency. The World Bank notes that "banks and financial players are also less likely to engage in meaningful levels of project origination" for these initiatives. The level of attention and financing for countries trading in AAUs from the development banks and bilateral agencies begs the question of whether players in the carbon markets are, in practice, working in line with global sustainable development objectives, safeguards, and principles.

ICTSD Reporting; "Ukraine to sell $3.5 bln more Kyoto carbon rights," REUTERS, 26 May 2009; "Hot Air? Carbon Markets and Sustainable Development," UNDP LSE, October 2008; "'Perfect storm' threatens poor nations' CO2 cuts," REUTERS, 28 May, 2009.

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