Carbon Markets

The Product: Carbon Emission Reduction certificate as a commodity

The underlying product in carbon markets is an allowance of green house gas emissions, measured in tons of CO2 equivalent. The supply of allowances stems from allocations to governments and carbon-reducing projects. Depending on the origin of the emission reduction, there are a number of different emission certificates (AAU, CER, ERU etc.) which may not be fungible. See description of rules below. However, each certificate represents an emission allowance of 1t.

Structure of Carbon Markets


National Emissions Account

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On an international level, the Kyoto Protocol is the current framework for reducing green house gas emissions. As part of it, 40 industrialized countries (Annex-1 countries) have committed themselves to reduce and stabilize their green house gas emissions by 5% below 1990 levels over a 5 year period (commitment period) from 2008 - 2012.

The U.S. has not ratified the protocol and is therefore not part of the Kyoto-based carbon market. Specific country targets vary from -8% (EU) to +5% (Australia) as set out in Annex-B of the protocol.

Each Annex-1 country is given an initial amount of emission allowances, AAUs (Assigned Amount Unit), calculated as follows:

AAU = Emissions in 1990 x target x 5

This represents the volume of the allowed emissions for the country over the commitment period. Some countries use another year as reference year, but the principle is the same.

Countries can achieve their targets by reducing their emissions as well as buying or selling allowances from other countries and projects by balancing their national emissions account,

National Emissions Account

by trading the following certificates:

  Certificate Name Source
AAU Assigned Amount Unit The allowance (set out in Annex-B) a country is permitted to emit.
ERU Emission Reduction Unit Certified emission reduction from a Joint Implementation (JI) project in another Annex-1 country. Since the other Annex-1 country is also subject to emission limits, JI projects do not create additional allowances. Instead, an ERU represents a transfer from one Annex-1 country to another.
RMU Removal Unit RMUs are generated in Annex-B countries by LULUCF (Land Use, Land Use Change & Forestry) activities, i.e. net changes in GHG emissions from sources and removals of sinks resulting from human-induced land-use changes, limited to afforestation, reforestation and deforestation activities since 1990. No credit is provided for the mere presence of carbon stocks and "business as usual" activities in forest or cropland management. The certificate must be backed by verifiable changes in carbon stock.
CER Certified Emissions Reduction CERs are generated from projects under the Clean Development Mechanism (CDM), hosted in a Non-Annex-1 country. Unlike ERUs, CERs represent additional emission allowances for annex-1 countries.

Some additional restrictions and regulations apply. Here are the important ones:

Commitment Period Reserve (CPR) Countries must maintain a minimum quantity of Kyoto unites in the national registry. The minimum amount is the smaller of 90% of initial AAUs or 100% of most recent emissions times 5 (years). Only units in excess of CPR are tradeable.
Excluded Emissions Emissions from international aviation and shipping are excluded.
Issuance of CERs and ERUs Project-based certificates are only issued once generated. Their delivery might take months.

Different rules apply to the different types of certificates with regards to carrying forward into the next commitment period (i.e. beyond 2012):

  • CERs and ERUs: Only 2.5% of a country's target AAUs can be carried forward.
  • RMUs: Cannot be banked.
  • AAUs: Can be carried forward without restriction.
Restrictions on "Hot Air" Some of the Aneex-1 countries have an emissions allowance surplus due to the fact that their emissions fell rapidly in the wake of the economic collapse of the Soviet Union. This leaves countries like Russia with a surplus of AAUs that could be dumped on the market without representing real green house gas reductions. Hence the name "hot air". In response to this threat, the EU will only accept AAUs from countries with surplus, if those AAUs have been "greened" with a verifiable reduction in emissions.

Developing countries (Non-Annex-1 countries) have no reduction obligation. Instead, they can sell emission rights under the CDM framework to Annex-1 countries. Also, they get money and investment for low-carbon technologies from Annex-2 countries (a subset of Annex-1 countries).


Company Emissions Account

Where a company is subject to a mandatory emission trading scheme, its target emissions are set by the government. Otherwise, it is free to set itself a target at any level. Companies have the opportunity to balance their compliance gap by purchasing or selling project-based and traded certificates subject to legislation.

Mandatory Scheme

The largest mandatory emission trading scheme is the European Emissions Trading Scheme (EU-ETS), covering some 12,000 energy-intensive organisations emitting 2.3bn tons of CO2.equivalent green house gasses. The scheme is now in its second commitment period (2008 - 2012). It has transferred some of its AAUs to those companies by issuing equivalent EUAs (European Union Allowances).

Company Emissions Account

A company can balance its emission account by reducing its emissions, as well as purchasing CERs and trading of allowances with other companies in the scheme. The following restrictions and rules apply:

Fungible Certificates EUAs, ERUs and CERs are fungible. I.e. they all count towards a company's emissions account in the same and are interchangeable.
Scope limitation for project-based reductions

Depending on the source of the emissions reduction, CERs / ERUs may not be allowed:

  • No CERs from nuclear projects
  • No CERs from forestry or cropland management
  • Projects involving hydro energy above 20MW need explicity approval from the World Commission on Dams.

If a company buys CERs, but project does not generate the projected reductions, it must buy them from other sources.

Volume limitation for offsetting Companies can only offset up to 10% of their allocation. The remainder has to come from reductions in emissions implemented within the company.
RMUs and AAUs Companies cannot buy RMUs or AAUs from other countries to offset their emission targets.
VERs Verified Emission Reductions are not accepted in the European Trading Scheme.


As CERs are fungible with EUAs, there is a secondary market for CERs, which are also traded on the European Climate Exchange. EUAs however, tend to command a premium of around 1€. The price for EUA in 1Q2010 was about €13.


Voluntary Trading Scheme

In the U.S. where the Kyoto Protocol does not apply, companies have created a voluntary trading scheme by setting targets for themselves, perhaps in expectation of a mandatory scheme in future. Analogous to the European Trading Scheme, emission allowances (CFIs) can be traded on the Chicago Climate Exchange, CCX. The CCX has its own accreditation process for verification of projects.

Voluntary Offset Market

For organisations that want to purchase carbon offsets outside the trading schemes, can do so in the voluntary offset market. The Verified Emission Reduction certificates trade around €8 (for "gold standard" certificates and €4 for others.


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