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Abstract: In the year of 2005, the EU ETS came into effect. After then, carbon trading markets have been emerging across the world and a large number of studies have been conducted about the mechanisms of carbon trading. However, as an emerging market, carbon trading still faces many obstacles and needs more profound research support. For this reason, this paper reviews current related research progress on carbon trading market mechanisms, mainly including carbon emissions allowance allocation, carbon asset pricing and carbon price risk measurement. And then the paper discusses the limitations of existing research and puts forward some possible research directions in the future. Hopefully, the paper is helpful to better understand the research status and problems, and more importantly provide some references to optimise the carbon trading operations.
Keywords: carbon emissions allowance; carbon trading market; carbon market mechanisms.
Reference to this paper should be made as follows: Zhang, Y-J. (2016) ‘Research on carbon emission trading mechanisms: current status and future possibilities’, Int. J. Global Energy Issues, Vol. 39, Nos. 1/2, pp.89–107.
Biographical notes: Yue-Jun Zhang is a Professor at Business School of Hunan University, China. He got his PhD degree in Management Science and Engineering from Chinese Academy of Sciences (CAS) in 2009. His research interests focus on crude oil price modelling, carbon trading mechanisms and energy policies. He is the director of Center for Resource and Environmental Management, Hunan University, and he also was a visiting scholar at Energy Studies Institute (ESI) of National University of Singapore (NUS).
1 Introduction
On 16 February 2005, the Kyoto Protocol was put into effect, which means a start for actions in response to global climate change taken by human beings. Afterwards, although international climate negotiations marched difficultly through the UNCCC (United Nations Climate Change Conference) all the way from Bali, Copenhagen,
Cancun, Durban, Doha to Warsaw in recent years, the beliefs and efforts to address global climate change have been fully recognised across the world, and what are the effective mechanisms and strategies to address climate change has also become one of the focuses of academic interests.
According to the Kyoto Protocol, through 2008 to 2012, the greenhouse gases (mainly the carbon dioxide) emissions of main industrialised counties (i.e., Annex I countries) should drop by 5.2% compared to the 1990 level. Under this constraint, carbon emissions allowance (or carbon quotas, carbon credits) becomes some kind of scarce resource and has properties of a commodity. In order to achieve the quantitative emission reduction target, the Kyoto Protocol provides three flexible mechanisms, say CDM (Clean Development Mechanism), JI (Joint Implementation) and IET (International Emissions Trade), among which CDM and JI are based on projects and IET is on quotas. This paper mainly focuses on carbon quotas market, namely the carbon emissions trading market.
The rules for carbon trading claim that, within a specified period (like one year), those regulated enterprises that cannot achieve their emissions reduction target can buy carbon credits in the carbon trading market; meanwhile, those enterprises that have accomplished the target ahead of schedule and have surplus carbon credits can sell their credits in the carbon trading market. In this way, the establishing of carbon trading market makes it possible for Annex I countries in the Kyoto Protocol to realise their quantitative targets and at the same time optimise internal resource allocation through the market mechanism. Currently, the positive role of carbon trading market has been accepted all over the world and a number of countries or regions have been or are preparing to establish carbon trading markets, such as the European Union, the United States, Japan, Australia, New Zealand, South Korea and Switzerland. And considering the market scale, liquidity and influence, the EU ETS (European Union Emissions Trading Scheme) should be the most representative carbon trading market across the world.
The Kyoto Protocol requests that, from 2008 to 2012, the average emissions for six kinds of greenhouse gases including carbon dioxide in the EU should decline 8% compared to the 1990 level. In order to Giúp its member states to meet their reduction commitments and draw lessons for the cap-and-trade pattern, the European Commission established the EU ETS and began to run it in January 2005. Under the EU ETS, the period from 2005 to 2007 is designed to be the first phase or trial phase, and 2008-2012 is the second phase or execution phase, which just matches with the time schedule of the Kyoto Protocol.1
However, the research on carbon emissions trading market mechanisms has just started across the world in recent years, and related understandings are still on a preliminary stage, although theoretical foundations of carbon trading market have been widely acknowledged and dozens of empirical articles are emerging. Especially for the mechanisms of carbon emissions allowance allocation, carbon emissions allowance pricing and market risk measurement, existing research outputs are far from enough. For these reasons, it is necessary to summarise exiting research on carbon trading market mechanisms and policies, and explore the possible research directions in the future.
Ever since the EU ETS began to run in 2005, carbon trading markets around the globe have been developing rapidly. According to the State and Trends of the Carbon Market Report 2012 released by the World Bank, after several years rapid growth, the
Research on carbon emission trading mechanisms 91
total value of global carbon market mounted to $176 billion and transaction volumes reached a new high of 10.3 billion tons of carbon dioxide equivalent in 2011; and following the same pattern observed in previous years, the global carbon market in 2011 was primarily driven by the EU ETS. Meanwhile, carbon market mechanism research has become a new hotspot, and a body of publications can be seen from international peer- reviewed journals, which have discussed the carbon market mechanism from various aspects and mainly focused on the EU ETS although some literature also concerns about other carbon markets.
Under this circumstance, we will review current research status related to carbon market mechanisms from three aspects, i.e., the carbon emissions allowance allocation, carbon asset pricing and carbon price risk measurement, and try to present some intriguing future research possibilities for each aspect.
The rest of the paper is organised as follows. Section 2, 3 and 4 presents the literature review and possible research directions about carbon emissions allowance allocation, carbon asset pricing mechanisms and carbon price volatility and risk measurement, respectively. Section 5 concludes the paper.
2 Carbon emissions allowance allocation mechanisms
2.1 Allocation principles
There have been already plenty of research findings concerning carbon emission allowance allocation. Existing literature mainly focuses on realising quantitative carbon emissions reduction targets in the Kyoto Protocol or IPCC proposals based on the “common but differentiated responsibilities” principle, and considers how to allocate carbon emission allowance among countries and regions in the world wide (Rowlands, 1997; Leimbach, 2003; Peng and Xu, 2005; IPCC, 2007; OECD, 2008; Stern, 2008; UNDP, 2008). It should be noted that fairness is the primary principle mentioned in current literature, which specifically concerns fairness in terms of carbon emissions per capita, historical responsibility and carbon emissions reduction ability. We may review the related literature as follows.
1 Carbon emissions per capita: A number of authors discuss the carbon emissions allowance allocation mechanism based on the equality of carbon emissions per capita. This idea is based on the principle of equalitarianism and suggests that every human being in the world has an equal access to air resource, so carbon emissions allowance should be allocated to countries and regions according to their population. Xu and He (2000) raise that, when considering children, the equality of carbon emissions per capita can be further classified to that of adults and children; and when considering inter-generational difference, it includes contemporary, generational and transitional equality per capital. Moreover, Chen and Wu (1998) find that the comprehensive allocation mechanism concerning carbon emissions per capital and carbon emissions per unit of gross domestic product (GDP) is an ideal choice from the combined view of fairness, efficiency and income. Additionally, the Global Public Resources Institute (GCI) (2005) puts forward the carbon emissions per
capita convergence method. This method sets up a benchmark year and a target year, during which developing and developed countries’ carbon emissions per capita may rise and fall respectively till converge on the same level eventually.
2 Historical responsibility: Some references focus on the principle of historical responsibility, which considers that the impact on climate change of historical cumulative carbon emissions differ from each country and region, so distinguished reduction responsibility should be taken for different historical carbon emissions. For instance, Rowlands (1997) calculates the carbon credits of OECD countries based on their historical carbon emissions. And some references propose to allocate the emissions allowance according to the cumulative carbon emissions per capita so as to embody historical responsibility principle. For example, He et al. (2009) hold that developed countries should take the lead in carbon emissions reduction and provide advanced carbon emissions reduction technologies for developing countries; and China should make full use of its advantages of low historical cumulative emissions per capita. Ding et al. (2009a) argue that the allocation plan based on historical cumulative carbon emissions per capita can finally realise the “common but differentiated responsibilities” principle. Furthermore, after simulating seven global carbon emissions reduction plans including IPCC, UNDP and OECD, Ding et al. (2009b) find that these plans do not consider the reality that developed countries’ cumulative emissions per capita was 7.54 times larger than that of developing countries from 1900 to 2005; but contrarily allocate more carbon emission allowances (namely 2.3 to 3.6 times larger) for developed countries than that for developing countries for the future carbon emissions allowance, which may severely deprive the basic developing rights of developing countries in the future.
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Abstract: In the year of 2005, the EU ETS came into effect. After then, carbon trading markets have been emerging across the world and a large number of studies have been conducted about the mechanisms of carbon trading. However, as an emerging market, carbon trading still faces many obstacles and needs more profound research support. For this reason, this paper reviews current related research progress on carbon trading market mechanisms, mainly including carbon emissions allowance allocation, carbon asset pricing and carbon price risk measurement. And then the paper discusses the limitations of existing research and puts forward some possible research directions in the future. Hopefully, the paper is helpful to better understand the research status and problems, and more importantly provide some references to optimise the carbon trading operations.
Keywords: carbon emissions allowance; carbon trading market; carbon market mechanisms.
Reference to this paper should be made as follows: Zhang, Y-J. (2016) ‘Research on carbon emission trading mechanisms: current status and future possibilities’, Int. J. Global Energy Issues, Vol. 39, Nos. 1/2, pp.89–107.
Biographical notes: Yue-Jun Zhang is a Professor at Business School of Hunan University, China. He got his PhD degree in Management Science and Engineering from Chinese Academy of Sciences (CAS) in 2009. His research interests focus on crude oil price modelling, carbon trading mechanisms and energy policies. He is the director of Center for Resource and Environmental Management, Hunan University, and he also was a visiting scholar at Energy Studies Institute (ESI) of National University of Singapore (NUS).
1 Introduction
On 16 February 2005, the Kyoto Protocol was put into effect, which means a start for actions in response to global climate change taken by human beings. Afterwards, although international climate negotiations marched difficultly through the UNCCC (United Nations Climate Change Conference) all the way from Bali, Copenhagen,
Cancun, Durban, Doha to Warsaw in recent years, the beliefs and efforts to address global climate change have been fully recognised across the world, and what are the effective mechanisms and strategies to address climate change has also become one of the focuses of academic interests.
According to the Kyoto Protocol, through 2008 to 2012, the greenhouse gases (mainly the carbon dioxide) emissions of main industrialised counties (i.e., Annex I countries) should drop by 5.2% compared to the 1990 level. Under this constraint, carbon emissions allowance (or carbon quotas, carbon credits) becomes some kind of scarce resource and has properties of a commodity. In order to achieve the quantitative emission reduction target, the Kyoto Protocol provides three flexible mechanisms, say CDM (Clean Development Mechanism), JI (Joint Implementation) and IET (International Emissions Trade), among which CDM and JI are based on projects and IET is on quotas. This paper mainly focuses on carbon quotas market, namely the carbon emissions trading market.
The rules for carbon trading claim that, within a specified period (like one year), those regulated enterprises that cannot achieve their emissions reduction target can buy carbon credits in the carbon trading market; meanwhile, those enterprises that have accomplished the target ahead of schedule and have surplus carbon credits can sell their credits in the carbon trading market. In this way, the establishing of carbon trading market makes it possible for Annex I countries in the Kyoto Protocol to realise their quantitative targets and at the same time optimise internal resource allocation through the market mechanism. Currently, the positive role of carbon trading market has been accepted all over the world and a number of countries or regions have been or are preparing to establish carbon trading markets, such as the European Union, the United States, Japan, Australia, New Zealand, South Korea and Switzerland. And considering the market scale, liquidity and influence, the EU ETS (European Union Emissions Trading Scheme) should be the most representative carbon trading market across the world.
The Kyoto Protocol requests that, from 2008 to 2012, the average emissions for six kinds of greenhouse gases including carbon dioxide in the EU should decline 8% compared to the 1990 level. In order to Giúp its member states to meet their reduction commitments and draw lessons for the cap-and-trade pattern, the European Commission established the EU ETS and began to run it in January 2005. Under the EU ETS, the period from 2005 to 2007 is designed to be the first phase or trial phase, and 2008-2012 is the second phase or execution phase, which just matches with the time schedule of the Kyoto Protocol.1
However, the research on carbon emissions trading market mechanisms has just started across the world in recent years, and related understandings are still on a preliminary stage, although theoretical foundations of carbon trading market have been widely acknowledged and dozens of empirical articles are emerging. Especially for the mechanisms of carbon emissions allowance allocation, carbon emissions allowance pricing and market risk measurement, existing research outputs are far from enough. For these reasons, it is necessary to summarise exiting research on carbon trading market mechanisms and policies, and explore the possible research directions in the future.
Ever since the EU ETS began to run in 2005, carbon trading markets around the globe have been developing rapidly. According to the State and Trends of the Carbon Market Report 2012 released by the World Bank, after several years rapid growth, the
Research on carbon emission trading mechanisms 91
total value of global carbon market mounted to $176 billion and transaction volumes reached a new high of 10.3 billion tons of carbon dioxide equivalent in 2011; and following the same pattern observed in previous years, the global carbon market in 2011 was primarily driven by the EU ETS. Meanwhile, carbon market mechanism research has become a new hotspot, and a body of publications can be seen from international peer- reviewed journals, which have discussed the carbon market mechanism from various aspects and mainly focused on the EU ETS although some literature also concerns about other carbon markets.
Under this circumstance, we will review current research status related to carbon market mechanisms from three aspects, i.e., the carbon emissions allowance allocation, carbon asset pricing and carbon price risk measurement, and try to present some intriguing future research possibilities for each aspect.
The rest of the paper is organised as follows. Section 2, 3 and 4 presents the literature review and possible research directions about carbon emissions allowance allocation, carbon asset pricing mechanisms and carbon price volatility and risk measurement, respectively. Section 5 concludes the paper.
2 Carbon emissions allowance allocation mechanisms
2.1 Allocation principles
There have been already plenty of research findings concerning carbon emission allowance allocation. Existing literature mainly focuses on realising quantitative carbon emissions reduction targets in the Kyoto Protocol or IPCC proposals based on the “common but differentiated responsibilities” principle, and considers how to allocate carbon emission allowance among countries and regions in the world wide (Rowlands, 1997; Leimbach, 2003; Peng and Xu, 2005; IPCC, 2007; OECD, 2008; Stern, 2008; UNDP, 2008). It should be noted that fairness is the primary principle mentioned in current literature, which specifically concerns fairness in terms of carbon emissions per capita, historical responsibility and carbon emissions reduction ability. We may review the related literature as follows.
1 Carbon emissions per capita: A number of authors discuss the carbon emissions allowance allocation mechanism based on the equality of carbon emissions per capita. This idea is based on the principle of equalitarianism and suggests that every human being in the world has an equal access to air resource, so carbon emissions allowance should be allocated to countries and regions according to their population. Xu and He (2000) raise that, when considering children, the equality of carbon emissions per capita can be further classified to that of adults and children; and when considering inter-generational difference, it includes contemporary, generational and transitional equality per capital. Moreover, Chen and Wu (1998) find that the comprehensive allocation mechanism concerning carbon emissions per capital and carbon emissions per unit of gross domestic product (GDP) is an ideal choice from the combined view of fairness, efficiency and income. Additionally, the Global Public Resources Institute (GCI) (2005) puts forward the carbon emissions per
capita convergence method. This method sets up a benchmark year and a target year, during which developing and developed countries’ carbon emissions per capita may rise and fall respectively till converge on the same level eventually.
2 Historical responsibility: Some references focus on the principle of historical responsibility, which considers that the impact on climate change of historical cumulative carbon emissions differ from each country and region, so distinguished reduction responsibility should be taken for different historical carbon emissions. For instance, Rowlands (1997) calculates the carbon credits of OECD countries based on their historical carbon emissions. And some references propose to allocate the emissions allowance according to the cumulative carbon emissions per capita so as to embody historical responsibility principle. For example, He et al. (2009) hold that developed countries should take the lead in carbon emissions reduction and provide advanced carbon emissions reduction technologies for developing countries; and China should make full use of its advantages of low historical cumulative emissions per capita. Ding et al. (2009a) argue that the allocation plan based on historical cumulative carbon emissions per capita can finally realise the “common but differentiated responsibilities” principle. Furthermore, after simulating seven global carbon emissions reduction plans including IPCC, UNDP and OECD, Ding et al. (2009b) find that these plans do not consider the reality that developed countries’ cumulative emissions per capita was 7.54 times larger than that of developing countries from 1900 to 2005; but contrarily allocate more carbon emission allowances (namely 2.3 to 3.6 times larger) for developed countries than that for developing countries for the future carbon emissions allowance, which may severely deprive the basic developing rights of developing countries in the future.
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