As Russia keeps the world waiting to hear whether it will ratify the Kyoto Protocol — thus making it a legally binding agreement — the European Union is pressing ahead with measures to ensure that its member countries meet their emissions obligations within the designated 2008-2012 period. Since the cost of physically reducing greenhouse gas emissions by the agreed amounts is likely to be prohibitive for most developed countries, the UN Framework Convention for Climate Change has set out three 'flexibility mechanisms' by which this cost can be reduced to an acceptable level. The first of these is to establish emissions trading markets through which countries can buy and sell emissions allowances in order to meet their targets.
For emissions trading to work,there must be significant differences in the costs of cutting emissions by the countries concerned. When such differences are evident,a country with high abatement costs can gain allowance credits by buying them from a country whose costs are lower. This transfer will have the same overall effect on emissions — since greenhouse gases have an equal effect on pollution wherever they are produced — but it will be less costly than if each country had simply borne the cost of cutting its own emissions to meet its cap. In practice, governments will allocate total emissions allowances to companies and delegate to them the task of meeting these constraints. The price that emerges through the trading of allowances should, in theory, be equal at any moment to the marginal cost of reducing emissions across all participants.
The first international emissions trading scheme will come into force at the beginning of 2005 in the European Union. In order to ensure liquidity, the scheme will include new entrants to the EU in 2004 and will allow the supplementary use of two 'flexibility mechanisms' created by the UNFCCC as adjuncts to emissions trading. Joint Implementation and the Clean Development Mechanism allow companies to gain emissions credits by investing in projects that will reduce emissions in another country. For example, a European utility could invest in a renewable-energy project in Asia and use the resulting cut in emissions to set against its own emissions in Europe.
The introduction of the EU scheme will have a long-term impact on the structure of the power generation industry in Europe. As companies attempt to meet their targets and the cost of carbon rises,high-emitting coal-and oil-fired plants will be relegated to peak loading and will eventually be replaced. Gas-fired capacity will increase sharply, raising European demand for imported natural gas, while the economics of renewable energy will improve.