Kyoto Protocol to come into force following ratification by Russia

The text of the Kyoto Protocol was agreed in 1997 by more than 160 countries, but to become legally binding it required that not less than 55 Parties to the UN Framework Convention on Climate Change (including developed countries whose combined 1990 emissions of carbon dioxide exceeded 55% of the total for Annex I Parties) needed to deposit, with the UN, their instruments of ratification, acceptance, approval or accession. This requirement was met on 18 November 2004, when Russia formally presented its instrument of ratification to Kofi Annan. Accordingly, since the Protocol takes effect 90 days after this threshold is reached, the Protocol will become legally binding on its 128 parties on 16 February 2005.

The obligations under the Kyoto Protocol, particularly the reduction targets, will have significant implications on the global approach to combating human-induced climate change. Real and effective long-term changes to emissions patterns will need to be made in order to avoid financial and legal penalties. The Protocol creates both challenges and opportunities for the governments and industries involved. The challenges will be in managing the changes in an efficient and fair manner, without compromising the economy; and the opportunities will be in participating in emission reduction projects and trade mechanisms on a domestic and international scale.

This article provides a general overview of the origins and objective of the Kyoto Protocol and a brief description of the mechanisms it introduces to encourage business opportunities.

Climate Change and Greenhouse Gases

Although the Earth's climate fluctuates naturally, there has been a recent, accelerated, global warming trend. Rising temperatures can produce changes in weather, sea levels and land use patterns, with enormous knock-on effects for business and society. If the warming trend continues, the impact will be significant on both the environment and the human population.

Many scientists believe the warming trend is linked to an increase of carbon dioxide, methane, nitrous oxide and other "greenhouse gases" (GHGs) in the atmosphere. GHGs act like a blanket around the Earth that delays the escape of infrared radiation (heat) produced by the reflection of the sunlight on the Earth's surface, creating a "greenhouse effect". Although oceans and land vegetation absorb carbon dioxide and maintain relatively constant levels of GHGs, it appears that the burning of fossil fuels, the cutting of forests, changes in land use, and some industrial processes have disrupted this balance. These activities are supplementing the natural levels of GHGs in the atmosphere, arguably creating an "enhanced greenhouse effect".

Over a decade ago, more than 165 countries joined the United Nations Framework Convention on Climate Change to begin to consider what could be done to reduce global warming and to cope with whatever temperature increases are inevitable. Parties to the Convention later agreed to a supplemental treaty, called the Kyoto Protocol, which introduces more powerful measures that seek to reduce current atmospheric levels of GHGs.

The United Nations Framework Convention on Climate Change

The United Nations Framework Convention on Climate Change was adopted in 1992 and came into force in 1994. It establishes general principles and sets an overall framework for intergovernmental efforts to tackle climate change. All parties to the Convention are subject to general commitments to respond to climate change, including collecting data on national emissions levels, promoting the development and transfer of environmentally friendly technologies, and submitting reports on actions taken to mitigate and prepare for climate change.

The countries that are parties to the Convention are divided into three groups according to their circumstances and each group has a different level of commitment:

• Annex I Parties: Industrialised countries that were members of the OECD (Organisation for Economic Co-operation and Development) in 1992, plus countries with economies in transition (EIT);
• Annex II Parties: These are the same as Annex I Parties, but do not include the EIT countries;
• Non-Annex I Parties: Developing countries.

The Convention was designed to allow the parties to weaken or strengthen the treaty in response to new scientific developments. The growing consensus that global warming and climate change may be partly attributable to human-induced GHG, gave birth to the Kyoto Protocol, which strengthens the Convention by creating specific measures that seek to reduce the current atmospheric levels of GHG.

The Kyoto Protocol

Although the text of the Kyoto Protocol was adopted in December 1997 by more than 160 countries, it has taken more than 7 years for it to become legally binding. The Protocol sketched out basic rules, but did not flesh out the details of how they would apply; it also required a formal process of signature and ratification or accession by national governments before it could enter into force.

Several rounds of negotiations took place before it was clear how the Protocol would operate and more detailed rules were adopted. The progress achieved in the Buenos Aires Plan of Action in 1998, the Hague Plan Break Down in 2000, the Bonn Agreements in July 2001 and the Marrakech Accords in October and November 2001, allowed most signatory parties to ratify, accept or approve the Protocol and new entrants to accede to it.

However, the Protocol required that at least 55 Parties to the Convention, including Annex I Parties representing at least 55% of the total carbon dioxide emissions for 1990 from this group, have deposited their instruments of ratification, acceptance, approval or accession before it could become legally binding. When the United States withdrew their support for the Protocol in 2001, ratification by the Russian Federation became a necessity if the Protocol was to come into force. On 18 November 2004, Russia's instrument of ratification was formally presented to the UN and the threshold was surpassed. This triggered a 90 days' period for the Protocol to enter into force, which will occur on 16 February 2005.

Except for Australia, Croatia, Liechtenstein, Monaco and the United States, which signed the Protocol but have not ratified or approved it, and Belarus, which is not yet a party to it, all Annex I Parties are committed under the Kyoto Protocol to cut their emissions of six main GHGs (carbon dioxide, methane, nitrous oxide, hydro-fluorocarbons, per-fluorocarbons and sulphur hexafluorides). The average reduction target for the first commitment period, i.e. 2008-2012, is 5.2% below 1990 levels.

The reduction targets for each country for the first commitment period, shown in the following table, are listed in the Kyoto Protocol's Annex B and expressed as a percentage of emissions in a base year. In most cases the base year is 1990, but EIT countries* may choose another base year and any party may choose a base year of either 1990 or 1995 for their emissions of hydro-fluorocarbons, per-fluorocarbons and sulphur hexafluorides.

Austria 92% Hungary* 94% Poland* 94% Belgium 92% Iceland 110% Portugal 92% Bulgaria* 92% Ireland 92% Romania* 92% Canada 94% Italy 92% Russia* 100% Czech Republic* 92% Japan 94% Slovakia* 92% Denmark 92% Latvia* 92% Slovenia* 92% Estonia* 92% Lithuania* 92% Spain 92% Finland 92% Luxembourg 92% Sweden 92% France 92% Netherlands 92% Switzerland 92% Germany 92% New Zealand 100% Ukraine* 100% Greece 92% Norway 101% UK 92%

* Countries that are undergoing the process of transition to a market economy.

The Flexible Mechanisms

Annex B countries that are parties to the Protocol will have to implement domestic actions in order to meet their reduction targets, i.e. encouraging or requiring private companies and government entities to limit or reduce their GHG emissions. However, the cost of limiting emissions or expanding removals will vary significantly from region to region, whereas the effects to the atmosphere will be the same. For this reason, the Protocol introduces flexible mechanisms that allow countries to reach their reduction targets by reducing or removing emissions in other countries. These mechanisms are stated to be supplemental to domestic action (and countries will therefore not be able to rely upon them to meet their targets to the absolute exclusion of this) and will create a market for carbon credits where governments and private entities will be able to trade through a network of national registries monitored by international entities.

Each Annex B country will receive an amount of tradeable carbon credits based on its reduction targets. Also, for each project that effectively reduces or removes GHG emissions, the investor government or private entity will be awarded carbon credits that may be sold to other governments or companies, subject to the approval of the government of the country in which the project is situated. At the end of each commitment period, each country will have to hold enough carbon credits to match their actual emissions during that period. If a country's domestic actions do not enable it to meet its reduction target, then that country will have to meet the deficit by buying carbon credits from another country or entity.

The following is a brief description of each of the flexible mechanism introduced by the Protocol.

International Emissions Trading

Each country will receive, at the beginning of each commitment period, an amount of tradeable Assigned Amount Units (AAUs) equal to its aggregate target volume of emissions for the relevant commitment period. Although AAUs will only be available for trading from the start of the first commitment period, i.e. 2008, transactions have already taken place in the form of options and futures.

In addition to the AAUs, the Kyoto Protocol creates the following carbon credits, which are explained below: Emission Reduction Units (ERUs), Removal Units (RMUs) and Certified Emission Reductions (CERs). Each AAU, ERU, RMU or CER will represent the right to emit one metric ton of carbon dioxide equivalent. The emission of one metric ton of methane, for instance, is taken to make the same contribution to global warming as the emission of 21 metric tons of carbon dioxide.

This trading mechanism should enable market forces to achieve the most efficient distribution of projects in order to meet the reduction targets at the lowest cost. In order to avoid an oversell of carbon credits, which could prevent a country from meeting its reduction targets, it will be mandatory for each country to hold a minimum level of carbon credits in its national registry.

Joint Implementation

Under the Joint Implementation mechanism, Annex B countries will be able to invest in emission reduction or removal projects in another Annex B country in return for carbon credits in the form of Emission Reduction Units (ERUs) for achieved reductions in emissions and Removal Units (RMUs) for emissions that are removed by new forests and other land use sinks. In order for such projects to be approved, they must demonstrate "additionality", that is, that the project will deliver emissions reductions over and above what would be achieved in a business as usual scenario.

In practice this is likely to mean investment in facilities in EIT countries (e.g. Russia), where the host country will benefit from foreign investment and advanced technology, while the sponsoring party will gain access to carbon credits which it can trade or use to meet its targets more cheaply than by reducing/removing emissions in its own country.

Clean Development Mechanism

Under the Clean Development Mechanism, Annex B countries may invest in emission reduction or removal projects in Non-Annex I Parties (e.g. Thailand) in return for carbon credits in the form of Certified Emission Reductions (CERs). As with joint implementation, credits will not be approved unless the project is shown to be "additional".

The host country will benefit from an influx of advanced technology and know-how, which should allow more efficient operation of emissions-generating processes and thus higher profitability.

Both the JI and CDM mechanisms encourage cross-border investment in the energy sector using environmentally friendly techniques and technologies. A country or company that invests in such projects will have the benefit of realising carbon credits as well as any other benefits derived from the projects themselves.

In a related development, the EU's Linking Directive, which amends the EU's GHG emission allowance trading scheme, has recently entered into force. As a result, businesses subject to GHG emission reduction obligations under the EU emission trading scheme will be able to use the ERUs and CERs obtained from investments in certain joint implementation and clean development mechanism projects to meet, at least in part, those obligations.

For further information please contact Mark Moseley on +44 207 367 3240 or mark.moseley@cms-cmck.comamanda.seaton@cms-cmck.comderek.woodhouse@cms-cmck.com, Amanda Seaton on +44 207 367 3454 or , or Derek Woodhouse on +44 207 367 3391 or