Emissions trading: an introduction to emissions units and trading

This factsheet explains what ‘emission units’ are, who can trade them, and how. It gives an overview of trading in the New Zealand Emissions Trading Scheme (NZ ETS), distinguishing between this and the voluntary market.

What are emission units and carbon credits?

Emission units are often referred to as carbon credits, allowances, or offset credits. An emission unit can represent one metric tonne of carbon dioxide itself, or the equivalent of any other greenhouse gas (carbon dioxide equivalent – CO₂-e)[The six greenhouse gases included in the Kyoto Protocol are carbon dioxide (CO₂), methane (CH₄), nitrous oxide (N₂O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulphur hexafluoride (SF₆).].

There are lots of unit types. On a basic level, units can be distinguished according to whether they fall within a compliance["Compliance" generally refers to a requirement of legislation or regulations.] or voluntary market. A variety of emission units are traded in voluntary and compliance schemes throughout the world.

What are emission units used for?

Emission units are used to "offset" a person’s or business’s emissions. Under the NZ ETS, an emitter can buy emission units and cancel or surrender [In simple terms, "cancel" means the unit can no longer be used – it is cancelled out. "Surrender" occurs when the participant transfers units to a surrender account for the purpose of meeting their obligations under the New Zealand Emissions Trading Scheme.] them against their emissions. Cancelling or surrendering units prevents anyone else from using the same units to offset their own emissions. By buying an emission unit, a person is effectively paying someone else to directly remove or avoid creating emissions.

Where do emission units come from?

The Kyoto Protocol provides a good example (at a global level) of how units are created in a compliance market. Each Annex B country["Annex B countries" refers to the industrialised countries (including those with transitional economies) listed in Annex B of the Kyoto Protocol that have legally binding emission reduction or limitation obligations.] that ratified the Protocol receives an initial number of assigned amount units (AAUs) in line with its specific emissions-reduction target under the Protocol (in New Zealand’s case, equivalent to its 1990 level of greenhouse gas emissions).

Other Kyoto units can be created through projects that reduce or store additional greenhouse gas emissions, such as renewable energy, fugitive emissions capture, energy-efficiency measures and certain types of afforestation.

Projects that generate Kyoto units must meet United Nations standards to be recognised under the Protocol, including that the project is "additional" to business as usual in the sense that it would not have happened without the issue of units.

Voluntary emission units, which are available for use on the voluntary market only, are also created through avoiding or removing greenhouse gas emissions. For example, a landowner could implement pest control measures within an existing forest, thereby increasing the amount of carbon that forest stores. This type of activity would not be eligible to receive emission units under the NZ ETS, but potentially could generate emission units for the voluntary market. A project must meet some standards to receive voluntary emission units, but these standards are determined by the entity issuing the voluntary emission unit, rather than imposed by the government.

The compliance market in New Zealand

Within New Zealand, the compliance market will be the NZ ETS. This market will come into operation once the Climate Change (Emissions Trading and Renewable Preference) Bill is enacted and participants begin trading in anticipation of meeting their NZ ETS obligations. Other market traders will also begin trading once the market is operational.

Participants

The NZ ETS requires certain persons – typically large companies – to participate and comply with its rules. These persons are called "participants". Other persons can also choose to opt into the NZ ETS as participants. One of participants’ main obligations is a requirement to calculate the emissions from their activities and surrender one emission unit for each tonne of emissions they are responsible for. Participants who do activities defined under the NZ ETS that remove greenhouse gas emissions from the atmosphere may also receive an emission unit for each tonne of emissions removed.

In the energy sector, participants are generally high in the supply chain, for example, fossil fuel producers or importers bringing in products to New Zealand with an emissions component. In the forestry sector, participants are generally landowners or third parties vested with the right to deforest land. The government is engaging with the agriculture sector on the appropriate place in the supply chain to place the obligation, such as the level of dairy/meat processors or farmers.

Trading – buying and selling units

While the NZ ETS specifies the obligations of participants, the actual trading takes place in the commercial marketplace, often called the "secondary market". People other than participants can also choose to trade. The government does not dictate a particular method of trading units. While transfers of units must be registered, market participants are able to choose their own preferred mechanism for trading the desired units for a negotiated price. Trading mechanisms can range from bilateral "over the counter" contracts to multilateral trades through a brokerage or on an organised trading exchange similar to the share market.

Unit of trade

The primary unit of trade for the NZ ETS is the New Zealand Unit (NZU), which is the unit created and distributed by the government. One NZU is equivalent to one tonne of carbon dioxide equivalent emissions.

Several other types of Kyoto emission units can also be cancelled or surrendered by participants to meet their obligations under the NZ ETS.

Assigned Amount Units (AAUs) – units freely allocated to Annex B countries to match the level of their emissions reduction or limitation commitment
Emission Reduction Units (ERUs) – generated by Joint Implementation projects that reduce emissions or create forest sinks in Annex B countries
Removal Units (RMUs) – awarded to Annex B countries on the basis of net removals by sinks in the land use, land-use change and forestry sector
Certified Emission Reductions (CERs) – generated by Clean Development Mechanism (CDM) projects that support sustainable development and reduce emissions or create forest carbon sinks in developing countries. Note that forestry CDM units (tCERs and lCERs) may not be surrendered to meet obligations in the NZ ETS[Forestry CDM projects use special units reflecting the impermanence of forest sinks: temporary CERs (tCERs) and long-term CERs (ICERs). CERs generated from a nuclear project are excluded from the New Zealand Emission Unit Register. Individuals are not permitted to hold ICERs in their New Zealand account and there are restrictions on the use of tCERs within the register.].

Economies in transition, such as Russia, the Ukraine and Belarus, may decide to sell some of their surplus AAUs to other Annex B countries. This would probably be by government-to-government trade, but sale to private companies is also possible. Other Kyoto units may be acquired either by direct investment or an off-take contract[An off-take contract is where a party buys some or all emission units or carbon credits from an abatement project. They could be from projects that have already been implemented or, more commonly, a forward contract for a future project.] from a project (the "primary market"), or by purchasing units on the "secondary market", for example, from banks and carbon funds. Direct investors may also have some equity in a project or the right to other revenues, for example, through power generated from a windfarm. Off-take contracts will usually be more expensive because the seller carries the project and delivery risk.

While no voluntary emission units are valid for compliance with the NZ ETS, certain people may choose to trade in voluntary units. For example, they may be seeking to offset their emissions over and above what is required under the NZ ETS. Equally, a person could voluntarily surrender Kyoto units or NZUs to cover emissions for which they have no obligation.

Where do I hold my emission units?

New Zealand has a Kyoto-compliant register called the New Zealand Emission Unit Register (NZEUR). People can already open online accounts under the NZEUR for the purpose of holding Kyoto units. Additional system functions are being developed to enable people to hold NZUs (allocated or purchased) or cancel or surrender NZUs, as required by participants with obligations under the NZ ETS.

Kyoto units enter into the NZEUR or a related Kyoto register in accordance with the rules of the Kyoto Protocol. Kyoto units can be transferred into the NZEUR from an overseas Kyoto register via the International Transaction Log. This is a United Nations-administered central emissions unit register for the purpose of tracking Kyoto units. The registry system provides prima facie proof of ownership.

The voluntary market

The voluntary market will continue to be relevant within New Zealand and can operate alongside the compliance market. It will provide an opportunity outside the NZ ETS for organisations to gain credits for reduction activities and to purchase emission units to meet, for example, their carbon neutral aspirations.

In contrast to the compliance market, the voluntary market does not require anyone to participate through regulation, but people may choose to purchase emission units for other reasons, including to:

offset personal carbon emissions or emissions associated with activities such as international air travel, perhaps through an altruistic desire to lessen their impact on the environment
offset emissions generated by a business, perhaps to:
- maintain market access for products and services
- meet consumer demands
- enhance their branding as being environmentally responsible as a point of difference
- signal a commitment to move towards carbon neutrality.

The voluntary market is not one distinct market; rather, it consists of a range of service providers offering a range of different units. In the voluntary market, emission units are commonly referred to as carbon credits.

Within New Zealand, there are a range of brokers, traders and suppliers of voluntary emission units. People considering participating in a scheme need to fully consider and evaluate the merits or risks of any scheme themselves.

Emission units generated through the voluntary market are not able to be traded on the NZUER.

What does "carbon neutral" mean?

Carbon neutral means there are no net greenhouse gas emissions generated by a person, business or activity. Becoming carbon neutral is a three-stage process.

Measuring the emissions or the "carbon footprint" from that person, business or activity.
Reducing or mitigating those emissions as much as possible cost-effectively.
Offsetting the remaining emissions. This may be done by buying and cancelling emission units within the NZ ETS, buying and cancelling other Kyoto-compliant credits internationally, or buying and cancelling units via the voluntary market.

The NZ ETS will not necessarily make businesses carbon neutral. However, emissions trading is a step on the way toward carbon neutrality. Businesses can choose to purchase and cancel extra emission units from the market to make themselves truly carbon neutral, or they may wish to participate in other voluntary offset programmes outside the NZ ETS, such as the carboNZero programme.

Where to go for more information

To access or find out more information about the New Zealand Emission Unit Register, visit www.nzeur.govt.nz

To find out more information about the New Zealand Emissions Trading Scheme, visit www.climatechange.govt.nz

To find out more about things people can do around the home to reduce their impact on the environment, visit: www.energywise.org.nz and www.smarterhomes.org.nz