Guide to Environmental Markets

www.kendrick-zale.com
Climate change - The Causes
On the broadest scale, the rate at which energy is received
from the sun and the rate at which it is lost to space
determine the equilibrium temperature and climate of
Earth. This energy is distributed around the globe by winds,
ocean currents, and other mechanisms to affect the
climates of different regions.
Factors that can shape climate are called climate forcings
or “forcing mechanisms”.These include processes such as
variations in solar radiation, variations in the Earth’s orbit,
mountain-building and continental drift and changes in
greenhouse gas concentrations. There are a variety of
climate change feedbacks that can either amplify or
diminish the initial forcing. Some parts of the climate
system, such as the oceans and ice caps, respond slowly
in reaction to climate forcings, while others respond more
quickly.
Forcing mechanisms can be either “internal” or “external”.
Internal forcing mechanisms are natural processes within the climate system itself (e.g., the
thermohaline circulation). External forcing mechanisms can be either natural (e.g., changes in solar
output) or anthropogenic (e.g., increased emissions of
greenhouse gases).
Whether the initial forcing mechanism is internal or external, the response of the climate system
might be fast (e.g., a sudden cooling due to airborne volcanic ash reflecting sunlight), slow (e.g.
thermal expansion of warming ocean water), or a combination (e.g., sudden loss of albedo in the
arctic ocean as sea ice melts, followed by more gradual thermal expansion of the water). Therefore,
the climate system can respond abruptly, but the full response to forcing mechanisms might not be
fully developed for centuries or even longer.
ENVIRONMENTAL MARKETS

What’s being done about it?
In 1997, with ever-stronger evidence for an
enhanced greenhouse effect driven by
human activities, and deepening concern over the
impacts the resulting changes in climate might have,
over 150 nations came together in Kyoto in Japan to
agree the first binding
agreement aimed at cutting global greenhouse gas
emissions: The Kyoto Protocol. But in 2009 the United
Nations Climate Change conference in Copenhagen
failed to agree on a binding agreement for all nations
on reducing emissions.
The Kyoto Protocol was drawn up to set specific
targets for reductions in greenhouse gas
concentrations in the global atmosphere. Emission restrictions were agreed for the
developed world nations. Targets ranged from a 28% cut for Luxembourg to a 27% increase for
Portugal, depending on the individual country and its circumstances. The UK committed to a 12.5%
cut. To become legally binding the protocol had to be ratified by at least 55 countries which
between them accounted for at least 55% of the total 1990 greenhouse gas emissions of developed
countries. This happened in February 2005, but without the US or Australia.
Cap and Trade
Emissions trading or cap-and-trade is a market-based approach used to control pollution by
providing economic incentives for achieving reductions in the emissions of pollutants.
A central authority (usually a governmental body) sets a limit or cap on the amount of a pollutant
that may be emitted. The limit or cap is allocated or sold to firms in the form of emissions permits
which represent the right to emit or discharge a specific volume of the specified pollutant. Firms
are required to hold a number of permits (or allowances or carbon credits) equivalent to their
emissions. The total number of permits cannot exceed the cap, limiting total emissions to that
level. Firms that need to increase their volume of emissions must buy permits from those who
require fewer permits.

The transfer of permits is referred to as a trade. In effect, the buyer is paying a charge for polluting,
while the seller is being rewarded for having reduced emissions. Thus, in theory, those who can
reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest cost to
society.
Trading systems - global
In 1997 the Kyoto Protocol was adopted. The Kyoto Protocol is a 1997 international treaty that
came into force in 2005. In the treaty, most developed nations agreed to legally binding targets for
their emissions of the six major greenhouse gases. Emission quotas (known as “Assigned amounts”)
were agreed by each participating ‘Annex I’ country, with the intention of reducing the overall emis-
sions by 5.2% from their 1990 levels by the end of 2012. The United States is the only industrialized
nation under Annex I that has not ratified the treaty, and is therefore not bound by it. The IPCC has
projected that the financial effect of compliance through trading within the Kyoto commitment
period will be limited at between 0.1-1.1% of GDP among trading countries.

The Protocol defines several mechanisms
(“flexible mechanisms”) that are designed to allow
Annex I countries to meet their emission
reduction commitments (caps) with reduced
economic impact (IPCC, 2007).
Under Article 3.3 of the Kyoto Protocol, Annex I
Parties may use GHG removals, from afforestation
and reforestation (forest sinks) and
deforestation (sources) since 1990, to meet their
emission reduction commitments.
Annex I Parties may also use International
Emissions Trading (IET). Under the treaty, for the
5-year compliance period from 2008 until 2012,
nations that emit less than their quota will be
able to sell assigned amount units to nations that
exceed their quotas. It is also possible for Annex
I countries to sponsor carbon projects that reduce greenhouse gas emissions in other countries.
These projects generate tradable carbon credits that can be used by Annex I countries in meeting
their caps. The project-based Kyoto Mechanisms are the Clean Development Mechanism (CDM)
and Joint Implementation (JI).
The CDM covers projects taking place in non-Annex I countries, while JI covers projects taking
place in Annex I countries. CDM projects are supposed to contribute to sustainable development in
developing countries, and also generate “real” and “additional” emission savings, i.e., savings that
only occur thanks to the CDM project in question.
Trading systems - European
The European Union Emission Trading Scheme (or EU ETS) is the largest multi-national, greenhouse
gas emissions trading scheme in the world. It is one of the EU’s central policy instruments to meet
their cap set in the Kyoto Protocol.
After voluntary trials in the UK and Denmark, Phase I commenced operation in January 2005 with
all 15 (now 25 of the 27) member states of the European Union participating. The program caps the
amount of carbon dioxide that can be emitted from large installations with a net heat supply in
excess of 20 MW, such as power plants and carbon intensive factories and covers almost half (46%)
of the EU’s Carbon Dioxide emissions.Phase I permits participants to trade amongst themselves

and in validated credits from the
developing world through Kyoto’s Clean Development Mechanism.
During Phases I and II, allowances for emissions
have typically been given free to firms, which
has resulted in them getting windfall profits.
Ellerman and Buchner (2008) suggested that
during its first two years in operation, the EU
ETS turned an expected increase in emissions
of 1-2 percent per year into a small absolute
decline.
In the initial 2005-07 period, emission caps
were not tight enough to drive a significant
reduction in emissions. The total allocation
of allowances turned out to exceed actual emissions. This drove the carbon price down to zero in
2007. This oversupply was caused because the allocation of allowances by the EU was based on
emissions data from the European Environmental Agency in Copenhagen, which uses a horizon-
tal activity based emissions definition similar to the United Nations, the EU ETS Transaction log in
Brussels however uses a vertical installation based emissions
measurement system.
This caused an oversupply of 200 million tonnes (10% of market) in the EU ETS in the first phase
and collapsing prices.
Phase II saw some tightening, but the use of JI and CDM offsets was allowed, with the result that
no reductions in the EU will be required to meet the Phase II cap. For Phase II, the cap is expected
to result in an emissions reduction in 2010 of about 2.4% compared to expected emissions without
the cap. For Phase III , the European Commission has proposed a number of changes, including:
· the setting of an overall EU cap, with allowances then allocated to EU members;
· tighter limits on the use of offsets;
· unlimited banking of allowances between Phases II and III;
· and a move from allowances to auctioning.
In January 2008, Norway, Iceland, and Liechtenstein joined the European Union Emissions Trading
System (EU ETS), according to a publication from the European Commission. The Norwegian Minis-
try of the Environment has also released its draft National Allocation Plan which provides a car-
bon cap-and-trade of 15 million metric tonnes of CO2, 8 million of which are set to be auctioned.

According to the OECD Economic Survey of Norway 2010, the nation “has announced a target for
2008-12 10% below its commitment under the Kyoto Protocol and a 30% cut compared with 1990
by 2020.”
Trading systems - North American
The California Air Resources Board (CARB)
adopted the state’s cap-and-trade rule on
October 20, 2011, and will implement and
enforce the program. The cap-and-trade rules will
first apply to electric power plants and industrial
plants that emit 25,000 metric tons of carbon
dioxide equivalent (CO2e) per year or more. In
2015, the rules will also apply to fuel distributors
(including distributors of heating and
transportation fuels) that meet the 25,000
metric ton threshold, ultimately affecting a total
of around 360 businesses throughout California.
The program imposes a greenhouse gas emission limit that will decrease by two percent each year
through 2015, and by three percent annually from 2015 through 2020.
Emission allowances will be distributed by a mix of free allocation and quarterly auctions. The
portion of emissions covered by free allowances will vary by industry, but initially will account for
approximately 90 percent of a business’s overall emissions. The percentage of free allowances al-
located to the businesses will decline over time. A business may also buy allowances from other
entities that have reduced emissions below the amount of allowances held.
The program imposes a greenhouse gas emission limit that will decrease by two percent each year
through 2015, and by three percent annually from 2015 through 2020.
Emission allowances will be distributed by a mix of free allocation and quarterly auctions. The
portion of emissions covered by free allowances will vary by industry, but initially will account for
approximately 90 percent of a business’s overall emissions. The percentage of free allowances al-
located to the businesses will decline over time. A business may also buy allowances from other
entities that have reduced emissions below the amount of allowances held.

Due to the nature of our business and our varied range of financial products our
employees are given market training from industry specialists. We are very confident
that our team possesses the skill set and efficiency required servicing your account
to complete satisfaction. As a client you will gain privileged access to our ‘member
only’ services.
To find out more about Kendrick Zale and environmental investment opportunities,
please visit www.kendrick-zale.com, or contact us:
Call us on 0845 004 2656.
Registered address
70 St Mary Axe
London
EC3A 8BE
Tel: 08450042656
General enquiries: info@kendrick-zale.com
SECURITY:
Our clients have the peace of mind knowing that they are dealing with a company which adheres to strict compliance
procedures. The products that we offer are either tangible or held in your very own holding account. We carry out
regular ‘in-house’ audit checks to ensure your records are kept up-to-date.
We treat client data with the upmost confidentiality adhering to the Data Protection Act 1998. We do not sell your data
or information to third parties.
In the unlikely event that we went into liquidation our solicitors would act on behalf of our clients with records of our
clients holding. This would be passed on to the liquidator so that it can be treated as separate property from the
company.
WHY KENDRICK ZALE?

Guide to Environmental Markets

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Guide to Environmental Markets