Kyoto Protocol -February 2008

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Zokirjon Abdusattarov, LL.M. Student, Institute for Law and Finance

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The Kyoto Protocol and Russia

Introduction

The Kyoto Protocol is the international Framework Convention on the Climate Change which

aims to reduce emission of green house gases that are considered to be one of the main causesof climate change. The Protocol was adopted on December 11, 1997 in Kyoto, Japan andentered into force on February 16, 2005. As of November 2007, 175 countries have joinedthe treaty.

The Protocol differentiates two types of members according to their level of economicdevelopment: Annex I and Non-Annex I countries. Annex I is comprised of developedcountries which bear the obligation of reducing the emission of green house gases during2008-2012 by certain percentage as to its level in 1990. Non-Annex I countries are developingcountries which do not have obligation to reduce the emission of green house gases but havethe obligation of monitoring and reporting of the green house gases emission within theirterritory.

As the current level of green house emission vis--vis the level of emission in 1990 isdifferent from country to country, the levels of reduction of green house gases for developedcountries differ. The average targeted reduction for the entire Annex I countries is 5 %. ForEU countries it is about 8 percent on average. For Australia, however, the contrary is true, thatis, it can increase the emission by 8 percent.

If an Annex I country cannot reach the limits set by the protocol, economic penalties willbe imposed upon it, and therefore there is a strong incentive for them to meet their objectives.They can reduce the emission of green house gases either by reducing their own gas emissionor by reducing the amount of green house gases in some other Member States by purchasinggreen house gases emission reduction credits from them or implementing joint projects. TheClean Development Mechanism (CDM) and Joint Implementation (JI) projects have beendeveloped for these purposes.

The CDM arranges green house gases reduction projects in Non-Annex I countries withassistance of Annex I countries. The CDM produces trade-able Kyoto credits called CertifiedEmission Reductions (CERs).

The JI implements projects between Annex I countries, including Eastern Europeancountries. The JI generates European Reduction Units (ERUs).

Similar to many other financial instruments, Kyoto credits are available on the financialmarket and investors can trade with them, create different derivatives and enter into futurecontracts. The Kyoto credit market has substantially been expanding since its creation in2003. As of 2007, the volume of this market reached $ 60 billion1.

Russia is a key player in providing the underlying of this financial product since itaccounts for 17 % of the emission of green house gases in the world and it emitted only 68 % 2of green house gases as compared with its level in 1990. Russia can sell a large number ofquotas to Annex I countries either in the form of hot air (out of the unused 32 % quotas) orthrough implementation of green house reduction projects.

Russian observers have different opinion relating to the sale of Kyoto credits and itsimpact on the fast growing Russian industry. In addition, legal regulation of implementinggreen house gases reduction projects in Russia until recently remained not so much clear.

1 http://www.pointcarbon.com/2: , . . , 2006. p. 32.


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Problems and Perspectives for Russia

Both before and after the joining the Kyoto Protocol Russia was and has been skepticalabout the economic benefits arising from the treaty. However, it signed and ratified theprotocol, to all intents and purposes, because EU promised easing up the way to joining the

WTO afterwards and it hoped for gaining economic/environmental benefits through sellingquotas and implementing joint green projects.

Some Russian observers3 believe that ratification of the Protocol can bring Russia $ 10billion in the next 10 years, half of it in the form of investment in clean environment projectsand reformation of energy sector, and the other half through trading Kyoto credits. The lowprices of the Russian Kyoto credits, which started from 3-4 euros per ton was very attractiveto foreign investors in 2005 when elsewhere they needed to spend 30 euros per ton (of course,world market price of the Kyoto credit is very volatile: at the end of 2006, it cost only 2-3euros, which was even lower than the prices in Russia and on March 5, 2008 EU AllowanceUnit cost 21.40 euros4). According to some evaluations, demand for the carbon quotas will bein the neighborhood of 700-800 million green house gases from 2008 running through 2012.

And Russia has unused quotas for 1.3 billion tons of green house gases 5. Russia may becomea big target for Annex I countries. Western experts in the area also assert that implementationof the Kyoto Protocol will be profitable for the Russian economy.

Moreover, Russia will gain the opportunity of enhancement of efficient energyconsumption, reconstructing the old factories which have been inherited from the SovietUnion. According to the observations of the International Institute for ManagementDevelopment, Russia has one of the highest energy consumption with proportion to GDPamongst the developed countries. This is so due to worn out plants and factories6, which havebeen inherited from the Soviet Union. Modernizing the Russian factories and plants for thecost of foreign investors will be financial cushion for Russia.

However, some other observers believe that the costs for the Russian economy might bedramatically high7. Pursuant to the calculation of some Russian experts based on the currentgrowth of the economy, emission of carbon gases in Russia exceeds the level that of 1990 bythe end of the first phase of the Kyoto Protocol. As a consequence, at the end of the firstphase, the financial losses will constitute tens of billions of dollars and in the followingphases, losses will rise up to hundreds of billions of dollars.

Even if carbon emission in Russia exceeds the level of 1990, it is alleged that there aresome other factors which jeopardize the financial situation of Russia. The main fear is thepossible lack of demand for Russian carbon credits. The main producers of green house gases,the US, will not participate in this trade since it hasnt joined the treaty. Canada also mayreconsider its plans about purchasing the Russian carbon credits. The EU countries might

invest in projects within EU or in Ukraine, abandoning Russia. The announcements of EUmember states about alleged substantial decrease in the emission in 2005 caused the prices forthe credits plummet to 2-3 euros per ton at the end of 2006. At the end of the day, Russiacannot earn a penny on the carbon credit trading. And this is not at all the end of the story forRussia. Since the demand for energy in EU will decrease due to the implementation of theKyoto Protocol and development of more efficient ways of using energy, Russia will earn lessmoney on its oil exports. What is more, Russia might have to cut the level of production and

3: , , 2005, onhttp://www.vedomosti.ru/newspaper/article.shtml?2005/09/13/969544 For more information see www.pointcarbon.com5 See supra note 2.6 See supra note 2.7 180 ?, http://www.regnum.ru


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export of aluminum and other relevant metals as this industry involves emission of substantialamount of green house gases.

Whats up on the Current Russian Market?

According to the data provided by the consulting company PointCarbon, by the middleof summer of 2007, 54 joint implementation projects were submitted to the Russiansupervisory authorities for approval. Since then discussions on dozens of projects have beenheld. For instance, RAO UES of Russia, which accounts for 30 % of green house gasesemission in the Russian Federation, has completed the inventory of emissions and isparticipating in on the development of renewable energy resources, namely, geothermalenergy8. On March 3, 2008 the UK-based Clean Planet Group has purchased 550,000 ERUs atthe auction held by RAO-UES9. The Finnish energy company Fortum and Dutch company onEnvironment Protection have entered into agreement about joint implementation projects for

these purposes10.The PointCarbon regularly publishes on its website about the joint implementation

projects. According to the information it provided:- on February 20, 2008 Finnish utility Fortum announced that it has entered into a

contract about purchase of 5 million carbon credits from the Russian utility TGC-1;- on February 1, 2008 BNP Paribas (a French bank) made an agreement with the

Russian bank Vnesheconombank to develop joint projects in Russia;- on February 22, 2008 Marubeni Corp., a Japanese trading house, announced its

agreement with the Gazprom about purchase of several hundred thousand carboncredits and discussion on possible joint implementation projects.

Unfortunately, the author couldnt find information regarding the market for selling hotair, i.e., the unused quotas of Russia. No data about purchase agreements on Russias alleged30 % of unused quotas has been publicized. Instead, in Russia the emphasis is rather placedon implementation of joint projects on the reduction of emission of green house gases.

Legal Regulation of Joint Implementation Projects and Carbon Trade

Despite the fact that a significant number of joint implementation projects have beenagreed upon between Russian companies and foreign counterparts, until recently necessary

legislation to regulate these projects didnt exist. The first legislation act in this regard waspassed on May 28, 2007. The Regulation On Approval and Examination of Realization ofProjects Carried out in accordance with Article 6 of the Kyoto Protocol to the UN FrameworkConvention on the Climate Change11 has set out detailed requirements as to application andimplementation of joint projects in the Russian Federation.

Pursuant to this Regulation, the Coordination Center for Preparation of Projects toApproval (thereafter Coordination Center) will be set up. The Coordination Center receives

8 See supra note 2.9 For more information see www.pointcarbon.com10 For further information see http://www.fortum.com11 28 2007 . N 332 , 6


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complete package of applications12. Besides the information concerning the parties to theproject and the information relating the project itself, an opinion of accredited independentexpert is required. The list of accredited independent experts is supposed to be published onthe Coordination Centers website. As of March 6, 2008 this website hasnt been launched.

Upon checking the completeness of application documents, within ten days the

Coordination Center hands the copies of documents to the Commission on ConsideringApplications on Approval of Projects carried out in accordance with Article 6 of the KyotoProtocol to the UN Framework Convention on Climate Change (thereafter theCommission). The Commission was only formed in January 2008 after the Ministry ofJustice registered the Regulation on the Commission of the Ministry of EconomicDevelopment and Trade of Russia.The Commission considers the applications based on the following:

1. Expert opinion;2. Feedback of responsible federal executive bodies on the project;3. Information provided in the application.

The Commission rejects the application in the following cases:

1. Application was submitted with incomplete, unduly prepared or incorrect information;2. Planned efficiency indicators are inconsistent with or lower than the minimum level of

the existing typical projects efficiency levels.3. Absence of positive expert opinion.

The Commission may reject the application in the following cases:1. Project cannot be implemented by 2012;2. Negative feedback was received from one or several responsible federal executive

bodies;3. The volume of planned reduction of green house gases in the project is above than

established limits for this sector of industry or agriculture by the legislation.With the effect of the Decree13 of the Ministry of Economic Development and Trade ofRussia from December 21, 2008, the volume of targeted reduction of green house gases is 300million tons. The Decree distributes this volume by sectors of sources in the following way:a) The limit for reduction of emission of green house gases:

- energy sector 205 million tons;- industry 25 million tons;- using solvent and other products 5 million tons;- agriculture 30 million tons;- waste products 15 million tons.

b) The limit for absorption of green house gases for the account of land-utilization,improvement of land-utilization and forestry 20 million tons.

In case there are fewer projects than expected, the above cited proportioned segmenteddistribution might be reconsidered.

The above mentioned three legislative acts are the specific regulations passed so far. Apartfrom that joint implementation projects and trade with quotes are subject to other legislativeacts, such as, the Civil Code, the Land Code, Tax Code and etc, which generally regulate thematters concerned. How efficient the adopted regulations in this regard is not so much clearyet.

12 The list of required application documents is provided in the concerned Regulation of May 28, 2007.13,

6 , 30 2007 . N 424,

Documents

Kyoto Protocol -February 2008