The Kyoto system set relatively easy targets for economies in transition, by selecting base years for greenhouse gas (GHG) emissions from the pre-transition period (1985-1990). GHG reduction targets are generally 6-8 percent for CEE countries¹ and 0 percent for Russia and Ukraine. Differences between emissions in the commitment period (2008-12) and target levels are often referred to as ‘hot air’, expressed in tons of CO2 equivalent, or as assigned amount units (AAUs). Allowing these countries to sell these credits can be viewed as compensation for the costs of transition, especially since additional emission reduction requirements could constrain their future economic growth. Will this opportunity be utilized to increase wealth and contribute to long term sustainability? Or will these countries squander this unexpected gift?

From the vantage point of international carbon markets, this ‘hot air’ represents an excess supply of AAUs. If it could be bought and sold with no restrictions, Russia’s and Ukraine’s hot air could simply be purchased by other countries, allowing Kyoto targets to be met without anyone actually reducing their GHG emissions. How then do the AAU sellers plan to use the income generated? Will national budgets ‘swallow’ this income without contributing to environmental sustainability? Or will this income be used to finance additional emission reductions?

Joint Implementation schemes

Joint Implementation (JI) and Green Investment Schemes (GIS) link revenues from carbon credits to emission-reduction projects. In the case of JI projects, the buyer country co-finances emission reduction projects in another country with Kyoto commitments, in exchange for an agreed proportion of (and price for) the latter country’s achieved emission reduction units (ERUs), also expressed in tons of CO2 equivalent. In theory, these projects would not take place without the extra financial help of carbon credits (additionality). By mid-2007, 156 projects were at various stages of development in the region.²

In addition to the GHG emission reductions (100 million tons of ERUs during 2006-2007) and the investment generated (450 million EUR), this carbon finance helped fund green energy projects in such areas as landfill gas (Poland, Hungary), biomass fuel switching (Hungary), and wind-farm development (Bulgaria, Hungary, Poland). Being among the first of their type, these projects helped refine green energy legal and regulatory frameworks, and forced countries to reflect on their priorities.

The first Hungarian projects focused on three large coal-to-biomass fuel-switching projects (the Ajka, Pécs, and Kazinczbarcika power plants).³ The introduction of stricter, more expensive sulphur dioxide emission requirements forced the shut down of coal-based production. The JI credits sold provided the extra funding needed to finance the switch to biomass. Did these projects generate compelling environmental and development benefits? Perhaps not. For one thing, the financial additionality of the carbon finance was dubious, as a generous feed-in-tariff scheme was already in place. Moreover, the switch from coal- to wood-fired electricity generation produced a massive (circa 1 million ton) increase in the demand for wood fuel. This higher demand increased wood prices, put enormous pressures on forests, and significantly increased wood imports from neighbouring countries (Romania, Ukraine, Slovakia) where forestry regulations are weaker than in Hungary. In part, these projects simply shifted natural resource extraction from Hungary to elsewhere in the region.⁴

Bulgaria’s experience with wind farms also raises some questions. Nature conservationists claim that wind farm projects are often pushed through thanks to pressure from governments and investors–at the cost of neglecting sensitive bird sanctuaries.⁵ Public support for renewables may be hard to obtain if environmental safeguards in other areas are disregarded.

When the first projects in these countries began, there were no national JI regulations in place. But buyers (e.g., Dutch Senter, the World Bank, the Austrian government, Mitsubishi) had guidelines with strict baseline calculations and requirements for environmental and public consultations, which subsequently passed into national regulations. Among other things, this helped introduce the concept of ‘buyers’ responsibility’ into the new EU member states. However, as EU regulations limit the use of JI credits in sectors covered by the EU’s Emissions Trading Scheme, growing numbers of JI projects seem likely to take place in Russia and Ukraine, where environmental and social safeguards are not as closely observed. Moreover, compared to projects in the new EU member states, projects in Russia and Ukraine are likely to be much larger–with larger potential negative effects.

Green investment schemes

With green investment schemes, Russia and Ukraine could by themselves satisfy all AAU demand (Ukraine, for example, has 1.5-2.2 billion tradable AAU potential). Countries with surplus AAUs are trying to ‘green’ their AAU sales by guaranteeing that revenues will finance further emissions reductions–in the hope that countries with strong environmental concerns will be more willing to buy into their projects. These agreements are typically made on a bilateral basis (e.g., in 2007: Japan-Hungary; in March 2008: Japan-Poland). GIS systems are currently under development in the region, with the first sales likely to take place in 2008.

All JI tracks by 2007 - host countries and annual emission reduction in 1000 tons (ERUs)

	Number of projects	Annual reduction in 1000 tons
Russia & Ukraine	45	19,338
Russia	31	14,468
Ukraine	14	4870
Eastern Europe	103	9204
Bulgaria	22	3382
Czech Republic	21	814
Romania	15	1590
Poland	14	879
Hungary	11	1437
Estonia	11	602
Lithuania	6	216
Slovakia	3	285
Others	8	705
Germany	3	194
New Zealand	5	511
Total	156	29,247

Source: Kovelva, M (2007)

At present, the legal and institutional basis for GIS projects is most advanced in Hungary. The Hungarian GIS framework affords buyers a government guarantee for the realization of their projects, sometimes even with 100 percent prepayment. There is greater flexibility for both parties, in terms of project types, size and procedures. Sellers can support technologies and beneficiaries (households and public sector) that are not eligible for other forms of subsidies, such as biogas for transport, buildings’ energy efficiency, or non-CO2 GHG emission reduction projects.

But areas of concern can be identified here as well. Because the discretion of the managing agency (i.e., the Ministry of Environment) is high, reporting rules may be loose, transparency may be more difficult to maintain, and tendering systems and priorities can be subject to ad hoc politics. As priority areas can be set by the managing agency, coordination with other subsidy schemes (under the national development plan, or via feed-in tariffs) might be weak. Some kind of international baseline standardization might therefore be a good idea.⁶

Do the new EU member states really need surplus emissions?

2008 is a landmark year for carbon markets. It is the first year both for the Kyoto Protocol’s international emissions reduction commitment period, and for Phase II (2008-2012) of the EU’s Emissions Trading Scheme (ETS). In Phase I (2005-2007) of the ETS, the European Commission acquiesced to an oversupply of national carbon allocations, thereby precluding large reductions in carbon emissions. It was clear that tighter national allocations would be needed to make Phase II work.

Despite this, European governments continue to insist on overallocation. The new member states were the leading ‘overshooters’: Latvia topped the list by requesting an allocation that was 55 percent greater than what was finally received. Estonia and Lithuania followed closely behind with overshoots of 48 percent and 47 percent, respectively; and Slovakia and Poland requested 27 percent greater carbon allocations than they finally received. The Czech Republic’s initial request overshot its final allocation by 15 percent; Hungary overshot by 12 percent. (Luxemburg was the only EU-15 country to overshoot its final allocation by more than 10 percent.)⁷ Backed by Finland, a number of the new member states threatened the Commission with legal proceedings in the course of these negotiations.

Differentiated GHG emission reductions can be justified within the EU on a solidarity basis, as is recognized in the Commission’s most recent proposal.⁸ However, 20 years after the collapse of socialism, new needs have emerged and new windows of opportunity have opened. While industrial emissions in the new member states have decreased overall, electricity consumption and transport emissions are growing rapidly. Meanwhile, investments in electricity infrastructure (in line with EU-wide trends) are lagging behind demand,⁹ and old production facilities in most of the new EU member states are in urgent need of replacement. Dirty coal and lignite-based producers are very much embedded into political structures, particularly in the Czech Republic, Hungary, and Poland. Policy inconsistencies are widespread: for example, despite lobbying for a 15-percent increase in carbon allocations under the ETS, the Czech Republic’s Energy Policy calls for a 13-percent reduction in GHG emissions for 2000-2010; while the National Climate Change Programme calls for an 18-percent emissions reduction. Despite lobbying for a 27-percent increase under the ETS, Poland’s Climate Protection Strategy calls for a 40-percent reduction in GHG emissions by 2020.

Moreover, the experience from Phase I suggests that the extra income gained from the overallocation granted under Phase II of the ETS is unlikely to be invested in new low-carbon technologies or energy-efficiency schemes. It is instead more likely to be treated as a windfall, to be used to subsidize polluting firms, and thereby enhance carbon lock-in.

Gábor J. Takács is Assistant Professor in the Foreign Economic Relations and European Union Department at the Budapest Business School.