Kyoto´s Effect on Multinational Companies

Originally published Winter, 2003.

Countries that ratified the 1992 United Nations Framework Convention on Climate Change, including the United States and all European Union member states, adopted the Kyoto Protocol in 1997. By 2012, the protocol is intended to address unwanted climate change by imposing a 5.2 percent reduction upon global emissions of six greenhouse gases (including CO2, methane, natural gas and others). When the Bush administration announced its intention this year not to ratify the protocol, it was widely assumed by the international community that it would not move forward because the United States accounts for the largest amount of greenhouse gas emissions (36 percent) worldwide. Since the protocol must be ratified by at least 55 countries representing at least 55 percent of the emissions of greenhouse gases from developed countries and "economies in transition" (mostly former Soviet states) to go into force, it was implied that without U.S. agreement to the protocol the parties would have to go back to the drawing board.

Nevertheless, the 55-country requirement has been met. The 55 percent emission requirement will most likely be met in early 2003, when ratification by Russia and Japan is anticipated. All of the EU member states, including the United Kingdom and Germany, have already ratified the protocol.

Companies with operations and markets in ratifying countries will find their businesses affected in myriad ways, even if they are based in a non-ratifying country, such as the United States. This will especially be the case in so-called Annex 1 countries. Annex 1 countries are developed countries and economies in transition that have agreed to reduce their greenhouse gas emissions by specified amounts below their "base year" emissions, which is usually the year 1990. Annex 1 countries that have ratified the protocol or stated their intention to do so include EU member states, EU accession countries (for example, the Czech Republic, Poland and Hungary), Russia, Canada and Japan.

To achieve these reductions, Annex 1 countries will have to either reduce their actual emissions of greenhouse gases from such sources as power plants, factories, cars, trucks, buses, airplanes, agriculture and landfills or acquire internationally sanctioned credits from other countries. Most developed countries cannot achieve their agreed reductions without buying such credits through one of the protocol's "flexible mechanisms."

Kyoto provides three credit mechanisms. The first is the trading of emissions allowances among Annex 1 developed countries that have ratified the protocol. The basic structure will involve national permits that grant a specified number of emission allowances, thereby limiting the greenhouse gas emissions of individual permittees. A permittee may live within its allotment, supplement its allotment by purchasing allowances from another permittee or, if it has allowances to spare, sell a percentage of its surplus allowances to others.

Other mechanisms are called "joint implementation" and the "clean development mechanism." These involve an investment by a party from a ratifying Annex 1 developed country into a ratifying economy in transition (joint implementation) or a ratifying non-Annex 1, developing country (clean development mechanism). If the parties can establish that this investment reduces the recipient country's emissions beyond what they would have been but for the investment, the investing party may take credit for additional allowances that it may use itself or sell.

The value of these trades has been estimated to exceed $30 billion; the infant existing market recently broke the $50 million mark. There are some pilot trading initiatives already underway, and it is expected that allowances markets and related derivatives will develop rapidly once the protocol goes into force. For example, pilot carbon funds have already been capitalized to bundle allowances and resell them as demand increases. In addition, international financial institutions are using anticipated allowances to assist in project financings.

The European Union is providing further momentum. The EU member states have entered into a burden sharing agreement, reallocating their country-specific emissions reduction targets to achieve an EU-wide reduction target. To help achieve these new targets, the European Commission has proposed a mandatory emissions trading directive. The European Parliament approved this proposed directive in October 2002, and the Council of Ministers has announced its intention to approve it in December 2002 so it may go into force in 2003. The European Commission is also actively considering carbon taxes on everything from cars to factories that emit excess greenhouse gases. In addition, each EU member state must issue a national plan to achieve its own target, and these plans are under active development.

Early action by multinational companies and financial firms will be desirable to maximize opportunities and minimize costs. Some such actions will involve adjusting capital, production and marketing plans; some will involve international and national lobbying in intergovernmental, governmental and non-governmental settings.