Hungarian companies, which have a cap on how much greenhouse gases can emit, gave back to the government their credits .
The Hungarian government, instead of taking those credits out of the system, decided to exchange the credits (CERs) for AAUs (other "monetary" unit) and to later sell them to a third party.
Those credits were offered as "new credits". However, they are not "new", they were from Hungary and were already used to demonstrate compliance with emission caps . In other words, they could be registered or used twice.
Will try with an analogy, a credit as a car:
Imagine that I give you a car, for whatever reason, and it is registered in a system. A lot of people use the sytem to buy and sell cars.
After some months you give me back the car because you do not need it. What I do is, instead of taking the car off the registry system, I just change the tyres and give it a new name. Then I sell it to someone else with its new name.
Later, maybe days, weeks or months after the transaction, that "someone" or even somebody else who bought the car, comes to the EU and offers and sells "a brand new car".... and the "brand new car" then gets registered in the system. It is not a new one, but a "recycled" one... it is the same car but only painted in a different color. And now is registered twice in the system. Because it was never taken out of the registry.
If you relied on that system to determine the price of cars (supply and demand), would you trust it if you found that this car, but maybe several others, were sold two or three times, thus being registered two or three times but actually being the same car?
At the end, may the registry is inflated and does not mean there are in reality more cars. Maybe for every "real" car, the system registered 2 or 3 cars because of the recycling of cars. Your confidence in the system may disappear and you just try to get rid of any car you have. Then the price drops to the floor... no one wants cars, no one knows if the registry is OK or if it is double-counting and therefore if it is inflated. The system is not working and I can't put my money there.
In the case of credits, their price is subject to the supply and demand. Every time a government issues credits for a company, those credits are registered and if the company sells them, then the transaction has to be recorded on the system. If the company sells them or give those back to the government, the system has to register how many were sold or given back and who is the current owner. The caveat is that the credits may only be used once.
Where the credits came from in the first place:
The European Union (EU) has the commitment, under the Kyoto Protocol, to reduce its greenhouse gases emissions by 2012. The commitment is established with different percentages for each of the countries within the EU. In order for the EU to comply in the most economically efficient way possible, the EU countries are able to trade carbon credits in the EU-ETS (emissions trading system).
Every EU country has a cap on how much GHG can emit. THe country establishes specific emissions limits to its different economic sectors, for instance, steel production, cement production, etc. The government of each country auctions a certain amount of credits according to a defined schedule. When the government asks companies to demonstrate their compliance with their emissions cap they can provide their emissions information and, if not in compliance, surrender the credits they bought. The credits were used and are now useless. The mistake is that those credits were offered to someone outside of the EU and offered as offsets, as if they were new, or in other words, as if Hungary had a new project that reduces emissions (maybe on waste treatment or forests or any other).
The problem is that if such practice continues the credibility in the whole carbon credits trading system disappears, because the system is not working and is "allowing" for double accounting of credits.
Hope this helps.
I have a different view:
There are two separate regulatory systems, the Kyoto Protocol which puts emission caps on certain countries and the EU ETS which puts emission caps on operators (utilities etc.) in the EU.
CERs are carbon credits which are issued for use by countries within the Kyoto Protocol system. Within the system of the Kyoto Protocol they are of equal value to AAUs and ERUs, the other types of carbon credits issued within that system.
The countries with emission caps must demonstrate at the time of the Kyoto true-up in 2015 that they hold an amount of Kyoto credits (AAUa, CERs and ERUs) at least equal to their respective emissions in the years 2008 to 2012.
Operators covered by the EU ETS must surrender an EU Alloawance ("EUA") for each metric tonne of carbon dioxide they emit. An EUA is technically a special AAU issued by an EU Member State in accordance with the respective National Allocation Plan. In other words EU ETS operators cannot just use any AAU for compliance but only those that are issued by EU Member States as EUAs.
EU ETS operators may alternatively use CERs for EU ETS compliance.
By 30 April of each year, the EU ETS operators must surrender to the government of the EU Member state where their respective installations are situated an amount of EUAs and/or CERs equal to the amount of their respective installations' carbon dioxide emissions in the previous year. All these EUA's and CERs then flow into the EU Member States Kyoto credit inventories. The EUAs turn into plain AAUs and the CERs become EU ETS used CERs.
The CERs which were previously used for EU ETS compliance cannot again be used for EU ETS compliance by EU ETS operators. Such use would be prevented by the EU ETS registry system software. However, they will be used by the EU Member States (or other countries) for Kyoto compliance.
The EU Member States are free to use their inventory of Kyoto credits for their own Kyoto compliance or - if they have excess credits - sell them to other countries which can then use them for Kyoto compliance.
In particular Eastern European EU Member States have an excess of Kyoto credits. As they hold different types of Kyoto credits in their inventories they need to decide how best to monetize these. As the market price for CERs (even CERs which cannot again be used for EU ETS compliance) is higher than the market price for AAUs it is rational for EU Member States with excess Kyoto credits in their inventories to monetize the CERs and hold the AAUs.
However, there are some problems:
a) As a market participant it is important to differentiate between CERs which have been used in the EU ETS and CERs which have not yet been used in the EU ETS. The former cannot be used for EU ETS compliance (anymore) the latter can. Thus, as a buyer you will need to make sure that you include the appropriate contract language and check your credits as part of the settlement process. This is a bit more problematic for buyers with existing contracts which do not specify the CER type. I would imagine it might also be a problem for the sellers in these deals as it should put them in a bit of a moral dilemma.
b) There are too many Kyoto credits. As a result of the US not joining the Kyoto system (and assuming there is no post-Kyoto need for Kyoto credits) the Kyoto credits should really have a pretty low value. Except for CERs which can still be used for EU ETS compliance that is. Their value derives from their useability in the EU ETS and not from the demand created by the Kyoto system. Now, if all CERs which have previously been used for compliance in the EU ETS are sold to Japan and if all CERs which have not yet been used for compliance in the EU ETS (including the ones currently under contract by Japanese companies) are sold to EU ETS operators than the price for CERs would come under serious pressure.
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