On the outskirts of Bangkok, generators fueled by methane from swine manure make electricity. In China's Inner Mongolia, wind farms are sprouting up along the breezy steppes. In India's Andhra Pradesh state, villagers power their tractors with a cleaner-burning diesel substitute pressed from seeds of the mighty honge tree.
What do these far-flung projects have in common? They're all the direct result of the 1997 Kyoto Protocol, a sprawling global initiative to reduce emissions of greenhouse gases linked to global warming. The U.S. and a handful of other nations spurned this treaty, in part because it exempted emerging nations from making their own cuts. But the innovative financial systems that Kyoto inspired have made it relatively easy for developing countries to hop on board.
Under the Kyoto treaty, developed countries are required to cut emissions by an average of 6% from 1990 levels by 2012. Each country is permitted to emit a certain number of tons annually of carbon dioxide or its equivalent. Governments then issue emission "allowances" to polluters within their borders, and these can be bought and sold by companies worldwide. Through this carbon trading system, big polluters in developed countries can pay companies in developing nations to cut emissions in their stead. Since many factories in developing countries use dirty, inefficient processes, it's often cheaper to clean them up than to replace the more modern equipment used in wealthy nations.
The system is helping foster green investments in countries that are home to some of the world's biggest polluters. In August, a Japanese consortium led by engineering outfit JGC Corp. and Marubeni Corp. (MARUY ) joined up with a chemical maker in China's Zhejiang Province to recover gases released in making refrigerants. The deal will result in a reduction of the equivalent of 40 million tons of CO2 -- creating credits worth about $200 million. Sumitomo Corp. and Rabo Bank of the Netherlands have a similar contract with Gujarat Fluorochemicals in India for 3 million tons of carbon credits. And Paris-based chemical maker Rhodia (RHA ) is cutting nitrous oxide emissions at its plants in South Korea and Brazil. Rhodia will likely sell those credits, equivalent to as much as 13 million tons of CO2.
Worldwide, developing countries are promising sweeping action, from cleaning up concrete plants, to sowing new forests that absorb carbon dioxide, to harnessing methane from landfills to generate power. So far, 39 projects have been registered with the U.N., and hundreds more are in the pipeline. Ultimately, the scheme could net as much as $12.5 billion for developing countries by 2012, the World Bank says. "There is a lot of appetite for these credits," says Edu Hassing, a project specialist with the Asian Development Bank in Manila.
Since the Kyoto accord took effect on Feb. 16, the market for emission allowances has soared. Most of the action is on the Amsterdam-based European Climate Exchange, or ECX. In the exchange's first month, 1 million tons of CO2 credits were traded. Next year, it's expected to be 700 million tons -- roughly 2 million tons a day -- and volume is expected to grow to some 4.8 billion tons in 2008. "It's a large baby for its age," says Sara Stahl, an ECX economist. The baby is getting richer, too. Since the beginning of the year, prices have more than doubled, to $26 per ton of carbon dioxide.
So far, credit purchases from developing countries are relatively rare, and more often than not they're funded by public institutions rather than private companies. For example, several European governments have pledged to buy up to $1.1 billion worth of credits through the World Bank, which is acting as matchmaker for companies in the developing world that want help funding cleanup efforts. Recent examples include wind turbines with capacity of 26 megawatts in a remote part of the Philippines and a project to capture and harness methane gas released from coal mining in China's Shanxi Province that will cut emissions by 4 million tons annually. But as 2012 approaches and companies in the West realize it's cheaper to buy credits than to clean up at home, purchases of credits from developing countries are expected to soar.
There's little doubt that India and China will be big sources of credits. Both are industrializing at a breakneck pace with little regard for the environmental consequences, so there's no shortage of areas where pollution can be reined in. India has already negotiated dozens of carbon credit sales in projects ranging from hydro stations to harnessing methane gas released by decomposing garbage. China, on the other hand, has been a relative laggard, with just three such deals so far. But many others are in the works. "China has a huge potential to become one of the largest markets" for pollution credits, says Kishan Khoday, team leader for energy and the environment at the U.N. Development Program in Beijing.
Some projects are clear winners. Gases released from making refrigerants, for instance, have 11,700 times the global warming potential of carbon dioxide. So capturing even small amounts can add up to huge numbers of carbon credits. Methane, meanwhile, does 21 times the damage of pure carbon dioxide, and it's a fuel in its own right, so harnessing it can offer a big payoff. Such projects are rarely undertaken without carbon trading, but with it they can be highly profitable, offering returns of as much as 30% per year, says Zhao Jianping, an energy specialist at the World Bank.
Other potential projects, though, will be harder to pull off financially. For example, in China it costs about 6.2 cents to produce a kilowatt-hour of electricity using wind power, compared with 3.7 cents for coal. Current prices for carbon credits translate into a subsidy of roughly 0.6 cents per kilowatt hour, though funding initiatives planned by Beijing may make wind power more attractive.
How valuable will carbon credits become? Currently, credits cost up to 70% less than allowances because if a project falls through and the developing-country partner doesn't clean up its act, the company that bought the credits is held responsible. "We must do a hell of a lot of due diligence," says Thorsten Ansorg, director of Noble Carbon Credits Ltd., a subsidiary of Hong Kong trading firm Noble Group that has bought millions of tons of credits from developing countries. "We have no desire to buy something that never materializes." But as the market gets more efficient at separating smart projects from wishful thinking -- and as companies in the West struggle to meet their Kyoto targets -- prices are likely to rise. "As the deadline gets near," says Andres Liebenthal, an environment specialist at the World Bank in Beijing, "there is going to be a scramble" for credits.
By Frederik Balfour in Hong Kong, with Laura Cohn in London and Nandini Lakshman in Bombay