Offset doubts increase

12 June 2008

The future of the UN's Clean Development Mechanism is unclear, with significant implications for emerging carbon markets, writes Stephen Gardner. In publishing earlier this year proposals to overhaul the European Union emissions trading scheme (ETS), one of the European Commission's aims was stability in a market that has seen its share of turbulence. But one aspect of the ETS remains uncertain: the use of credits from the Clean Development Mechanism. The CDM is the United Nations' giant carbon offsetting scheme. Mandated by the Kyoto Protocol, it allows companies to earn carbon credits by funding emissions-cutting projects in developing countries. The reductions must be “additional”, for example energy efficiency measures that would otherwise not happen. Credits shipped west CDM credits – Certified Emission Reductions (CERs) – are then shipped to the west, chiefly Europe. EU governments buy CERs to help meet their Kyoto obligations. Companies covered by the EU ETS polluting excessively can either buy extra credits on the EU carbon market, or splash out on CERs. CERs are attractive because they are cheaper to generate than EU credits (an EU ETS credit on average cost $24.30 in 2007 compared to around $13.50 for a CER, according to the World Bank's State and Trends of the Carbon Market report). EU countries have set limits to stop the import of CERs becoming a free-for-all. Limits are very variable: 20 percent of the national cap in Germany and Lithuania, whereas Estonia does not allow CERs at all. The UK limit is eight percent. High thresholds in some countries have led to concern the ETS is being undermined and that “Europe is reducing more emissions outside than inside,” says Juan Delgado, an economist from Brussels think tank Bruegel. But, according to International Emissions Trading Association president Henry Derwent, speaking at a recent European Parliament hearing, CERs are “not a way of avoiding responsibility. They are all about timing.” Companies need breathing space to make emissions-cutting investments. Access to offsets in the meantime is essential for carbon compliance. If ETS-participants buy in the maximum volume of CERs allowed, they will offset rather than cut 1.4 billion tonnes of carbon dioxide – one third of their total reduction target between 2008-2020. Furthermore, if the CERs are not used up during the current ETS phase (2008-2012), companies can carry them over into the next one (2013-2020). One reason for this is the Commission does not want to dissuade companies from investing in CDM projects that may only bear fruit towards the end of the current phase. But more importantly, the CDM will only continue if an international agreement is signed to replace Kyoto after 2012. No sudden end? For carbon traders, it is hard to imagine the CDM – which has created a market worth $13 billion in 2007 – suddenly drying up. Jill Barker of EcoSecurities, one of the largest carbon reduction project developers, says “we are pretty confident of a post-2012 framework. Demand for carbon credits is not going away.” She cites as “a really positive sign” the possible inclusion of CERs in a future US emissions trading scheme. The CDM has also generated its own momentum, with a 1000th project registered in April. Signals about it from international climate meetings have been positive, says Kai-Uwe Schmidt, Secretary to the CDM Executive Board. “Business has to be able to invest with assurances,” Schmidt adds. This will be a stick to prod policymakers along. But the CDM also has detractors. Criticisms range from lack of capacity, to more serious concerns about its effectiveness and impact in developing countries. On the first count, says EcoSecurities' Barker, there has been an “explosion” of market activity with new entrants and a sharp increase in the number of project submissions. The CDM has struggled to cope. There are bottlenecks in approving new projects, and a lack of transparency in CDM decision-making. Project developers say reasons for a project being rejected are not always clear. There have also been technical hold-ups, such as delay in connecting the International Transaction Log, which tracks CERs, to the EU ETS. However, the CDM “understands the predicament the market is in,” says Barker. “Things are starting to move in the right direction.” Measures to improve procedures include the launch of a project developers' forum and the planned publication of a project monitoring and verification guide. Serious questions But more serious questions are also being raised. Juan Delgado says there is a risk the CDM may “displace national policies” in countries like China, and “could lead to emerging economies not having incentives to reduce emissions.” In other words, China, for example, benefits from CDM investment, but continues anyway to build coal-fired power plants to meet its growing energy needs. Michael Wara of Stanford University has argued in a paper that China is using the CDM as a means of holding the west to ransom. It is funding renewable energy capacity using the CDM, but would probably do this in any case, because it has its own reasons for increasing efficiency and reducing pollution. Like everything else relating to the carbon market, the future of the CDM will be determined in Copenhagen in December 2009, where the international community will attempt to finalise a successor to Kyoto. “Time is short and the job is very difficult,” says Kai-Uwe Schmidt. But international talks so far have indicated that “the CDM should continue, but could be improved.” A version of this article originally appeared in Climate Change Corporation.

 

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