Carbon time bomb (source: GuenterHH)

The carbon markets have had a troubled few weeks. While the price of the world’s most popular and valuable carbon product, the European Union Emissions Trading Scheme allowance, shed some 22% in one week, the Australian government has finally announced a potential path for the country to join the small group of emissions trading nations.

At the same time, the United Nations’ Clean Development Mechanism (CDM) is in a period of transition (see Climatico post): policy decisions made by its regulators could have significant impacts on the ability of the mechanism to deliver useable and robust offsets (called Certified Emission Reductions – CERs).

Superseded supercritical?

One particularly interesting issue has been focussed on the CDM Methodology Panel, who is charged (among other tasks) with maintaining the methods that are used to calculate how many equivalent tonnes of CO₂ (CERs) are mitigated from projects. The panel recommended to the CDM’s regulatory body, the Executive Board, that one methodology based on supercritical coal plants should be placed on hold since it could potentially overestimate emission reductions/CER generation by some 25% on average (pdf here).

Green groups have long argued that fossil fuel based projects breach CDM criteria. On the other hand, the EB consider that since supercritical coal plants are more efficient, and thus emit less carbon, they should be able to qualify for CERs.

Following the panel’s recommendation to pause the methodology, the EB was split on how to proceed with the decision. Despite uncertainties, the EB registered another supercritical coal project and eventually decided not to follow through with a suspension, yet.

Blast from the past

While none of the five registered supercritical coal projects have yet issued any credits, the situation is reminiscent of other methodological problems.

Only recently have CDM methodologies been centre of a controversial debate: doubts surrounding CDM projects based on the destruction of industrial gases (HFC and N₂O) (see Climatico post) shook the CDM community. One of the results of the debate was that the largest demand source of CERs, the EU ETS, placed a ban from 2013 on the use of CERs from these projects for compliance.

With 39 supercritical coal projects within the CDM pipeline at various stages of development, a decision to reject the suspension request could become the next controversy in the CDM. One of the main groups scrutinising the announcements from the EB has been European NGO, CDM-Watch, who expressed fears that the new decision was politically motivated.

Green groups had successes in the HFC/N₂O debate. Even if the EB continues to allow supercritical coal projects in the CDM, there is a risk that the issue could grow into something bigger and out of their control. Instead of targeting the supply of CERs, groups may want to aim for changes in the demand side, which is equally important in the development of the CDM.

Following some poor 2010 growth results, the EB will want to decide carefully if they mean to prolong the longevity of the world’s largest international offset mechanism.

Wind farm (Source: Axel Bruns)

Following the spectacular milestone of 3,000 projects registered into the world’s largest carbon offset mechanism, this month marked a time for reflection for those involved in the United Nations’ Clean Development Mechanism.

With over one-third of the registered projects now issuing Certified Emissions Reductions (CERs – the currency of the CDM, each equal to one tonne of CO₂ equivalent), the last four weeks have seen over 23 million issued, taking the overall total since 2005 to almost 650 million.

On the surface, the CDM has managed to clear some dead wood from last year, when only 132 million CERs were issued; 2011-to-date has seen past this already, with 50 million issued in January. So why is investment in the CDM falling?

The ‘Gap’

It became clear to negotiators at the recent Bonn climate change conference that a ‘gap’ in the Kyoto Protocol may be unavoidable. The CDM is widely regarded to be the most significant outcome from the KP, but they are intrinsically linked: the former depending on the regulatory and legal framework that is generated by the latter.

When the KP’s binding emission reduction targets finish at the end of 2012, investors, participants and UN policy-makers have been mulling over what happens to the CDM. The number of applications for new entrants has been dwindling for instance, suggesting a slowing demand for investment in the primary CDM market – where CDM projects are still under development and not yet at a stage to generate offsets.

Moreover, the World Bank’s State and Trends of the Carbon Market 2011 (issued earlier this month – pdf), suggested that the global carbon market stalled in 2010 with overall value declining slightly compared with 2009 (the global carbon market including the EU Emissions Trading Scheme, CDM, Joint Implementation and the controversial Assigned Amount Units – so-called ‘hot-air’).

Value Erosion

One of the major upsets in 2010 was that value of the primary CDM market fell some 48% to $1.5 billion, bringing it lower in value than 2005 when the CDM was in its inception year. On the other hand, the overall value in the carbon market remained somewhat stagnate at $142 billion compared with $144 billion in 2009.

The continuing lack of clarity in the carbon markets after 2012 and the loss of political momentum on setting up new ETSs were given as the primary reasons for the sideways movement in growth. Despite the EU ETS being legally extended to 2020, regulatory decisions in Europe have major impacts on all other carbon markets. The high profile decision to ban CERs generated from the destruction of industrial gases (HFC and N₂O) after 2012 has placed a lot of pressure on the CDM to deliver offsets to the EU by other project types (see Climatico post).

What the Future Holds

If new investment in the CDM seems a little risky for investors, the chair of the CDM regulatory body, the Executive Board, remains positive: “I’m quite confident that the CDM has a future, and we need to make sure that it’s going to fit for a more ambitious [climate] agreement”.

While 2010 has been seen as a bit of a disaster for carbon markets around the world, legislation failing to materialise in the US, Japan and Australia, the CDM has ramped up to end the KP 2008-2012 period on a high note.

What this life after 2012 looks like is still up in the air. Reassuringly, CERs issued after 2012 from projects registered before 2013 will remain eligible for use as compliance instruments under a replacement international agreement. The things that CDM participants should be looking out for are what this international agreement will look like, if it will contain binding emissions targets that CERs can be used with, and critically, if it will all happen before 2013.

Sourced from UNFCCC

This week marked a significant milestone of the United Nations’ Clean Development Mechanism (CDM). A wind power project in Inner Mongolia, China, has become the 3,000^th project registered under the world’s largest international offsetting mechanism.

There is no doubt that the process is speeding up: it took 18 months to register the first 1,000 projects; the second thousand took 22 months, but the last thousand only 16 months. So is the CDM able to further build capacity to help countries meet their Kyoto Protocol compliance by 2013?

Improved Updates

Initially conceived out of the Kyoto Protocol to aid global carbon reductions, the CDM has become the international standard in carbon offsetting. This is where developed countries can fund projects to abate carbon in developing countries and in return receive Certified Emission Reductions (CERs) – the currency of the CDM.

The last few years have been somewhat unsettling in the CDM space. The governing body of the CDM, the Executive Board (EB), has been under pressure (see previous Climatico post) to increase administrative speeds whilst reducing backlogs in order to allow more and more projects to deliver carbon reductions in more and more developing countries. Under new leadership, the EB has listened to its participants and the UNFCCC (UN Framework Convention on Climate Change) and made some significant improvements with respect to appeals processes and approval systems.

Foreseeing Growth?

Now in 71 developing countries, the CDM has issued over 600 million CERs in reductions from over 1,000 of the now 3,000 registered projects.

To put this into context, the first five months of 2011 has issued over 100 million CERs (half of this in January), versus only 132 million for the whole of 2010, 123 million in 2009 and 138 million in 2008.

Analysts have been quick to increase issuance forecasts to the end of 2012, when developed countries’ compliance under the Kyoto Protocol ends. In 2006, total pre-2013 issuance volumes were placed around two biillion CERs. This has since been updated many times by the majority of analysts.

According to Thomson Reuters Point Carbon, they predict just under 1.1 billion CERs issued by 2013, compared with 1 billion CERs from UNEP’s Risø Centre and 965 million from IDEAcarbon.

Importantly, 2013 also marks the start of the so-called Third Phase in the European Union’s Emissions Trading Scheme (ETS), the largest demand source for CERs currently. After 2012, the EU carbon market regulator, the European Commission, has decided to ban all CERs originating from the destruction of industrial gases for compliance under the EU ETS (HFC or N2O projects – see previous Climatico stories here and here).

Keeping Ahead of the Regulation

Any EU ETS compliant participant who has vested interest in these projects, which have contributed over 70% of all CERs issued, thus may be incentivised to use the offsets generated while they are still eligible as is discussed below. This is supported by the large increase in CER use for compliance in the EU ETS during 2010. Results from the European Commission show that the number of international offsets (CERs and the Joint Implementation Emission Reduction Units – ERUs) used for compliance under the EU ETS increased by some 68% from 2009 to 2010.

Details of the process, called surrendering, will not be fully published until May 16 2011, but reports (ENDS Europe, Point Carbon) suggest that participants may be eager to offload credits while they still can. Current figures indicate that 117 million CERs and 20 million ERUs were surrendered in 2010, accounting for some 7% of emissions under the ETS.

The impact of such a ban has been immediate and wide-ranging. It is clear that the linkages between the CDM and the EU ETS are as strong as ever. Until more emissions trading schemes that allow the use of offsets are rolled out throughout the world (one of many outcomes from the international climate negotiations), this connection may continue for the next few years at least.

Cylinders (sourced from Tony Spencer)

In 1989, the Montreal Protocol laid out an extensive set of environmental rules that regulate and phase-out gases which contribute to the depletion of the ozone layer: including hydrochlorofluorocarbons (HCFCs), chlorofluorocarbons (CFCs) and halons.

Coming only 10 years later, the United Nations’ were able to build on that success when the Kyoto Protocol (KP) provided a legal basis on which developed countries could actively pursue reductions in greenhouse gases (GHGs) economically and sustainably. One such GHG was a group called hydrofluorocarbons (HFCs): a set of gases that have global warming potentials many thousand times the potency of carbon dioxide and were excluded from the MP (HFCs can be direct bi-products from HCFC productions).

This time however, Parties under the KP were able to take advantage of the Clean Development Mechanism (CDM) to receive many millions of Euros in exchange for destroying HFCs. As a result, projects that generate offsets from destroying HFC (specifically HFC-23 from HCFC-22 productions) have sat uneasily in the CDM.

A Fluorinated EU?

The HFC sector in the CDM has been the target of much criticism (see previous Climatico blog) that questions the underlying environmental credibility of HFC Certified Emission Reductions (CERs – the currency of the CDM).

Since each avoided ton of HFC-23 generates 14,800 CERs (worth €170,000 at current prices), the recent announcement that the EU Emission Trading Scheme (ETS) will no longer accept HFC CERs for compliance from May 2013 to some extent highlights the EU’s position on discouraging HFC tolerance despite its worth.

In an effort to curb HFC use further, several countries (US, Canada, Mexico and Micronesia) proposed extending the MP to also cover HFCs, paving the way for rapid de-fluorinisation.

Replacements

Some environmental groups including CDM-Watch and Greenpeace, however, feel that the political inertia could place the wider realm of fluorinated gases (a set of potent GHGs that include HFCs, perfluorocarbons – PFCs, and sulphur hexafluoride – SF₆) under heavier regulation.

After the success of the Montreal Protocol to ban HCFCs and CFCs, the so-called F-gases were widely applied to fill the void of various industrial uses such as refrigeration, air conditioning and electrical transmission.

Despite their low toxicity, low flammability and non-ozone depleting properties, F-gases have global warming potentials many times that of carbon dioxide meaning they contribute to anthropogenic climate change. Moreover, the climate effect of these gases is relatively short-lived compared to carbon dioxide; meaning that action can return prompt benefits, helping to reduce atmospheric temperature increases.

A Low-Carbon Future

Since 2006, EU legislators have implemented a set of regulations and one directive to ensure the so-called F-gases remain subject to strict controls. These regulations only resulted from a conciliation procedure since the European Parliament and the Council of Ministers were unable to reach an agreement on two separate occasions.

Only last week did the European Commission publish a proposal to take the EU on a track to reduce emissions 80-95% by 2050 from 1990 levels (Roadmap 2050). To reach the target, the report recommends that comprehensive economy-wide policy changes should be required.

For instance, emissions in the industrial sector will need to be reduced by some 40% by 2030 and then 80% by 2050. The power sector will need to undertake a major and rapid change: at least 60% reduction in sector emissions by 2030 with almost full decarbonisation by 2050.

The Council is expected to debate the Roadmap today (March 14). While the scope of the proposal and effort required to implement the recommendations is colossal, some groups believe that addressing the EU’s use of F-gases cannot be underestimated and should not be overlooked as the EU lawmakers discuss potentially momentous proposals.

While F-gases account for approximately 4% of EU annual carbon dioxide equivalent emissions, their potential climate change toxicity means that their future regulation in the EU, or under a suitable international treaty, remains an important part of the solution in a move to a low-carbon and sustainable economy.

Tokyo Night (sourced from Doronko)

Following the minor operational successes from Cancun in December (see Climatico’s comprehensive report – PDF), the United Nations’ Clean Development Mechanism (CDM) has undergone something of a resurrection: issuing the 550 millionth offset almost five and a half years after the first, and surviving a period of undeniable uncertainty over the future of the mechanism.

The CDM coming of age has not been without controversy however, as industrial gas projects take centre stage in the discussions while other groups propose replacement schemes. Industrial gas projects (those that destroy HFC-23 and N₂O) helped the CDM abate hundreds of millions of tons of CO₂-equivalent. Rather pertinently, industrial gas projects accounted for 60% of the volume of issuances since Cancun, accounting for only 11% of the number of issuances.

Controversy

The European Commission’s proposal to ban offsets from industrial gas projects being used for compliance in the European Union Emissions Trading Scheme (EU ETS) from May 2013 was somewhat unsurprising.

Commissioner for Climate Change Action, Connie Hedegaard (from Copenhagen negotiations infamy), had made inferences beforehand that these offsets had a shorter shelve life than others, especially within the EU. The Commission said its decision was due in part to “absence of sufficient progress towards CDM reform and the establishment of sectoral market mechanisms at UN level”.

As the largest demand source for Certified Emission Reductions (CERs – the currency of the CDM), the future of the CDM is, and always has been, inherently linked to the EU ETS with over 10,000 potentially buyers.

A ban in Phase III of the EU ETS (2013-2020), when the majority of participants no longer receive free allowances and total offset use is capped at 1.7 billion tons, could alter the playing field enormously. Should the European Parliament pass this proposal into law, the number of buyers may be limited to the UNFCCC developed countries outside of the EU. Even then, it is likely that some will choose not to buy them considering concerns over environmental integrity.

Competition

Climate policy is a young and evolving arena; the mere suggestion that some CERs may be ‘environmentally tainted’ has far reaching consequences for the CDM’s longevity. As a result, it was not long before alternatives were investigated.

Since the beginning, Japan has been major buyers of CERs (including those from industrial gas projects): supporting the various carbon funds or being directly involved in project development. In addition, the private sector has enthusiastically taken part in acquiring CERs for voluntary emission reduction compliance, in turn being passed to the government who can use them for Kyoto targets.

Despite this clear interest in the CDM, on-going delays and uncertainties compelled the world’s fifth biggest emitter last year to begin several offsetting projects in South Asia. The difference being that they were non-CDM, bilaterally agreed with governments, use existing Japanese technologies and allow offsets from nuclear and forest management.

Only this week did Japan build on the idea. It submitted to the UNFCCC a proposal for a new international offsetting mechanism to sit alongside existing ones – see below for Reuter’s summary of the proposal. Establishing a complementary mechanism that has a similar objective function will upset the CDM community.

It is unlikely that the UNFCCC will consider additional offsetting mechanisms to be included into an international agreement. The CDM was designed to deliver quality offsets. But nevertheless the stringency of its processes has been matched by its degree of complexity. Many lessons have been learned since its inception and in this environment experience is almost everything.

The CDM may still be experiencing some teething troubles. If the CDM Executive Board can build on the progress that has been made in the last six months and defend the CDM against competition, they may not be far from the streamlined, efficient and fair mechanism that was envisaged in 1997’s Kyoto Protocol. With the potential to generate perhaps many billions of offsets for many more years to come, watch this space, because undoubtedly everyone else is.

—

Summary points of Japan’s proposal for a new international offset mechanism from Reuters:

• Market-based mechanisms are cost-efficient, and some of the funds raised from them can be used to finance efforts by developing countries.
• New mechanisms should allow a variety of approaches, including a project-based one like the CDM and a sector-based one that the European Union is working on.
• New mechanisms should promote transfer and use of low carbon technologies, products and services to developing countries, including least-developed countries.
• New mechanisms need to be efficient and facilitative to help drive emission reduction efforts by a growing number of players and to enlarge the scale of market-based mechanisms as a whole.
• New mechanisms should mobilise all available technologies and not preclude such large-scale emission-cutting technologies as nuclear power or carbon dioxide captures and storage (CCS).
• To ensure the transparency and credibility of new mechanisms, countries should apply principles agreed at U.N. meetings in their measurement, reporting and verification (MRV) of emissions cuts and report regularly to the UNFCCC secretariat on how the mechanisms are used.
• Measures are needed to avoid double counting between different mechanisms.

No Gas (sourced from: The U.S. National Archives)

The United Nation’s flexible mechanisms were introduced as a cost-effective and efficient method to help poorer countries develop sustainably, whilst providing developed countries another option to meet commitments under the Kyoto Protocol.

The Clean Development Mechanism (CDM) and the Joint Implementation (JI) have progressed at different rates, with different levels of engagement and varying degrees of scope in the ensuing emission reductions. One project sector has benefited more than others and recently, has come under fire for its environmental credibility. But what is the issue and why is it so politically toxic?

A Failure or Success?

The Montreal Protocol was established to regulate a certain type of gas: ones that are believed to be responsible for ozone depletion. Difluoromonochloromethane, better known as HCFC-22, is one such gas that is still used in refrigeration and air conditioning processes in many developing countries. It is a by-product of HCFC-22 in which we are interested: HFC-23 (another hydrogen-based gas also called fluoroform).

HFC-23 has a 100-year global warming potential of between 11,700 (UN) and 14,800 (Intergovernmental Panel on Climate Change), meaning that over 100 years, one metric tonne of this gas has the equivalent global warming impact of 11,700 tonnes of carbon dioxide. Its use is not currently governed by the Montreal Protocol, but the UN Framework Convention on Climate Change (UNFCCC) realised that the potential impact to the atmosphere was too significant to ignore. As a result, they chose to include the destruction of HFC-23 in the CDM and JI via the Kyoto Protocol.

Because reducing one tonne of CO₂ equivalent by a project generates one Certified Emission Reduction (CER – the currency of the CDM), destroying one tonne of HFC-23 generates 11,700 CERs. Consequently, the emission reductions generated through the CDM by destroying HFC-23 have outstripped all others: out of the 421 million CERs issued to date, HFC-23 contributes 52% from only 18 projects.

To some, CDM projects that destroy HFC-23 have been a great success, by increasing liquidity and bulking up the volume of CERs that are generated. But to others, the vast amounts of CERs which have been generated are windfall profits to polluters, and can perversely incentivise the increased production of HFC-23.

Rocking the Boat

Environmental NGO, CDM-Watch, proposed last month an amendment to the methodology which CDM HFC-23 projects conform. CDM-Watch alleged that some operators of HFC-23 projects could be “gaming” the system in order to gain more CERs (which on the secondary traded market are currently worth approximately €12).

The group questions the adequacy of the ratio of HCFC-22 to HFC-23 that is used by projects to calculate their emission reductions. Currently, the rules set the maximum ratio at 3%, so 0.03 tonnes of HFC-23 to 1 tonne of HCFC-22. But the proposal sees this reduced to a minimum of 0.2%

The CDM’s Methodology Panel, the body charged with overseeing the methodologies of the CDM, chose to ask the higher-profile CDM Executive Board (EB) to decide on the issue. There remains a good chance that the EB fails to reach a verdict and instead passes the issue up to the UNFCCC because of how politically charged this topic has become.

Indeed, CDM-Watch appears more than aware of the politically sensitivity that surrounds the HFC-23 controversy. CDM-Watch warned that EB members from China, India, Netherlands, UK, Japan and Norway should abstain from voting on the proposed methodology revision due to conflicts of interest. These countries either host the projects or have vested interest in the CER generation.

In any case, the proposal has caused a stir in the CDM and participants are looking for certainty. The EU and the US have both made suggestions that offsets generated by the destruction of HFC-23 may be banned from their respective carbon reduction plans after 2012 (if one is ever enacted in the US). So investors in HFC-23 reduction projects are right to be concerned.

If restrictions are approved, it is still unclear when they will take place. Current project contractual agreements indicate that the EB may have to wait until a project requests an extension to their crediting period (usually seven years, with the possibility of two extensions) before amending the methodology. In fact, a request to extend the crediting of a certain HFC-23 in South Korea was postponed last month by the EB until a later date, certainly until something more concrete has been decided.

It seems that the workhorse of the CDM is under threat. Just less than 50% the world’s HFC-23 is included in the CDM (since no HFC-23 projects were eligible after 2004). A proposed amendment to the Montreal Protocol could cover the rest, essentially sealing off HFC from further commercial interest. But how the CDM, JI and their participants react to its current piece-of-the-pie remains to be seen.

The Executive Board of the United Nations’ Clean Development Mechanism (CDM) assumes full responsibility for its administration. Their remit is to uphold the environmental integrity of the CDM whilst ensuring the processes remains efficient and effective so projects can deliver the emission reductions.

Warning by SorbyRock

Since climate policy is a relatively immature, fast moving arena, the Executive Board (EB) needs to keep up and alter its actions accordingly. In December 2009, the UN’s climate change body provided the EB with orders to reform the CDM; guaranteeing its credibility and maximising its generation of emission reductions. Just last week, the 54^th meeting of the EB took place, but has progress been made in reforming the CDM?

EB and flow

Led by chair, Clifford Mahlung (see previous post), the recent meeting of the EB was a busy affair. Mahlung was charged with overhauling the CDM in what could be viewed as the most significant of its existence.

With the end of the Kyoto Protocol at the end of 2012, the supportive framework on which the CDM is based ceases to legally exist as we know it. The ongoing UNFCCC negotiations are quite literally paving the way to a new internationally binding agreement – including the extension of the flexible mechanisms, where the CDM fits in.

Until then however, the EB has to make do with what it has available: a project-based mechanism with the ability to potentially deliver almost one billion tonnes of carbon reductions by the end of 2012. But the CDM may be capable of more as it is currently plagued with teething problems. If it was made a simpler, cheaper and ultimately more efficient process, Mahlung could see vast improvements in the output from the CDM.

Streamlining Reform

Positively, the EB managed to adopt new procedures for project registration and issuance of Certified Emission Reductions (the currency of the CDM where one CER equates to a one tonne reduction in carbon). Essentially, these changes would help streamline regulatory processes and, in return, allow for an improvement of the timescales involved for a project to issue CERs.

One of the key measures for checking if a project meets the criteria set out by the EB is known as additionality. Essentially, for a project to be registered under the CDM, it needs to prove that it could not go ahead without the income generated from CERs.

Regardless of the physical size of a project, each has to undergo the same criteria testing. Small-scale projects, usually micro-level renewables, have usually suffered because the timings and costs involved can cripple a project. In an effort to mitigate this barrier, the EB has decided that these projects will automatically pass additionality testing, subject to certain factors: geographical (remote locations) and beneficiaries (community not connected to an electricity grid).

Secondly, with regards to the costs involved, the EB is considering a loan system to help poorer countries to adopt projects more easily. The money will originate from interest accrued on the CDM’s reserve funds, currently in the millions of dollars.

It is hoped that these changes will kick start a range of reforms which will extend the scope of the CDM to regions that are currently not able to take advantage of the CDM, such as sub-Saharan Africa (see previous post), and increase the number of registered/issuing projects.

A Warning

In a recent keynote address, the incoming head of the UNFCCC Christiana Figueres, made it clear that the EB was no longer the only blockade to CDM productivity. Instead, Figueres placed emphasis on the auditors of the CDM who are required to validate and verify the projects and emission reductions respectively.

With the EB announcing that it will carry out an additional management restructure and hire 28 people for the secretariat to deal with the CDM, the auditors may need to undertake some similar efficiency improvements if they are to take advantage of a new wave of projects.

Put simply, some progress of reforming the CDM has been made. However, it is far from over. The EB has a lot of work still to do if it is to overhaul the CDM and relive the heights of the expectations when it was first conceived.

Industrial Gas – by Shahram Sharif

The Clean Development Mechanism (CDM) seeks to deliver emission reductions in developing countries whilst providing sustainable development, training, technology and finances.

In return, developed countries are able to offset their own emissions by receiving Certified Emission Reductions (CERs): the currency of the CDM. But, recent developments concerning the largest demand source for CERs, the European Union Emissions Trading Scheme (EU ETS) might see certain offset credits being preferred.

Super Gases?

Since economic theory tells us that the easiest and cheapest emission reduction projects will be used first, this say a vast movement of investment to China and India; specifically utilising projects which reduce emissions by the destruction of the so-called industrial gases – HFC-23 and N­₂O.

What we have seen already is that since 2005, these projects have delivered approximately75% of the 414 million tonnes of CO₂ (equivalent) reductions. Any changes to the demand favourability of such credits will have a clear and immediate impact on price.

The EU ETS currently is the main driver for CER demand, where any one of the 12,500 participants can use a certain amount of CERs for use under their compliance target to reduce emission. Because of this, CER price is invariably set using their worth for compliance in the EU ETS.

Recently, the European Commission, the executive body of the EU, detailed draft plans should the EU wish to adopt a target of a 30% emission reduction on 1990 levels by 2020 rather than the current 20% target. It was hinted that the EC may choose to limit the compliance value of CERs from industrial gas projects after 2012.

In other words, offsetting one tonne of your company’s emissions with reductions from an industrial gas project may require two CERs, instead of one. This would effectively half the worth of such CERs for compliance. Interestingly, it may also bring down the value of other offsets because of the uncertainty surrounding compliance.

This is despite the fact that any project officially registered before 2012 (when the Kyoto Protocol framework legally finishes), then any CERs generated will be eligible for compliance purposes until 2015, regardless of the location or type of emission reduction. This means that the EC may choose to restrict use of industrial gas projects when they are still valid under Kyoto compliance.

Market Impact

What this means is that a two-tiered system could develop where CERs originating from industrial gas projects are traded separately to those coming from non-industrial gas projects. The latter would also be costed at a premium over the former.

The current market feeling is that industrial gas projects are known to be ‘environmentally tainted’. The generation in revenue from producing CERs from industrial gas destruction projects could encourage the use of HFC-23 or N₂O as bi-products of refrigeration in developing countries.

Most CDM investors are specifically looking away from controversial projects because there is a risk that any CERs that are generated may be worth less because of any quality restrictions placed by governments/legislators.

Slowly, the CDM is filtering into countries other than China, India and Brazil (where emission reduction opportunities were cheap and plentiful). Next on the list are countries in South East Asia and Latin America, with the largely untouched African countries receiving interest last.

In terms of project types that are least likely to face restrictions, wind farms, small hydroelectric schemes and other renewable energy initiatives remain relatively safe.

Although the announcement made by the EC created quite a stir in the market, participants were confident that the CDM allows for a wide choice in offset projects, that any impact on the non-industrial gas side would be minimal.

So this could mark the first steps towards what a post-2012 CDM would look like. Because of its relative immaturity as a market-based mechanism, it was always expected to take a few years to gain momentum and iron out any issues. The industrial gas projects, although beneficial for the early success of the CDM, may be killed off to save its future.

Retreating Lake (image by: suburbanbloke)

Just last week, the United Nations’ Clean Development Mechanism (CDM) reached a monumental milestone of delivering reductions of 400 million tonnes of CO₂ (equivalent) sourced from developing countries all over the world.

Critically, market participants are disappointed by the progress of the CDM so far, but should we be dejected by what we have seen?

Stunted Growth

It should not come as a surprise that the mechanism is receiving some questionable commentary.  The main direction of criticism comes predominately from the numbers of the emission reductions made through the project-based mechanism.  The main unit of currency for the CDM is the Certified Emission Reduction (CER) where one CER equates to the reduction of one tonne of CO₂(e).

Initial forecasts by analysts expected the CDM to generate at least 1.4 billion tonnes of emission reductions up to the end of 2012.  Since CERs are the main source of income for most emission reduction projects, they are important for the whole operation of mechanism.

Projects have been issuing CERs from sometime in October 2005, this meant that at the beginning, the CDM was anticipated to generate at least approximately 200 million per year.  So why has it only generated 90 million per year on average and what is now expected going forward?

Complex Simplicity

The beauty of the CDM, when it was born out of the flexible mechanisms in the Kyoto Protocol (KP), was that it brought a new direction to reducing emissions.  Simply, it allowed rich, developed countries to offset their emissions whilst ensuring that poorer, developing countries took a sustainable path to development and additionally received a flow of cash from rich to poor.

However with its simplistic basis, it was essentially a unique and complex creation that bridged political, regulatory, development and economic ideologies.

All bases had to be covered, and all parties involved had to benefit equally which brought with it a host of teething problems:  procedural delays by the administration of the CDM; projects under-delivering on their expected emission reductions; poor market prices for CERs discouraging project owners from issuing CERs; the recession limiting CDM output and other issues relating to auditors and developers lacking knowledge coupled with a steep learning curve.

Importantly, the official link between the project proponents (developers, owners, etc.), the auditors and the body charged with oversight of the CDM requires a great deal of attention.  Fortunately, looking ahead, this reform is beginning to receive the consideration it needs- see previous blogs on this subject.

Timing is Crucial

Since the CDM began, over 2,100 projects have been registered.  This is perhaps the most crucial stage on the project timeline – it means that the project can begin to keep track of its carbon reductions.

Of these registered projects, almost 700 have actually issued CERs.  It is from these projects that the 400 million tonnes of emission reductions have originated.  We are waiting for around two-thirds of the registered projects to issue, which potentially leaves a lot of reductions in the pipeline.

Positively, the future is bright for the CDM.  So far, almost 40 developing countries are benefiting from transfers of technology, expertise and the sustainable development criteria that all projects have to meet, not to mention monetary flows.  Secondly, the carbon market is also immature relative to other, more established markets and problems in its operation are likely to occur but can be fixed.

A point to mention is that presently, around 75% of the emission reductions in the CDM originate from only two project types: the industrial gas projects.  This is because these projects were the cheapest and easiest to carry out, with the largest return – the so-called ‘low-hanging fruit’.  What this means is that the rest of the projects are going to deliver relatively smaller reductions, hence limiting the potential output of the CDM in the long-term.

In addition, an overarching issue with the CDM is that it is directly linked to the Kyoto Protocol.  Unfortunately the KP is only technically valid until the end of 2012; the first commitment period being 2008-2012.  Consequently, the CDM is also only technically valid until the end of 2012 bringing with it a wide range of uncertainties that could stifle any prolonged investment.

Should we see 500 million before the end of 2010, it will mark a significant response of the CDM to the challenges mentioned above.  The extension of the flexible mechanisms beyond 2012 is a major concern that current UNFCCC negotiations are aiming to tackle among other things.  Watch this space.

The body charged with the administrative oversight of the United Nations’ Clean Development Mechanism (CDM) is showing signs that a critical transition in the technical framework may be coming.

The CDM Executive Board (EB); currently the judge, juror and executioner of the Kyoto Protocol’s cornerstone carbon offsetting mechanism, could receive a much needed shake up, and not a minute too soon.

CDM-EB Meeting

Pressure Points

The demands from the mechanism until the end of 2012 are sure to be intense as the UN (and its climate policy body, the UNFCCC) are placed under pressure to deliver on international climate policy.

Providing the framework to extend the life of the CDM beyond 2012 is one of the crucial outcomes required from UNFCCC negotiations.  The lack of any concrete resolutions on this matter from Copenhagen in December did little to allay the vast uncertainty that currently resides in the CDM.

Without the Kyoto framework, which technically ceases to exist from 2013, the CDM is in danger of failing simply because of regulatory and political uncertainties.  In order to survive, the challenges in the next few years need to dealt with head on if expectations are to be met, and criticism subdued.

Meeting the Challenge

The EB’s recent 52nd meeting (taking place approximately every six weeks) was the first one following December’s negotiations.

Among the usual list of actions which required their attention (project approvals, issuance reviews, methodology considerations, etc.) were a wide range of important topics that had to be considered; including appointing a new chair and vice-chair and establishing an independent committee to assume technical responsibility for project approvals et al.

The EB was also urged to speed up processes and to increase the volume of emission reductions delivered from projects.  The daunting task to improve the overall time it takes projects to enter the pipeline and issue the all-important Certified Emission Reductions (CERs) falls to one person.

Clifford Mahlung, lead climate negotiator for Jamaica, was promoted from vice-chair to resume control of the EB during what will arguably be the most important two years of its existence.

The proposed improvements are anticipated to increase the scope and scale of the CDM, especially in terms of volumes of CERs issued and the regional distribution of the projects to countries that are yet to benefit from the CDM.

Balancing Point

Mahlung is expected to steer the CDM towards equilibrium of the three central inputs to any project-based mechanism: quality, time and cost, whilst ensuring the emission reductions in the CDM remain environmentally credible and uphold the integrity of the mechanism.

In an effort to reduce the time it takes projects to move through the milestones in the CDM pipeline, which has been the main drawback experienced to date, Mahlung is hoping to adopt a more automatic approach to project approvals.  However, the detrimental impact this may have on the quality of emission reductions and cost of projects needs to be accounted for.

The EB has so far been overwhelmed by the administrative demands on its members.  So the introduction of a Project Assessment Committee (PAC), a group of 12 technical experts, is expected to lighten the load on the EB from its technical approvals and reviews.

Whether this proposal aids processes, or merely increases the depth of bureaucracy in the CDM by adding another committee into the mix, remains to be seen.

In any case, signals of technical improvements could be just what potential participants are looking for.  There was a danger that a lack of clarity surrounding the CDM after 2012 was severely stifling potential investment.  After all, when the outlook for a healthy return on investment is uncertain, investors will be understandably discouraged.

Positively, what Mahlung has quickly accepted is that until the ‘post-2012 problem’ is figured out on the international arena, his immediate responsibility lies with improving the CDM now.  The opportunity for underlying growth in the CDM before the 2013 Kyoto deadline is considerable, but is matched in size by the challenges ahead.

As ever, time will tell whether Mahlung is up to the task.