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.

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