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.
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.
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.