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.

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