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.

(Image by: bslmmrs)

Founded in 1919, Société Générale de Surveillance, commonly known as SGS, are now potentially the world leading Designated Operational Entity (DOE) working within the remit of the United Nation’s Clean Development Mechanism (CDM).

But did they become so well established through raw business acumen, taking the ‘first mover’ advantage in a fledgling industry, or being at the right place at the right time with the right connections?

Experience Always Helps

SGS were fortunate to be in a position to possess all of the above.

The responsibilities of the DOEs are extensive: verifying the emission reductions of projects and ultimately ensuring that this verification leads to the all-important Certified Emissions Reduction (CER) issuance.

In many cases, CER issuance will be the principal income stream during a project’s lifetime, so the choice of DOE is an important one.  Historically however, this decision has been somewhat restricted, with the market taking on a distinct oligopolistic structure.

The most recent CDM performance data, supplied from the UNEP Risø centre, reveals that 93% of issued CERs came from five DOEs – from over 365 million CERs in total since 2005.  Interestingly, and rather poignantly, 49% of all issuances were verified by SGS, with the next largest holding only 23%.

The dominant share that SGS accounts for in terms of issuance volume can be partially explained by the fact that it holds most of the large industrial gas projects in the CDM as clients.  These sectors deliver around 75% of the total CER volume, and do so with relative frequency, i.e. once every 2-3 months.

Delving further into the CDM pipeline shows that SGS has projects operating in more countries than any other DOE.  Importantly, these are predominantly projects located in China and India, the two most productive locations in the CDM.

In the relatively short CDM lifetime, SGS picked up a wealth of experience in the right areas: sectorally and geographically.  It was a primary business aim to quickly establish themselves as the DOE of choice for any project in any location.  SGS were performing well and leaving many in their wake.

Does Experience Always = Best?

In September 2009 however, the legitimacy of the CDM suffered a severe shock following the CDM Executive Board’s decision to suspend SGS for three months, after it was unable to prove its staff had adhered to inspection rules or that they were qualified to do so in the first place.

During this time, SGS was not permitted to upload any further project reports to the UNFCCC website, or submit any further requests for issuances.  Despite this, it was only until 12 January 2010, after the suspension had finished, that issuances from SGS-verified projects ceased; such was the volume of their future issuance pipeline.

But this was not the first time that a large project auditor has been found failing to follow Executive Board procedures.  SGS was the second such company to be suspended.  Norwegian-based Det Norske Veritas (DNV) was found wanting during a spot check in November 2008 for comparable reasons as the above, and was similarly suspended for approximately three months also.

With a reputation comes a pressure to sustain business demand.  During this suspension, a ‘gentlemen’s’ agreement was installed to help prevent other DOEs from poaching clients from DNV.

It is credible to assume that this approach was also adopted during the suspension of SGS, much to the relief of the company shareholders.  Any delay in CER issuances as a result, particularly involving large volumes, would likely test the patience of sizeable project owners and their clients, who may not be as forgiving should it happen again.

As such, critics were quick to conclude that the suspension only further highlights the inadequacies of the CDM, and that such actions do nothing to allay any fears that the CDM is a risky venture.  After all, project proponents already have many risks to deal with that span political, regulatory and eligibility boundaries.

Conversely, supporters of the flexible mechanisms suggest that these suspensions emphasize that the processes installed are working and that the credibility of the CDM is upheld because of it.  Contracting is a required part of the project process and goes some of the way to safeguard CER buyers and in some certain circumstances, sellers.

In any case, until competition in the DOE market begins to show signs of improvement, it appears that SGS may yet hold onto their place as the most experienced of the CDM verifiers.  And with project developers holding onto their mantra of ‘experience experience experience’, who can blame them?

The Indian government has favored the CDM to promote climate-friendly practices. CEO of British-based Carbon Rating Agency, Yuvraj Dinesh Babu, noted that all sectors of Indian’s domestic economy have engaged with the CDM market–making India attain the highest number of unilateral CDM projects and with many Indian industries having accumulated their allotted Carbon Emission Reduction  (CER) credits (the main instrument facilitating CDM markets). Currently, India faces low CER credit prices but  with prospects of a more aggressive push in the international market, CER prices may rise, causing more credit selling by Indian industries and further boost India’s CDM market.   

There has been recognition of the economic advantage of CDM markets within India. For example, as the Indian state of Himachal Pradesh which seeks to be the India’s first carbon-free state, seeking opportunities to finance the goal through the CDM.  However, effectiveness, accountability and transparency of the process are a concern in CDM’s credibility within India paralleling broader debates over the CDM in general. In the city of Kolkata, the promotion green buildings, failed to get recognition for carbon reductions that could be utilized in the CDM schemed due to difficulty in explicitly account for energy savings under current CDM methodology. CDM practices can be skewedby promoting ‘greenwash’ approaches by businesses and seen as a vehicle for environmental injustice. Himachal Pradesh’s ambitious goals, comes with the cost of imposing on local livelihoods and environments.   

The extent to which the UNFCCC aims to streamline the CDM process will be an important feature in 2009 for industries in India actively engaged in CDM projects with “efficiency and quality” as key goals. While the booming CDM market within suggest that India would favor maintaining the CDM’s overall mission, there is definitely a need to support a restructuring of the Mechanism if the Indian government seeks to be inclusive in ensuring climate change policies are conducive to all- businesses and citizens.