Carbon markets: time to clean up

The Clean Development Mechanism is widely derided as a source of easy pickings for wealthy polluters. So how, asks Terry Slavin, can it be made fit for purpose?

Can we trade our way out of the mess that we have made of the planet? Nicholas Stern thinks so. His influential report on the economics of climate change [see ‘Stern Stuff’] argued for a huge expansion of trading between rich and poor countries in permits to emit CO2.

Most of this happens under the auspices of the UN’s Clean Development Mechanism (CDM). When countries and companies have to reduce their emissions, they can do so by funding carbon-cutting projects in the developing world – earning themselves ‘carbon emissions reduction’ credits (CERs) which they can offset against their own ongoing pollution.

“In theory, unlocking a flood of finance for renewable energy throws the full weight of global capitalism at a problem that poorer nations cannot solve on their own”

Unlocking a flood of finance for renewable energy and energy efficiency projects can, say CDM’s fans, throw the full weight of global capitalism at a problem poorer nations cannot solve on their own – and so speed genuinely sustainable development.

On the surface, it makes perfect sense. It is, after all, in countries such as India, China, Mexico and Indonesia that the battle to curb carbon will be won or lost. The International Energy Agency has calculated that three-quarters of the global increase in CO2 levels expected by 2030 will take place in emerging economies like these.

But is CDM up to the job? Certainly not the way it has been operating since it began three years ago. As Stern himself acknowledged, investment generated by the CDM “falls significantly short of the scale and nature of incentives required to reduce future emissions in developing countries”. A similar conclusion was reached by a UN report on the eve of the Bali climate summit in December.

To date, 60% of emissions reductions achieved through the CDM market have had nothing to do with renewable energy, nor with energy efficiency as commonly understood. Instead, they involve huge projects to destroy the industrial gas HFC 23 – which is nearly 12,000 times more destructive than CO2. It’s necessary work, but the cost of cleaning up the gases is a fraction of what they generate in CERs. It’s been described by its critics as a cynical plucking of some very juicy low-hanging fruit, which does nothing for wider sustainable development.

Enthusiasts counter that such easy pickings are essential to kick start the market. Among them is Michael Schlup, director of the Gold Standard, a Swiss-based NGO which stamps its approval on projects offering both genuine emissions reductions and wider environmental and social benefits. He points out that renewable energy and energy efficiency projects accounted for 24% of carbon credits in 2006, more than double their total in 2005. And, he adds, they will attract much more finance once all those juicy HFC fruits have been plucked.

At the moment, though, Schlup says, the difference in profitability between HFC projects and renewable energy ones remains vast. The price for carbon, now sitting at just above €20 a tonne on the EU market, is not high enough to attract the sort of investment required for sustainable energy schemes.

China, which has generated half of all global carbon credits, has come up with a nifty solution. It levies a 60% tax on HFC-style projects, and uses the proceeds to provide funds for renewable energy. But other countries have failed to take China‘s lead, which highlights one of the biggest problems with CDM: individual governments are left to decide the way projects are administered, so the goalposts shift from country to country. Michael Grubb, visiting professor of climate change at Imperial College London, describes CDM as “a funny hybrid between a market and a political construct. It’s not a pure market by any stretch, and there’s a lot of discretion being taken about where people want to spend money. But it‘s better than nothing, and it‘s something that can be improved.”

The most urgent improvement needed is over the thorny question of additionality – that is, whether a project required CDM funding to make it viable, or whether it would have happened anyway (in other words, would not have been ‘additional’). India provides a sobering example of the failure to address this. On the surface, it’s a triumph for CDM: 33% of all projects winning CER certificates are from India, pipping China’s 25%. But unlike China, most projects approved by the Indian authorities are speculative ventures that go ahead regardless of whether they win approval from the CDM’s executive board. In other words, they’re not dependent on carbon finance – so belying the whole point of the CDM. Dr Axel Michaelowa, an advisor to the CDM’s executive board, told Channel Four News last year that one third of the 50 projects he had surveyed in the country failed the additionality test. And it is not just a problem in India. Last November, WWF suggested that one out of five CERs globally were issued to projects that inflated the level of emissions reduced, lacked additionality or, most perverse of all, were awarded to projects that generated emissions in order to obtain CDM funding.

The CDM’s executive board has responded by cracking down on its approvals processes. Over the past six months it has sent back more than half the projects for review. This may have soothed the critics, but it has generated huge delays in projects, and created ructions in the carbon trading market. Industry giant EcoSecurities saw almost half of the value of its shares wiped out in a single day in November, when it announced that one fifth of its expected CDM projects would not materialise because of the delays.

Belinda Kinkead, head of project implementation for EcoSecurities, said the executive board had over-reacted by burying the process in red tape. “They would rather exclude thousands of legitimate credits than run the risk of a single non-additional credit getting through,“ she said, adding that the burden of proof of additionality is now so high it’s almost like defending a criminal case.

“One lesson we’ve learned is that it’s not worth doing small projects any more. The costs of getting these projects through are just as high [as big projects] and the chances of getting them through are much less.” This risks stymieing some of the more innovative local energy schemes in remote communities, for example, where CDM money really could be transformative.

But others are less pessimistic, believing that the CDM’s board is acting with necessary diligence to preserve the integrity of the whole process. “It needs to put a lot of scrutiny on projects,” says Michael Schlup. He points to concerted action by the board to get round the barriers of high transaction costs for small projects. It recently began to allow small projects of the same nature to be bundled together so that they can share a single transaction cost. One of the first of these may be in India, where the Bureau of Energy Efficiency has a proposal to provide low-energy lights to domestic homes for the same price as incandescent bulbs, a move that would save 240 million tonnes of CO2 a year.

Schlup thinks the voluntary market in carbon credits (as traded in the form of carbon ‘offsets’ – see ‘Golden opportunity’) could be a useful testing ground for new approaches. The Gold Standard has just adopted a methodology that would allow large volumes of household biodigesters to be bundled together to gain credits on the voluntary market. Biodigesters, which convert animal and human waste into liquid fuel for cooking, lighting and heating, are a triple win in the climate stakes because they reduce CO2, avoid destructive methane emissions, and reduce the pressure on forests for firewood [see the GF special supplement, Light emerging, July 2005]. Schlup said the methodology had generated a lot of interest, including among key figures in the UN climate change system.

“Everyone’s problem with CDM would go away if the cost of carbon doubled”

For Neil Eckert, chief executive of Climate Exchange plc, which owns the London-based European Climate Exchange, CDM’s success in reducing emissions stands or falls on the price of carbon. At the moment the price on the EU market is far too low to generate much interest in risky, small-scale renewables projects, he says. “I think everyone’s problem [with CDM] would go away if the cost of carbon was €40, not €20.”

It would help if the EU tightened up its emissions ceilings, Eckert says, but what is really needed is for the US to join the party. At the moment it is only European countries and companies that have to buy carbon credits to comply with the Kyoto Protocol. There are regional voluntary carbon trading markets in the US, and pressure is growing for a nationwide cap on emissions. But no decision will be taken until a new president is in the White House in 2009, believes Eckert, and then it will be another three years before a market could be up and running, when whatever diplomatic deal to succeed Kyoto will kick in.

But Harvard University climate economist Robert Stavins has a somewhat different vision. He thinks that once the US has a mandatory trading scheme, which he expects, like Eckert, to happen during the next US administration, the existing voluntary carbon exchanges dotted around the world will also become mandatory. Trading in CDM credits will be the one common feature that links them, creating in effect a global price for carbon – something that Stern has argued for. If that were to happen, the price of carbon would rise dramatically, and the cost of cutting CO2 emissions could drop.

“I’m fairly optimistic about climate change,” says Stavins. “There will be a time in my kids’ lifetimes when we will have dealt with that… I believe the nations of the world will get in place policies to accelerate the transition to low-carbon technologies.”

Coming from a man who was a lead author on the notoriously gloomy Intergovernmental Panel on Climate Change, such a prognosis is both welcome – and credible.

Terry Slavin is a regular contributor on energy and environmental issues for The Guardian and Green Futures.

19 March 2008

Terry Slavin