Archive for the ‘Offsets’ Category

While all fossil fuels are contributing to the accumulation of carbon dioxide in the atmosphere, coal stands apart as really problematic, not just because of its CO2 emissions today (see chart, global emissions in millions of tonnes CO2 vs. time), but because of the vast reserves waiting to be used and the tendency for an emerging economy to lock its energy system into it.

Global energy emissions

Global emissions, million tonnes CO2 from 1971 to 2010

I recently came across data relating to the potential coal resource base in just one country, Botswana, which is estimated at some 200 billion tonnes. Current recoverable reserves are of course a fraction of this amount, but just for some perspective, 200 billion tonnes of coal once used would add well over 100 billion tonnes of carbon to the atmosphere and therefore shift the cumulative total from the current 580 billion tonnes carbon to nearly 700 billion tonnes carbon; and that is just from Botswana. Fortunately Botswana has quite a small population and a relatively high GDP per capita so it is unlikely to use vast amounts of this coal for itself, but its emerging neighbours, countries like Zimbabwe, may certainly benefit. This much coal would also take a very long time to extract – even on a global basis it represents over 25 years of use at current levels of production.

This raises the question of whether a country can develop without an accessible resource base of some description, but particularly an energy resource base. A few have done so, notably Japan and perhaps the Netherlands, but many economies have developed by themselves on the back of coal or developed when others arrived and extracted more difficult resources for them, notably oil, gas and minerals. The coal examples are numerous, but start with the likes of Germany, Great Britain, the United States and Australia and include more recent examples such as China, South Africa and India. Of course strong governance and institutional capacity are also required to ensure widespread societal benefit as the resource is extracted.

Coal is a relatively easy resource to tap into and make use of. It requires little technology to get going but offers a great deal, such as electricity, railways (in the early days), heating, industry and very importantly, smelting (e.g. steel making). In the case of Great Britain and the United States coal provided the impetus for the Industrial Revolution. In the case of the latter, very easy to access oil soon followed and mobility flourished, which added enormously to the development of the continent.

But the legacy that this leaves, apart from a wealthy society, is a lock-in of the resource on which the society was built. So much infrastructure is constructed on the back of the resource that it becomes almost impossible to replace or do without, particularly if the resource is still providing value.

As developing economies emerge they too look at resources such as coal. Although natural gas is cleaner and may offer many environmental benefits over coal (including lower CO2 emissions), it requires a much higher level of infrastructure and technology to access and use, so it may not be a natural starting point. It often comes later, but in many instances it has been as well as the coal rather than instead of it. Even in the USA, the recent natural gas boom has not displaced its energy equivalent in coal extraction, rather some of the coal has shifted to the export market.

Enter the Clean Development Mechanism (CDM). The idea here was to jump the coal era and move directly to cleaner fuels or renewable energy by providing the value that the coal would have delivered as a subsidy for more advanced infrastructure. But it hasn’t quite worked that way. With limited buyers of CERs (Certified Emission Reduction units) and therefore limited provision of the necessary subsidy, the focus shifted to smaller scale projects such as rural electricity provision. These are laudable projects, but this doesn’t represent the necessary investment in large scale industrial infrastructure that the country actually needs to develop. Rooftop solar PV won’t build roads, bridges and hospitals or run steel mills and cement plants. So the economy turns to coal anyway.

This is one of the puzzles that will need to be solved for a Paris 2015 agreement to actually start to make a difference. If we can rescue a mechanism such as the CDM and have it feature in a future international agreement, it’s focus, or at least a major part of it, has to shift from small scale development projects to large scale industrial and power generation projects, but still with an emphasis on least developed economies where coal lock-in has yet to occur or is just starting.

For a country that has been so polarised on the climate issue and has struggled to make progress implementing effective mitigation policy, it is surprising how often the subject appears on the front pages of the national newspapers. I am in Australia for a couple of weeks visiting friends and relatives and seemingly on cue the carbon issue is front and centre of The Australian [$$] on the day I arrive. A previous visit timed itself perfectly with the announcement by then Prime Minister Julia Gillard that the country would have a carbon tax (now in the process of being repealed).

This time, the story headline is “Heartache as carbon credits turn to debt” and it discusses the challenge that one particular farmer is having banking his soil carbon credits. This may sound a bit obscure for the front page of a national daily, but such is the issue in Australia that a story like this becomes national news. Soil carbon is now at the heart of the national mitigation effort, with the government implementing an Emission Reduction Fund to encourage farmers to change their tilling, land management and crop growing practices to build up carbon in the soil. The increase in soil carbon can be converted to carbon credits and sold to the government.

EC11127_Fa

In the case of the farmer in this story, the stored carbon on his property and its potential for credit issuance is not being recognised as an asset by his bank and therefore his farm is under threat due to debt issues (unrelated to the credits). The problem the bank has is that under the current rules soil carbon credit issuance requires a guarantee of permanence that stretches out 100 years. This in turn ties up the land for that period, which potentially impacts on the bank should it end up with the property due to mortgage default.

There are plans by the current government to change the permanence requirement to 25 years, which may help solve the problem above and others like it, but in turn raises a new problem related to the mitigation potential of soil carbon. The point about carbon sequestration, whether it be via CCS, reforestation, soil carbon buildup or other means is that it should be permanent because of the cumulative nature of carbon emissions to the atmosphere. Simply reducing the flow of carbon to the atmosphere in a given year isn’t good enough if that same carbon eventually makes its way into the atmosphere later on.

While a 100 year permanence requirement doesn’t guarantee true sequestration either, it does at least shift any future release of that carbon into a time when the energy system should have substantially changed and other anthropogenic emissions are therefore much lower or even approaching zero. This can’t be said for a 25 year requirement. In such a relatively short space of time the energy system will still look largely as it does today, even if big change is underway. We need to be able to store carbon well beyond the fossil era or ensure that permanence actually means permanent.

With soil carbon now so important to Australia, these and other issues related to its implementation and most importantly, effectiveness and therefore recognition internationally are bound to continue to make news. While resource development is now the primary generator of national wealth, the country is nevertheless turning again to its rural sector to make ends meet.

Emissions Trading via Direct Action in Australia

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The Australian Government recently released a Green Paper describing in more detail its proposal for an Emission Reduction Fund (ERF), the principle component of its Direct Action climate policy. The ERF will sit alongside renewable energy and reforestation policies, but is designed to do the bulk of the heavy lifting as the Government looks for some 430 million tonnes of cumulative reductions (see below) over the period 2014 to 2020. The ERF will have initial funding of about AU$ 1.55 billion over the forward period, with the money being used to buy project reductions (as Australian Carbon Credit Units or ACCUs) from the agriculture and industrial sectors of the economy by reverse auction. These reductions will be similar to those that are created through the Clean Development Mechanism (CDM) available under the Kyoto Protocol.

 Australia Reduction Task to 2020

Although the fund and reverse auction process are discussed in some detail and appear as central to the policy framework, this may not be the case as the system is rolled out and the full framework developed. The issue that comes from such an approach to emissions reduction is that despite buying project reductions from the economy, the overall emissions pathway for the economy as a whole still does not follow the expected trajectory. The ERF may also encounter a number of issues seen with the CDM, all of which are some form of additionality;

  1. Determining if there would have been higher emissions had the project not happened. Perhaps the reduction is something that would have happened anyway or the counterfactual position of higher emissions would never have actually happened. For example, an energy efficiency gain is claimed in terms of a CO2 reduction but the efficiency gain is subject to some amount of rebound due to increased use of the more efficient service, therefore negating a real reduction in emissions. Further, the counterfactual of higher emissions might never have existed as the original less efficient process would not have operated at the higher level.
  2. Double counting – the project presumes a reduction that is already being counted by somebody else within the economy as a whole. For example, an energy efficiency gain in a certain part of the supply chain is claimed as an emissions reduction, but this is already intrinsic to the overall emissions outcome for another process.
  3. Rent seeking – project proponents seek government money for actions already underway or even construct an apparent reduction.

The Australian emissions inventory will be measured bottom up based on fuel consumption, changes in forest cover and land use and established estimates / protocols for agriculture, coal mine fugitive emissions, landfill etc. It will not be possible to simply subtract the ERF driven reductions from such a total unless they are separate sequestration based reductions, e.g. soil carbon. This is because the ERF reductions are themselves part of the overall emissions of the economy.

The Green Paper clearly recognizes theses issues and proposes that the overall emissions pathway through to 2020 must be safeguarded. In Section 4 it discusses the need for “An effectively designed framework to discourage emissions growth above historical levels . . . “, with associated terminology including phrases such as “covered entities”, “baseline emission levels”, “action required from businesses” and “compliance”.  The safeguarding mechanism, rather than being a supplementary element of Direct Action, could end up becoming the main policy measure for decarbonisation if significant CO2 reductions are not achieved under the ERF. While this may not be the objective that the Government seeks, it does mean that the implementation of the safeguard mechanism needs to incorporate the design thinking that would otherwise be applied to the development of intended emission trading systems, such as the Alberta Specified Gas Emitters Regulation.

As currently described, the safeguarding mechanism looks like a baseline-and-credit system, with the baseline established at facility level either on an intensity or absolute emissions basis (both are referred to in the Green Paper). Should a facility exceed the baseline it could still achieve compliance by purchasing ACCUs from the market, either from project developers or other facilities that have over performed against their own baselines. Although the Government have made it very clear that they will not be establishing a system such as cap-and-trade that collects revenue from the market, facilities will nevertheless face compliance obligations and may have to purchase reduction units at the prevailing market price.

The level of trade and the need for facilities to purchase ACCUs will of course depend on the stringency of the baselines and this remains to be seen, however in setting these the Government will need to be mindful of the overall national goal and its need to comply with that. The development of a full baseline and credit trading system also raises the prospect of the market out-bidding the Government for ACCUs, particularly if the Government sets its own benchmark price for purchase, as is indicated in the Green Paper.

As Australia moves from a cap-and trade system under the Carbon pricing Mechanism (CPM) to the ERF and its associated safeguarding mechanism, the main change for the economy will be distributional in nature, given that a 5% reduction must still be achieved and the same types of projects should eventually appear. However, the biggest challenge facing any system in Australia could be around speedy design and implementation, given that the time remaining before 2020 is now very limited and the emission reduction projects being encouraged will themselves take time to deliver.

While there was plenty of talk at COP 19 about financing, national ambition, increasing pre-2020 ambition and adaptation, another core subject that struggled for high-level attention (the other one being CCS) was the idea of carbon pricing, specifically delivered through carbon markets. This is one of those subjects that an observer of the process would expect to see appearing in almost every discussion, yet it didn’t make it out of the SBSTA working group meetings. This meant that the high level discussions towards the end of the COP (when the national delegations are typically bolstered by the presence of a Minister) didn’t get to hear about carbon pricing at all (or CCS).

There is no doubt that carbon pricing appears on many national agendas, with of course the EU leading that trend through the 2005 start of the EU ETS. Parts of the US and Canada, New Zealand, Kazakhstan (pilot phase) and a few others have already incorporated carbon pricing within parts of their energy systems and China, South Africa and others are in various stages of preparing for it. These are positive developments, but carbon pricing really only works at its most efficient when coverage is both widespread and coordinated, otherwise leakage (in various forms), arbitrage and rent-seeking can undermine local implementation. Further to this and as I have discussed in previous postings, if carbon pricing isn’t a core element of the eventual climate policy framework, then emissions may not go down at the necessary rate or if they do decline it will likely be at a much higher cost than would otherwise have been necessary.

Carbon pricing is also the potential lever for large scale financing of mitigation projects, as has been seen to some extent with the CDM. By far the largest flow of finance to projects in developing countries has come through the application of the CDM and subsequent sale of CERs on international markets, not through public financing of projects through funds, development aid and the like. While these latter approaches are also important, they will never be sufficiently large or aggressive enough to underpin the scale of global mitigation required. Well over a billion CERs have been created since the start of the CDM, which equates to some $10 billion in carbon financing and possibly $30-$70 billion in underlying project financing.  But even discussions on the CDM in Warsaw were lacklustre, with some CDM negotiators continuing to think and operate as if the year was 2006 and demand for CERs was on an rise. At the beginning of the Warsaw talks, there was some discussion amongst negotiators about having the Green Climate Fund (GCF) utilise the CDM as a results-based financing tool, and allowing the CDM to become a ‘net mitigation tool’ for non-Annex 1 countries to utilise as they prepare for tabling contributions next year and in 2015. In the end, no such language emerged from Warsaw, which raises the prospect of even this mechanism struggling to survive in the post 2015 world.

One could argue that carbon pricing is simply part of national implementation and therefore shouldn’t feature at the UNFCCC level, but as noted above, that is not an efficient approach. There is a potential role for the UNFCCC to create a framework which both encourages the use of carbon pricing and coordinates its implementation through linkage, leading eventually to the much desired “global carbon market”. Within the current negotiations, the only place a UNFCCC role might be created is through the New Market Mechanism (NMM) within the Framework for Various Approaches (FVA). Some thoughts on this can be found here (Carbon Pricing, the FVA and the NMM), where the FVA/NMM is proposed to include a linking framework for all countries to use.

 NMM and FVA

There is also a second argument that linkage can be achieved bilaterally, such as California and Quebec have negotiated and Australia had proposed with the EU (presumably now defunct given the repeal of carbon legislation now underway in Australia). But bilateral linkage runs its course very quickly before multilateral discussions are required. For example, if Quebec now reached out to another party to link to, California would have to be involved given the existing link, so a trilateral discussion would be needed. This would quickly get very complex and large potential linking partners such as the EU would have to shift to a multilateral approach of some description.

So what happened to carbon markets in Warsaw? The short answer is not much.

The FVA and NMM discussions ground to a standstill in the first week. Concerns about basic form and function of the FVA dogged the discussion, compounded by other concerns relating to whether these were pre or post 2020 mechanisms. In the end, the FVA and NMM discussions were postponed until the regular SBSTA meetings in June. The UNFCCC posting on the FVA and NMM in Warsaw shows nothing more than the input documents that were available prior to the COP, with no conclusions whatsoever.

On a positive note this delay at least offers more time to develop FVA and NMM thinking along the “carbon market” lines outlined above, rather than have a weak agreement that precludes such a possibility and leaves them languishing as information sharing bodies – an entirely possibly outcome from this process. But the lack of attention to carbon pricing and carbon markets in the context of a global deal that is meant to rapidly drive down global emissions is worrying. There remains of course the sterling efforts of the World Bank and their Partnership for Market Readiness, but initiatives such as these won’t be sufficient without some overarching policy action to create the markets in the first place.

Can a (second) global carbon market emerge?

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At the very end of May Carbon Expo was held in Barcelona. It was an excellent event, overall attendance was good and there were still quite a few exhibitors at the Expo hoping for life in the project mechanism market of the current “global carbon market”. But this is an area of trade that is clearly struggling. 

Carbon Expo

The conference also offered an opportunity for the World Bank to release a new review of carbon market activity, which showed that there is at least quite a lot, even if price development is far from the levels required to ever make any discernible difference to global emissions.

 Carbon Markets (world Bank)

 

Carbon Expo consists of many events, plenary panels and side meetings and through these one of the subjects that attracted plenty of attention is the ongoing desire to see a global carbon market take shape. This seems like a rather odd desire since we have had something along these lines for the past decade under the Kyoto Protocol, but nobody really wanted to discuss that, even though it is clearly the approach that makes the most sense, is most robust in terms of compliance and has all the necessary bits and pieces actually up and running. Equally, it is withering on the vine. 

The desired alternative to a Kyoto style global market has yet to be specified, but it builds on the reality of the World Bank report which shows that there are lots of carbon market systems in various stages of development, implementation or operation and that if they could somehow be linked together a global market would coalesce. This follows from the excitement around the proposed link between the EU and Australian Emission Trading Systems.

Both the EU and Australia have called their proposed linkup a bilateral arrangement. That may well be the case, but it would have been an order of magnitude more difficult were it not for the fact that both systems were designed under the Kyoto Protocol framework, recognized the same types of offsets, counted carbon the same way etc. I discussed this back in September last year after the linkup was first announced.

So here we are in a world that has started once down the pathway towards a global carbon market, built all the required institutions and instruments necessary to run it, balked at using them but perversely still wants the market to develop. As such, discussions continue on how a global market might catalyze, with four models now in the picture. They are:

  1. The creation of an international compliance unit and a standard set of offset mechanisms. This is effectively a spinoff of the Kyoto Protocol, using the CDM, but creating a new international unit to replace the AAU (the KP “glue”). Such a unit would underpin national ETSs that voluntarily opt-in to the global market. An international registry would exist to keep track of the market and manage national compliance.
  2. A set of “exchange rates” evolve between national compliance units and project mechanisms, akin to currency exchange rates. This then supposedly solves the problem of different levels of national ambition, quality of offset projects and so on. The problem here is that CO2 is more like a fixed commodity type instrument, whereas currency (where exchange rates exist) is not a commodity but effectively a security (like a company share). The value of a security is set by the value of the whole that it represents (e.g. a company, a country). By contrast, a tonne of CO2 will always be a tonne of CO2.
  3. Bilateral arrangements continue and linkages simply evolve over time. The challenge comes when A links with B then B talks to C but A doesn’t want to link with C. Also, some very different designs may never be suitable for linking.
  4. International Measurement / Reporting / and Verification rules are expanded to cover the necessary requirements for linking. This is effectively like (1) above, but without the international unit or internationally regulated compliance.

The most robust approach exists in (1), but this is currently looking like the least likely outcome – many nations seem to be opposed to such an approach, at least for now. The opposition appears to extend from the idea of the UN managing national sovereignty in any form, such as evaluating national programmes and allocating international units against them, even though this is positioned as a voluntary opt-in process.

The exchange rate approach has instant appeal, simply because it allows the market to decide. But so far, I have not seen an explanation as to how it might actually work.

Evolution through bilateral agreement appears to be the most likely path forward, so the question remains if there is any role for the UNFCCC in such an approach. Perhaps it’s role is limited to maintaining offset mechanisms such as the CDM.

This remains a nascent discussion, with much thinking to be done.

 

In search of a new home for CERs

Two recent publications highlight the challenges ahead in the multilateral process that continues to seek an equitable global approach to the issue of growing CO2 emissions. But comparing and contrasting them illustrates the contradictions that exist as negotiators attempt to maintain existing structures and work within the spirit of the Durban agreements.

Two weeks ago, a major report issued by the High Level Panel on the CDM Policy Dialogue recommended a very broad range of actions for stabilizing and reversing the ongoing price collapse in the CER market (Certified Emission Reduction, the carbon unit within the CDM), with a view of re-establishing the CDM as the cornerstone of the global carbon market and thereby kicking off a further round of emissions mitigation action.

This week, the Harvard Project on Climate Agreements issued a policy brief  which outlines the shape of the new paradigm that the UNFCCC process has hopefully entered following the creation of the Durban Platform for Enhanced Action at COP 17 last December. Their ambitious interpretation of the agreement sees the Berlin Mandate effectively consigned to history (which enshrined the notion that emission reduction was effectively the responsibility of developed countries and which led to the 95-0 vote on the Byrd-Hagel Resolution in the United States Senate) and a new order emerging which results in all countries acting to manage emissions. There is no doubt that the latter interpretation is the only one that makes sense, but only time will tell if this represents the new reality. The Harvard think piece ends with the challenge;

Having broken the old mold, a new one must be formed. A mandate for change exists. Governments around the world now need fresh, outside-of-the-box ideas, and they need those ideas over the next two to three years. This is a time for fundamentally new proposals for future international climate-policy architecture, not for incremental adjustments to the old pathway.  We trust that this call will be heard by a diverse set of universities, think tanks, and advocacy and interest groups around the world.

Rescuing the CDM as recommended by the Policy Dialogue is a laudable ambition, but perhaps falls into the category of “incremental adjustments to the old pathway” rather than “outside of the box ideas”. Conversely, the Policy Dialogue proposal is attempting to stave off the collapse of the very idea of “carbon markets” by rescuing the one global example of their application. While “out of the box” thinking is certainly welcome, it is also hard to argue that we are done with carbon pricing/markets and now need something new. In fact, carbon pricing remains core to the solution.

As such, we end up with the dichotomy of needing new ideas but not wanting to see the structures of the past slip through our fingers; but should we mind that they institutionalize some of the ideas within the Berlin Mandate?

The CDM was a bold idea when conceptualized in the Kyoto Protocol, starting with the simple phrase;

A clean development mechanism is hereby defined.

But has it reached its use-by date and should it be consigned to the dustbin along with the Berlin Mandate? Unfortunately the answer is both “yes” and “no”. It does represent an era of action and financing being the responsibility of developed countries only, which is no longer a tenable paradigm within which to operate. It was designed to help developed countries meet their mitigation goals and to channel funding from developed to developing countries for the purpose of sustainable development. Yet it did demonstrate a mechanism which allowed a broader range of actors to get involved in the carbon market than those immediately impacted by the cap on allowances. This has become a design feature of more recent cap-and -trade systems, albeit with home grown offset systems.

The solution for the CDM, both to rescue the market today and to prepare it for the “out of the box” solution of tomorrow, must be to disentangle it from the Kyoto Protocol and make it available as a general offset resource under the UNFCCC, perhaps even one that any nation could use when it wants to involve part of its economy in the market without actually applying a cap to it (such as the farming sector in Australia).

Considerable resource is required to establish an offset mechanism, both in design and operation. Reinventing this multiple times around the world hardly seems like the best use of government resources, but that is what is happening. Unshackling the CDM wasn’t discussed in the Policy Dialogue report, perhaps because it then enters into the complex realm of Kyoto Protocol politics. The closest it got to this was a proposal to broaden the use of CERs.

To unlock the full potential of the CDM, all countries should be enabled to use CERs, not only those with mitigation targets under the Kyoto Protocol.

But the Kyoto Protocol represents the Berlin Mandate and, according to the Harvard Project, the new paradigm is a world without such a legacy. It also makes little sense under the accounting rules of the Kyoto Protocol to have other parties dipping into that market when their compliance obligation may be governed by another system. This leaves only the more radical approach of decoupling the CDM from the Kyoto Protocol, but then following the recommendations of the Policy Dialogue to broaden its scope and expand its use.

This also takes the CDM into the world of another discussion, that of the New Market Mechanism. Under such an approach, the CDM could migrate to become the NMM, but for all nations to use within the design of their emission trading systems.

Is the CDM now increasing emissions?

Late last week Point Carbon reported that the Executive Board of the UNFCCC’s Clean Development Mechanism has (re)agreed to allow energy efficient coal fired power plants to be included under the mechanism. Point Carbon said:

The governing body of the U.N’s Clean Development Mechanism (CDM) has agreed to allow the most energy efficient coal-fired power plants to earn carbon credits under the scheme, causing outcry from green groups who claim the carbon market could be overrun by millions of low-quality offsets. The CDM Executive Board’s decision to lift its ban that prevented coal plants from seeking credits could allow some 40 projects, mostly based in China and India, to earn Certified Emission Reductions (CERs).

The credits are awarded to projects that cut emissions of greenhouse gases and can be used by companies and governments to meet carbon reduction targets.

. . . . .

. . . . .

The Board approved six coal plants for CDM registration before agreeing in November 2011 to suspend and review the methodology that outlines how many credits the schemes could earn, effectively stopping new projects from earning credits.

While it is always good to use a resource more efficiently, this move has potentially negative consequences for the very issue it is setting out to address, a reduction in the total emissions of CO2 to the atmosphere.

In this instance the CDM is not acting as a carbon pricing mechanism, rather it is simply incentivizing energy efficiency. In a recent paper written by a colleague (featured in a July posting), the secondary impacts of energy efficiency policy as a climate change response are explored. This particular action by the CDM Executive Board falls right into one of the problem areas.

The paper presented the argument that energy efficiency action on its own could actually result in an increase in CO2 emissions. The diagram below explains this. On the vertical axis is the cost of providing an energy service, such as electricity. At the margin, this may be driven by non-fossil provision operating within the economy, such as a wind farm or the like. On the horizontal axis is a measure of the available carbon resource base. As the price of non-carbon alternative energy rises or falls, so too does the long term availability of the fossil alternative for a given technology set. At high alternative prices, more money is available to spend on expanding the fossil resource and vice versa. As the fossil resource expands, the cumulative number of tonnes of CO2 emitted will also grow, even if it takes longer for this to happen.

Assuming a given alternative cost of providing electricity (pnon-fossil), the more efficient the power stations that burn coal, the more the electricity provider can ultimately afford to pay for the coal that is used. As more coal is used and the price rises (all other things being equal), so the resource base expands (from UC1 to UC2 in the figure above) and so does cumulative CO2 in the atmosphere. Further, as the CO2 issue is basically an atmospheric stock problem, this then drives up long term warming, even if the rate at which CO2 is emitted happens to fall in the short term.

From a climate finance perspective the CDM has been a successful mechanism, albeit with some significant operational difficulties. It has paved the way for carbon pricing in many countries and has been an important catalyst for change in some areas (e.g. landfill methane). But subsidizing more energy efficient coal fired power plants, while well intentioned, may in fact have negative environmental consequences. The CDM needs to act in its purest sense, which is as a carbon price in the energy system of true developing economies.

N.B. Just prior to posting this, a colleague noted that the Executive Board may have only allowed the issuance of CERS against already approved projects to proceed, rather than allowing future projects to apply by releasing the current hold on the underlying methodology. Hopefully this is the case, but in any case the argument still stands.

While much of the focus in the recent UNFCCC meeting in Bonn was on the protracted discussion around agenda and chair for the ADP (Ad-Hoc Working Group on the Durban Platform for Enhanced Action), some progress was made in other meeting rooms. On the middle Saturday a workshop was held for initial discussions around the call for a “New market Mechanism” (NMM). A report out from the workshop can be found here.

So far, the discussion on a NMM has tended to focus on the crediting of mitigation activities in developing countries, such as the role performed by the CDM. The talk is often about up-scaling rather than having an initial discussion about the market conditions necessary for crediting to be effective or alternatively to ask what a market mechanism actually is. For some, the CDM can be represented as shown below. 

This is a very supply biased conversation, when in fact the full description of the mechanism must include both the creation of supply and the likely demand. The mechanism is much broader than the CDM and involves the core design of the Kyoto Protocol and the various elements within it. 

There are many definitions of “market mechanism”, but all talk about the process of the whole market rather than just a sub-part within it. Here are three;

  1. Means by which the forces of demand and supply determine prices and quantities of goods and services offered for sale in a free market.
  2. The use of money exchanged by buyers and sellers with an open and understood system of value and time tradeoffs to produce the best distribution of goods and services.
  3. The process by which a market solves a problem of allocating resources, especially that of deciding how much of a good or service should be produced, but other such problems as well. The market mechanism is an alternative, for example, to having such decisions made by government.

As the NMM discussion matures and eventually becomes part of the ADP, a much broader discussion on the need for a viable carbon market will be necessary. This cannot be limited to a discussion on crediting mechanisms because these, if standing alone, are not market mechanisms. A working mechanism requires some means of establishing price and particularly demand, a feature not inherent to the CDM.

The assumption that demand for credits will somehow be created is arguably a flawed one. The Kyoto Protocol addressed this by assigning AAUs to certain countries and making the CER (from the CDM) a fungible instrument, thereby allowing interchange for compliance. The AAU approach created demand in countries that had compliance obligations which in turn completed the market mechanism. Nations that held AAUs tended to cascade the instrument directly into their economies or if not, a proxy (e.g. the EUA under the EU ETS). Either way, the compliance obligation remained and allowed private investors to participate in the market.

There was a certain elegance in the market mechanism design of the Kyoto Protocol, one that shouldn’t be lost in the transition to a new international agreement. While it may not be smart politics in some quarters to highlight the benefits within the KP, the NMM discussion will do well to learn from what was developed in years gone by and not throw the baby out with the bathwater.

Cancun: Spending the money

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What started in Copenhagen as an aspiration for $30 billion in fast-start financing and up to $100 billion per annum by 2020 in North-South financing flow has been translated into the Cancun agreements as the beginnings of long term arrangements for specific funding purposes. In particular there is the Green Climate Fund in the AWG-LCA text;

 Decides to establish a Green Climate Fund, to be designated as an operating entity of the financial mechanism of the Convention under Article 11, with arrangements to be concluded between the Conference of the Parties and the Green Climate Fund to ensure that it is accountable to and functions under the guidance of the Conference of the Parties, to support projects, programmes, policies and other activities in developing country Parties using thematic funding windows;

Although the Green Climate Fund and the $100 billion per annum are not necessarily the same thing, many commentators quote them in the same breath. In reality, much of the $100 billion per annum will be delivered through the market and not as direct funding. But the Cancun Agreements do create a link at least to some extent in paragraph 100 of the AWG-LCA text, appearing in the Long-Term Finance section of the document;

Decides  that a significant share of new multilateral funding for adaptation should flow through the Green Climate Fund.

Given that this is mentioned just two paragraphs after the $100 billion reference, it at least establishes the notion that many billions of dollars will flow through the Green Climate Fund on an annual basis by 2020. But actually achieving this may be considerably more challenging.

Recent experience in the EU shows that even a highly focused, clearly defined funding mechanism for large scale mitigation takes many years to actually deliver real reductions. In 2007 the EU Council of Ministers agreed to the goal of 10-12 large scale CCS demonstration projects, although offered no insight at the time as to how this might be funded. Even then, with a carbon market in the range € 20-30 it was clear that the carbon price was insufficient to do this. So began the development of what is now the NER-300, a set aside of 300 million allowances in the EU-ETS for award to CCS projects. The mechanism itself was defined progressively throughout 2008 and eventually passed into EU law in December of that year. It then took two years (until December 2010) for the Commission to define the rules of operation of the mechanism to the extent that they could issue a call for projects, which has now been done. The closing date for project sponsors to submit application forms to their Member States is 9th February 2011. The deadline for Member States to complete an eligibility assessment and forward the application with the submission forms to the European Investment Bank is 9 May 2011. EIB will conduct its assessment of projects in 15 months (by October 9, 2012). Finally, the Commission will have to approve and submit projects to Member States. If all goes well, projects will be awarded funding by end 2012/early 2013.

From concept to first award, the above process will have taken 5-6 years and as noted that is for a very specific set of projects on a defined timeline. Concept to mitigation will therefore be at least 8 years.

In the LCA discussion, the Green Climate Fund is in its infancy. There is some description as to the makeup of the Board, the nature and responsibility of the trustee and an invitation to the World Bank to serve in that capacity for the initial years. But that is far from a going concern which is actively distributing significant levels of financing to very large scale projects. The Global Environment Facility (GEF) has been operating for 20 years now, yet large projects take many years to move from proposal to completion. For example, a $300+ million South African public transport project which first entered the GEF pipeline in January 2005 should be completed at the end of this year, a seven year process. Such a project would probably take even longer under the proposed Green Climate Fund because of the likely startup lag as terms of reference are developed, people appointed, rules agreed and implemented and finally projects called for.

This means that major developing countries (e.g. South Africa) could struggle to develop the necessary projects in time for their 2020 pledges to be met. In the case of South Africa, they have offered the following in a letter to the UNFCCC at this time last year:

South Africa reiterates that it will take nationally appropriate mitigation action to enable a 34% deviation below the ‘business as usual’ emissions growth trajectory by 2020, and a 42% deviation below the ‘business as usual’ trajectory by 2025,” said Environmental Affairs DDG Alf Wills in the letter to the UNFCCC. “The extent to which this action will be implemented depends on the provision of financial resources, the transfer of technology, and capacity building support by developed countries,” he added.

While the intention is to provide the necessary funding, the reality of doing so through a Green Climate Fund to facilitate the delivery of the 2020 pledges is very challenging. A stepped up approach under the existing Clean Development Mechanism offers an alternative, but is largely defeated by the lack of potential buyers for the credits that it would generate. There is now little medium term prospect of a market based approach to mitigation in the USA, which removes them as a significant potential buyer (there will of course be California and perhaps some scope for offsets under the EPA). If China or Japan were to step into the arena with new project mechanisms driven by domestic trading systems, a considerable lag would still exist before projects began, simply because of the time it will take to define the domestic systems and create the attached mechanisms. Even if all this happened to come together quickly, there would still be a lag as developing countries identify the necessary mitigation projects.

Dozens of large scale mitigation projects will be needed in South Africa (and similarly for other countries) to meet their 2020 pledge as well as many hundreds of smaller scale initiatives. The current likely timelines for the development of the necessary financing facilities, their start-up and then use give little room for optimism that this will happen in time to create the reductions necessary to meet the pledges. Nonetheless, the fund will no doubt be successful – in the end  – in terms of making available much-needed monies to mitigation projects.

Good News or Bad News

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Recently Reuters reported that the Japanese government is looking at developing its own version of the Clean Development Mechanism (the offset / project mechanism instrument within the Kyoto Protocol). Japan has been a significant buyer of CERs (Certified Emission Reduction Units) in recent years, both directly and through voluntary agreements with Japanese industry but like many participants in this market has reportedly been frustrated by the bureaucracy of the CDM and the specific requirements placed on a project such that it is eligible. Nevertheless, with Japan and the EU as the principal buyers of CERS, the CDM system will have issued some 1.8 billion CERs by the end of 2012, which in turn equates to about $25 billion in carbon value and certainly more in overall project investment. Whilst the same investment may well have gone to developing countries anyway, it would not have been so focused on low carbon projects such as land-fill methane capture, wind and hydro.

To its credit much has been achieved under the CDM, but it remains an instrument of the Kyoto Protocol and subject to the jurisdiction of the CDM Executive Board (EB) which in turn operates through the Meeting of the Parties to the Kyoto Protocol. Above all else, the CDM has shown that a project mechanism can work and importantly can enable a targeted low carbon investment stream into developing countries. As a result, the idea of an offset / project mechanism of some sort exists in many government’s plans for legislation. But therein lies what is becoming a problem – each government wants a “made at home” solution. The latest incarnation of this is Japan.

Apart from government-to-government AAU transactions (under the Kyoto Protocol), the CER is the pretty much the only single fungible carbon price instrument globally. It can be utilized by all the Kyoto Annex 1 countries for compliance and in some cases that compliance has been cascaded down through the economy such that business trades CERs. This in turn links the carbon price those economies and allows at least some measure of optimization between them, albeit limited today. Optimization in turn means a lower cost of compliance for the economies in question. Multiple, jurisdiction specific offset mechanisms would prevent this from happening. The accreditation of a given project would typically be against one set of rules and therefore the resulting credits could only be used for compliance where those rules originate. Project developers would find the cost of multiple jurisdiction accreditation prohibitive. This means that there would be no linking mechanism between the systems and no opportunity to optimize. The result – a lost opportunity and a higher cost outcome. There will also be additional costs for the governments involved. Establishing the necessary monitoring and accreditation bodies is a complex and expensive task, just look at the CDM EB. Finally, it may be wrong to assume that it will all somehow be easier if done at home – even local solutions will have teething problems and will likely face all of the issues all over again that have been dealt with by the CDM EB.

So whilst it is good news that governments continue to favour market mechanism approaches to emission reductions, it may be bad news if they each try a home grown solution. At a very minimum, a global deal on project mechanism design and implementation, ideally building on but learning from the CDM, would be a solid achievement from the UNFCCC process in Cancun.