The CDM is still the hostage of ambition
posted by Rob on 25th Sep 2012
“Essentially collapsed” were the words that resonated from an independent high-level panel’s report on the recommendations for the future of the clean development mechanism (CDM). Established in 2011 at the UNFCCC Conference of the Parties (COP) in Durban, South Africa, the 11 member panel makes up the CDM Policy Dialogue whose remit was to make reflections on the past as well as the future of the CDM. It would provide recommendations on how best to “position the CDM to respond to future challenges and opportunities and also on how to ensure the effectiveness of the CDM in contributing to future global climate action”.
Released on the 11th September, the report made twelve wide ranging recommendation which essentially seek to tighten supply, restore credibility, improve sustainability and move the CDM beyond a simple base line and credit approach. Sandbag emphatically supports some of the recommendations included, e.g. to stop registering new industrial gas (HFC-23 and N2O adipic acid) projects, to enhance reporting of sustainable development and the suggestion to move the CDM beyond offsetting and toward a net mitigation role.
For Sandbag, who approaches the CDM through the prism of the EU emissions trading scheme (ETS), the reports first recommendation, to “urgently address the immediate crisis of demand” is particularly thought-provoking. Insufficient demand for credits has long dogged the CDM, with bountiful supply continually driving the price down. The ‘market mechanism’ basis of the CDM has worked very effectively in this respect. It has successfully and repeatedly found emission reduction opportunities and brought them to market; the fabled ‘low hanging fruit’ was found early and exploited heavily. Despite serious concerns about credits from non-additional projects the issuance of the billionth CDM credit is proof that the institutional arrangement is trusted, investment is flowing and carbon credits are being generated. But for all its successes the great failing of the CDM is that it’s held hostage to international political ambition on climate change - notably that of the EU ETS.
The EU ETS remains the principle market for credits from the CDM, leaving the offset market particularly vulnerable to the trading scheme’s convulsions. Recession and over allocation of free allowances has left the EU ETS internally oversupplied with its own European allowances (EUAs). A staff working document of the European Commission estimated a potential oversupply of allowances and offsets to be as high as 2.4bn by 2020. The subsequent lack of demand for allowances has left the carbon price languishing and unable to drive emissions reduction or investment in low carbon technologies. Despite this oversupply, the European traded sector is still expected to fully exploit the 1.6 billion offset budget available to it, further weakening the demand for carbon allowances.
The European Commission is in the process of trying to remedy the weak carbon price and surplus of allowances in the EU ETS by withholding allowances from the start of the next trading period, which many see as a potential precursor to their permanent cancellation. The high-level panel makes strikingly similar recommendations to prevent the collapse of the CDM, recommending to “investigate the establishment of a new fund and/or enable existing or emerging funds to purchase and to cancel part of the current overhang of CERs”. It seems oversupply is a common feature of carbon markets, in both the EU ETS and the CDM (and Kyoto itself which is estimated to have overhang of 13bn AAUs).
Sandbag believes it’s paramount to remember that the CDM is not an end in itself. As an offsetting mechanism - which allows for the reduction of emissions to take place in one region, in order to allow emissions to continue happening elsewhere – the CDM does not contribute to the additional mitigation of emissions, rather it provides a means of least cost abatement for countries and companies which have a legally binding obligation to reduce emissions. It has been very successful in this role and this should help spur countries towards adopting more ambitious targets. Only then is it helping deliver net additional mitigation.
Ambition in compliance markets is everything. The EU ETS is not functioning as envisaged and as such cannot support the additional mechanisms that depend on it. The desperation of these mechanisms to feed into the only sizable market is damaging both the EU ETS and the CDM. The European Commission recently noted that the more offset credits coming into the market [the] more downward pressure is placed on the EUA price.
In a fitting twist, shortly before the high-level panel announced its findings of an oversupplied CDM market China announced the approval of 78 CDM projects adding even more credits to a saturated market and reducing the value of carbon credits. Furthermore, the recent decision by the CDM Executive Board to issue credits from a highly dubious coal project does to little defend the reputation or sustainability of the CDM or stem the flow of superfluous credits. CDM credits are currently worth an all-time low of just a couple of Euros each. Some analysts have already commented that they see it unlikely that the price will ever rebound above €3, while others have predicted that CDM credits will cease to be traded on the spot market and will move towards pricing on a case by case basis, rather than the current listed price.
It is beyond doubt that developing countries need assistance and investment in low carbon technologies as well as governance and capacity building expertise. But does this have to come exclusively from the CDM? The Global Finance Initiative agreed in Copenhagen is one alternative and there are undoubtedly others. The world needs to up its ambition in terms of reducing emissions, not simply shifting them around the world. The EU, Australia, New Zealand, South Korea, California and China either have or are in the processing of implementing compliance ETSs. These schemes need to be built on ambitious reductions targets with only limited access to international offsets.
The CDM looks unlikely to fully collapse given the enormous efforts invested in developing the institutions, infrastructure and methodologies not to mention its prominent position in International Negotiations. Nevertheless carbon markets are evolving in a bottom up fashion and the CDM must evolve too. The collapsing price shows there is no shortage of abatement options - this should support the adoption of greater ambition which is what is needed urgently. Hopefully the fear of total collapse helps focus the conversation meaningfully on the bête noire of all compliance emissions trading schemes: ambition.