The Clean Development Mechanism By Yesinawo Awadzi

1. The Clean Development Mechanism By Yesinawo Awadzi

2. BACKGROUND The Kyoto Protocol Legally binding emissions targets for annex 1 countries. Developed countries to reduce their collective emissions of 6 key green house gases by at least 5%. Targets should be achieved by 2008-2012. Source: UNFCC (united nations framework convention on climate change)

3. Countries would have certain degree of flexibility in the measurement of their emissions reduction. • Emissions trading program • Joint implementation • Clean Development Mechanism (CDM)

4. Emission trading program • Parties can acquire units from other annex 1 countries to meet their targets. • To prevent “overselling” parties are required to keep a minimum level of ERUs, CERs, AAUs and RMUs.

5. Joint implementation (JI) • Parties can implement projects that reduce emissions, or remove carbon from the atmosphere, in other Annex I Parties, in return for emission reduction units (ERUs). The ERUs generated by JI projects can be used by Annex I Parties towards meeting their emissions targets under the Protocol

6. Eligibility Requirements • They must have ratified the Kyoto Protocol. • They must have calculated their assigned amount, as referred to in Articles 3.7 and 3.8 and Annex B of the Protocol in terms of tonnes of CO2-equivalent emissions. • They must have in place a national system for estimating emissions and removals of greenhouse gases within their territory.

7. Eligibility contd. • They must have in place a national registry to record and track the creation and movement of ERUs, CERs, AAUs and RMUs and must annually report such information to the secretariat. • They must annually report information on emissions and removals to the secretariat.

8. Clean Development Mechanism (CDM) • Encourages a developed country party to invest in a host country earn CER credit to meet their Kyoto obligations. • The CDM is expected to generate investment in developing countries, especially from the private sector, and promote the transfer of environmentally-friendly technologies in that direction

9. Hans H. Kolshus, JonasVevatne, Asbjørn Torvanger, and Kristin Aunan.(CICERO Working Paper 2001:8) • Norway proposed that cost-effectiveness could be increased by separating the emissions targets from the method of abatement . • Not all countries involved in the climate negotiations supported the idea of joint implementation. • Source: Center for International Climate and Environmental Research

10. In order to qualify, a CDM project must deliver multiple benefits: credits for reducing GHG emissions to the investors and sustainable development to the developing country which hosts the project • contributes to stabilizing GHG concentrations in the atmosphere below dangerous levels. • A successful CDM energy project can, for example, earn certified emission reductions (CERs) during a minimum of seven and a maximum of 21 years

11. For an investor, the effect of an AAU or ERU is no different from the effect of a CER. However, a reason for distinguishing could be that Article 12 states • that a CER can only be transferred when the project generating the CER has proved to be in line with sustainable development criteria. No such criteria exist for AAUs and ERUs. • The extent to which the sustainable development criteria are enforced will naturally be a significant factor in determining the size ofthe CDM market.

12. Michaelowaa and Jotzo (2005) • The CDM can become an important mechanism for achieving cost-effectiveness in reducing global GHG emissions because developing countries have prevailing high emission intensities and low abatement costs. • The resources required for reducing a ton of carbon in a developed country could typically offset more emissions in a developing country.

13. However, the CDM’s potential efficiency can be distorted if its design does not take into account incentives for cheating, leakage, and uncertainties. • It is essential to define mechanisms with low transaction costs that lead to real and measurable emissions reductions (Michaelowa & Dutschke, 1999). Important issues in this respect are project validation, monitoring, and certification.

14. By using CERs, industrialized countries and companies can comply with their Kyoto and/or national targets at costs below those commonly encountered for domestic projects. • By being mutually beneficial, the CDM can break new ground in North-South collaboration for the global commons.

15. Projects can include afforestation and reforestation • Energy projects such as hydro-power, solar energy and natural gas as alternatives to fossil fuels • Nuclear power projects are excluded

16. Additionality • In order to execute a CDM project, it is essential to establish emissions additionality, that is emissions reductions must occur with the implementation of the project. This in means one has to • clearly define project boundaries • develop an emissions baseline for the project (which will help establish environmental additionality and determine the carbon credits) • measure, verify, and certify actual emission levels once the project has been implemented.

17. Baseline-the scenario that reasonably represents the anthropogenic emissions by sources of greenhouse gases that would occur in the absence of the proposed project activity. A baseline shall cover emissions from all gases, sectors and source categories listed in Annex A • a scenario that represents the net changes in carbon stocks and greenhouse gas emissions that would have taken place on the project land in the absence of the project.

18. Additionality- “A CDM project activity is additional if anthropogenic emissions of greenhouse gases by sources are reduced below those that would have occurred in the absence of the registered CDM project activity.” • Types • environmental • Technological • Investment

19. Additionality issues • How much of the potential GHG offsets created by a project would have occurred in the absence of the program? • How much should the potential offsets should be discounted to account for the non additional portion so they are creditable offsets?

20. Leakage- “the net change of anthropogenic emissions by sources of greenhouse gases which occurs outside the project boundary, and which is measurable and attributable to the CDM project activity”.

21. Main issues • How much leakage does a GHG project stimulate? • How much should the potential offsets created by the project be reduced to account for the leakage stimulated?

22. Permanence issue- when the emission reduction cannot be guaranteed or a temporary. • This can be seen especially in land use, land-use change and forestry (LULUCF) projects.

23. Main issues • What is the differential value of non permanent potential versus permanent fully creditable emissions offsets? • How do contract terms on project duration influence the creditable value of an offset? E.g. replacing a lost forest or implementing a discount factor to generated credits

24. The issue of transaction cost and institutional rigidity

25. Since its inception, a major issue in climate policy has been how abatement could be implemented cost-effectively in a world where not all countries have emission reduction targets. • Cost-effective measures ensure that a goal (emissions reduction) is reached by using as few resources as possible. • Different marginal abatement costs across countries is the driving force. • Source: Hans et al CICERO Working Paper 2001:8

26. Axel Michaelowaa, Frank Jotzo(2005) • Theoretically the CDM will lead to an equalization of marginal abatement costs throughout the world. • A number of modeling exercises have calculated a global market price assuming friction-free trading of emission credits (Weyant, 1999; Springer,2003). • However, it is becoming increasingly clear that there will be substantial transaction costs and other institutional barriers that could considerably reduce the size and change the distribution of the CDM

27. The issue of transaction costs have been addressed only in a few models, usually by shifting marginal abatement costs curves vertically (e.g.B.ohringer and L.oschel, 2002, p. 152ff). • They investigate the emerging evidence on CDM transaction costs, incorporate the findings in a simple model of the global market for greenhouse gas permits, and analyze a range of scenarios.

29. Heller (1999) rightly argues that transaction costs strongly depend on the institutional framework. • The situation may differ considerably between host countries and this influences the negotiation of all mechanisms, as well as the approval costs of the project-based CDM and JI. • Transaction costs will be higher in countries with an inefficient regulatory framework and lead to a competitive disadvantage vis-"a-vis other countries.

32. Transactions cost for emission trading vrs CDM • Brockman et al. (1999, p. 90) quote transaction costs of SO2 trading in the US of 1% of the project volume. • In the beginning, they were about 5% (Klaassen and Nentjes, 1997) but when an active spot market with several specialized brokers developed, they quickly came down. • Kerr and Mar!e (1997) found broadly defined transaction costs of about 10% in the case of the US lead phase down program, the first large scale emissions trading program, albeit with a relatively small number of participants.

33. Brokerage fees in the grey market for greenhouse gas emission rights are currently not transparent, but thought to be around 5–7%. • A lower boundary for transaction costs in a highly liquid market of a well-defined financial commodity may be 0.2%—these are the rates quoted by direct brokerage firms in securities and bonds

34. Therefore, the CDM supply has to bear higher transaction costs and is much more affected by increasing marginal transaction costs—as one moves into project categories with higher implementation costs, transaction costs increase as well. • project options higher up the marginal cost curve also carry higher transaction costs.

35. Based on the empirical data described above, transaction costs tilt the CDM supply curve upward, rather than just shifting it, as commonly assumed and illustrated in Fig. 1. • All in all, the share of the CDM in the carbon market will be less than in a world without transaction costs

37. Institutional rigidities in host countries • Countries can host CDM projects only if they have set up a ‘‘Designated National Authority’’ (DNA) that formally approves project proposals. Moreover, they must have ratified the Kyoto Protocol. • By July 2003, only 16 developing countries had notified their DNA to the UNFCCC Secretariat. • In many countries, the decision on the DNA has been stalled due to inter ministerial conflict for several years. It is likely that projects in those countries will suffer serious delay.

38. Thailand has stipulated that every CDM proposal has to be approved by cabinet; one can imagine the transaction costs caused by that rule. • If a country has managed to set up its DNA, it has to decide about the fees charged to project proponents.

39. Sri Lanka plans to levy 1% of estimated CERs. Moreover, countries could contemplate levying a tax on CERs akin to royalties for natural resource exploitation. • Many countries, among them China and India, are unhappy with the current low market price and have discussed setting a minimum price before approving CER sale

40. Impact of transactional costs and institutional rigidity on CDM • Implementing the Kyoto Protocol without the United States and Australia means the demand in the global carbon market will be greatly reduced. • Under projections by the US Department of Energy (EIA, 2002) used for the modeling here, emission reduction requirements of OECD Annex B countries except the United States and Australia amount to 1.3 Gt CO2/yr in the energy sector. This figure does not take into account non carbon dioxide emissions and crediting for sequestration.

43. Hans H. Kolshus, Jonas Vevatne, Asbjørn Torvanger, and Kristin Aunan. • CDM has the dual objective of promoting sustainable development in developing countries and ensuring international cost-effectiveness in reducing greenhouse gas (GHG) emissions. • The idea is to assist the developing countries onto a more sustainable path through, for instance, technology transfer, capacity building, and financial resources. At the same time, reducing GHG emissions.

44. Benefits include local and regional improvements. E.g.. when energy-savings programs make the building of a new fossil-fuelled power plant superfluous. This not only reduces emissions of CO2, but also of nitrogen oxides (NOx), sulphur dioxide (SO2) and particles. • positive effects on health conditions. (Seip et al.,2000).

45. Implication for Sub-Saharan African countries • There are indications that SSA countries would benefit from flexibility mechanisms • CDM is important because there are no carbon markets existent

46. Sectoral distribution of current GHG emissions from Africa

47. Attracting CDM investments • Defining property rights- customary land ownership vs. customary land ownership • Availability of land for large scale investments • Land banks e.g. Tanzania • Overall improvement of the continents image

48. Example of Registered CDM projects. • Bonn, 18 November 2004 –the first project of the Clean Development Mechanism (CDM) was registered. The project will reduce emissions of methane from a landfill in the state of Rio de Janeiro, Brazil • The project is located in the state of Rio de Janeiro, Brazil. It aims to reduce greenhouse gas emissions from a landfill site by capturing methane to use it for generating electricity and will have direct health and environmental benefits for the local community of Nova Igacú.

49. Possible research areas • Economic impact of CDM on developing countries • Making CDM more attractive taking into account the transactions costs. • Acceptable CDM methodology

50. References • Michaelowaa,A and Jotzo F “Transaction costs, institutional rigidities and the size of the clean development mechanism” Energy Policy 33 (2005) 511–523 • Kolshus H., Vevatne J, Torvanger J, and K. Aunan, “Can the Clean Development Mechanism attain both cost-effectiveness and sustainable development objectives?” CICERO Working Paper 2001:8 • The Clean Development Mechanism and Africa, New partnership for sustainable development – Report from regional workshop (Accra, Ghana Sept. 1998) • United Nations Framework Convention on Climate - http://unfccc.int