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The international market for carbon credits grew in value to an estimated US $30 billion in 2006, three times greater than the previous year, it is predicted that demand will grow as countries in the developed world are unlikely to meet their Kyoto target of reducing their GHG emissions by an average of 5.2% below 1990 levels by 2012.
While the term carbon trading is used, what is actually being traded in all cases are emissions rights measured in tonnes of CO2. While the concept of carbon trading has been on the radar screen since the signing of the Kyoto Protocol in 1997, it has only really started to gain momentum over the last two years through the European Emissions Trading Scheme (EU ETS).
There is now a live traded price for CO2 similar to any other commodity. In addition to EUAs (EU Allowances, which are the permits allocated to participants in the EU ETS), the flexible mechanisms of Kyoto have created a class of carbon credits (CERs and ERUs) that provide another source of global CO2 assets. Through the growing number of schemes and products, there now exists a real platform for the development of an increasingly sophisticated, liquid and at some stage global market for carbon emissions.
In addition to setting the first ever international target for reducing greenhouse gas emissions, the Kyoto Protocol was groundbreaking as it established, for the first time, a means for developing countries to get involved in climate change mitigation, enabling a market-based solution to an environmental problem and bringing the issue of greenhouse gases to the mainstream of clean energy planning.
The Kyoto Protocol approved the use of 3 “flexible mechanisms”. These mechanisms are primarily designed to allow emissions savings to be made on a least cost basis. They achieve this by making the actual emissions abatement of greater importance than the location.
- Emissions Trading: allowing the international transfer of national allocations of emission rights, between different Annex 1 countries
- The Clean Development Mechanism (CDM): a mechanism which allows for the creation of Certified Emission Reduction (CER) credits through emission reduction projects in developing countries, regulated by the CDM Executive Board
- Joint Implementation: the creation of emissions reduction credits undertaken through transnational investment between countries and/ or companies of the Annex 1 (industrialised countries)
Emissions Trading – the EU ETS
In terms of emissions trading, Europe has taken a lead in creating the EU ETS, a mandatory trading system for CO2 – and a major step toward creating a truly international carbon market. Instead of waiting for Kyoto to come into force in 2008, Europe has set up its own cap and trade scheme that started in January 2005. Under the EU ETS, 12,000 carbon intensive installations in seven different industries have, in total, been allocated approximately 2.2 billion EUAs. The EU ETS operates in Phases – Phase I between 2005-07 and Phase II between 2008-12 which coincides with the first Kyoto commitment period. With Phase III running from 2013 possibly out to 2020.
As a result of the EU ETS, Europe has the most active private participants in the carbon market. In January 2005, the EU ETS transformed carbon trading from a largely theoretical concept to a day- to-day reality for those businesses impacted by the scheme. This helped to buoy up investor confidence as it provides a more liquid and easily quantifiable market than would be provided by simply selling in bulk to national governments.
The Clean Development Mechanism
The CDM is by far the more dominant Kyoto mechanism. As of May 2007, the CDM is projected to create circa 2.5 billion tonnes of reductions to 2012, compared to JI’s 153 million. A large degree of the CDM’s success is down to host country governments putting in place the required institutions and regulations in a timely and efficient manner. Since January 2006 the number of new projects added to the CDM Pipeline has increased in a linear state. The 169 new projects in September 2007 were mostly renewable and energy efficiency in industry: Hydro (67), Wind (20), EE industry (20), Biomass energy (18), Biogas (16), Landfill gas (12), Fossil fuel switch (5), EE supply side (3), transport (2), Coal bed/mine methane (2), Forest (1), EE Service (1), HFC (1), and solar (1).
The CDM Process
There are several components to the CDM process, registering a project under the CDM can often be a lengthy process. The UNFCCC (United Nations Framework Convention on Climate Change) are the governing body that sets an overall framework for intergovernmental efforts to tackle the challenge posed by climate change. Within this body the CDM Executive Board (EB) was established, its purpose is to supervise the CDM.
For projects to qualify as valid mitigation activities in the context of the Kyoto Protocol, they have to fulfill a series of eligibility criteria. The principal criteria are described below:
- Host country approval – a GHG mitigation project has to be acceptable and approved by the host country government under its own evaluation criteria. Imbedded in these criteria are their respective sustainable development objectives (social, economic, environmental) and other developmental criteria
- Additionality – For CERs to be acceptable under the terms of the Kyoto Protocol, no project can claim GHG emission reductions unless project proponents can reasonably demonstrate that the project’s practices are ‘additional’ to the ‘business-as-usual’ or baseline scenario
- Approved methodology – for a project to participate in the CDM, it must follow a methodology that is to be previously approved by the CDM Methodology Panel. Such methodologies must include instructions as to the determination of the project baseline, the quantification of emission reductions generated by the project, and monitoring plans
In addition to fulfilling the eligibility criteria described above, the development of a CDM project has to follow a certain order and a series of activities that form the CDM Project Cycle.
The CDM cycle refers to the procedure that a project must undergo in order to be considered a genuine CDM project and successfully receive CERs. The main components of this cycle are shown below:
Project Design Document – The PDD is essentially an ‘application form’ whereby all the relevant information concerning the project, i.e. how it qualifies as a CDM project, how it will be built, operated and funded, where it is, when it will be built etc., are all included in a concise document.
Host Country Approval – The CDM cycle requires that all CDM projects receive the approval of the governments where the project in question is physically located.
Validation – As part of the CDM cycle, a project wishing to receive CERs must be validated – both the site and the PDD must be inspected by an organisation designated by the CDM Executive Board to insure all relevant requirements are met.
Registration – After successfully passing validation, the project must then be submitted to the EB for a final review and registration.
Financing and Implementation – This critically important stage refers to the actual funding and building of the project. The project developer must ensure that adequate funds are secured and that the project will be built within a satisfactory timeframe and with a level of quality.
Monitoring – Monitoring refers to the recording of relevant raw data that will be used as proof of the project’s effectiveness in reducing emissions and form the basis upon which CERs will be issued.
Verification – The data collected and recorded during the monitoring stage will need to be ‘verified’ before it can be used to apply for CERs. Similar to validation, verification is conducted by an organisation designated by the EB with the task of inspecting the data collected and the monitoring system that was utilised to collect it.
Issuance of CERs – This final stage is reached once the EB is also satisfied with the monitoring data and CERs will be issued in accordance to the numbers indicated by the monitoring data collected.
CDM Success – Working in practice
The first of its kind to be registered with the CDM in Mexico, the Aguascalientes EcoMethane Landfill Gas (LFG) project was developed to address the LFG emissions from two local landfills, San Nicolas and Cumbres. In addition to reducing greenhouse gases (GHGs) through capture and flaring of the LFG, the project has also installed 2-4 MW of electricity which reduces fossil-fuelled grid energy. As such, the project provides a strong example of how the CDM can be used to address climate change while also encouraging the goals of sustainable development.
The Aguascalientes LFG project was developed by EcoMethane, a joint venture between EcoSecurities and Biogas Technology, to finance, construct, and operate a project that would capture and make productive use of the methane emissions from the local landfills.
Properly collecting and destroying the flammable LFG being emitted at Aguascalientes generated a number of important environmental benefits. In addition to reducing GHG emissions, the destruction of LFG also improved the local environment by reducing noxious air pollution that had previously been responsible for considerable nuisance, odours, and health risks to the local community. The Aguascalientes project also provides a model for managing LFG, a key element in improving landfill management practices throughout Mexico.
The project thus acts to demonstrate the benefits of clean technology, encouraging less dependency on grid-supplied electricity, and representing a significant technology transfer. Overall, sustainable management of the landfills at Aguascalientes will accelerate waste stabilisation such that the full decomposition of landfill waste will be largely complete within 30-50 years.
The project at Aguascalientes has helped Mexico fulfill its goals of promoting sustainable development by diversifying electricity generation sources, increasing jobs, using clean and efficient technologies, conserving natural resources, and acting as a demonstration project for improved landfill practices. The project thus shows how the CDM can be used to make GHG reductions and sustainable development both economically feasible and practically possible.
The future of CDM projects post-2012
The First Commitment Period of the Kyoto Protocol set targets for ratified countries which must be met within a five-year time frame between 2008 and 2012. Currently there is no international agreement regarding a post 2012 regime, however, negotiations will begin at the UNFCCC Conference of Parties in Bali in December. Optimistically most participants in the international carbon market are beginning to agree that mounting factors will dictate that the CDM will continue post 2012, but whether it will be within a Kyoto framework is yet unclear.
One of the key questions hanging over the current post 2012 negotiations is the thorny issue of whether or not developing nations will, or even should, take on emissions budgets. Currently it seems unlikely that host nations will take on emissions caps in the next round of negotiations. This is logical for a number of reasons; the developed world has benefited greatly from the very technologies that cause global warming and is continuing to do so. European per capita emissions compare favourably to those for the US, for instance 11 tonnes per head per year for the UK versus 24.3 for the US. However both sets of figures look bloated in comparison to the per capita emissions of India and China 1.9 and 3.9 respectively.
Considering this justifiable reluctance from the developing world to take on emissions targets, and the insistence of some developed world players that they do so, it would appear that an impasse has been reached. There is a way out however, and the answer lies in the figures and ethics.
Challenges for CDM
The CDM has, to date, been the most successful aspect of the Kyoto Protocol’s flexible trading mechanisms. It has largely avoided the institutional inertia that has to date held back both JI and AAU trading in the form of Green Investment Schemes (GIS). However, seven years after its inception, the CDM’s level of success has, ironically, created many of the challenges that need to be addressed in order to sustain its development post 2012. These include additionality, avoiding fallback, resourcing within the UNFCCC, and the interaction of the CDM with an expansion of coverage in post 2012 emissions budgets.
Additionality
One of the biggest problems facing the CDM is implementing the concept of additionality as energy use evolves towards cleaner technology. Additionality can be defined simply as being the need for a project to be additional to the business-as-usual scenario. In practice this means that the project either has to overcome financial or normal practice barriers in order to be implemented. Both of these are being defined and refined in an iterative process of self regulation by the CDM Executive Board (EB) If the CDM successfully transfers technology Emissions to a region or country, then at some point the technology will become both normal practice and economically viable. This means that it will also cease to be additional, and therefore ineligible for the CDM.
Preventing fall back
Some project types will, in the absence of national legislation, always be additional. These project types pose a particular risk of emissions fallback if they are removed from the CDM. Fallback refers to the risk that when a technology or sector is removed from the CDM it reverts back to its previous emissions patterns. Unfortunately these project types are also the ones facing a mounting volume of political pressure for them to be removed from the CDM.
Conclusion
Finally, all of the challenges facing the carbon market must be considered in the wider context of fighting global warming on multiple levels. There is an urgent need for action. We may have a five or ten year grace period during which we can continue to pollute without tipping the world over onto an irreversible path to catastrophic climate change. The investments taking place in the carbon market today will be locked in for the next 30 to 40 years. It will be far easier to ensure that installations being built today are sustainable now, rather than pushing for their large scale closure and replacement 5 or 10 years from now. The vast majority of that new infrastructure is being put in place in the developing world, which is why the flexible mechanisms of Kyoto are so vital.
Published: 01st Jan 2007 in AWE International
