The Clean Development Mechanism – evolving to meet climate and development challenges

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Hans Jürgen Stehr, Chair of the Executive Board of the Clean Development Mechanism

The Clean Development Mechanism is addressing both climate and development issues. It is up and running but the challenge now is to increase efficiency, and scale up the mechanism so that CDM can fulfil its potential.

Let projects in developing countries earn saleable credits for reducing greenhouse gas emissions, and let developed countries buy those credits to help meet their emission targets. It’s a simple idea, so simple in fact that it takes up less than two pages in the Kyoto Protocol. Those few paragraphs, Article 12, which describe the mechanism’s objectives of emission reduction, sustainable development and support for adaptation to climate change, have given rise to the first globally traded environmental commodity: the certified emission reduction (CER).

The rules, the so-called modalities and procedures, and the growing body of guidance, tools and clarifications on how projects can actually create CERs, are more complex. Yet the mechanism is up and running, and it works. CDM is stimulating green investment flow to developing countries and giving industrial countries some flexibility in how they meet their emission reduction commitments. The next challenge is how to make the CDM fulfil its potential.

NUTS AND BOLTS OF CDM

Despite its good start, there is still a great deal of confusion about CDM, indeed about emissions trading in general, and its role in combating climate change and contributing to sustainable development. The central feature of the Kyoto Protocol is a requirement that developed countries accept commitments to limit or reduce emissions, bound by international law – in a word, ‘caps’. The adoption of caps creates a commodity – emission credits – which can be traded and sold. Countries or companies that emit below their cap have credits to sell, and those that go over their cap must look to the market.

The ability to trade emission credits:

Gives countries/companies some flexibility in how they plan for and meet their emission targets.
Offers lower cost opportunities to meet emission targets.
Provides a market-based financial incentive to reduce emissions.

What about developing countries? How might they be involved in efforts to reduce emissions? More importantly, how might they secure the investment necessary to carry them down a green path to development, and spurn the well-worn path that has led the planet to its present crisis? What about adaptation to climate change? Where will the most vulnerable countries find resources to counter the effects of climate change? These were questions that occupied the negotiators of the Kyoto Protocol. An idea was floated that a fund be created for adaptation, financed through fines for non-compliance.

This idea evolved into a plan to generate revenue for adaptation as a by-product of some flexible means of assisting countries to comply with their emission targets. Thus was born the CDM. Reasoning that an emission reduction in one part of the world is as good for the atmosphere as an emission reduction achieved anywhere else, the negotiators provided for a market-based mechanism that would allow projects in developing countries to earn saleable credits for emission reductions that are real, measurable, verifiable and additional to what would have occurred without the project. A portion of the CERs generated would be placed in a fund for adaptation to climate change. It is somewhat ironic that a country which played a big part in the birth of the CDM, the United States of America, is not a Party to the Protocol.

Interest in CDM is strong in developed and developing countries alike. In a few short years, more than 840 projects have been registered, and about another 1,800 are in the validation/registration pipeline. The projects could generate more than 2.5 billion CERs, each equivalent to one tonne of carbon dioxide, by the close of the Kyoto Protocol’s first commitment period in 2012. The numbers, still on the rise, tell a story of success, even if the estimated volume of credits is reduced because not all projects might fully live up to expectations.

The other achievements of the CDM are less obvious, but perhaps far more important. Consider how it has engaged the private sector, for without the private sector’s participation and imagination, little can be achieved. Consider the partnerships it has forged between developing and developed countries. Forgetting for a moment the billions of dollars in investment flow that CDM will generate, emissions trading and the CDM have given virtually all the countries of the world a common, cooperative means by which to take action against climate change.

Is CDM the answer to global climate change? No. CDM is only one of the answers to climate change. The objective now is to consolidate, increase efficiency and scale up the mechanism to take advantage of its great potential.

ACHIEVING POTENTIAL

A new, promising way of scaling up CDM will be through registration of programmes of activities. Until now, the mechanism has focussed on single projects at single sites. It was a necessary first step in the ‘learning by doing’ process, akin to learning to walk before you run. The Executive Board issued procedures and guidance on programmes of activities in June 2007, which means the way is now clear for registration of programmes with activities operating at multiple sites, and activities can be added to a programme over time. It’s the difference between installing energy-efficient light bulbs in a single home and successively installing energy efficient bulbs in an entire town or state. That’s just an example, but it is quite helpful in illustrating the potential of programmes of activities to leverage the considerable work that necessarily goes into setting up a CDM project, not least the development of methodologies for determining baseline emissions and then monitoring resulting emission reductions.

Exactly what such a programme would look like is up to project developers, because the CDM is basically a bottom up process. The modalities and procedures for the CDM were agreed upon in Marrakesh in 2001. Since then, project developers have built the mechanism, one project at a time. The Executive Board’s role, aided by expert groups and panels, has been to ensure that what developers submit meet the criteria: emissions must be real, measurable, verifiable and additional to what would occur without the project.

traffic jam Along the way, the Board, assisted by the secretariat of the United Nations Framework Convention on Climate Change (UNFCCC), has crafted a wide array of guidance and clarification. Also along the way, the number of meeting days per year has more than doubled. Against a backdrop of dynamic growth and development, the Board provides the professional and regulatory competence needed to supervise the CDM, a mechanism of substantial size, global spread and sectoral diversity. To help the Board keep pace with activities, the resources in the UNFCCC secretariat have had to be increased. This has allowed for, among other things, improved communication with CDM stakeholders, for example through the holding of information forums for the national authorities that handle CDM. Nevertheless, the Board sees the need to increase dialogue with project participants and other stakeholders in its endeavour to strike the right balance between environmental integrity and flexibility and practicability.
This is the kind of challenge that the Board is pleased to face. It means that the mechanism is working and is expanding. Where might it go from here? The programme of activities offers one route to expansion. Might there be other ways to leverage the mechanism? Surely there are, and these will no doubt be proposed and pursued by the many stakeholders that engage in the mechanism: project developers, investors, financiers, multilateral development agencies and banks, brokers, analysts, consultants and national authorities.

THE CHALLENGE OF AFRICA

As at November 2007, sub-Saharan Africa has hosted 15 registered CDM projects. This equals 1.8 per cent of all projects. Twelve of the projects are hosted by South Africa. Forty of the 45 sub-Saharan African countries have ratified the Kyoto Protocol, but many have limited ability to implement CDM projects. Twenty-six have established Designated National Authorities to dminister CDM activities. Several of these countries, however, have not invested sufficient resources in establishing the required institutional structure to approve CDM projects due to the number of other development priorities they face, such as poverty alleviation, food security, health and education. The limited capacity is reinforced by the lack of designated operational entities (DOEs) from these countries. Project verification and validation are undertaken by these third party entities, which are generally large international consulting firms whose rates are expensive for project developers in poor countries.

What is true for African countries, is also true for many countries in other less developed regions. Many countries have suffered from a lack of capacity building. The largest amount of official development assistance for CDM capacity building has gone to middle income countries that are better positioned to capitalise on carbon funding due to their better investment climates and greater potential for emission reductions. Important lessons can be learned from these efforts, leading to greater efficiency and improved results in activities in sub-Saharan Africa and elsewhere.

South-South cooperation and transfer of learning could prove effective for sub-Saharan Africa and developing countries in other regions. The market-based nature of the CDM means that most investment will naturally gravitate to low-risk, high-opportunity projects and locations, similar to foreign direct investment (FDI). In this respect, a number of variables affecting the ability of sub-Saharan African countries to attract CDM investment are the same constraints that limit FDI in the region. Studies indicate that multilateral finance predominates in the region, and trying to do carbon investment projects relying on private finance is exceptionally difficult. The continent has a low savings rate and few indigenous financial institutions. This indicates the need for innovative financing arrangements and risk reduction schemes.

MICROFINANCE AND CDM

In the context of promoting a more equal regional distribution of CDM projects, the CDM Executive Board has identified potential synergy between CDM and microfinance activities in least developed countries. This could develop into a major initiative, in combination with a programme-of-activities approach to expand CDM’s usefulness to the poor. Poor people rarely access services through the formal financial sector. They address their need for financial services through a variety of financial relationships, mostly informal. Credit is available from informal commercial and non-commercial money lenders, but usually at a very high cost to borrowers. Savings services are available through a variety of informal relationships, such as savings clubs, rotating savings and credit associations and other mutual savings societies that have a tendency to be erratic and insecure. Provision of financial services for the poor has proved to be a powerful instrument for poverty reduction that enables local populations to build assets, increase incomes and reduce their vulnerability to economic stress. However, nearly one billion people, especially the very poor, still lack access to basic financial services. As such, the Executive Board is naturally interested in exploring the complementarities of microfinance and programmatic CDM, in order to further expand the reach of microfinance and enhance the quality of life of people in developing countries.
Microfinance as a development strategy combines massive outreach, far-reaching impact and financial sustainability, which makes it unique among development interventions. However, it is usually not considered to be a key strategy in addressing climate change. After all, the poor contribute relatively little to the build up of greenhouse gases. Then again, considering that developing countries, and particularly their poorest residents, are among those most likely to be adversely affected by climate change, it makes sense that the Executive Board explore ways to leverage a proven development approach. CDM, a market-based mechanism, might be a perfect match for microfinance, a finance-based sustainable development approach.

RESPONDING AND EVOLVING

The Kyoto Protocol’s first commitment period runs to 2012. Already countries must begin working diligently to craft what will come next. Whatever that is, it should be guided by a long-term emission goal and be clearly anchored in the sustainable development aspirations of Parties. It will need to address adaptation to current and foreseeable impacts, while delivering aggressive mitigation action to minimize further climate change. It will need to establish effective enabling mechanisms to allow emission reductions to be cost effective, while allowing countries with varying national circumstances to actively contribute to the effort. And any agreement will need to stimulate the diffusion, transfer and deployment of existing technological solutions and investment in additional technological solutions.

The clean development mechanism has shown that it can respond and evolve. Its success has led people negotiating the international response to climate change to suggest that market-based mechanisms, such as CDM, could be central to an agreement after 2012. Meanwhile, CDM is up and running and already doing its part to spur investment and reduce greenhouse gas emissions.

Author

Hans Jürgen Stehr is currently serving his second term as Chair of the Executive Board of the Clean Development Mechanism. He is former Director for Research and Development at the Danish Energy Authority, where he was responsible for the implementation of the Danish Energy Research Programme and for developing Danish energy research and innovation strategies. Prior to his assignment on energy research and development, Mr Stehr supervised Danish preparations for the UNFCCC Kyoto conference in 1997 and legal and political follow up activities nationally and in relation to EU regulations. He holds an MA in Law from the University of Copenhagen, and was for many years Assistant Professor of Constitutional Law.

Organisation

The Clean Development Mechanism was established in Marrakesh in 2001, following negotiations at the Kyoto Protocol in 1997 and comes under the remit of the UN Framework Convention on Climate Change (UNFCCC). It was established as a market-based mechanism that would allow projects in developing countries to earn saleable credits for emission reductions that are real, measurable, verifiable and additional to what would have occurred without the project. These credits can be bought by developed countries to help meet their emission targets.

Picture credits: Women harvesting cereal - Glibbery/UNEP/Still Pictures; Traffic jam - Olivier Blondeau/iStockphoto

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