whither the cdm? investment outcomes and future prospects
TRANSCRIPT
Whither the CDM? Investment outcomes and futureprospects
Arnaud Brohe
Received: 3 March 2013 / Accepted: 21 June 2013� Springer Science+Business Media Dordrecht 2013
Abstract Following an abrupt fall in carbon credit prices, 2012 has witnessed a disin-
terest on behalf of investors in the Clean Development Mechanism (CDM). In this paper,
we aim to take a step back and provide an assessment of the CDM through a careful
analysis of 6 instrument evaluation criteria. Our study indicates that, despite the important
number of projects developed under the CDM, the initial ambition of a scheme that would
contribute to sustainable development in developing countries has not materialised.
Moreover, the environmental integrity of numerous projects is seriously questioned. Given
the interaction of the mechanism with other national policies, notably in the renewable
sector, the search of carbon reduction opportunities does not lead to cost-effective
abatements. If the CDM governance does not score really well in terms of predictability,
the mechanism’s transparency is an example for the development of future climate and
development policies at a multilateral level. Finally, the lack of consideration for the
demand side of the offset mechanism seriously jeopardises the persistence of this instru-
ment. Therefore, we recommend that any CDM reform considers the demand side, for
instance through the setting of a guaranteed minimum price coupled with an obligation of
repurchase. One cannot expect progress in host countries if new sources of demand for
carbon credits are not rapidly created in developed countries.
Keywords Clean Development Mechanism � Kyoto � Carbon market �Instrument evaluation
1 Introduction
The Clean Development Mechanism (CDM) is the largest carbon-offsetting scheme in the
world with 5,511 registered projects (as of 31 December 2012). With an average price of
A. Brohe (&)Institute for Environmental Management and Land-Use Planning, Free University of Brussels (ULB),CP130/02, Avenue F.D. Roosevelt 50, 1050 Brussels, Belgiume-mail: [email protected]; [email protected]
123
Environ Dev SustainDOI 10.1007/s10668-013-9478-5
approximately €10 between 2006 and 2012, the capital transfer between project developers
and credit buyers is estimated at around €10 billion.
Despite these impressive outputs, the CDM is at a crossroads. Whilst the CDM Exec-
utive Board (CDM EB) recently celebrated the issuance of its one billionth certified
emission reduction (CER) to an Indian biomass project, the world’s only global system of
carbon trading, designed to give poor countries access to new green technologies, has
‘‘essentially collapsed’’ (Harvey 2012). This failure is explained by three main factors:
firstly, the cap on the use of CER within the EU Emission Trading System (EU ETS) has
almost been reached (Shishlov and Bellassen 2012), drying up the main source of demand
for carbon credits; secondly, the competition from cheaper and oversupplied assigned
amount units (AAUs) discourages the purchase of CERs from governments; and finally, the
institutional uncertainty in the future of Kyoto institutions remains a concern for investors.
The impressive price drop, from €9 in September 2011 to less than €1 one year later, is
jeopardising future flows of finance to the developing world and the hopes of project
developers who recently invested in less developed countries (LDCs). On a positive side,
the new ETS schemes in Australia and China might provide some fresh air to project
developers though it is unlikely they will create enough demand (Shishlov and Bellassen
2012). The failure of governments to provide firm guarantees to continue with the system
beyond 2012 has raised serious concerns over its survival.
The objective of this paper is to provide a complete evaluation of the functioning and
results achieved by the CDM up to 2012. This question is particularly timely given the
troubled context of the CDM.
The first section sets out the methodology used for the evaluation and describes our
approach for the data collection. The second section presents the results of our evaluation,
assessing each evaluation criterion individually. The third section draws out the implica-
tions for policy makers and businesses and analyses the (inter)dependences between the
chosen criteria. The final section concludes and identifies areas for further research.
2 Evaluation methodology and data collection
2.1 Research aims
This paper sets out to provide a comprehensive evaluation of the performance of the CDM1
up to 2012. Whereas a substantial body of work exists on the CDM, this work has often
focused on specific aspects or fine-tunings of the mechanism (Paulsson 2009). For instance,
Trexler et al. (2006), Michaelowa (2007), Streck (2010) and Gillenwater (2012) raise
questions about the interpretation of the concept of additionality. Olsen (2007), Schneider
(2007), Sirohi (2007) and Boyd et al. (2009) propose reforms to increase the contribution
of the offsetting scheme to sustainable development. Streck’s research (2010) aims at
improving the governance. Wara (2007) and Schneider (2011) raised concerns over
1 The Clean Development Mechanism (CDM) is a mechanism established by the Kyoto Protocol whoseaims are to reduce greenhouse gases (GHG) emissions and promote sustainability principles in countrieswithout emission limitation while simultaneously assisting countries with binding targets (Annex B Parties)in achieving compliance with their objective. For every monitored tonne of carbon dioxide equivalentreduced or absorbed through a registered project, an investor receives a carbon credit called CertifiedEmission Reduction (CER). These credits can be sold, under certain conditions, on different carbon markets.The price of CERs fluctuates depending on the scarcity of allowances in cap and trade schemes and/orrestrictions on the use of credits.
A. Brohe
123
industrial gases projects, whilst Haya (2009) proposes to exclude large hydro projects from
the CDM given their negative social and environmental impacts. With our evaluation, we
aim to take a step back and study the overall performance of the CDM in a systematic way.
According to Scriven (1991), an evaluation refers to the process of determining the merit,
worth and value of something, or the product of that process. Vedung (1997) limits
evaluation to retrospective assessment and considers that evaluations have a role to play in
future, practical action situations. Evaluations being normative by nature, they need some
criteria on which to base judgments (Weiss 1998). Note that the release of the final report
of the High-Level Panel on the CDM Policy Dialogue coincided with the completion of our
research (CDM Policy Dialogue 2012). When appropriate, we compared the results of our
analysis with this ‘‘official’’ review of the CDM.
2.2 Criteria for CDM evaluation
Our selection of the evaluation criteria is based on the reviews of the literature in the
context of environmental policy (Gupta et al. 2007; Mickwitz 2003).
Environmental and sustainability effectiveness is used to assess the degree to which the
CDM meets its environmental and sustainability objectives. It is mostly analysed in terms
of additionality and sustainability goals achievement. The questions that need to be
answered to assess this criterion are as follows:
• What is the additionality of emission reductions?
• Are there any indications as to how the CDM contributes to sustainability?
Cost-effectiveness refers to the extent to which the CDM can deliver carbon abatements
and sustainable development solutions at a minimal cost. It is analysed through a review of
investment costs and achieved reductions for different project types. The evaluation of
cost-effectiveness was based on an analysis of the investment costs compared to the GHG
reduction achieved in each project type. Two questions led our research:
• To what extent investments were spurred towards the most cost-effective reductions?
• What are the key sources of transaction costs and how do they affect the cost-
effectiveness?
Distributional considerations such as fairness and social justice are clearly a key
parameter of climate policies, and some authors even argue that this is a key principle for
any climate policy which wants to avoid conflict (Rose 1990; Solomon and Ahuja 1991;
Grubb 1995). The distributional considerations are analysed at two levels. Firstly, we
consider the fairness of the scheme in host countries. Then, we consider the distributional
implications between ‘‘developed’’ and ‘‘developing’’ nations (Annex B and non-Annex I
Parties). Our two guiding questions are as follows:
• Does the CDM contribute to poverty alleviation at a local level?
• Is the CDM a fair mechanism for developing and emerging countries?
Predictability is a criterion that aims to evaluate whether it is possible to foresee the
outcomes of the policy instrument. Businesses and other parties involved in the CDM want
to be able to predict the consequences of the rapidly evolving governance of this flexibility
mechanism (Backstrand 2010). In order to be successful, a mechanism such as the CDM
needs to create an economic environment in which business risks may be rationally
assessed. This can only be achieved if the participants consider that the process is pre-
dictable and fair. Therefore, we have asked the two following questions:
Investment outcomes and future prospects
123
• What is the perception of the project participants and stakeholders in terms of
predictability?
• What factors influence the predictability of the decision-making process?
Transparency is used to assess the degree to which the CDM and the projects developed
under this mechanism are observable for outsiders. It has been argued (e.g. Fung and
O’Rourke 2000) that sometimes much of the impacts of some environmental policy
instruments are because information is made public that had not been available previously.
We will analyse whether this was the case for the CDM. In our evaluation, we assess the
transparency from two different perspectives. Firstly, we take the viewpoint of stake-
holders (local, international NGO, academic, public authorities) who want enough infor-
mation to understand the environmental, social and economic impact of new CDM
projects. Then, we analyse whether the available information benefits or harms parties that
are not concerned by the CDM. Consequently, our two research questions are as follows:
• Is there enough information on the CDM projects?
• Does the transparency of the CDM lead to unexpected impacts (positive and negative)?
Persistence assesses whether the effects are lasting and the instrument sustainable. Due
to the complexity of the CDM governance and in particular due to its reliance on private
investments and other schemes to create a demand and price for carbon credits, the
question of persistence is particularly timely. Our evaluation considers both internal and
external factors which might affect the long-term viability of the scheme. In this respect,
the following questions were used to guide our analysis:
• Is the CDM a long-term instrument to mitigate GHG in developing countries?
• What main factor(s) affect the future viability of the CDM?
2.3 Methods used for our data collection
The data collection methods used to feed our assessment varies in function of the evalu-
ation criteria and the defined guiding research questions. Firstly, we have relied on primary
sources from project developers available on the UNFCCC Website and aggregate data
compiled by different organisations active in the monitoring and/or promotion of the CDM
(UNEP RISØ, IGES, World Bank, CDC Climat). Reviews and academic publications were
used to evaluate criteria which could not be assessed when relying exclusively on primary
data. Thirdly, background legal documents were examined in detail. Finally, we incor-
porated the results of a dozen of thematic interviews with policy makers and relevant
stakeholders we carried out in the context of a study on the integrity of the CDM com-
missioned by the European Commission (Ruthner et al. 2011) as well as the results of a
survey we conducted at Carbon Expo 2012 Fair held in Cologne, Germany, in June 2012.
Despite our willingness to include comments from experts from both Annex I and non-
Annex I countries, there might be some bias as the majority of our respondents were based
in Europe. Two hundred paper questionnaires were distributed to carbon markets experts
and 74 were sent back completed.2 The aim of this survey was to capture the sentiment of
2 A total of 74 completed reply forms were received, mostly from carbon experts working in verification/audit, finance or government (including international organisations). Some 73 % of the respondents work inmultinational organisations. On average, the respondents have 10 years of professional experience of whichfive are in carbon markets.
A. Brohe
123
market players and project developers following the abrupt drop in carbon prices as well as
to understand the perceived benefits and limitations of the CDM.
3 Results of the evaluation
3.1 Environmental and sustainability effectiveness
As an offset mechanism, the CDM does not generate additional GHG reductions globally.
Indeed, every credited emission reduction made in a country without binding target can be
sold to cover an extra emission in a country with a binding target. In other words, a
perfectly functioning CDM scheme, where all credited reductions would be measurable,
real and additional, would at best be neutral. The neutrality of the CDM is only maintained
if reductions generated by the CDM project activity are demonstrably additional compared
to a scenario without the policy intervention (i.e. a hypothetical scenario without the
development of the project).3 The ability to deliver such a result depends heavily on having
a reasonably effective way to achieve additionality on an aggregate basis and to set a
baseline such that the number of credits issued does not, in total, exceed actual reductions.
However, the concept of additionality is difficult to handle for projects developers and the
current tool for the demonstration of additionality is not a good filter. For Schneider
(2007), the current barrier analysis is ‘‘unlikely to result in a reasonable differentiation
between additional and non-additional projects’’. To illustrate this, Haya (2009) has shown
that many hydro projects have been built in China with these same barriers whilst not
benefitting from CERs. The guidance for investment analysis or common practice dem-
onstration is also ambiguous.
For instance, the discount rate used in investment analysis ‘‘is often chosen in an
arbitrary fashion’’ (Michaelowa 2007). The same is true for CERs prices used in this
analysis as we found out that there is a factor of up to 10 between them (e.g. €3.3/CER for
project 8, a landfill project in Brazil vs. €33 for project 5,186, a wind project in India). CER
values above €25 are dubious as there is no proof of transactions at such a high price on the
primary market and it is possible that the financial support of CERs has been exaggerated
in order to help demonstrate the financial additionality.
Registered projects are distributed across a wide range of technologies (cf. Fig. 1).
However, taking the size (i.e. number of credits generated by a project) into account, larger
projects are concentrated in the destruction of industrial gases (65 %) as we see in Fig. 2.
For example, 43 % of the credits issued come from the destruction of HFCs, which
accounts for just 0.6 % of registered projects.
In order to assess the overall environmental integrity of the scheme, we have split CDM
projects into two groups and analysed the project types that yielded most credits in each
category. The first group comprises 3,359 projects where external factors such as energy
prices remain the main driver of profitability. Wind and hydro projects represent the lion’s
share of this category (both in terms of issued credits and number of projects). The second
group includes all projects where carbon credits were the main source of income such as
methane or industrial gases destruction (937 projects by July 2012).
3 The usual definition of additionality considers that a CDM project activity is additional if it createsemissions that would not have happened in a scenario without the project. Gillenwater (2012) critiques thisdefinition because it is imprecise and circular. For this author, the failure to specify a policy intervention hasabandoned additionality and baseline assessments to politics and ad hoc justifications.
Investment outcomes and future prospects
123
In a renewable energy project, it can be problematic for an investor to demonstrate that
the absence of CERs revenues would have prevented the investment as power sales (or
savings for efficiency projects) remain the main source of income and profitability. The
same is true for projects in transport where ticket sales represent a much larger share of
revenues and where public subsidies are often needed to ensure financial viability (Table 1
shows that projects in transport only earned CERs revenues to cover 0.04 % of the initial
investment). On average taking CERs revenues into account raised the IRR of wind pro-
jects from 7 to 9.8 %. For hydro projects, the profitability raised from 7.6 to 11.2 %. In
both cases, expected CERs revenues helped go above the profitability benchmark meaning
that the project passed the investment analysis. However, several analysis and opinions
contradict the fact that those projects were developed thanks to carbon credits revenues
(Schneider 2007; Wara and Victor 2008; Haya 2009; interviews with project developers).
Fig. 1 Number of projects per category
Fig. 2 Issued CER per project category
A. Brohe
123
Ta
ble
1In
ves
tmen
tsan
dC
ER
sre
ven
ues
inC
DM
regis
tere
dpro
ject
s(A
ugust
2012)
CD
Mp
roje
ctty
pes
Inst
alle
dca
pac
ity
(MW
)
MW
per
type
(%)
Inves
tmen
tin
regis
tere
dpro
ject
s(m
illi
on
US
$)
Inv
estm
ent
per
typ
e(%
)E
stim
ated
CE
Rre
ven
ue
aso
fA
ug
ust
20
12
(mil
lio
nU
S$
)
CE
Rre
ven
ue
per
typ
e(%
)C
ER
rev
enu
e/in
ves
tmen
t(%
)
AF
OL
U0
03
76
0.2
42
0.4
11
.2
Bio
mas
sen
erg
y1
2,0
42
3.1
5,9
51
2.8
25
62
.54
.3
Co
alb
ed/m
ine
met
han
e1
,469
0.4
1,1
96
0.6
15
91
.61
3.3
EE
resi
den
tial
sect
or
00
10
60
.05
10
.00
.9
EE
sup
ply
side
78
,01
32
0.1
12
,98
86
.21
70
.20
.1
Fo
ssil
fuel
swit
ch4
0,3
29
10
.41
1,7
31
5.6
34
83
.53
.0
HF
Cs
00
.07
60
.04
4,2
89
42
.55
,60
8.6
Hy
dro
11
0,2
29
28
.45
8,8
45
28
.19
78
9.7
1.7
Lan
dfi
llg
as2
,008
0.5
2,7
22
1.3
25
62
.59
.4
Met
han
eav
oid
ance
6,4
59
1.7
1,3
93
0.7
11
71
.28
.4
N2O
00
.04
82
0.2
2,2
02
21
.84
56
.9
PF
Cs
and
SF
60
0.0
19
30
.11
80
.29
.4
So
lar
6,6
55
1.7
3,4
05
1.6
10
.00
.04
Tra
nsp
ort
00.0
12,5
61
6.0
50.0
0.0
4
Win
d1
15
,77
82
9.9
83
,11
93
9.6
74
27
.40
.9
Oth
er1
4,6
72
3.8
14
,52
77
.06
50
6.4
4.4
To
tal
38
7,6
53
10
02
09
,67
31
00
10
,08
01
00
4.8
So
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r’s
anal
ysi
sb
ased
on
UN
EP
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pip
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a
Investment outcomes and future prospects
123
One interview with a project developer active in China revealed that the impressive
growth of the Chinese wind energy industry4 has been driven by national renewable energy
policies and cannot be attributed to the CDM. However, despite a generous feed-in tariff,
90 % of wind farms in China apply for CDM registration. The same is true for hydro
projects as the vast majority of large hydro projects nearing completion in China are now
applying for CDM registration. Globally, the number of hydro projects which registered on
a yearly basis was multiplied by four between 2007 and 2011 (cf. Fig. 3). Since almost all
new hydro and wind power plants in China apply for CDM registration, this means that
should these projects be truly additional, there would be no new hydro or wind plants built
in China without the CDM, which is a very implausible scenario given the political support
to the power sector diversification (Wara and Victor 2008).
Whilst at the dawn of the CDM, one was expecting the offsetting scheme to contribute
mostly to the diffusion of renewable and energy efficiency technologies, 15 years later
70 % of certified reductions come from projects that were not linked to the production or
management of energy. The success of this type of project is explained by their obvious
additionality,5 limited investment costs (end-of-pipe technologies) and huge return on
investment as illustrated in the last column of Table 1. However, it has been shown that the
destruction of HFC-23—a by-product from the manufacture of refrigerants—can create
distortions in the carbon market. Wara (2007) found that developers of HFC-23 projects
can earn twice as much from the destruction of this gas than from the production of the
refrigerants themselves (their core business). It is a major distortion of the market since
these manufacturers have an interest in producing more refrigerants than are needed for the
market because their production is subsidised by the CDM (Schneider 2011).
Contributing to sustainable development in the host country was explicitly one of the
objectives of the CDM (UNFCCC 1997). The Marrakech Accords (UNFCCC 2001)
emphasise that it is the host country’s prerogative to define whether a project contributes to
sustainable development. In most countries, this means that a Designated National
Authority (DNA) evaluates project documentation against a set of pre-defined criteria,
which tend to encompass environmental, social and economic aspects of sustainability.
Consequently, non-Annex I countries can define sustainable development criteria for CDM
projects in their country according to their own sovereign requirements and, in most cases,
their guidelines are vague and not stringently applied (Gillenwater and Seres 2011). The
0
20000
40000
60000
80000
100000
120000
140000
0 100 200 300 400
2005
2006
2007
2008
2009
2010
2011
Average expected CERs per registered hydro project
Number of Projects
Fig. 3 Evolution of registeredCDM hydro projects between2005 and 2011
4 The installed capacity was multiplied by 50 between 2005 and 2011 where it reached 62 GW.5 In the absence of the carbon revenues, there is no incentive to eliminate HFC-23, N2O or CH4.
A. Brohe
123
absence of international sustainable development standards combined with a competitive
CDM market and little or no price premiums to be gained from investing in projects with
higher contributions to sustainable development has resulted in a trade-off in favour of the
most cost-efficient emission reduction projects (Ruthner et al. 2011). The absence of
monitoring requirements also makes it difficult to evaluate the sustainability performance
of projects and to control the negative impacts of some CDM projects on human rights and
other harmful issues. Finally, it is also interesting to notice the negligence of sustainability
criteria by Annex I countries (see Teravainen 2009 for a case study with the Finnish
climate policy). Annex I countries often use the CDM with a strongly nationally oriented
approach to promote national technology, using the CDM as an opportunity to boost
exports and often failing to consider the development needs at the local level. This strategy
is however compatible with one of the perceived benefits of the CDM, namely its con-
tribution to technology transfer. For instance, our Carbon Expo survey indicated that two-
thirds of the respondents consider that the CDM leads to technology transfers.
According to the findings of three interviews with NGO and governmental experts, large
hydro, supercritical coal power plants and industrial projects have lower or no sustainable
development benefits compared to small projects. Therefore, the fact that by 2012, 90 % of
issued CERs originated from projects avoiding more than 50,000 tonnes of CO2e annually
(IGES 2012) might limit sustainability promotion. The link between the size of a project—
expressed in CERs—and the lack of performance in terms of sustainability contribution is
also confirmed by Sutter and Parreno (2007), who assessed the contribution to sustainable
development of 16 registered CDM projects and whose findings showed that less than 2 %
of the credits generated originate from projects that contribute significantly to sustainable
development in the host country.
Given the fact that large hydro projects can score particularly bad in sustainability
(Lohmann 2006; Haya 2009), we analysed the trends in that particular sector. Our analysis
is synthesised in Fig. 3 and indicates that the average size of hydro projects has signifi-
cantly increased (multiplied by 5 between 2005 and 2011) along with an increase in the
number of registered projects (multiplied by 15 between 2005 and 2011). Whilst most
projects were small scale (below 15 MW) in 2005 with an average power capacity of
7 MW, in 2012 many registered projects are large scale with an average power capacity
above 30 MW. As a result of this rapid expansion, the share of credits issued from hydro
projects is expected to double. Setting a limit on the issuance of credits from large hydro
might well be needed in order to maintain control over the oversupply of credits. Some-
what surprisingly, given that the audience was comprised largely of managers from the
private sector, 75 % of our Carbon Expo survey respondents agree that there should be a
limit on the issuance of credits from large hydro, with only 6 % strongly disagreeing with
this statement.
To conclude this section, note that the registration of supercritical coal power plants
under the CDM is also a source of concern for the environmental integrity of the scheme.
Those projects, responsible for the release of huge absolute emissions, will receive millions
of credits due to their higher efficiency compared to older technologies despite the fact that
they are often economically viable without carbon credits.
3.2 Cost-effectiveness
The philosophy behind the CDM was to bring cheaper emissions reduction options to
developing countries compared to those that can be achieved in developed countries.
Whilst cost-efficient reductions have been realised in industrial gases, the most prevalent
Investment outcomes and future prospects
123
investments are very cost-ineffective reductions in wind and hydro projects (cf. Table 1).
Costly renewable energy projects account for more than 70 % of the total investment.
Somewhat surprisingly, energy efficiency projects, which are often credited with low or
even negative marginal abatement costs (Enkvist et al. 2007), have yielded very few
reductions for an initial investment of US $13 billion.
Based on the investment costs declared in the project design documents (PDD), HFC
projects are the least capital intensive projects. With a total investment of US $76 million,
they represent only 0.04 % of the total investment spurred by the CDM (cf. Table 1). At
the other side of the spectrum, wind and hydro projects are among the most capital intense
projects. In total, the 116 GW of installed capacity of CDM wind power projects6 and 110
GW of installed capacity of hydro projects represent an investment of US $142 billion or
68 % of all investments in CDM projects.7 Note that the capital flow to hydro and wind
projects do not necessarily represent foreign investment from a developed country, nor
technology transfers, as many Chinese and India wind and hydro projects are developed
unilaterally (i.e. development and financing comes from the developing country itself).
Analysing the penultimate column of Table 1, it is particularly remarkable that AFOLU
(agriculture, forestry and other land use), energy efficiency in the residential sector and
transport projects received less than 1 % of the credits whilst these sectors account for
more than half of developing countries emissions.
At the individual level, the distribution of carbon credits is also unequal. With an initial
investment of only US $0.2 million, the N2O destruction project in Onsan, South Korea,
received more than 65 million credits, an amount large enough to offset the yearly GHG
emissions of the Republic of Ireland. The 13 registered projects which issued the largest
amount of credits all relate to the destruction of N2O or HFC and received more than 50 %
of the credits. The first decile of most profitable registered projects received more 90.5 %
of the credits, leaving only 9.5 % of the issued credits for the remaining 3,860 registered
projects.
Quite disturbingly, the CDM does not reduce the global cost of reduction because the
marginal cost of abatement is not an investment driver, especially since largest investor in
the CDM are typically utilities from emerging companies with no binding target and
therefore no abatement costs (see Lutken 2012). Also, whilst the CDM has reduced the cost
of compliance for (installations in) Annex I countries, several examples show that GHG
reductions could have been achieved at a much lower cost if ‘‘own-actions’’ were taken by
developed and developing countries. The destruction of industrial gases, a very cost-
effective abatement opportunity, clearly illustrates this.8 In Table 1, we see that invest-
ments in HFC-23 projects only cost €76 million. This would have been the abatement cost
to capture and destruct HFC-23 if those facilities were fully and directly subsidised;
whereas via the CDM, it cost more than €4 billion to CERs buyers. The CDM Policy
Dialogue (2012) proposes a radical response to this situation and considers that one should
stop registering new projects involving gases with comparatively low marginal costs of
abatement (i.e. HFC-23 and N2O from adipic acid plants) and that new regulation should
ensure the phase-out of these industrial gases.
6 This is a power capacity equivalent to the installation of approximately 60,000 turbines.7 This is a power capacity equivalent to 5 times the Three Gorges Dam.8 The main reason why industrial gases have low abatement costs is that they have a very high globalwarming potential. Therefore, the destruction of a small quantity results in large volumes when aggregatedinto CO2 equivalent.
A. Brohe
123
High transactions costs are also an important parameter which can affect cost-effec-
tiveness. This is particularly critical for developers of smaller projects. According to
estimates based on interviews with project developers and the analysis of offers from
service providers, validation and registration costs range from €50,000 to €100,000 for a
small-scale project and between €100,000 and €200,000 for other CDM projects (Brohe
et al. 2009). In some cases, transaction costs can represent as much as €2.5 per issued CER.
The number of credits delivered by the Programme of Activities9 is still too small in 2012
to assess whether micro and small projects will be able to cross the transaction cost barrier,
but given that prices went below €1 at the end of 2012, it is unlikely that those projects
could be profitable and survive without additional subsidies.
3.3 Distributional considerations
The geographical distribution is quite concentrated with more than 90 % of credits issued
coming from just three countries (China, India and South Korea, cf. Fig. 4). This uneven
distribution has long been recognised (Jung 2006) but, despite several reforms aimed at
addressing this, the top three beneficiaries actually increased their total share by more than
10 % between 2008 and 2012. The top seven countries in terms of credits issuance are all
countries which have experienced rapid growth over the last decade. Only 0.02 % of the
credits originate from one of the 48 least developed countries (LDC), a ratio which is 700
times less than LDC’s share in non-Annex I countries total population. China and India
together account for 69 % of registered projects before July 2012, an increase of more than
10 % on February 2009 (cf. Fig. 5).
The unequal distribution of projects, together with the dominance of large industrial and
energy projects, significantly limit the role of the CDM in poverty alleviation. However,
the recent development of PoA has allowed the development of projects which contribute
to poverty alleviation and social justice. Despite this progress, the fact that GHG emissions
in the baseline scenario of most LDC are already negligible remains a serious barrier. The
Fig. 4 Top countries by issued CERs
9 Whereas stand-alone CDM projects must be registered individually by the CDM EB, a PoA needs to beregistered only once by the CDM EB. After that, it can include an unlimited and unspecified number ofindividual CDM Programme Activities (CPAs) without recourse to the CDM EB.
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development of ‘‘suppressed demand’’ guidelines which allow a ‘‘minimum service level’’
in the baseline scenario, i.e. a baseline when the minimum human needs, such as energy for
lighting, cooking and water supply, are satisfied, is especially important for the development
of projects in poorer countries but might well prove insufficient given the barriers in LDCs.
When one assesses the fairness of the CDM in the context of a future global agreement,
one must realise that the absence of strict enforcement mechanisms together with several
loopholes in the allocation and accounting of Kyoto units jeopardises the distributional
objective of the CDM. Canada’s withdrawal from the Kyoto, the overallocation of assigned
amounts and the large amount of non-additional offsets from land-use activities in Annex I
countries (e.g. art 3.4 of the Kyoto Protocol was very beneficial for a country like Aus-
tralia) are all factors that have diminished the demand for CERs (and hence the price and
capital transfer to developing countries). Low prices on the CER market, which are mainly
explained by the absence of demand from the developed world, will inevitably create
disappointment and frustration in the developing world and seriously limit the willingness
of developing countries to use similar instruments which are linked to (financial) market,
especially when unilateral and unexpected decisions from developed countries can threaten
the financial viability of thousands of development projects.
3.4 Predictability
Our interviews with project developers and investors reveal that the decisions and inter-
pretations of the EB are perceived as unpredictable, notably because the tools for addi-
tionality assessment and associated guidance are ambiguous, lack objective and transparent
criteria and contain unclear definitions of several concepts (e.g. ‘‘first-of-its kind’’ and
‘‘common practice’’). This situation leads to subjectivity in both interpretation and
application, in addition to unpredictability concerning whether projects might be reviewed
and rejected. The lack of institutional memory, due to the rotation of the EB members, and
the insufficient technical expertise of some members are two factors that increase the risk
of unpredictable decisions, as already underlined by Streck (2007). The CDM Policy
Dialogue confirms this perceived lack of predictability when it concludes that ‘‘the CDM
remains burdened by a perception that it is slow, opaque, unresponsive and politicized’’.
Fig. 5 Evolution of registered projects by country
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123
3.5 Transparency
Despite the perceived lack of transparency in the decision process, one can argue that the
CDM framework is quite transparent as all the information about the projects is audited
and made publicly available online. Moreover, every issued CER is traceable on a registry
with a serial number that links the credit to the project and its corresponding issuance
period. In theory, the public scrutiny of the CDM plays an important role and allows the
possibility of public participation at the project level. This transparency enabled con-
structive criticism to emerge from a great variety of stakeholders: project developers,
through the International Emissions Trading Association (IETA); auditors, through the
Designated Operational Entities and Independent Entities Association (DIA), academic
community and NGOs such as CDM Watch,10 Sandbag or WWF (Shishlov and Bellassen
2012). This criticism helped the CDM EB identify pitfalls and loopholes in the framework
and fed several reforms (on HFC-23 accounting, E?/E-, PoAs, qualification of EB
members, standardised baselines guidelines, etc.).
The CDM has also improved market transparency in several sectors, notably in the energy
and refrigerant industries. This has contributed to creating greater investor confidence in clean
technologies. The mechanism has positively influenced the awareness and understanding
about clean technologies, emission trading and future action for climate change both in the
private and public sectors. After 10 years of development, the CDM has produced a library of
over 150 standardised methodologies which cover a diversity of project types and standardised
manuals, rules and templates for auditing GHG emissions are now available. A great deal of
time and resources have been expended developing, reviewing, approving and testing meth-
odologies (Gillenwater and Seres 2011), and this material might benefit any future climate
policies, including the development of nationally appropriate mitigation actions of developing
country parties (NAMAs) or the improvement of measurement, reporting and verification
(MRV) rules. The CDM merits in terms of transparency also include its contribution to the
development of a global registry system and international financial system for carbon trading
which might be useful for any future GHG emissions global pricing scheme.
3.6 Persistence
The CDM, also known as the ‘‘Kyoto surprise’’ (Werksman 1998), was not intended as a
long-term solution to rising emissions from the developing world. According to a nego-
tiator from a developed country, the CDM was rather seen as a transitional step until the
most advanced developing countries were able to accept binding targets.
Clean Development Mechanism projects have been developed between 2005 and 2012
mainly because project developers thought that the carbon pricing signal created in Annex
B countries would be sustainable and would create a demand for CERs at an acceptable
price. Now that prices have plunged and the EU has set a strict limit on the number of
credits which can be used by EU ETS installations, the demand for CERs is drying up.11
Following a plunge in prices, 2012 has witnessed a disinterest on the part of investors in the
CDM, as confirmed during our survey at Carbon Expo in June 2012. Since the primary
driving force for project developers should—according to the additionality requirement—
10 CDM Watch was renamed Carbon Market Watch in November 2012, as this NGO now wishes to expandits work beyond the CDM, yet another sign that the future of the CDM is not bright.11 Note that the CDM represents a small portion of the overall carbon markets. According to World Bankfigures (2012), the trade of CERs represented approximately 13% of the total trade of carbon units in 2012.
Investment outcomes and future prospects
123
be the value of carbon credits, fewer additional projects will be registered and one must
wonder if and how the CDM can survive the current CER crash (Fig. 6).
4 Discussion
A major insight emerging from this evaluation is that the CDM presents much contrasted
results. Whilst the scheme is unique in many respects and can be considered a success
given its contribution in capital, technology and skills transfers towards developing
countries as well as its influence on the development of new carbon-accounting method-
ologies, the overall evaluation has highlighted many limitations, flaws and unsolved issues.
The problem is that the CDM’s proven performances against the formal objectives (sus-
tainable development as defined by the host country and additional GHG reductions, as
assessed by accredited third parties and ultimately the CDM EB) are less obvious than the
achievements of other optional expectations (technology transfer, foreign investment,
capacity building, etc.).
In the light of the evaluation results, we will now briefly revisit the criteria. The overall
impact of the CDM has probably been larger than what was expected during the negoti-
ations of the Kyoto Protocol. In 1997, no one could have expected that 15 years later more
than 5,500 projects would be registered and that the mechanism would have contributed to
the development of projects whose total value exceeds US $200 billion.12 When it comes
to environmental impact, one must also realise that the reduction volume remains marginal
compared to the growth witnessed in emerging countries. For instance, whilst China issued
131 million credits in 2011, its emissions increased by more than 800 million tonnes of
CO2 in the same year (BP 2012). The Chinese trend highlights the limits of a bottom-up
approach and the rationale for a sectoral approach where sector-wide emissions baselines
are defined nationally (or even on a regional or global scale, in sectors with a high risk of
carbon leakages) and reductions credited when below the targeted baseline. Similarly with
0
2
4
6
8
10
12
14
16
18
CER prices
EUA prices
Fig. 6 Evolution of CER and EUA prices between January 2011 and December 2012 (spot prices)
12 This amount represents the total investment leveraged by CDM projects. This is approximately 15 timesbigger than the total value of carbon credits generated by the CDM.
A. Brohe
123
PoA, this approach avoids project-by-project additionality demonstration and may help
achieve a wider coverage.
As additionality remains a complex and unsolved issue, given its counterfactual nature,
future mechanisms should limit the subjective element of an approach which aims to
understand project developers’ motivations. One way could be to develop positive/negative
lists, i.e. a list that comprises of specific project types of a particular size. The projects
which meet the eligibility criteria of the list are automatically considered as additional.
This concept of establishing a positive additionality list ‘‘is easy to implement and, if
applied conservatively, less prone to continuous controversy than the project-by-project
additionality testing’’ (Streck 2010). Similarly, a negative list includes project types that
are automatically deemed non-additional and are thus excluded from the CDM. This
concept of positive and negative lists has also been highlighted by the CDM Policy
Dialogue as one way to solve issues surrounding additionality.
Despite its stated aims, the CDM is not an instrument fit for purpose when it comes to
sustainability and development in poorer communities. Although not covered in our
evaluation of the mechanism, imposing demand-side restrictions, such as EU regulations
on credits issued from large hydro and industrial gas projects might be the easiest way to
improve the overall sustainability of the CDM. However, credits buyers are not as legit-
imate as UN bodies to set quality rules and one might fear that political motives will
ultimately guide future regulations led from the demand side alone.
More fundamentally, the mechanism has also experienced some flaws which contradict
the initial assumption that it would lead to cheap reductions. Our analysis shows that the
majority of the investment is directed to technologies which are excessively expensive for
developing countries. The structure of the CDM is not designed to generate the most cost-
effective reductions. More worryingly, when the mechanism has allowed the detection of
highly cost-efficient reductions, such as in the case of industrial gas destruction, this has
led to perverse incentives and strategic behaviours at the expense of the environmental
integrity of the scheme. The scale of transaction costs is likely to be different for each
project but transaction costs appear to remain a major issue only for smaller projects.
However, with declining prices for CERs, transaction costs could become problematic for
more projects.
There is an uneven distribution of cost and benefits with both demand and supply
concentrated in certain sectors and in certain countries. This seriously limits the global
outreach of a UN scheme and raises ethical questions as few actors benefit from the scheme
and least developed countries are left behind. Also, with regard to equity, one should also
understand that unilateral decisions or actions from rich countries can have a significant
impact on the demand for credits and ultimately the financial compensation developing
countries can expect from the mechanism.
Predicting the outcome of validation and registration processes remains challenging for
project developers. The high risk of unexpected rejection has even led some investors or
banks to disregard carbon credits whilst their actual purpose is to motivate the initial
decision to invest. As a novel instrument whose risks cannot be assessed by economic
players, and which is likely to miss its target, the lack of persistence and the rapidly
changing rules are clearly an issue for a mechanism targeted towards the private sector.
The CDM Policy Dialogue clearly identified the promotion of regulatory certainty as a key
and urgent reform.
Perhaps the criterion where the CDM scores best is transparency. The level of trans-
parency achieved in the CDM should guide the development of future support schemes for
mitigation actions in developing countries. The transparency of the decision-making
Investment outcomes and future prospects
123
process during registration can certainly be improved, for instance through the establish-
ment of an independent mechanism for appeals and grievances.
Ensuring the permanence of market-based mechanism is a key concern for project
developers of infrastructures who generally invest for a long time frame. The price
uncertainty is an important element to bear in mind. Financial incentives and solutions
should be found to limit the vulnerability of developing countries.
The consequences of the 2012 price crash, which remain to be evaluated in greater
detail, should be borne in mind before implementing similar schemes (e.g. REDD?13).
Although it is beyond the scope of this paper to find a solution to fix the pricing of CERs,
we suggest that setting a minimum price and coupling it with an obligation to repurchase
from Annex B parties might provide more stability to project developers and developing
countries alike, and ultimately reinforce the fairness, predictability and permanent char-
acter of the mechanism. A less radical route to increase prices was also proposed by the
CDM Policy Dialogue which proposed that ‘‘nations actively consider the establishment of
one or more funds to purchase carbon credits and stabilize carbon prices in order to restore
market confidence about future prices’’.
The results from this study confirm that most reforms are the result of trade-offs
between criteria. One can observe that the object of each criterion used is not completely
apparent nor totally independent from the rest. Improving one policy objective can often
only be achieved at the expense of other(s), so trade-offs will have to be found. For
instance, improving cost-effectiveness can be achieved at the expense of the environmental
integrity, sustainability or even transparency. Likewise, the transparency of the mechanism
has led to numerous reforms which have had an impact on predictability.
5 Conclusion
The objective of this paper was to provide a complete evaluation of the functioning and
results achieved by the CDM up to 2012.
The evaluation has shown that, left to market forces, the CDM has primarily focused on
large emerging economies such as China, India, South Korea and Brazil. The results of the
assessment indicate that neither Annex B countries nor host countries have any incentives
to implement strict sustainable development criteria which led to a focus on cheap
emissions reductions at the expense of sustainability.
If the evolution of the CDM has followed a learning-by-doing approach, the reforms
that have been developed to respond to the main criticisms have not yet borne fruit.
Moreover, the current state of oversupply in the market is likely to impede the success of
these reforms. The barriers for smaller projects remain and our analysis of the most recent
data shows that measures such as the development of PoA or the introduction of suppressed
demand in baselines have not yet materialised in the issuance of credits from LDCs.
Disturbingly, transport, AFOLU and residential sectors remain largely excluded from this
support mechanism whilst they are the main source of emissions in developing countries.
Despite these issues, the CDM experience can also serve as an important lesson for the
development of new mitigation instruments in developing and emerging countries. The
CDM has provided a laboratory to better understand how to regulate and support carbon
mitigation projects; it has enabled developing countries to gain first-hand experience in
addition to enhancing both their local human capacity and institutions for managing and
13 Reducing Emissions from Deforestation and Forest Degradation.
A. Brohe
123
controlling GHG emissions. It has contributed to the professionalisation and development
of verification and carbon finance activities which together have built a significant, but not
necessarily resilient, carbon market infrastructure for project development. According to
the CDM Policy Dialogue, the CDM should assist with the design of new financing
instruments, including the Green Climate Fund. However, given the fact that unregulated
demand and supply of credits led to the current crisis, one must wonder if it is not the
Green Climate Fund which should help maintain the CDM. Clearly, interventions will be
needed, both on demand and supply sides, if we want the CDM to survive this decade. The
decision taken in Doha to extend the Kyoto Protocol by eight years is not a sufficient signal
as the signatories with commitments only account for 15 % of world emissions and there
are no provision to address the oversupply of allowances and credits.
The most critical issue for the CDM (or any future similar international baseline and
credits scheme) is whether there will be a price signal that encourages additional emission
reduction in host countries. Given the current state of the EU ETS and the newly estab-
lished restrictions on the use of CERs, the CDM experiment might well significantly be
reduced in both scope and size, or even disappear if no immediate actions are taken. This
may have negative consequences as a disintegration of the CDM could set back interna-
tional climate cooperation, as forewarned by the CDM Policy Dialogue.
Acknowledgments The completion of the research for this article was enabled by generous funding fromthe David and Alice Van Buuren Foundation. I thank the dozen of policy makers who accepted to respond tomy interviews as well as the 74 participants who answered my survey conducted at Carbon Expo (Cologne,Germany) in June 2012.
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