Clean Development Mechanism: an Urgent Need for Reform
May 29th, 2008 by David G. Victor, Stanford UniversitySerious efforts to address the climate challenge face several daunting tasks. Among them is the engagement of developing countries—in particular the emerging markets such as China and India that account for a substantial and growing share of world emissions of greenhouse gases.
Another major challenge is the need to design national cap-and-trade systems so that the costs of compliance are sufficiently predictable that industry can plan investment and so that costs do not unexpectedly spiral up to levels that are politically unsustainable.
Efforts to implement the Kyoto Protocol have combined these two challenges through the mechanism of CDM offsets. Similar ideas are gathering steam in the U.S. debate, with many parties keen to allow liberal use of offsets—including international CDM-like offsets—so that it will be less costly to comply with a cap on emissions. These ideas are misguided. Experience with the CDM suggests that many CDM projects do not reflect real reductions in emissions. Moreover, the actual issuance of emission credits through the CDM mechanism operates at a pace and with exposure to severe administrative bottlenecks that make it unlikely that CDM can supply the emission credits needed, with sufficient reliability, to be a good cost control mechanism. A more transparent “safety valve,” focused solely on the task of cost control, would be much superior.
It is possible to fix the CDM and the U.S. should use its leverage in carbon markets to push for much needed reforms. Improving the quality of the CDM would require much stronger regulatory oversight and much improved verification systems. That approach will also imply that CDM will become a smaller market with a possibly even less predictable supply of emission credits. Such conclusions underscore the need for a separate cost control mechanism since failure to have such a mechanism will generate strong political pressure to relax and ease the CDM rules to generate needed supplies of emission credits and keep compliance costs in a cap-and-trade system within politically sustainable limits.
Finally, in our recent working paper we have raised concerns about offsets as a mechanism to engage developing countries. Ultimately, in order to address climate change on a globalbasis, the energy sectors of all major emitters will have to accept binding limits on their emissions of greenhouse gases. Currently however, most important developing countries are unwilling to enter into discussions that contemplate such limits because they are seen as inconsistent with their development path. Ideally, the financial incentives provided by carbon offsets along with other financial and diplomatic tools would encourage changes in behavior now that will ultimately make the transition to binding emissions limits easier for these understandably reluctant nations. Our analysis of CDM energy sector projects indicates that just the opposite may in fact be happening. The CDM encourages countries to avoid binding limits on emissions and to concentrate emission-reduction activities on marginal investments for which it is easiest to assert that the investment is “additional.”
Serious reductions will require a different strategy involving multiple approaches including a tighter offsets program, a climate fund to finance reductions not amenable to the offsets approach, and investments in more radical changes in energy infrastructures whose effects are necessarily difficult to measure at the margin. Finally, all U.S. efforts towards reducing developing country GHG emissions should be made with a focus on eventual inclusion of these emerging markets in a system of binding limits.
Michael W. Wara and David G. Victor, Stanford University
May 29th, 2008 at 4:56 pm
Wonderful piece up until the last 5 words “a system of binding limits.” As Cooper (1998), Frankel (2004), Nordhaus, Stilgitz (2007) and Mankiw (2008) have explained, caps won’t be accepted, and there’s an obvious alternative — a global carbon-pricing policy.
This requires each country to collect revenue = CP * emissions. The EU can of course keep its cap & trade, they just have to make sure permit prices stay high enough to collect enough revenue. A sliding scale for P based on tons C/capita will address fairness. That leave the price non-uniform, but there’s a simple trading/enforcement mechanism to largely fix that, and in any case the EU’s carbon price is non-uniform between coal and oil by about a factor of 10, as explained here recently.
There’s another inherent problem with buying permits / offsets. Their cost is about double the cost of compliance because they are priced at the marginal cost of compliance. (In practice it’s been far worse). Trading tax rates solves this problem, and allows developed countries to get far more for their dollar spent on reducing developing country emissions.
May 30th, 2008 at 4:16 pm
The Fund mechanism is interesting. As I understand it, Funds would run a set of isolated technology-specific Dutch auctions for “CERs”. This has as least three advantages:
1. It acts as a discriminating monopsonist, capturing the technology-differential producers’ surplus.
2. With technology-specific transactions, it is likely to have much lower contracting and compliance-monitoring costs.
3. The a priori technology-specific allocation of funds moves the “additionality-asssement” mechanism from the project level to the technology level, where it will be more efficient, more transparent, and less subject to self-serving bias.
August 28th, 2008 at 2:02 pm
The major problem in developing countries is a lack of proper information as to the working and benefit of CDM.
The best way to make it work would be to offer direct incentives whereby the upfront project cost is subsidized by amount of expected CDM improvement I have been recently advising a major corporate entity in the process of developing a 1200MW coal based power project. They were least interested in incorporating the ultra super critical technology because they would not accept an up front additional investment and then try reclaim over the life of project. Since they dont have any legal obligation to induct he latest technology, they would rather do without it.
The mechanisim of benefiting from CDM is limited to only very large entities in developing countiries and we need to invest in briniging the concept closer to general public. At the present scenario of regular power outage, the people seem to be least concerned about environment and climate change issue and we need to seriously work on this.