The Clean Development Mechanism (CDM) is a market-based mechanism written into the Kyoto Protocol as a measure aimed at achieving the dual goals of reducing greenhouse gas emissions while encouraging the transfer of technology and expertise to developing countries. The carbon credits generated by CDM projects, called Certified Emissions Reductions (CERs), have become a multi-billion dollar component of the global carbon market. But questions abound about the future of the CDM, and smart carbon shoppers would be wise to prepare.
Expiration Date: 2012
The Kyoto Protocol, including the CDM, is set to expire at the end of 2012. International negotiations are ongoing, culminating this December in Copenhagen, to hammer out a successor agreement that would take effect beginning in 2013. Whether this framework will contain a provision for CDM, and whether and how the CDM might change, remain open questions.
Here is what we do know. While reaction to the CDM has been mixed at best, much of the criticism levied at the CDM has been addressed. For example, after it was revealed that project developers were making windfall profits off of hydrofluorocarbon destruction projects, the CDM Executive Board which evaluates new projects and methodologies no longer accepted projects of that type.
And though some issues remain (notably the backlog of projects waiting to be approved by the Executive Board), the CDM has largely functioned as intended, allowing developing countries to leapfrog many polluting technologies while serving as a cost-containment mechanism for European and Japanese companies looking to reduce their emissions at least cost.
As of now, most industry observers believe that the CDM will continue to function in much the same way after 2012 namely, as a means for more sustainable development and providing cost containment and flexibility in meeting emissions reduction requirements. Indeed, the continuation of the CDM is implied in the most recent outline released by the UN to be discussed at the next round of talks leading up to Copenhagen.
All Eyes on China
That said, however, the CDM landscape could change markedly depending on which countries agree to binding emissions reductions in Copenhagen. China, which is host to more CDM projects than any other country, appears to be inching closer to setting an emissions cap in the foreseeable future. This would end its eligibility as a CDM host country, thereby dramatically reducing the supply of CERs.
Other countries that currently host CDM projects such as South Korea, Mexico, and Brazil could agree to national or sectoral binding emissions caps beginning in 2013, further altering the CDM landscape. By reducing CER supply, such a realignment could significantly increase the cost of meeting reduction requirements in all countries likely to have an emissions cap in place by 2013 including the US.
Yet this uncertainty also represents an opportunity for companies in the US and Europe facing the need to reduce or offset emissions. European firms with compliance obligations can take advantage of comparatively cheap post-2012 CERs, knowing that it is highly likely they will be accepted in a post-Kyoto climate framework.
In the US, although the details have yet to be finalized, the draft version of the Waxman-Markey bill under debate in the House of Representatives would allow up to one billion offsets from international projects, likely including CERs. Savvy buyers would be well-served to explore post-2012 CERs as a cost-effective way to meet emissions reduction requirements.
What to Watch for:
Whether the CDM, or a similar measure, is included in any agreement reached in Copenhagen; if so, post-2012 CER demand (and prices) will likely go up.
Whether China, Brazil, India, and other large developing countries agree to binding emissions caps in Copenhagen; if so, the projected supply of post-2012 CERs will decrease, thereby adding to the potential for CER price increases.
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