The European Commission is taking a big gamble with the CDM
By Gareth Brydon Phillips
Many of my colleagues in the climate investment space were shocked by the European Commission’s proposal to exclude international emission reductions from the fourth phase of the EU ETS starting 2021. Here is a handful of reasons why it’s a short-sighted proposal and why it is taking a very big gamble.
The concept of a cap is only acceptable if there is flexibility to cope with a situation where the cap becomes a limit on the economic growth of an economy. In a situation where the cap is reached and there are no additional permits to emit, then the price of emissions will rise excessively and strangle the growth. Emission reduction units from project-based activities and international emissions trading provided this flexibility under the Kyoto Protocol. In this proposal, the Commission has thrown out emission reductions and made their use (to meet an additional -5% target) conditional upon strong commitments from other governments in Paris in 2015. Based on past performance, the chances of the Parties actually agreeing 2020 actions in Paris is not high which means that for any investors who are still holding on, there won’t be any positive news before 2015 at the earliest, and the best that could be expected in 2015 is an agreement to use some kind of emission reduction unit. For an industry which is already on life support, that’s not much of a lifeline to hold on to.
As noted above, there are two sources of flexibility in the KP – emission reduction units and international emissions trading. After dispensing with emission reduction units, the Commission’s proposal relies on using linkage with other schemes to provide flexibility – the ETS equivalent of international emission trading. Unfortunately, this is where the plan may fail. Firstly one might ask which domestic emission trading schemes the EU ETS plans to link with? There are plans for ETS in a number of countries, and a small number are already operating but how many are currently compatible with the EU ETS? There are many issues which need to be aligned before linkage can occur, not least of which is the process of allocation. The EU ETS is 9 years old and well into its third phase and is still wrestling with the consequences of over-allocation. A sort-of-solution is at hand via “backloading” but it will be another 5 to 10 years before the excess is worked out of the system. Secondly, if there are other schemes to link with, will they be using emission reductions as offsets or not? The EU is hardly in a position to specify that NOT using emission reductions is a condition of linkage, and if a linked scheme uses emission reductions then they will simply buy cheap emission reductions and sell their allowances on to EU buyers and pocket the difference, thank you very much.
An alternative scenario as to why the EC might gamble with the future of the international emission reduction units is that they are not concerned about the possibility of breaching the cap, in other words, the economy can manage -40% relatively easily. Critics have said that -40% is not ambitious, whilst the Commission maintains that it is. Either way, it’s short-sighted because at some stage, caps will get tighter.
Back to those other ETS that might want to use the international markets as a source of flexibility. The existing mechanisms of JI and CDM under the UNFCCC have had their share of challenges but we know a lot more about how to manage them today. The CDM has become a beacon of transparency and a tool for sustainable development and for many, its role in engaging developing countries in climate change action is clear. From the perspective of emission reduction units, the CDM offers a single comparable standard to be applied independently and with transparency in multiple sectors around the world. The alternative to the CDM is a plethora of local standards transacted in local languages without international oversight. How can the EU ETS propose to link to a scheme which uses its own domestic emission reduction standard?
Finally, I am not suggesting that it is the EU’s responsibility to stand up for climate action in the rest of the world but the EU has assumed a leading role and citizens of the EU probably do not realize how much they have to lose from climate change induced instability. It is in the EU’s interests as much as in any other nations’ interests to see the climate negotiations succeed. Developing countries which are unlikely to implement ETS need some sort of mechanism to get involved and after close to 15 years of capacity building, the CDM is performing that function to date. Developing and developed countries that will implement ETS will need to look for flexibility mechanisms but self-defined emission reduction standards could be a barrier to linkage – the CDM has provided a single mechanism which has enabled, on paper and for a short period, two schemes to link – the EU ETS and the Australian CPM. Without that common emission reduction standard, flexibility will be much harder to find. And a cap on an economy without any breathing room is not good economic policy.
So why is the EC’s proposal so important? The EU really kicked off investment in the CDM through the 2004 linking Directive which allowed captured entities and not just Governments to import emission reductions to meet compliance obligations. This opened the door to investment and triggered demand for infrastructure, in particular the Designated Operational Entities who validate and verify projects and Designated National Authorities in Non-Annex 1 counties who approve projects. It also spawned much of the work of the UNFCCC Secretariat. A significant proportion of the UNFCCC ecosystem survived off the registration and issuance fees of CDM projects whilst DOEs were paid by project developers. DNAs were left to fund their own activities (which in retrospect may have been a mistake – they would have benefitted from more support). Without a steady stream of projects, this infrastructure will disappear – in fact much of it already has. The industry has been on life support hoping for a positive signal. The EC proposal is neutral to negative for the CDM, even for CDM in least developed countries. Without a definite and quantified role in the future there is no interest in maintaining the CDM and our efforts to combat human induced climate change will be significantly worse off without the CDM.
