Clean Development Mechanism & CDM Introduction
- Introduction
- What is the CDM?
- Who are the key CDM parties?
- What are the main project types?
- What are CERs?
- What types of CERs are there?
- What is the current state of the market?
The Clean Development Mechanism is one of the instruments created by the Kyoto Protocol to facilitate carbon trading. It is the first of the flexible mechanisms to come into effect, with the launch of the regulatory body, the CDM Executive Board in late 2002, and the approval and registration of the first project, based in Brazil, in late 2004.
Hailed as the "Kyoto surprise", the CDM enjoyed unexpected support from developing countries, and was the compromise solution between Brazil's proposed creation of an adaptation fund for climate-vulnerable countries – the Clean Development Fund – and the USA's demand for a market mechanism similar to the Joint Implementation scheme, but with developing countries.
Key to the support was the CDM's explicitly stated twin objectives of not only emissions reductions for industrialised countries, but also accelerated sustainable development in developing nations. These twin goals are emphasized in the Marrakech Accords, which reiterate that a key feature of the CDM should be the successful transfer of environmentally safe technology and knowledge.
What is the Clean Development Mechanism?
The Clean Development Mechanism may be described as having several roles. It enables industrialized Parties with emissions reductions commitments to efficiently reach their targets, in an economically efficient way. The incentive to invest in projects is created by the different costs of carbon abatement – an industrialized country seeking to reduce emissions domestically is likely to face substantially higher costs, compared to investment in Clean Development Mechanism projects to abate emissions overseas.
By providing investment incentives, the Clean Development Mechanism acts as an aid to project finance in host countries, encouraging sustainable development through the adoption of cleaner energy sources, or more efficient industrial processes. Host countries which tax the revenue from local projects, as is the case in China, will also be able to build a national fund which may be used for local adaptation to climate change.
The Clean Development Mechanism is a project-based financing mechanism, whereby eligible Annex 1 Parties may purchase carbon credits generated by projects hosted in developing non-Annex 1 countries. Such Annex 1 Parties may be purchasing carbon credits to fulfill compliance requirements, or for speculation, as is the case for US companies.
Projects hosted in non-Annex 1 countries, such as Asia, South Africa and South America, may be developed unilaterally, or bilaterally with investment or support from companies and Governments in Annex 1 countries, as long as the project helps the host country meet its own goals for sustainable development, and does not divert Overseas Development Aid away from the country. Although the first 'Commitment Period' of the Kyoto Protocol does not start until 2008, under the Clean Development Mechanism, projects can generate emission credits known as Certified Emission Reductions (CERs) from 2000 onwards.
Who are the key CDM parties?
CDM Executive Board
The CDM is regulated and overseen by the Executive Board, which was established by the Marrakesh Accords during the 7thConference of the Parties. It comprises 10 board members, with 10 alternates, from industrialized countries with emissions reductions commitments (Annex B) as well as non-Annex B countries.
Members serve on the board for a term of two years (maximum of two consecutive terms), with the chair and vice-chair elected by the Executive Board, with one being a member from an Annex B Party and one being a member from a non-Annex B Party. The chair and vice-chair alternate annually between members from Annex B and non-Annex B Parties respectively.
To assist in carrying out its responsibilities, the Executive Board may establish panels or working groups. There are currently five Panels/groups:
- Clean Development Mechanism Registration and Issuance Team: responsible for assessing requests for registration.
- Meth Panel: responsible for developing guidelines and recommendations on methodologies based on submitted proposals
- Afforestation and reforestation working group: responsible for developing recommendations on affo / refo methodologies in collaboration with the Meth Panel
- Small scale working group: responsible for developing recommendations on small scale methodologies
- Accreditation Panel: responsible for preparing material related to accrediting operational entities
The long-term future of the Clean Development Mechanism is guided by the proceedings of the Conference of Parties, held yearly since 1995 and comprising of delegates from all countries which are Parties to the UNFCCC. Since the entry into force of the Kyoto Protocol in Feb 2005, another annual event, combined with the COP, is the Meeting of the Parties to the Kyoto Protocol. The first COP/MOP was held in Montreal in Dec 2005, and the second COP/MOP2 was held in Nairobi, Kenya in Nov 2006.
Designated National Authorities (DNA)
At a national level, each country involved in the CDM has a Designated National Authority (DNA) responsible for granting approval to local projects which have fulfilled national criteria for sustainable development and with a good chance of succeeding at eventual registration, as well as acting as a focal point for CDM activities. The UNFCCC maintains a list of DNAs and contact persons, and most DNAs will have dedicated websites and online resources.
It is a requirement for parties who have ratified the Kyoto Protocol to specify a DNA – Buyers will require approval from the DNA of the industrialized country where they have commercial operations in, while Sellers will require approval from host country DNAs.
If you have a specific interest in a particular country, please contact us for more information on approval processes, updated DNA contacts or general queries.
Designated Operating Entities (DOE)
These are third-party independent parties which act as "auditors" for the CDM project. These companies have to be certified by the CDM Executive Board as Designated Operating Entities (DOE) , before they are able to provide this service to project owners. DOEs are responsible for checking and validating the Project Design Document (PDD); this is a technical document which fully describes the CDM project.
Private parties
On the sell-side, these include project owners based in host countries – these are typically entities which own the assets which may be developed into CDM projects e.g. farms, chemical factories, steel plants, cement plants, or state-owned energy companies seeking to develop alternative power generation sources. Project owners may also be the project developers if the CDM activity is related to their core industries – however, there is a growing market here for environmental/technical consultants which advise on implementation, compile the required project documentation, and which manage the bulk of the CDM process. DNAs will typically have a list of recommended consultants which undertake this work locally.
On the buy-side, there are many different types of buyers ranging from public and private utilities, oil companies, investment banks, government programmes and institutional and private hedge funds. While some Buyers approach Sellers directly, others prefer to operate through brokers. Sellers are also likely to be able to access a much wider market of interested buyers through using a CER broker.
Please contact us if you would like to find out more about our financial CER brokerage services.
NGOs
Non-governmental organizations such as the WWF, CDM Watch, and many local non-profit organizations play an important role in promoting and raising awareness of the sustainability of CDM projects. This may be through monitoring listed CDM projects, participating in local and international stakeholder consultations, or taking an active role in project development.
Key issues highlighted by these organizations include the potential impacts of palm oil biomass projects on deforestation, large hydropower on village displacement, and low-quality project documents which do not adequately address local concerns and views.
What are the main project types?
CDM projects can be designed using established guidelines, or if none exist for the project type, guidelines can be established specifically for the project. These guidelines are referred to as a methodology, and must be approved by the CDM Executive Board. Methodologies are split into three main types:
- Small-scale: Includes renewables, energy efficiency and other project. Projects must be less than 15MW in the case of energy generation projects to qualify as "small-scale"
- Non-small-scale methodologies and consolidated methodologies, which combine several different approachs: This category spans project types such as renewable energy, incineration of industrial chemical waste streams such as HFC23 and N2O, methane reduction activities such as landfill and animal waste management, and other types such as energy efficiency.
- Forestry: Afforestation / Reforestation, typically remediation of degraded land. Methodologies for avoided deforestation are currently under discussion.
This list of approved methodologies has primarily been driven bottom-up, where project developers originate and design new methodologies based on their CDM projects, and submit it to the regulatory body, the CDM Executive Board, overseen by the UNFCCC, for approval.
Working from the top-down, the CDM Executive Board is also supposed to encourage the submission of such methodologies through a transparent assessment procedure, in a speedy manner.
What are CERs?
CERs, or Certified Emission Reductions, are carbon credits generated by CDM projects which have completed the registration process. Each CER represents the abatement of one tonne of carbon dioxide equivalent, and CERs are only issues by the CDM Executive Board once estimated abatement volumes have been validated independently, and a stringent verification process is in place for ongoing monitoring.
What types of CERs are there?
There are three main types of CERs available in the market:
- Issued CERs – these are already generated and issued to projects for emissions abatement already undertaken.
Due to the low-risk involved with issued CERs, issued CERs command a premium to forward streams of CERs, which have yet to be generated and as such carry more risk.
At present, many issued CERs fall into the 'prompt start' category, where in order to kick-start the CDM market, projects were allowed to claim credits for emissions abatement from 1 January 2000 while the eventual rules and regulations were still being finalized in climate negotiations
However, such early projects must submit requests for registration by 31st March 2007, in order to qualify for these retroactive credits. This deadline has already been extended once in order to afford more time for project developers. The registration fee must also be paid by 31stJan 2007, with the required project documentation submitted in time for uploading to the UNFCCC website by 15thFeb 2007.
- Forward streams of CERs – these are credits yet to be generated by projects that are typically under construction, but which are expected to come online in Phase I of the Kyoto Protocol (2008-2012). Such projects may sell expected volumes of CERs throughout their chosen crediting period, with payment by Buyers upon delivery of CERs at an agreed future date, in order to secure a revenue stream. Transactions involving forward streams of CERs are referred to as forward contracts, where a signed agreement binds the Buyer to pay the Seller a pre-arranged amount upon delivery of the CERs at a future date.
- Secondary Market CERs – this refers to CERs which are offered with a guarantee of delivery by a rated entity such as a bank or fund. As all project and delivery risk is borne by this entity, as opposed to a standard 'off take contract' with a project, secondary market CERs often command a higher price than those bought directly from a project.
What is the current state of the CDM market?
Several organizations regularly provide updates of the state of the CDM market. These include the States and Trends of the Carbon Market by the World Bank, IETA, and The Developing CDM Market by the OECD Environment Directorate, Climate Change division (published in May 2006).
Broadly speaking, CDM projects are currently clustered in South America and Asia, although there are several emerging countries in Africa where CDM projects are currently being developed. There is a clear need to focus capacity building in sub-Saharan regions, as highlighted by the 2006 COP/MOP2.
The largest volumes of CERs are being generated by project types such as large-scale chemical processes e.g. HFC-23 destruction, but there are only a handful of these projects. Projects involving renewable energy generation tend to be more modestly-sized, but dominate the project pipeline in terms of number of projects both registered and in development. It is expected that opportunities to develop projects such as HFC-23 will be exhausted within the near future, to be replaced by more expensive options of carbon abatement such as renewables, energy efficiency and process based projects.