Clean Development Mechanism

The Clean Development Mechanism (CDM) is a process created under the Kyoto Protocol that allows developed countries listed in Annex 1 of the Protocol to invest in projects that reduce greenhouse gas (GHG) emissions in developing countries and have those reductions count toward their Kyoto targets. CDM-approved emission-reduction projects can earn certified emission reduction (CER) credits, which are equivalent to one metric ton of CO2. These CERs can be then bought, sold, and traded by industrialized countries to a meet a part of their emission reduction targets under the Kyoto Protocol.

For emission reduction credits to count under the CDM, the planned reductions could not have occurred without the additional incentive provided by emission reductions credits, a concept known as "additionality."¹ CERs can also be used by operators of installations covered by the European Union Emission Trading Scheme (EU ETS) to comply with their obligations to reduce their emissions. CERs can also be sold on the voluntary offset market.

Background

The Kyoto Protocol is based on the concept of differentiation of commitments, whereby developed countries accept greater commitments than developing countries. The principle rationale for different levels of commitments is that global warming is a cumulative problem that began when the developed world first started industrializing several centuries ago.²

Under this principle, Annex 1 countries of the Kyoto Protocol have accepted binding greenhouse gas emission reduction limits, which are listed in Annex B, as well as financial commitments that do not exist for developing countries. Kyoto sets targets for 37 developed countries to reduce emissions an average of 5 percent below 1990 levels by 2012, when the Protocol’s first commitment period ends.³

The goal of the CDM is to reduce the costs of emissions reductions for these industrialized countries by giving them some flexibility in how they meet their emission reduction limitation targets, while stimulating technology transfer and emissions reductions in the developing world.

Example

Here is a hypothetical example of how the CDM works:

An industry in a European Union nation emits 1 million metric tons of carbon dioxide per year. To comply with the national laws implementing Kyoto, this industry must reduce its carbon dioxide emissions to 900,000 tons.
The company cuts 50,000 tons carbon dioxide by changing some of its industrial processes.
However, the company decides that it is too expensive to buy emissions-control equipment to cut the second 50,000 tons, so instead it buys 50,000 of ''certified emission reductions,'' or CERs, and applies those to meet its emissions limit of 900,000.
The 50,000 CERs were generated by a developer who installed wind turbines in a developing country. The CDM certified the project as having reduced emissions by 50,000 metric tons, compared to what would have been produced had the wind turbines not been installed. The money generated by the sale of CERs helps to finance the cost of the wind turbine project.

Principle of supplementarity

The CDM process is intended to supplement each country’s efforts to reduce their own emissions. This principle, referred to as “supplementarity,” works to ensure that Kyoto’s emission limits act as a driver for developed countries to focus on reducing their own internal domestic emissions of green house gas emissions.⁴

This principle acts as general guidance to the parties to the Protocol. Kyoto does not set a specific limit on the amount of emissions a Party can offset through the purchase of CERs. Each Party sets its own limits. In the European Union, for example, limits on the use of offsets in each country vary between 0 percent and 20 percent, with an average limit of about 12 percent.⁵

Number and type of projects

Any project that reduces one of the six green house gases covered by Kyoto is eligible for consideration under the CDM, with the exception of nuclear projects, new HCFC-22 Facilities and avoided deforestation. Hydropower projects must meet the requirements of the World Commission on Dams. In addition, purchasing countries may place restrictions of the use of CREs. The European Union, for example, does not allow the use of offsets from forestry projects.⁶

Since it began operations in 2004, the CDM has registered 1382 projects, rejected 87, and has more than 4200 projects in the approval pipeline.⁷ Of the 262,159,765 CERs requested, the CDM has issued 252,039,060.⁸

The CDM market has grown rapidly in the past few years. CDM transactions increased over 200 percent from 2006 to 2007, when they totaled nearly US $13 billion.⁹ This growth is expected to continue. The CDM expects that the projects in the approval pipeline will generate 2,900,000,000 CERs by the end of 2012.¹⁰

Currently, CERs can be generated by more than 100 different project types, such as anaerobic digestion of animal manure, industrial energy efficiency and installation of renewable energy like wind, hydropower and geothermal.¹¹ The vast majority of projects involve the energy industry.

Almost 69% of CDM projects are located in the Asia Pacific Region, 28% in Latin America and 2% in Africa. As of February 2009, China has the most projects, with 404, followed in order by India with 392, Brazil with 150, and Mexico with 111.¹²

Process

CDM projects need to seek approval of the Executive Board, which is answerable to the Parties to the Protocol. The Executive Board consists of a 10 person team from different UN Regions.¹³ The Executive Board has set up a number of panels and working groups to support CDM operations.¹⁴ These include:

Accreditation Panel establishes the decision making of the Executive Board in accordance with the procedure for accrediting operational entities.
Methodologies Panel develops recommendations to the Executive Board on guidelines for methodologies for baselines and monitoring plans and prepare recommendations on submitted proposals for new baseline and monitoring methodologies.
Afforestation and Reforestation Working Group prepares recommendations on submitted proposals for new baseline and monitoring methodologies for afforestation and reforestation project activities.
Small Scale Working Group prepares recommendations on submitted proposals for new baseline and monitoring methodologies for CDM small scale project activities.
CDM Registration and Issuance Team appraises requests for registration of project activities and requests for issuance of CERs, and is chaired by a member of the Board on a rotating basis.

Projects qualify through a process designed to ensure that that GHG reductions are real, measurable, verifiable and additional. Project proponents need to select a crediting period for activities, either a maximum of seven years that can be renewed at most two times, or a maximum of ten years with no renewal option.¹⁵

The Designated National Authorities (DNA) from the country where the project will occur must first approve the project. Projects developers must also receive a letter of approval from the host country stating that the project helps that country to achieve its sustainable development goals. Independent third-party review of the project design and certification of the emissions reductions must be part of the approval process.¹⁶ A number of specific rules and conditions will apply based on the type of project being considered.¹⁷

Two percent of the carbon credits awarded to a CDM project are allocated to a fund to help cover the costs of adaptation in countries severely affected by climate change (the 'adaptation levy'). This adaptation fund may provide support for land use activities that are not presently eligible under the CDM, for example conservation of existing forest resources.¹⁸

In addition to the adaptation levy, some of the proceeds from carbon credit sales from all CDM projects are used to cover administrative expenses of the CDM. It is prohibited to divert official development assistance (ODA) to fund CDM projects.¹⁹

Ensuring additionality

The key concept to any carbon offset scheme, including that established by the Clean Development Mechanism, is “additionality.” Without additionality, there can be no guarantee that the credits purchased are actually helping to reduce green house gas emissions. Additionality is established when there is a reduction in emissions from a baseline scenario because of the proposed project.

To avoid giving credits to projects that would have happened anyway, the CDM has established official guidelines to ensure additionality. The CDM Executive Board considers a project additional if certain conditions are met, including if its proponents can document that realistic alternative scenarios to the proposed project -- ones with higher green house gas emissions -- would be more economically attractive and that the proposed project faces barriers that CDM can help it overcome.²⁰

Determining the additionality of a proposed project depends on the construction of the hypothetical baseline scenario of the project and the projected emissions from the proposed project, and then measuring the reductions in green house gas emissions because of the project. The baseline refers to the emissions that would have occurred without the project and may be estimated through reference to emissions from similar activities and technologies in the same country or other countries, or to actual emissions prior to project implementation. Under CDM rules, the baseline and actual emissions of a proposed project need to be verified by an independent third-party.

Successes and issues

The CDM has been a trailblazer in providing a standardized emissions offset instrument, CERs, and in channeling investments to the developing world for emission reduction projects. In a relatively short period of time, it has handled a tremendous amount of complicated and novel issues that have strongly influenced the development of the carbon market. The CDM additionality tool, for example, is seen as a benchmark against which to compare other additionality testing procedures used by other offset programs.

Because of it central role in the Kyoto, the work of the CDM has been closely monitored by governmental, non-governmental and academic organizations, and a number of important issues and problems have been raised. Among these are:

Not all Projects are Additional -- Studies and reports have indicated that a number of CDM projects would have been implemented even without the CDM, undermining the principle of additionality. Without additionality, the whole purpose of the CDM and offsets are undermined, raising questions about whether some project developers or others involved in the process manipulate the CDM process to obtain extra financing.²¹

Limited contribution to sustainability -- Most evidence indicates that the CDM has had a limited effect on sustainability, and that the technologies used in the projects are often already commercially available in the host country.²²

High Transaction Costs -- Many commentators have pointed out the high transaction costs of being involved in the CDM process, especially for small-scale projects in poor countries. This is compounded by the fact that the revenues are generated only after approval of the projects’ methodology, registration of the project and issuance of the credits. ²³

Deters Adoption of Government Policies -- Some commentators have suggested that the CDM process can deter governments from enacting strong domestic programs since that might reduce the opportunity for CER credits by making additionality harder to obtain.²⁴

Weak Long-term Market Signal -- Because the Kyoto Protocol does not have binding targets and timetables beyond 2012, there is no firm market for CERs after 2012, which leads to uncertainty about the long term strength of the CDM and its status in a new post 2012 agreement.²⁵

Looking Forward

The future of the CDM is uncertain, and will be determined as part of the larger negotiations on a post-Kyoto climate agreement. The extend to which developed countries can use offsets to meet climate targets set by international agreements is currently under discussion as part of these negotiations. In one signal of a possibly more limit role for the CDM, the European Union has suggested that a cap be placed on the use of offsets in meeting Kyoto targets, which could restrict the market for CERs.

In addition to this larger issue, a number of proposals are being considered to improve the operations of the CDM that involve streamlining and simplifying the approval process of projects, and better targeting certain project types, industrial sectors and countries. Many experts have recommended that the CDM move toward a sectoral approach, whereby emission reductions are credited based on the level below baselines that are established for specific sectors, such as the aluminum and cement sectors. This eliminates the need for project specific determinations of additionality, but this approach requires good baseline data, which may be problematic in many countries.

Footnotes

¹ See http://unfccc.int/kyoto_protocol/mechanisms/clean_development_mechanism/items/2718.php

² Carbon dioxide, for example, the principle GHG, has an atmospheric lifetime of 50 to 200 years. For an explanation of how reductions in green house gas emissions would affect atmospheric concentrations over time, see, IPCC Fourth Assesment Report, Working Group 1 Report, The Physical Basis of Science, p. 125.

³ Under the Protocol, for example, the European Community would reduce emissions 8 percent below 1990 levels and Canada, 6 percent. The United States would have been required to reduce their emissions by 7 percent. Not all industrialize countries are required to reduce emissions. The Protocol set Russia’s emissions at 1990 levels, while Australia’s were allowed to increase 8 percent. Kyoto Protocol, Annex B.

⁴ Article 12.3.b of the Kyoto Protocol states, "Parties included in Annex I may use the certified emission reductions accruing from such project activities [those certified under the CDM] to contribute to compliance with part of their quantified emission limitation and reduction commitments under Article 3[…]".

⁵United States General Accounting Office, International Climate Change Programs: Lessons Learned from the European Union’s Emissions Trading Scheme and the Kyoto Protocol’s Clean Development Mechanism, page 42, footnote 52.

⁶ Anja Kollmuss, Michael Lazarus, Carrie Lee, Clifford Polycard, A Review of Offset Programs: Trading Systems, Funds, Protocols, Standards and Retailers, Stockholm Environment Institute, October 2008, page 44.

⁷ http://cdm.unfccc.int/Statistics/index.html (viewed on February 5, 2009).

⁸ http://cdm.unfccc.int/Statistics/Issuance/CERsRequestedIssuedBarChart.html (viewed on February 5, 2009).

⁹ The World Bank, State and Trends of the Carbon Market, Washington, D.C., 2008.

¹⁰ See footnote 7.

¹¹ http://cdm.unfccc.int/methodologies/index.html

¹² http://cdm.unfccc.int/Statistics/Registration/NumOfRegisteredProjByHostPartiesPieChart.html (viewed on February 5, 2009).

¹³ http://cdm.unfccc.int/EB/background.html

¹⁴ http://cdm.unfccc.int/Panels/index.html

¹⁵ Modalities and procedures for a clean development mechanism, as defined in Article 12 of the Kyoto Protocolparagraph 49.

¹⁶ The complete procedures are set forth in Modalities and procedures for a clean development mechanism, as defined in Article 12 of the Kyoto Protocol