Can We Talk Sensibly About The ETS Now?


Like most of the population, the Rudd Government has given every sign that it wants to keep the climate issue on the agenda. And whether it’s by making a third attempt to get some form of its ETS through the Senate, or by fighting this year’s federal election as a referendum on climate change, it’s most likely that the changes they’ll be pushing will be roughly the same as the CPRS they originally proposed.

Now that the Opposition has (apparently) settled on a complete rejection of the CPRS, a new space has opened up for mainstream debate over the actual validity of Rudd’s scheme. In particular, there is the matter of its extreme reliance on a carbon trading scheme called the Clean Development Mechanism — a mechanism that is currently dead in the water following the lacklustre "Copenhagen Accord". Disagreement around the CDM, however, dates back to long before the COP 15 meeting and concerns the serious problems with nearly every aspect of its operations.

These problems have been examined in some detail here on, but despite all the criticism they have received, CDM offsets remain very attractive to many. It’s an attraction felt most strongly by investors keen to trade in a fresh derivative, by Western governments keen to find a way of cheaply paying other countries to do the work of actually reducing emissions, and by the governments of developing nations desperate for income.

Unfortunately for the growing CDM industry, the lack of consensus at Copenhagen on the future of the CDM has left it with no fixed future beyond the end of the Kyoto Protocol in 2012. Rules about the CDM and its reform remain to be negotiated, so that unless future Conference of the Parties (COP) meetings give the CDM a longer lease on life, it is likely to become a less attractive trade option for investors.

That may be a very good thing. Here in Australia, the Government’s proposed CPRS sets no limits on the amount of carbon offsets Australia can purchase in developing countries through the Kyoto Protocol’s flexible mechanisms, largely through the CDM. That means that all of the 5 per cent emissions reduction target that the Rudd Government has proposed as a minimum through the CPRS could be met simply by purchasing carbon credits overseas through the CDM, rather than reducing any emissions here at all. However, the Kyoto Protocol requires that these credits be "supplementary" to domestic action. In not setting a limit to the use of such credits, as environmental strategist Guy Pearse has pointed out, Australia is in danger of violating the Kyoto Protocol requirement.

The problems with relying heavily on the CDM to achieve most of our emission reduction targets come down to the way it works. It provides an easy way for companies to over-pollute by relying on developing countries to clean up the mess. This does not necessarily reduce carbon, but does shift responsibility for it from one place to another. Aside from these fundamental issues with the CDM’s structure, there are also glitches in its operation.

One serious problem with the system is that most CDM projects would have occurred even without CDM funding. The CDM works as a structure where investors (largely from developed countries) set up projects to reduce emissions in developing countries and sell the carbon credits to developed countries to meet their own Kyoto targets. However, for CDM projects to be approved by the UN, and to have their emission reduction credits saleable, credit reductions are required to be "additional" to those that would have occurred otherwise. That is, CDM investors must show that the emission reductions they receive would not have occurred without the income from the CDM.

Patrick McCully, of US think-tank International Rivers, found that almost three-quarters of projects being approved by the CDM executive board were already completed at the time of approval — proof of the elasticity of the additionality requirement.

An example of how this is happening is in China, which hosts the largest portion of the CDM market. China meets around a quarter of its energy needs through hydroelectricity, and was on a hydropower development trajectory prior to the introduction of the CDM. Yet almost all new dams being built in China are being registered as CDM projects. In this way, it appears that a very large section of the market is ignoring the additionality requirement, as many hydro-electricity projects would have occurred with or without the CDM funding. Meanwhile, back in the countries that bought the credits sold by these projects, that much local carbon pollution is now considered to have been "offset".

A similar abuse of the additionality criteria is arising over the destruction of trifluoromethane (HFC-23) gas, which generates three-quarters of the CDM’s emission reduction credits. This gas — the most potent of any greenhouse gases — is a waste product from the manufacture of a refrigerant gas. Under the CDM, chemical companies can earn almost twice as much from destroying HFC-23 gas and selling the carbon credits as it can from selling the actual refrigerant gases. There is real concern that refrigerant producers might manufacture waste gases just so they can destroy them and claim these as emissions reductions through the CDM.

The only safeguard the CDM has to prevent this is its requirement that in order to sell carbon credits, refrigerator manufacturers must have been in business for three years to prove they didn’t start up just to cash in on the CDM carbon market — it has no way of preventing existing manufacturers cashing in this way, or of preventing new manufacturers exploiting this system in three years’ time.

Aside from the problems in proving that projects would not have occurred otherwise, there are other problems emerging from the CDM. The CDM requires that projects must provide developing countries with "sustainable development" according to the criteria set by the host country in which a project is located. However, there is no international Kyoto standard for sustainable development, and also no external evaluation for ensuring project developers achieve the sustainable development asked of host countries.

The majority of CDM projects favour cheap emissions abatement to the detriment of the sustainable development requirement. CDM projects receive no financial incentive to achieve sustainable development — save that generated by a small niche European market. Consequently, the sustainable development requirement of the CDM is mostly avoided or ignored completely by project developers.

In Indonesia, a CDM host country which closely reflects the operations of the global CDM market in terms of its representation of buyers, only a very small number of its registered CDM projects actually meets every one of its sustainable development criteria. The majority is meeting few of them and some are meeting none at all, but are rubber stamped by both Indonesian and UN authorities regardless.

The European Union’s Emissions Trading Scheme (EU ETS) makes up most of the global carbon market. Unlike the Australian Government’s reliance on this severely flawed mechanism, the EU has already recognised the need to set limits on the amount of CDM credits that can be purchased by EU countries in order to meet their emission reduction targets.

Mark Lewis, the Paris-based head of carbon markets at Deutsche Bank, has said that once it is introduced, the CPRS will have a serious impact on the international carbon market. According to Lewis it could make up nearly one third of the CDM market, making it all the more important to ensure that the credits Australia will purchase are real, long-term and contribute quickly to a low carbon economy in developing countries.

As the CPRS will see Australia take a more significant role on the carbon market, it is important that the number and type of CDM credits purchased by Australia are strictly regulated. Establishing limits to CDM offset credits is crucial to the legitimacy of the CPRS or any variation on a cap-and-trade scheme that the Australian Government may introduce.

Without strict limits on offset credits there is a real risk that there’ll be no transition to a low carbon economy in Australia and that polluting industries will instead be able to continue emitting at (or above) our current decadent emission rates which are the world’s highest per capita. If we do not take this opportunity to look closely at alternatives to the Government’s cap-and-trade scheme, Australia’s climate policy — and a significant slice of its economy — risk becoming locked into a heavy reliance on inflated carbon credit offsets that have not lived up to the hopes placed in them by the Kyoto Protocol.

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