The Clean Development Mechanism (CDM) of the Kyoto Protocol is supposed to allow developed countries to help subsidize sustainable development, such as energy from renewable resources, in their less developed counterparts. In exchange, the developed countries get credits that can be used towards meeting their Kyoto greenhouse gas reduction commitment. It seems simple, virtuous and perhaps even elegant but, as the Ecosystem Marketplace discovers, the process of getting such a global system up and running has been far from smooth. In 1936, Swiss food and beverage company Nestlé opened a factory in the Andes mountains, midway up the long spine of Chile. Over the next seven decades, the Graneros factory produced baby foods, breakfast cereals, and Nescafé, among other products, while burning roughly 11,000 metric tons of coal every year. In 2003, Nestlé partnered with MGM International — a Miami-based firm that creates opportunities for companies to reduce greenhouse gas emissions — on a plan that would cut the carbon dioxide (CO2) Graneros spewed out of its smokestacks by more than 400,000 metric tons over the next two decades of its working life. The company planned to do this by burning natural gas instead of coal to fuel production. Since natural gas is a more expensive fuel than coal, the switch meant replacing expensive equipment. To help defray this cost, Nestlé and its partner MGM applied for credit under the terms of the Clean Development Mechanism (CDM) of the Kyoto Protocol. The CDM allows greenhouse gas (GHG) sources in developed countries to offset their own GHG emissions with approved GHG reductions in developing countries in an effort to both address climate change globally and encourage sustainable development in less-affluent parts of the world. A buyer was found for Nestle's expected credits, or certified emission reductions (CERs): J-Power of Japan. The amount of avoided GHGs was calculated. Even the amount of methane that might leak from new pipes was estimated. And a formal proposal — the project design document, or PDD — was drafted and submitted for review by an independent international consultant: Det Norske Veritas, more commonly known as DNV. With everything in order, the project was submitted to the CDM Executive Board — a supervisory board of 10 members from varying countries that evaluates CDM projects to ensure that they deliver credible reductions. The Board duly undertook the first step in its process, submitting the methodology whereby Nestle and MGM estimated their reductions to its Methodology Panel in May of 2003. And then the trouble began.
The first methodology was rejected due to concerns about the lifetime of the new equipment used and whether or not such equipment replacement would have happened anyway. One of the strict tests imposed by the Marrakech Accords of the Kyoto Protocol is that every project must prove its "additionality," i.e. that it would not have happened without the money provided through the sale of carbon credits. The methodology thus was reconfigured and resubmitted in August 2003, ultimately leading to its approval at the 11th meeting of the CDM Executive Board in mid-October 2003. Next, the DNV set out to approve — or "validate" — the project and its PDD. One year later, all the necessary forms and protocols had been acquired and followed, including a month-long public comment period. On 5 November, 2004, DNV formally submitted the Graneros project to the CDM Executive Board for registration. After having received the blessing of the host country, Chile; the buying country, Japan; an internationally respected consultant accredited by the CDM Executive Board, DNV, and even the CDM's own Methodology Panel, the Board nevertheless demanded a review of the Graneros project. It still had concerns about the lifetime of the credits. MGM and Nestle were, to say the least, frustrated. And the Graneros project is not alone. The Nanshan project in China — a proposal to use the natural gas from a coal mine to produce electricity — has been slogging through the Methodology Panel since June 2004. Project managers say they finally received feedback in February. Meanwhile, the Cuyamapa project — a small dam in Honduras — ran into delays because it doesn't yet have a designated buyer for its credits. The CDM's details, it seems, are proving devilish for those seeking to create a carbon market capable of addressing climate change and bolstering sustainable development in developing countries.
Background: Kyoto Compliance
Projects like Graneros are made possible because the Kyoto Protocol requires its signatories in the developed world — dubbed Annex 1 countries — to reduce their greenhouse gas emissions. GHG emissions have skyrocketed in Annex 1 countries in recent years. Canada, for example, has committed to reduce its GHG emissions by 6% below 1990 levels between 2008 and 2012, a laudable goal given that the country saw emissions rise by more than 20% during the 1990s (Canada, therefore, must reduce its emissions by 26%, or more than 190 million metric tons in order to meet its Kyoto commitment). Since Kyoto's architects foresaw that achieving such substantial reductions domestically might be prohibitively expensive — politically as well as economically — for countries like Canada (witness the current government brawl over the plan), they also allowed Annex 1 countries to purchase 'credits' from CDM projects in developing countries with "real, measurable, and long-term benefits related to the mitigation of climate change." As countries have begun crunching the numbers, this second option has become increasingly appealing to those seeking cost-effective reductions. After all, a CDM credit, which is the equivalent of one metric ton of greenhouse gas reduction, only costs between US$4 and US$8, according to market participants. Reductions costing Canada billions of dollars at home, might — via the CDM — cost the country only millions abroad. This logic, of course, presumes there will be CDM credits available – an end towards which numerous project facilitators (MGM International, EcoSecurities, Trexler Climate & Energy Services, etc.) and market pioneers (World Bank's Prototype Carbon Fund and the Dutch governement's CERUPT program among them) have been working tirelessly. Will their efforts pay-off? The answer now depends, in large part, on the actions of the CDM's Executive Board. "The Board has an interest in making the CDM work, not in seeing it fail," claims Christine Zumkeller, secretary of the CDM Executive Board from the United Nations Framework Convention on Climate Change (UNFCCC). Indeed, developers, consultants, environmentalists and government officials, alike, regard the fact that the CDM Executive Board got up and running in just under three years as a miracle of bureaucratic efficiency. "It is a global system. It is multi-sectoral. It's a system where many people have interests from different perspectives and it has been set up in an intergovernmental context," Zumkeller notes. "Some people have been quite stunned at how fast it has been set up."
Gumming up the works
Nevertheless, there are a number of significant challenges facing the CDM. First and foremost is funding. Theoretically, a small tax on the sale of CDM credits is supposed to fund the board. Since very few credits have been approved for sale, such economic self-sufficiency is still a ways off. "Some upfront seed money is needed," Zumkeller explains. "Some resources are needed to get over the hurdle that is particularly there in 2005 and 2006." "The EU member states are probably planning on spending EU$500 million or more in purchasing emission reductions," notes Gareth Phillips, global product manager for the climate change program at SGS, an international consulting firm that validates CDM projects. "That's just the EU. Japan and Canada are going to have to shell out a lot of money [to meet their Kyoto commitments]." Contrast that with what CDM Executive Board needs right now — EU $3-4 million — and the latter investment, he says, looks like "peanuts." In addition to a lack of money, the CDM Executive Board and its panels suffer from a lack of support, with each Board member working on a part-time basis. "Funding alone may not help," argues Sushma Gera, current chair of the Board from Canada, "there have to be structural changes… People with full time jobs serving the board and the panels may have to spend much more time towards the activities of the board in order to meet the growing demand for its services." According to the Board's inaugural agreement, it must meet every two to three months for a few days, with no professional support staff. This means Board members must do their day job in their home country and squeeze in CDM obligations in their spare time. "These people just work part-time, they do it on the weekend," explains Board member Martin Enderlin from Switzerland. Enderlin compares the workings of the CDM to playing "a first division soccer game with third class referees", a situation he says, "makes it a bit difficult to cope with the tasks we are mandated." Just printing the necessary documents, Enderlin bemoans, can take a full day. "We just have to accept that we actually should have a core team that is professionalized, that just works on the CDM," he says. "They can prepare the documents well in advance, prepare summaries, and make it easier for the Board to take positions." "As it is now," he adds, "the Board has to take positions but quite often we are not able to do that because we do not fully understand the issues."
More than Just Money
Further complicating the matter, the CDM Executive Board must change its members after just a few years service, with another round of replacements scheduled for 2006 and 2007. "Having people replaced every two to three years is an enormous waste of know-how," Enderlin says. "It takes at least half-a-year to understand the issues, so you have to re-start the discussions again. It's really ridiculous to change these people once they are experts in the field and know how the system works." On top of these structural problems, the CDM process itself was designed to be a bottom-up approach. Rather than dictate what projects might be done, the CDM Executive Board must examine a wide variety of projects to determine their eligibility. "It's learning by doing, there was a bit of trial and error involved," Zumkeller says. "You did not always get the ideal inputs right from the start." And, from the perspective of those on the bottom trying to figure out what those on the top might do, the process can be quite opaque. "The process related to the CDM Executive Board and the Methodology Panel is a black box process," says Bruce Usher, CEO of consulting developer EcoSecurities. "In other words, there's no dialogue… One submits, one gets a response at some point in the future, and then one is expected to respond to that response." "What we observe," explains SGS's Phillips, "is that whenever they have anything difficult or contentious to discuss they go into closed session. So it's very difficult for us to know what they're thinking." Ultimately, however, the main reason for delay may simply be that the CDM Executive Board and its panels are unlike anything the world has ever seen: a unique and untested institution that has been charged with setting up a global system for trading in a strange new commodity. "Where else do you have a regulatory body, which is looking at all sectors in the whole world, ranging from small scale reforestation projects all the way to large projects in the chemical industry?" asks Zumkeller. "What is too long? What does one compare it with?"
The process of creating the CDM may be new, untested, and unique, but its growing pains could have far-reaching consequences for the emerging carbon market. The CDM, after all, is not the only source out there for countries seeking to fill their carbon credit gap. The Kyoto Protocol, for instance, allows developed countries to obtain credits by investing in Joint Implementation (JI) projects in countries like Bulgaria or Romania – designated "economies in transition" — where state-directed economies are transitioning to free markets. And, as of 2008, countries like Russia and Ukraine — where economies have contracted and emissions dropped since 1990 – will be able to sell some of their unused emissions allotments on the market. If developed countries decide to buy this so-called "hot air," the Protocol's emissions targets might be met in most countries with ease, albeit without real environmental benefit. "There are buyers who will refuse as a principle to buy 'hot air', but principles change over time depending on economic conditions," explains Marco Monroy, founder and president of MGM. "I'm not that worried in the near future because CDM offers more options. But the longer that the [Board] delays things, 'hot air' gains more importance as a mitigation option." The fact that projects failing to register by the end of 2005 won't receive credit for emission reductions prior to 2001 provides an additional time crunch. According to Adriaan Korthuis, Director of the Dutch consultancy Climate Focus, "by the end of this year, the project developers must have a good feeling that the registration process is working and it doesn't take ages to get a project registered." This, he says, means that for all practical purposes, "the Executive Board must have registered 20 or 30 projects to show the world that the process is working." Even the CDM Executive Board agrees that the process must be improved. "Good CDM projects are still preferred to just greening [hot air]," says the CDM EB's Enderlin. "That is exactly why we have to speed up this process rapidly. We do not have the time to wait another one or two years but must make a radical shift [in the process] this year." The Chair of the CDM's EB, Gera, agrees. "In the early days," she says, "when the organizations and institutions are being set up, it takes time to elaborate the rules, procedures and guidelines." But, she adds, "now, real implementation starts. The real test for the Board is going to be here onwards, meeting the heavy demand for its services."
Can the Challenge Be Met?
The challenge, fear some, may be insurmountable. "We're talking about a market where we have no idea what happens after 2012," explains Mark Trexler, president of Trexler Climate & Energy Services, a corporate and market strategist, "no idea when the US comes back in, no idea what Russia is going to do and, at this point, we don't even know if the key countries are even going to comply. We hear rumors out of Canada and elsewhere that they may not do it. How do you get a market off the ground when everything is in flux?" Still, the CDM is gaining momentum. "Once the rules and institutions are in place," claims Xuedu Lu, CDM Board member from China, "the process should move much quicker. I anticipate from now on it would move fast." Already, the CDM has approved more than 35 individual methodologies and another 30 or so are in the works. More helpfully, some of these methodologies have been approved for generic use. "We've got eight or ten methodologies submitted in the landfill gas sector," says SGS' Phillips, "all trying to do the same thing but all slightly different. The Methodology Panel has pulled those all together and made them a generic methodology. And that greatly helps." Projects using already approved methodologies, he explains, are likely to have a much smoother ride.
Timely, Yes, but Also Credible
Timeliness, unfortunately, isn't the only concern: The CDM EB also has to pay particular attention to credibility. No one wants projects that lack environmental benefit. According to Ben Pearson of CDM Watch, an organization based in Australia dedicated to monitoring the CDM process, "The methodology panel is doing its job of assessing the methodologies in a rigorous manner and the simple fact is that it takes time to do so." He believes that "a lot of grumbling about how long it takes is coming from people who had unrealistic expectations." From environmentalists, the complaint is that CDM has not yet provided support to wind farms, solar power, and other renewable forms of electricity generation. Instead, wrote Pearson in a recent paper analyzing the market, the majority of CDM projects are those that "capture or destroy gases with high global warming potential, like methane, nitrous oxide (N2O) and hydrofluorocarbons (such as HFC-23) at existing facilities." Still, even Pearson agrees that the environmental stakes of a dysfunctional CDM process can be high. "The consequences of delay," he admits, "are simply that less CERs will be available and more [hot air] will be bought." In fact, in the eyes of environmentalists, government officials, and business leaders, it is crucial that the CDM not fail due to delays or lack of resources. "Without the support of the [Kyoto signatories]," says the CDM EB's Lu, "this process will face big problems that may lead to very serious consequences, that is, there would not be enough CDM projects to generate CERs for meeting the commitments of the Kyoto Protocol." "Consequently," he adds, "the international community may lose confidence in fighting climate change using the Kyoto Protocol." Like Lu, EcoSecurities' Usher is keeping his eye on the long-term prize. He explains that "the CDM today is not a solution to climate change, but it is extremely important that it succeed in order to be a model for future climate programs." A successful CDM, he believes, "becomes a very powerful argument that climate change can be dealt with at reasonable cost. An unsuccessful CDM is a powerful weapon for those who are against dealing with climate change."
Slow start in need of a fast finish
At present, the numbers are cause for concern: As of November, 2004, the CDM Executive Board has registered only four projects and more projects have been rejected than registered. Meanwhile, fuel switching at Graneros and the dams at La Esperanza and Cuyamapa all remain under review, waiting to join the lucky few approved projects. Their roads have been long but, they hope, may be getting easier. "Cuyamapa was relatively smooth and we hope it will be registered next month," says EcoSecurities' Usher. "It's been about a year and that's relatively good." But, he observes, "Nobody involved in CDM should be happy with that. That's not good enough, we've got to make it faster." David Biello is a freelance writer based in Brooklyn. He can be reached at email@example.com.