Climate Change: CDM, CER & PRC

I have a hate-love relationship with acronyms. At first, I have no idea what they mean which results in a trail of Googling and Wikipediaing until I have a grasp of what some seemingly random stream of capitalized characters stands for. Then, I can express myself simply, clearly, precisely and more correctly, for it would be a tragedy if I confused China with the People's Republic of China (PRC) with the Republic of China, especially since at least two of the those are rumored not to exist. The tragedy is that once I understand the acronyms and commence with their use, no one else can understand what I'm saying.

The world of energy is rife with acronyms, CPUC, CAISO, CEC, EAP, RPS, RAR, QF, LSE, LDC... That list doesn't even get you out of California, let alone into the US federal energy world. The international energy world is full of acronyms. The important ones fall under the Kyoto Protocol: Clean Development Mechanism (CDM), Certified Emission Reduction credits (CERs), greenhouse gases (GHGs). Today we'll be taking a look at how these acronyms play out, and where the PRC fits in.

One of the most significant things that the Kyoto Protocol created was the Clean Development Mechanism (CDM). The CDM allows Annex B Countries to receive CERs for developing GHG reducing projects in non-Annex B countries, such as China. These CERs can then be used to lower the actual emissions of the Annex B country on paper in order to comply with the emission cap set by Kyoto. Call it, a legal fiction which has resulted in a fully functional commodities market with price largely determined by the validity of the CER according to the UN.

China is the largest producer of CERs in the world. In 2006, China produced 44% of the world's CERs, and India came in at number 2 with 16% of the world's CERs. China has been a prime target for CER production for two reasons: 1) the main source of energy in China is coal; 2) incentives for foreign direct investment (FDI). The size of the CER produced is the difference between the amount of GHG emitted per energy unit by the main source of energy in China, coal, and the amount of GHG emitted per energy unit by the source of energy constructed by a foreign firm in China. Wind farms and solar farms are the most popular energy sources constructed because they are the most successful at exploiting the two reasons above to their fullest. Wind and solar produce virtually zero GHG emissions which means that every kilo Watt produced is also converted into a CER using one of the dirtiest electric generation facilities, coal burning plants, as the baseline. Also, high-tech renewable energy should continue to see FDI tax incentives from both China's federal and local governments. Almost 90% of approved projects fell in the priority area of investment encouraged by the government, and this should largely continue.

Overseeing CERs in China is the National Development and Reform Commission (NDRC). Ther main task is approving CDM projects, and filing and recording CER production. The NDRC has also been instrumental in developing further incentives for the construction of CDM projects producing CERs. Through September 2006, 46% of the projects that have been approved are wind powered projects. Wind power costs about twice as much as coal to generate the same amount of energy. The revenue from CERs, which have increased in value in China from US$5/ton of CO2 in November 2004, to $9.90 in September of 2006, does not cover the difference in generation cost. The Chinese government, according to Gao Guangsheng and Li Liyan of the NDRC, has implemented preferential policies to further the goals of mitigating climate change. The preferential policy takes the form of charging the wind power projects lower fees for accessing and transmitting electricity across the grid which results in revenues from energy sales more in line with the coal producing plants.

One thing that those proposing CER projects in China should be aware of is that China has special provisions on CERs. The revenue from the transfer of CERs is owned jointly by the Chinese government and the energy project owner, and the government is paid a 2% royalty of that sales revenue.

Opinion on CERs

I think that those who developed the CDM genuinely developed it as a way to lower emissions and curb global climate change, while providing a market based financial incentive. The drafters of Kyoto say that they developed the CDM because the overall goal should be reducing global GHG emissions, period, not reducing global GHG emissions just in developed countries.

That said, this is a commodities market created by a legal fiction. A CER could cease to hold value next week if the UNFCCC conference does not go well. Also, there will be a time when the CDM is no longer the proper way to go about reducing emissions, and when all countries will be called on to reduce pollution.

The CDM will serve the valuable purpose of reducing emissions and creating wealth, but much like junk bonds and sub-prime mortgages, the winners are going to be those who get out earliest. Except for the CEOs of banks.



Special thanks to friend and Senior Project Manager at EcoSecurities Dubai, Nicholas Dreves.

Reading List:

Equal Exchange: Creating A Fair Price for Carbon by CD4CDM

Making Carbon Markets Work by David G. Victor and Danny Cullenward in Dec. '07 Scientific American