/ 14 September 2012

Climate Change: Carbon market needs efficient global rules

Global mitigation to achieve the 2°C target will require an enormous effort to restructure our economies on a low-carbon footing.
Global mitigation to achieve the 2°C target will require an enormous effort to restructure our economies on a low-carbon footing.

The world stands at a ­critical juncture. The effects of climate change are accelerating and the predicted rise in global temperatures will have an increasingly devastating impact on food security, human settlement and our ability to survive as a people and a planet. But global action to address this looming crisis falls far short of what is needed. This lack of action to cut carbon dioxide emissions (referred to as "mitigation" in climate jargon) is also having an impact on carbon markets.

When they were first conceived, carbon markets were considered to be highly theoretical. After all, the idea of buying someone else's reduction of emissions is fraught with the challenge of proving that those are real emission reductions. But after eight years of development and negotiation, carbon markets took off and became the success story of the global climate-mitigation system.

The primary mechanism in carbon markets has been the United Nations-sponsored clean development mechanism. It has resulted in about 4 500 projects in 75 developing countries with a collective investment of $215-billion. These projects have reduced one billion tonnes of carbon-dioxide emissions that would otherwise have gone into the atmosphere.

The only problem is that the bottom has dropped out of the market. This is because demand in carbon markets is created by countries setting caps on their emissions and the current level of mitigation ambition is just not sufficient to sustain it.

Why are carbon markets important? Does it really matter if they collapse?

Global mitigation to achieve the 2°C target will require an enormous effort to restructure our economies on a low-carbon footing. This will impose a heavy burden in terms of costs and job losses. It is vital for the world that we are able to find the least costly way of cutting emissions. Inevitably, the negotiated system of national emission reductions, which will impose some form of caps on emissions of the major emitting countries, will be an imperfect solution – some countries will face a much higher cost of reducing emissions than others.

This is where the carbon market comes in. As a global market, it allows trade between countries and entities, in this case between those that need to reduce their emissions and those that have reduced emissions in excess of their requirements and have emission reductions to sell. If it is cheaper for an entity to buy someone else's emission reductions than to cut their own emissions, there is a basis for making a trade. So carbon markets are a crucial part of the mitigation architecture that we need going forward.

Rapidly eroding
But the collapse in the market means the capacity that has built up in carbon markets over the past few years is rapidly eroding. Market players are leaving the market in droves, taking their institutional knowledge with them and eroding the carefully constructed architecture of the system.

South Africa is less exposed to carbon markets than other developing countries, partly because we were slow to take advantage of the clean development mechanism. We took a long time to set up the regulatory infrastructure for it and were slow to promote it. China, Brazil and India are the largest beneficiaries of the mechanism, with China alone accounting for 68% of all emission reductions under it.

There is also some scepticism about the mechanism among South African government officials, which seems misplaced given the carbon-intensive nature of our economy. South Africa will need carbon markets more than many other countries to manage the costs of its mitigation effort.

The UN appointed a high-level panel to take a long, hard look at the mechanism and the future of carbon markets and make recommendations. The panel recently released its report, which sets out a comprehensive plan to address the crisis in the mechanism and in carbon markets and make them fit for the future.

Central to the panel's prescription is an understanding that for carbon markets to be a useful instrument to serve social and economic ends, they need to be properly regulated. Similar to currency and financial markets, there needs to be a central banking-type facility that is the ultimate guarantor of the integrity of the market and manages the balance between supply and demand to smooth out the prices in the market. In the context of the current crisis, we all know that long-term demand has to be buoyant, because mitigation ambition must increase dramatically to address the climate challenge. But we do not have a way to bridge the gap between the current lack of demand and the future. It is vital that the excess supply in the market is temporarily soaked up to enable carbon markets to continue functioning.

At the same time, we need to start experimenting with new ways to create a greater impact with carbon markets. These include moving away from individual projects to programmes that involve multiple sites and eventually to interventions that include entire sectors of the economy. This is about scale.

Customer-relations record
We also need to experiment with ways of increasing the mitigation impact. This means moving away from the mechanism's current one-to-one credit arrangement to one in which entities selling credits are first  required to reduce their emissions below a certain baseline before they can start earning credits.

There are also a number of governance reforms that need to be made. The mechanism is an overly complex and bureaucratic system that has caused enormous headaches for project developers and stakeholders. Its decision-making is not transparent and UN officials do not have a particularly good customer-relations record. There are also a number of other regional and national carbon-trading mechanisms shooting up and challenging the once unquestioned dominance of the mechanism.

If we can survive the downturn in carbon prices, we are clearly heading towards a more diverse and complex market in which multiple potential mechanisms offer different types of products. The crucial issue for such a market to work is "fungibility"; that is, the ability to ensure that the value of different carbon credits is comparable and the currency interchangeable. For this to happen, we need common global standards, and the mechanism has played a pre-eminent role in developing these. We also need to be able to avoid the double-counting of emission reductions (ensuring that the same emission reduction is not sold or paid for more than once). This will require a common global registry for recording reductions. The mechanism has spent some time in developing such a registry, which can easily be translated into a global facility.

It will require a profound shift in mind-set to one in which the mechanism's knowledge assets are actively communicated and shared with a world that is hungry for the value they can deliver.

In the interests of an effective future global carbon market, it is vital that the UN system and especially the mechanism's executive board take a careful look at the panel's recommendations and implement them expeditiously.

Action urged to shore up clean development mechanism

United Nations climate bodies announced this week that its one-billionth certified emission reduction credit had been sold under the Kyoto Protocol's clean development mechanism, a new milestone for the global greenhouse gas offset mechanism. The credit was issued to a project at a manufacturing plant in India that switched its fuel source from coal and oil to locally gathered biomass.

The announcement came shortly before the release of a South African-generated research report into the current crisis facing the global carbon market. The mechanism is under threat because of the low prices paid for carbon credits, low demand, manipulation of the market and uncertainty over the future of the protocol.

The research found that, over the past decade, the mechanism has mitigated about one billion tonnes of greenhouse gas emissions and mobilised more than $215-billion in investments in developing countries.

Valli Moosa, chairperson of the mechanism's executive board, urged nations to restore faith in global carbon markets. "Although the mechanism has been the subject of extensive criticism, it has improved markedly in recent years and has helped to combat climate change by mobilising the private sector through markets," he said at the release of the report.

The independent research panel recommended 51 actions to secure the future of the mechanism and the carbon market. The aim is to bring them into effect in time for the COP18 UN climate change conference in Doha in December.

Industrial gas projects
Among the panel's more ­controversial recommendations is the phasing out of credits for industrial gas projects, fundamental reforms of the mechanism's operating procedures and the professionalisation of its executive board, and the rapid implementation of the global green climate fund.

Although South Africa is heavily dependent on fossil fuels, its uptake of carbon credits has been slow, accounting for about 0.9% of the registered annual credits worldwide. Africa's share of the market was just 2.2% in May.

South African projects registered under the mechanism range from biofuels to energy efficiency, waste management and hydropower plants. The most successful so far have been nitrogen oxide emission-reduction projects.

Several landfill methane gas-to-electricity projects are earning credits and a growing number of solar energy and wind farms that plan to supply clean electricity to the national grid have applied for registration in the past year.

Private and government initiatives that aim to boost energy efficiency by distributing compact fluorescent lamps to residential households have also applied. – Fiona Macleod

Crispian Olver is an independent researcher and analyst. He has ­co-ordinated technical and research work for the high-level panel on the clean development mechanism