In November the Clean Development Mechanism (CDM) celebrated its one billionth emission reduction and its positive impact on developing countries. But falling global carbon prices have placed the future of the scheme in question. Oliver Crouch explains why, and what this means for businesses taking action through the voluntary carbon market.

In September the Clean Development Mechanism (CDM) celebrated its one billionth emission reduction and its positive impact on developing countries. But falling global carbon prices have placed the future of the scheme in question. 

The CDM is one of the mechanisms for reducing emissions defined in the Kyoto Protocol, verifying compliance grade credits from projects in developing nations that can be bought and sold by Annex I countries and organisations. It covers more than 4,500 projects in 75 developing countries. In September the CDM reached a major milestone with the issuance of its billionth CER, the unit that represents one tonne of emissions reduced. 

In a statement the UN climate change secretariat, Christina Figueres, noted, “The CDM is not only having an important impact on developing countries through technology transfer and sustainable development, but it can also encourages developed countries to increase their emission reduction targets by making mitigation more affordable.”

What are the issues facing the CDM?

Despite this milestone significant uncertainties remain over the future of the scheme, mainly that a second period of the Kyoto Protocol, which provides the legal basis of the CDM, does not get finalised at the Doha climate summit in November. 

There is also the issue of oversupply. Based on the known CDM project pipeline, IDEAcarbon estimates more than four billion CERs, the crediting unit produced by CDM projects, are likely to be issued 2013 – 2020. 

The primary source of demand for CERs is the European Union Emissions Trading Scheme (EU-ETS. Installations regulated by the EU-ETS can surrender a portfolio of CERs and an equivalent crediting unit called EU allowances (EUAs) for compliance. However the EU-ETS caps the use of U.N. carbon offsets at 1.4bn between 2008 and 2012 allowing a further 300 million or so to be surrendered between 2013 and 2020. Significant oversupply of CERs looms. 

What are the issues facing the EU-ETS? 

A growing surplus of EUA’s has built up in recent years as industrial activity and related energy use has dropped due to the economic recession across Europe and the successful introduction of energy efficiency policies. Overlaying this is the on-going uncertainty of EU climate ambition post 2020. 

Importantly the volume of EUAs is consistent with the EU’s 2020 reduction target.  However, the oversupply and resulting low prices are insufficient to drive the investment in low carbon power generation necessary to deliver the deeper targets beyond 2020. 

What are the options for the EU-ETS?

The third phase of the EU-ETS runs 2013-2020 and the EU Commission is considering delaying the auctioning of up to 1.2 billion allowances for years 2013-2015 until a date during the 8 year phase. This back loading of allowances is hoped to raise prices in the short term and lead to a steadier price in the long term.   

Linking to other international trading scheme could generate demand, but new CER demand stemming from a link between the EU scheme and Australia’s upcoming market from 2015 is estimated to be small in comparison to the level of oversupply. 

The other lever to create scarcity within the cap and trade scheme is to tighten the cap. This could be achieved by stepping up the EUs climate change ambition for 2020 to a 30% reduction. But there is little political appetite for this given Europe’s more pressing economic woes.   

What does all this mean for the voluntary carbon market?

Paul Simpson, Chief Executive of the Carbon Disclosure Project, has suggested that: “Businesses could help support the carbon markets while international climate talks remain deadlocked by becoming more active in the voluntary carbon market. The private sector does many things voluntarily. There is a relatively small voluntary carbon market... and I think there is a role in the short term for the private sector to take more voluntary action to help shore up the carbon market.” 

While I agree there is significant scope for more voluntary action by businesses, I disagree that voluntary action should be used to shore up the regulated carbon market. 

The voluntary market currently transacts around 60 million tonnes per year so simply doesn’t have the scale to “shore up” the far larger regulated carbon market. If the looming CER surplus was dumped on the voluntary market a more probable scenario is suffocation of the supply of innovative Gold Standard and Verified Carbon Standard projects designed specifically for voluntary carbon market buyers. If this happens, the death of the CDM could prove fatal for the voluntary carbon market.

Responsibility for restoring confidence in the CER market remains with governments not businesses. It is important to remember CERs were designed as an instrument for governments to achieve national goals and have been adopted as compliance instruments in the EU-ETS. Interventions are needed to address the challenges faced by the CDM, but they can only be solved through political action.  However tempting it might be to use low cost CERs for voluntary action, we cannot risk suffocating the voluntary carbon market in a futile effort to shore up the regulated carbon market. 

I fully support businesses taking more action on a voluntary basis but this action needs to be focused on the instruments and standards developed specifically to serve the needs of the voluntary carbon market. The voluntary carbon market continues to be an effective way for businesses to reduce emissions and to encourage the adoption of renewable technologies and sustainable development practices. As governments prevaricate about the future of international climate action, businesses have an important role to play in showing governments the way through their own climate action.