What’s broken about carbon credits

Published 13th October 2009 - 5 comments - 2174 views -

Imagine the following scenario. You are a funding agency for projects. You decide to fund only those projects which are barely scrapping through and making a profit. You decide not to fund the most attractive and well managed projects with potential for growth. Its the survival of the weakest!

Sounds stupid, even hypothetical? Unfortunately thats how projects eligible for carbon credits in developing nations are picked. A quick introduction to carbon credits is below the picture.

Carbon credits or Certified Emission Reductions (CERs, commonly known as carbon credits, where each unit is equivalent to the reduction of one metric tonne of CO2e, e.g. CO2 or its equivalent) are awarded to projects which reduce greenhouse gas (GHG) emissions below a certain baseline. Carbon credits are awarded in developing nation countries, because the cost of decreasing emissions is lower in these countries than in developed nations. Thus you are reducing the overall greenhouse gas emissions in the atmosphere. Companies can use these carbon credits to achieve their emission reduction targets, because they are 'offsetting' their GHG emissions. Basically you trade emissions that you cannot reduce yourself.

The Clean Development Mechanism (CDM) is a 'flexibility' arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment (called Annex 1countries) to invest in projects that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries. (wiki)

During my stint at New Energy Finance as an analyst, I was working on some data from biomass CDM projects. From a few Internal Rate of Return(IRR is used to compare profitability of investments) figures, I realized none of these projects would be investment worthy without earning from CDM/carbon credits. That was a correct observation because I then found this fascinating condition/clause for CDM/carbon offsetting. Financial Additionality is necessary for carbon offsets. Which basically means you cannot gain carbon credits for your renewable energy projects if you do not prove that without earnings from those offsets, the project would be non-viable. I say unviable, because if the return that you gain from your renewable energy project is low, then you would obviously not invest in such a project.

In fact 'Financial additionality' is defined as an economically non-viable project becoming viable as a direct result of CDM revenues.(wiki) So to be eligible for carbon credits you have to ecoomically non-viable, you have to be the slow sperm.

It immediately seemed like a stupid clause to me at first, but then just later Sara, my manager, and SustainableJohn explained, ‘Because to offset emissions in another country, you need to prove that the project would not have happened without CDM.  Otherwise, it’s not really offsetting, it’s just giving renewable projects in another country an added incentive to develop. It is proving that the project is beyond business as usual.  Additionality comes mainly in two forms: investment and barrier.  Investment additionality is most often used by proving that your project has an IRR lower than the industry benchmark, but that the IRR would be higher if extra  revenue from sale of carbon credits could be earned. Barrier additionality has more to do with technology availability/other policy or market barriers.’

Makes sense from the perspective of the developed countries looking to offset, but to me this is just another reason why I don’t like CDM. The viability of the entire project depends on the price of the CERs and nobody is really gaining much in terms of revenues. Maximum IRR I’ve seen yet is 28.33% and avg is around 15.45%, which is really low. And the worst outcome of this clause is that companies now need to make their financial projections very pessimistic to be eligible for carbon credits. So you have to downplay all your growth and potential, basically say that you'll do much worse than in reality you will.

Because of this clause, which picks the weakest projects for carbon credits, a lot of projects do not do well and shut down. And few of these shut down projects actually continue to gain carbon credits because of monitoring flaws in the system. We really need to repair the CDM framework and a start would be to remove the financial additionality clause.

In this post I've written a perspective of CDM, normally not written about. There are many other things wrong with carbon credits, but I think they have enough attention already. What are your thoughts about carbon credits and CDM? Let me know!

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Category: Greenhouse Gases, UN Climate Change Conference 2009, | Tags: unfccc, carbon neutral, emissions trading scheme, cdm,

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Abhishek Nayak
New Delhi, India
Student

Abhishek is interested in sustainable development. He is a part of the Indian Youth Delegation to the COP15. He previously deferred a semester to work as a researcher and analyst at the Hyderabad office of New Energy Finance, world's leading provider of information and analysis in clean technology and carbon markets. He has also startedup and worked in microfinance, web and non-profit sectors. He was a speaker at the FORTUNE Global Forum, 2007 and a student delegate to the 39th St Gallen symposium. He dreams of a day when he can be completely self-sustained and live in the country side far away from any civilization.

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