Carbon for sale!

OUR PLANET 9.3 - Climate Change

Carbon for sale!


describe a win-win strategy for reducing
greenhouse-gas emissions in
developing countries

smoke stacks

The science of climate change has finally reached a reasonable degree of consensus - but the same is not true of its political and economic aspects. The world is at the height of a heated debate over the basic questions of who will reduce greenhouse-gas emissions, by how much, and by when.

Under the Berlin Mandate, stemming from the First Conference of the Parties to the United Nations Framework Convention on Climate Change in 1995, industrialized (or 'Annex 1') countries have committed themselves to 'setting quantified limitation and reduction objectives within specific time frames for anthropogenic emissions by sources and removals by sinks of greenhouse gases not covered by the Montreal Protocol'. These objectives - and policies and measures for reaching them - are to be adopted in Kyoto. The Mandate also states that the Parties would 'not introduce any new commitments' at this time for other non-Annex I countries.

In the short run, legally binding commitments for reductions by developing countries are not politically viable. It is unreasonable to expect countries whose per capita emissions are a fraction of those of the major emitters to adhere to the same standards, particularly when they have a lower standard of living. In the long term, however, the alarming rise in human population and rapid economic expansion in developing countries dictate that, in the future, their emissions will overtake those of the presently industrialized. So they will need to make emission reductions if ecological disaster is to be avoided.

Binding reductions, typically implemented through the use of national emissions caps, cannot be discussed until the industrialized countries show reasonable compliance with targeted reductions within agreed timetables. But there is a great opportunity immediately to engage developing countries in voluntary efforts to cut the release of greenhouse gases: indeed, they are already participating in them. A study by Jose Goldemberg and Walter Reid recently published by the World Resources Institute (WRI) concludes that: 'Since OECD countries overall will fail to meet voluntary targets for returning emissions to 1990 levels... developing countries may be achieving equivalent or greater CO2 emission savings than OECD countries in absolute terms and, since they are starting from a lower baseline, significantly greater savings as a percentage of their emissions.'

Economic incentives

The WRI study shows that current emission savings in developing countries stem not from climate change concerns, but from basic economic incentives. And therein lies the lesson. As long as it is economically advantageous to do so, developing countries will continue to increase emission savings regardless of whether a legally binding cap is imposed upon them or not. Economic incentives for reductions include cost savings from new efficient technology and payment for the environmental service of saving emissions of greenhouse gases.

This environmental service - the 'decarbonization' of the atmosphere - can be attained either by reducing or avoiding carbon dioxide (CO2) emissions, as through increased energy efficiency or renewable energy generation, or by sequestering carbon, as through improved land uses. While a similar case can be made for methane, for the purpose of the argument we have focused on CO2.

It is important to understand the difference between the primary products of decarbonization activities, such as electricity and wood, and the secondary product - carbon. Decarbonization projects are comprised of two parallel flows, and the differences between them are just as critical as their interaction. The first flow is typical of any traditional investment in an electricity generation or forestry project. The project goes through the stages of prefeasibility, feasibility, development and, if found viable, financing and construction (for power generation) or planting (for forestry). The products are electricity or wood. This 'traditional flow' must have a manageable level of risk and an acceptable internal rate of return, as the project is typically financed by multilateral or private commercial banks or specialized funds (or a combination of them), and undertaken by an investor aiming to recover costs or make a profit.

The second flow is the 'carbon flow'. Here, the project goes through the stages of measuring the incremental mitigation of greenhouse-gas emissions additional to those that might have arisen in the absence of the project, as well as certification, monitoring and verification. The products of this flow are the avoidance or reduction of CO2 emissions (for energy projects), or fixed carbon (for land-use projects) - 1 tonne of carbon is equivalent to 3.67 tonnes of CO2, both of which are hereafter referred to as 'carbon'. These products can be purchased by greenhouse-gas emitting sources, such as thermal power generation companies, to offset their own emissions.

Selling rights

The market price of carbon must cover the direct costs of reducing it (as in all the above stages of the carbon flow), the transaction costs, and its opportunity cost. Ultimately, what are being sold are future emission rights. This can positively affect the internal rate of return (IRR) of the entire project. Where projects have a healthy IRR on the traditional flow, selling the carbon provides an incentive to implement more greenhouse-gas efficient ones. Where they are not quite commercial - in the specific case of a conservation project, for example, the carbon flow is the only flow of the project unless commercial activities such as bio-prospecting or ecotourism are incorporated - the carbon sale could make them viable. In both cases, demand for projects with decarbonization components will increase.

Once a project is segregated into these traditional and carbon flows, it is easy to see the differences between the two. Whereas, for example, electricity and timber have reasonably established markets, the market for carbon is only just being created: some transactions have occurred but the market has been thin and the forces of supply have been greater than those of demand. This has caused erratic variances in both the price and the quality of the carbon. There is, as yet, no regulatory framework, and in the absence of legally binding reduction commitments by industrialized countries, there is no substantial demand for carbon and hence no clear incentive to invest.

The risks incurred by each flow are also different. Within the traditional flow, an investor or debt provider weighs and assumes the risks of financing, technology, delays in operation and such country-specific risks as political or regulatory changes. Within the carbon flow, the investor must weigh all of these typical risks - and the probability of emission caps and the emergence of a fully fledged carbon market, insurance mechanisms, certification and verification.

The interrelation between the two flows is equally important. A project planned exclusively on the traditional flow will seek to maximize the output of energy or wood, without any regard for greenhouse-gas emissions. The same project, if planned on the mutual reinforcement of both flows, may incorporate changes in design and implementation changes which increase greenhouse-gas mitigation in order to maximize the return on the combined output.

Covering costs

Covering costs It is critically important that the carbon flow must be monetarized separately from the traditional flow as a distinct product: it can never be diluted into the overall project as a 'gift'. Carbon reduction has intrinsic costs, and these must be covered. There is no free carbon! Carbon, sold as a commodity, is the only incentive currently available for encouraging developing countries to mitigate emissions further than they might achieve from unrelated economic measures. Without paying for decarbonization, the supply of this service will be less than optimal, and the global cost of climate change mitigation will be unnecessarily increased to irresponsible proportions.

This scenario is not simple. There are baseline, leakage, certification and accounting challenges to be met. Several proposals have been made on how to approach worldwide carbon transactions, including the World Bank Global Carbon Initiative, the Brazilian Clean Development Fund, and the Costa Rican Certified Tradeable Offsets. These proposals are quite distinct, but they are based on three common principles:

- They emphasize the important role of developing country participation in greenhouse-gas mitigation activities.

- They treat carbon as a commodity resulting from payment for the decarbonization service.

- Most importantly, they depend on the industrialized countries assuming legally binding reduction commitments in order to launch the carbon market.

Many countries in the developing world are reaching a critical juncture in their economic development. Decisions are being made about generating energy that will affect worldwide greenhouse-gas emissions for many years to come. Developing countries will eventually agree to some form of legally binding emission caps, probably based on differentiated growth baselines. In the meantime, however, they can only choose a low-emission path of development if there is a clear economic reason to do so.

Paying for the decarbonization service gives developing countries an economic reason to participate voluntarily and immediately in activities to mitigate climate change, and opens the way for them to choose a cleaner development path. The innate elegance of this mechanism is that it represents a substantial cost saving for industrialized countries at the same time. The world cannot afford to miss this win-win opportunity.

Christiana Figueres is Executive Director and Anne Hambleton is Program Director at the Center for Sustainable Development in the Americas.

Complementary articles in other issues:
R.K. Pachauri: Start locally (Climate & Action) 1998
Rubens Ricupero: The new green marketplace (Climate & Action) 1998
Ernst Ulrich von Weizsacker and Hermann E. Ott:
Tax bads, not goods (Climate & Action) 1998
Richard L. Sandor: Trading gases (Climate & Action) 1998
Stephen O. Andersen: Industry in the lead (Ozone) 1997
Theodore Panayotou: Win-win finance (The Way Ahead) 1997

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