Kick-starting the Clean Development Mechanism to resume investments

Introduce a “Net Mitigation Benefit Fee” to clean energy investments in developing countries

CDM project in China
The Xinjiang Tianfeng Dabancheng Second Phase Wind Farm Project in China is an example of a CDM project undertaken by the UNFCCC. Image: Yi Zhang, UNFCCC

The global carbon markets are awash with allowances from the over-generous government and international allocation processes, for example, in the European Union. This is exacerbated with the global economic decline and the oversupply of carbon credits, or certified emission reductions (CERs) from the United Nation’s Clean Development Mechanism (CDM).  

CDM projects alter the course of business as usual activities and re-route them onto lower emission pathways. The resulting emission reductions, once independently verified and certified into carbon credits, can be used to “offset” excess emissions in capped economies.

But the market for CERs has collapsed to less than USD0.50, existing CDM projects are failing and new projects are not starting, stopping what we have argued elsewhere was a trillion-dollar clean energy injection into developing countries in its tracks.

We have a solution which is “win win” for everyone, from the planet, developing countries, developed countries and to all other CDM stakeholders including project developers.

It is also a very simple solution: Require developing countries to levy a fee (the “Net Mitigation Benefit Fee” or “NFee”) at the point of issuance and require that the levied CERs are cancelled against the voluntary (or in due course, legally binding) commitments of these developing countries. In other words, developing countries should be allowed to use CERs to offset their voluntary carbon emission reductions that have been pledged under the UNFCCC process.

This simple change will solve several challenges at a stroke. 

First, the CDM will instantly acquire an additional dimension by providing a mathematical ”net mitigation benefit” equal to the cancelled CERs, in addition to contributing to sustainable development by transparently reducing emissions in the host country.

While CDM methodologies are conservative and do not count all of the emission reductions they create, the extent of this conservativeness cannot be quantified. We know CDM projects are good, we just don’t know how good. The factual “net mitigation benefit” we are proposing would simply and transparently turn the CDM into a mitigation instrument overnight.

Second, the supply of CERs will decisively decrease, thus helping prices recover and investments in clean energy in developing countries resume. 

Third, developing countries will be able to take a full seat at the table, having now begun to deliver on commitments to reduce emissions. 

Fourth, this will empower host country DNAs (designated national authorities, the domestic regulators of CDM in developing countries) and get them to direct foreign investment into CDM projects, thus protecting their “low hanging” emission reductions and directing investments into technologies and regions which they cannot reach. They can integrate the CDM with E-policies and start to phase out the double counting of emission reductions.

E-policies are policies that encourage low carbon technologies. For example, a feed-in tariff for renewable energy will encourage investment in renewable technologies. The same investments can also qualify for CERs but this can lead to an element of double counting. This should be phased out and the NFee would provide a transparent way of doing so. 

Fifth, developing countries can start to use the CDM to transition individual CDM projects into a Nationally Appropriate Mitigation Action, which is an all-encompassing plan that aims for a holistic goal such as supplying 500MW of renewable capacity by 2025 for example. 

Here’s how our “NFee” would work:

  • Countries, via the current review of the CDM Modalities and Procedures, would either empower or instruct developing countries to take a share of CERs at issuance from new CDM projects in their backyard (this change cannot be forced upon existing projects – but we’ll come back to this point)
  • The CDM Executive Board would provide guidance and rules on the setting of this NFee. These rules would follow some basic principles:
    • Advanced developing countries would set higher tax levels than least developed countries and Small Island Developing States
    • Projects implemented in a E-policy environment (i.e. where projects benefit from financial support from other policies such as feed in tariffs) would be subjected to a fee rising to 100 per cent within 21 years of the start of the crediting period. The 21 years, though, is merely a suggestion based on the maximum duration of a crediting period, and this can be revised depending on the technologies
  • Developing countries will have the ability to vary this NFee depending on technology – so as to favor technologies which are new in their market and perhaps discourage existing technologies
  • The NFee could also vary by region in order to encourage investment in under-developed areas
  • The NFee would also vary depending on the age of the project and technology in question. For example, some technologies generate underlying revenues such as renewable energy and, if financed correctly at the outset, may be able to be weaned off CDM support over a number of years whilst other projects, such as the supply of fuel efficient cook stoves, will always need financial support to continue
  • NFee percentages would be transparent and listed on the UNFCCC webpage as well as inscribed in the Host Country Letter of Approval at the time of issuance and would apply for the duration of the crediting period
  • The CERs (the NFee is earned in CERs as explained above) would be deducted at issuance and transferred into an account in the CDM Registry for cancellation against host country pledges – and therefore never sold in the market  

Buyers or regulators of Emission Trading Schemes would now have the option to purchase CERs from new projects which have a transparent mitigation impact. Instead of applying unilateral qualitative restrictions, buyers and regulators can now agree to purchase or allow the surrender of CERs from projects which pay a mitigation fee consistent with the guidelines – so buyers control access to the markets but host countries themselves decide whether or not they gain access.

What about existing projects? Well, here’s the interesting bit. Existing projects can voluntarily apply for a new host country LOA, including the host country mitigation tax and can thereby “upgrade” the quality of their CERs and hence gain access to new markets. In return, they will receive fewer CERs (the NFee would be deducted from what they would otherwise receive) but what they can sell should attract a significantly higher price.

Currently there is little or no demand for CERs and existing investors are losing out. There are proposals for one or more funds, and there are still some government buying programmes, but they have made noises about buying selectively and buying only from new projects. Whilst buyers consider CERs from existing projects to be inferior to new projects, existing investors will lose out and avoid further investments. By allowing existing projects to “upgrade” the quality of their CERs by volunteering into the NFee, access to new markets can be gained. This will be to the benefit of all stakeholders in the process and help to keep the CDM alive. 

Our NFee proposal should jolt the market back into life, allowing clean energy investments driven by the Clean Development Mechanism to resume their trajectory to $1 trillion. 

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