Climate Change Response at a Crossroads
September 30, 2008
CER-based trading of emissions rights has long-term implications for global political and economic power distribution and raises ethical questions about ownership of the right to use the atmosphere.
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Globally as well as nationally, we are all at a crossroads. From Rio to Bali, we made efforts to build alternative institutional arrangements for international cooperation to address the problem of climate change. Over these years several positive steps have emerged, but real-world action is still far from the desired level (IPCC 2007, Stern 2007). There has been a marked jump in media coverage on climate change since 2007, but there is a need for further action. The United Nations Framework Convention on Climate Change (UNFCCC) suggests differentiated responsibilities in mitigation due to differences in levels of fossil-fuel-based economic activity.
In the 1997 Kyoto Protocol, countries were grouped into Annex I and non-Annex I countries. Annex I are the OECD countries with high emissions, which were asked to meet reduction targets. Developing nations with lower fossil fuel consumption were grouped as non-Annex I countries and exempted from meeting targets. This arrangement recognized the reality that GHG emissions stay in the atmosphere for more than 100 years; Annex I countries, which have been using fossil fuels since the Industrial Revolution, have largely been responsible for the stockpiling of GHGs in the atmosphere.
Though the Kyoto arrangement seemed logical, it was not ratified by such large emitters as the United States and Australia. And the free-riding attitude of the big emitters failed to induce cooperative solutions to the problem. To prompt action, there must be promises of a reward for the actions taken.
Reassessment of the CDM
The Clean Development Mechanism under the Kyoto Protocol is probably the only platform to coordinate the actions of both developed and developing countries toward a common cause by accommodating differentiated responsibilities and the need for incentives. Under this mechanism, an Annex I country is allowed to locate mitigation projects or buy emission reduction credits from developing countries to achieve its Kyoto emission reduction target. Developing countries, meanwhile, benefit from investment and technology transfer, helping their economies to grow on a low carbon pathway - a characteristics of sustainable development. A reassessment of this mechanism makes good sense, as the Kyoto negotiated period will be reviewed from 2009 with a view beyond 2012.
The CDM requires that greenhouse gas reductions from mitigation projects be calculated using a counterfactual baseline that approximates emissions levels without the project. Estimating GHG reductions is a multiple-step process (Sathaye et al. 2003), including (1) determination of additionality or eligibility of a project, (2) construction of a baseline approximating emissions levels that would have occurred without the project, (3) adjustment of the baseline to account for free riders, (4) calculation of project emissions, (5) adjustment of these calculations for potential leakage, and finally, (6) estimation of GHG reductions relative to the baseline.
Additionally, the estimated baseline may be subject to adjustment periodically to reflect changes in business-as-usual conditions. In order to receive credits for reducing GHG emissions within a given carbon trading scheme, a project may be subjected to additionality or eligibility tests (step 1) before being accepted as a qualified project. These tests are designed to ensure that a proposed project will result in real emission reductions.
Trading of CERs
This reassessment of the CDM will not discuss in detail the actual mechanism of certified emissions reductions or challenge its concept. Here, the objective is to highlight two issues associated with CERs that are not well understood, discussed, or researched. When CERs are introduced to an existing socio-political-economic landscape, they represent a completely new "good." It follows from the basic concept that if emissions are "bad" and impose costs on the society, then emission reductions are good and produce benefits. The production of such "good" primary products as power, steel, cement also leads to the generation of undesired emissions.
Suppose a 6 MW power generation project in India proposes to use rice husks as a new fuel by taking advantage of new technology. The goal of the project would be to replace coal, a fuel with high carbon content. Suppose, this project can reduce 40,000 tons of CO2 annually compared to a coal-fired plant. The project would then be eligible for 40,000 CERs while producing 6 MW of power. Like power, CERs can be exchanged and traded on the market. However, given the location of the project in developing countries with no Kyoto-related constraints, the 40,000 CERs generated by the project can now be sold to Annex I investors (although this is not automatic and requires a lengthy process, as mentioned above).
Under the Kyoto regime, Annex I countries with binding reduction targets may require such CERs to achieve their goals. Thus the Annex I countries represent the demand side of the CER market and non-Annex I countries the suppliers. The price of CERs will be determined by the relative market supply and demand. Given the voluntary nature of participation under the Kyoto regime, at present the size of the market is small. With the nonparticipation of large emitters, moreover, the demand is extremely small, keeping the price of CERs at very low levels. As of March 2008 total CERs issued globally were 121,122,134 metric tons (CO2 equivalent) and the price varied from 7 euros to 22 euros per metric ton. This is not to argue how the price situation can be improved but rather to show the implications of owning CERs.
Ownership of Global Natural Capital
CERs may be owned by any party. A unique characteristic of CERs is that their ownership effectively provides ownership over global natural capital, that is, the right to use the atmosphere. In simple terms, a new capital good is being introduced, ownership of which will result in global market power in the near future, not unlike knowledge capital and physical capital. Creation of such rights or ownership has both long-term implications for global political and economic power distribution and crucial ethical implications. Unless regulated within a target emission level, the creation of CERs will distort climate stabilization, market power and world order.
Non-Annex I countries like India and China that are market leaders with large supplies of CERs and no binding mitigation target under the Kyoto Protocol have little incentive to hold onto their CERs and may wind up squandering ownership over natural capital now and forever. There may even come a time when they will have to buy back those same CERs at a higher price at a later date.
No study exists to show whether countries lose or gain as late entrants in the market. But it can be predicted that they will forfeit an early mover's advantage despite their high potential. In the longer run this is going to be an issue of ownership of natural capital and global commons. Under the circumstances it makes good sense for non-Annex I countries to take up binding emission targets both from an efficiency and equity point of view.
But deeper issues must also be discussed. One is the ethical question of managing a global common property through inappropriately defined private ownership. Who will own the rights to a global common good? Should it be individual investors, banks, financial institutions, governments, or all future generations of humans on Earth? Ownership by one group, by definition, excludes that by others for the same resource. So under current CDM arrangements, the sellers of CERs are by implication selling off their rights to use a global common property without any institutional arrangement with symmetric information on defined ownership.
High transaction costs, limited market size due to the absence of a cap for non-Annex I countries, large-scale uncertainty on ownership type, lifetime of the market, and what happens beyond Kyoto are all inviting attention to reassess the CDM and CER market. The current state of affairs can be considered a period of learning and experimentation. Asymmetry in information and the ethical issue of providing a "global good" for private trading is bound to generate global conflict sooner or later unless the CDM is crafted properly. The learning process combined with new knowledge can pave the way toward global target setting and a binding target for all whereby each player can choose its role on a level paying ground. This will ensure efficiency as well as equity, but ethical questions will still remain unresolved. Neither does it solve the problem of free riding in the Kyoto regime. There is thus still a long way to go in finding a nondistorting solution.
It is time to understand that GHG emissions reduction is an economic activity. It makes good business sense to invest in the low-carbon development pathway. However, without a limit to emissions generation, the CDM will limit participation and distort the situation. A new regime is needed to replace the emphasis on voluntary action. Binding targets needs to be taken up by each emitter, however small or large, from the viewpoints of efficiency and equity.
Targets may be decided by nation-states and negotiated within the global goal of stabilizing emission levels. Under any circumstances, there is a need to coordinate national priorities and goals with those of the international community. Although nation-states are free to decide their own national policies, it can be predicted that those who benefit will be those who can best coordinate national and global goals.
The views presented in this article are of the author and in no way represent those of her country of origin, India, or the IPCC .
Intergovernmental Panel on Climate Change (2007). "Climate Change 2007: Mitigation of Climate Change." Working Group III contribution to the Fourth Assessment Report of the IPCC. Cambridge University Press.
Sathaye, J., Scott Murtishaw, Lynn Price, Maurice Lefranc, Joyashree Roy, Herald Winkler, and Randall Spalding-Fecher (2003). "Multiproject Baselines for Evaluation of Electric Power Projects," Energy Policy , Vol. 32/11 pp 1303-17.
Stern N. (2007). "The Economics of Climate Change." The Stern Review . London: Cambridge University Press.