Carbon Credit Watch

A Carbon Trading System Draws Environmental Skeptics

(October 12, 2010) The New York Times’ Patricia Brett looks at the many criticisms directed at the corruption- and fraud-prone carbon market.

PARIS — Carbon credit trading has long been decried by some climate change experts as an ineffective way to combat global warming, compared with imposing regulatory limits on polluting greenhouse gas emissions.

But after more than a decade of negotiations, the Kyoto Protocol established a carbon emission credit system, in 2006, overseen by the United Nations. Known as the Clean Development Mechanism, or C.D.M., it allows companies in industrialized countries to sponsor a greenhouse gas emissions-reducing project in a developing country. The sponsor picks up carbon credits while the host country obtains cash from the sale of carbon rights and access to pollution-free, innovative technology.

C.D.M. projects represent billions of dollars. The World Bank started preparing for the program 10 years ago by setting up a prototype fund worth $160 million and today it runs a whole family of funds worth $2.5 billion, the bank said in a report this year. In 2008 alone, carbon credit transactions amounted to close to $7 billion, it said.

Yet five years after its introduction, and despite several changes, the mechanism remains open to abuse, according to many involved in climate change issues.

“The problem is that the whole mechanism is conceptually fundamentally flawed,” said Patrick McCully, executive director of International Rivers, an environmental organization in Berkeley, California, and a consultant for the U.N. Environment Program.

A condition for access to the C.D.M. program is the notion that a qualifying project would not be able to attract investment without the added support provided by carbon credits — a criterion known as additionality in U.N.-speak.

This can be difficult to prove, particularly in a new project, where the intangible savings in greenhouse gases depend on defining a theoretical baseline. Determining whether carbon credits are critical for financing means “being asked to read the developer’s mind,” Mr. McCully said.

All claims must be documented and supported and must be screened by independent auditors who validate the projects. The final decision to accept or reject a proposal lies with the U.N.’s C.D.M. Executive Board. Once credits are awarded, they can be traded. One metric ton of carbon dioxide is worth one credit.

Since it began operating in 2006, the board has validated 2,918 projects, 40 percent of them in China, according to the U.N. Environment Program’s database at the Risoe Center, in Denmark, which tracks every project in the C.D.M. pipeline. The center’s data show that 1,668 projects are in hydroelectric power and 1,060 of those are in China.

“China is the most sophisticated player, and they have figured out how to manipulate the baseline to generate as many credits as possible with the least amount of effort,” said Professor David G. Victor, director of the Laboratory on International Law and Regulation at the University of California, San Diego.

China’s surging energy needs and its chronic pollution problems are not new. Shattering the country’s coal-dependence has been a problem for two decades, Mr. Victor said.

Axel Michaelowa, a climate change expert who helped start the C.D.M. program, said that major Chinese energy policy changes in 2002 put an emphasis on diversification and developing renewable energy. Measures to spur investment in renewables included a requirement for utility companies to buy production at a set rate; preferential loans; tax cuts; and the establishment of a renewable energy fund.

As a result, wind, solar and hydro projects have flourished across China. Rural electrification, too, has been a major priority under government policies to encourage development, alleviate poverty and strengthen central authority in the country’s far western provinces. Many of these projects have been financed in part through the C.D.M. program.

For the most part this has represented an inappropriate use of the mechanism, say Manuel Bogner, a graduate student, and Lambert Schneider, a climate change expert, in a case study on China prepared for publication by the German publishing house Lexxion.

The most blatant misuse of the program has been to support large hydropower dam projects, said Mr. McCully of International Rivers.

While C.D.M. credits might have been crucial for small Chinese hydroelectric plants generating less than 20 megawatts of power, medium or large projects mostly have been so-called free riders, topping up the profitability of dams which would have been built “with or without the C.D.M.,” Mr. Schneider and Mr. Boger found.

This calls into question the efficiency of the system in tackling climate change, their study points out. If a project does not depend on carbon credits for its existence, then the notional carbon savings are bogus. Yet the credits will nonetheless be sold to a polluting industry which will then pollute more — probably in Europe. The European Union is the only area with mandatory greenhouse gas reduction rules and is the most concerned by the C.D.M. process.

The Achilles’ heel of the system lies with the auditing firms that validate the carbon trading projects.

At first, the Executive Board assumed that auditors would be objective and fully investigate the claims presented by project managers. The committee did not check applications, it just moved them through to full accreditation, Mr. Michaelowa said. But it quickly became clear that auditors were faced with a conflict of interest: although they were required to be impartial, their reputation — as well as their market share — would be determined by the number of proposals that they approved for accreditation. Auditors had an incentive to accept the claims of the project manager without too much inspection.

In a study carried out in May 2009 for the conservation group WWF, the five most active auditing firms all rated poorly — the best was graded D on a descending scale from A to F.

The system is “not without deficiencies,” said Simone Ruiz, European policy director for an industry group to which the auditors belong. But, she said, the desire to curb excesses must be “balanced with the desire to see continued auditor and investor interest.”

In a process described by the World Bank as “learning by doing,” the executive board has since decided it needs to establish its own regulations and verification system. It recently raised staff levels and now takes a closer look at applications, requiring better documentation of claims. Auditors are inspected by U.N. teams and if found lacking are suspended until their methods improve. Most are reinstated within six months, minutes of board meetings show.

These changes are an improvement, but they have added to both the cost and the validation time for applications, the World Bank has found. And this added burden weighs most heavily on lesser developed countries.

Both these outcomes are contrary to the original goals and expectations of the Clean Development Mechanism. It was meant to aid the least developed countries — yet Africa receives only 2 percent of C.D.M. credits; and it was intended that C.D.M. administrative costs would decline, not rise.

The bank is now calling for more streamlining of the “complicated rules and the onerous documents required,” Mr. Michaelowa said.

No one has quite figured out how to administer offset credits because the “proof” required is ultimately a matter of judgement, not fact, said Mr. Victor of the Laboratory on International Law and Regulation. “The executive board has been trying to fix things but there are still some problems,” he said.

One suggestion, backed by International Rivers among others, is to set a fixed rate for audits and to allow the Board to appoint the auditor in a transparent basis. Or better yet, said Mr. McCully, since the mechanism is based on proving a negative, and can only work “in alternative universes that don’t exist,” it would be best to scrap the whole system and apply strict greenhouse gas reduction regulations in each country. That view is shared by the authors of the case study on China, who say that estimates of carbon credit misuse globally “range from 20 percent to 66 percent.”

Yet, radical change is unlikely to happen, Mr. McCully said, because there are “lots of revolving doors in the carbon trading industry where people go from different parts of the private sector, from auditors to developers, to brokers, to funds like the World Bank, to government, and then to the U.N. Executive Board.

“It’s quite a small world and people circulate a lot within that world; and there is nobody in that world that is critical of the process because they are all making their living off it.”

Furthermore, the system is fed by demand from the European Union and Japan, which must comply with strict emission regulations, Mr. Victor said.

“They are getting as many as credits as they can now because they can save them up and use them in the future when the regulations will be stricter,” he said. “So they have every incentive to sponsor projects.”
Patricia Brett, New York Times, October 12, 2010

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