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3. CDM project crediting criteria
3.1 Insurance of Certified Emissions Reductions (CERs)
Emissions reductions resulting from CDM projects must be measurable and certified by auditors. Insurance could be taken against the risk of shortfalls in carbon reductions, particularly in the case of project failure resulting from any number of technical, economic, political or other factors.
CERs should either be banked, post-certified reductions or be insured
against potential failure where this is deemed appropriate by the Executive
Board.
While a CDM project is required to reduce GHG emissions measurably at the project site, it may be that the project has merely displaced the source and thus resulted in no net reduction of emissions or fewer than it is being credited for. So-called 'leakage' can occur at local or international level. Thus the physical amount of GHG emissions reductions from CDM projects is subject to a certain degree of uncertainty. Keeping track of possible leakages across regions and especially internationally is an important task, which can add a substantial burden to monitoring and verification bodies. All attempts should be made during project appraisal to assess the likelihood of local and trans-national leakages and these should be included in the assessment of baselines.
Leakage inside and outside the project boundary must be identified,
measured, reported and deducted from CERs. In the case of land-use change,
projects should be scrutinised from a regional perspective to measure cross-border
leakages.
3.3.1 Entities involved in CDM project verification
For the CDM to fulfil its mandate it is essential that confidence should exist in the number and value of CERs. To improve the chances of establishing and maintaining confidence in the CDM, third party entities acting as CDM project facilitators or auditors need to be in place. Similarly, the agreements between investors and hosts require third parties with a keen knowledge of the eligibility criteria for CDM projects. Facilitators could also be trained and assigned arbitral responsibilities in cases of conflict between stakeholders.
In practice, CDM projects would involve two primary levels of engagement. First, between Annex 1 and non-Annex 1 Parties engaged in the project, and second, between project developers and project beneficiaries.
If the project beneficiaries are under-capacitated to make decisions and undertake activities, the sustainability of projects will be severely jeopardised. Facilitators will have to be in a position to assess problems and command the resources to develop an equitable understanding of the implications of Parties' actions.
Verification of CERs must be undertaken by institutions which are accredited by the Executive Board of the CDM and which have no interest in the results of CDM projects. Any potential conflict of interest should be publicly declared prior to accreditation.
Criterion 20: Facilitation of CDM projects
The facilitation of CDM projects must be undertaken by institutions
that have a keen understanding of CDM criteria, the requirements for sustainable
projects and the resources to implement them. The CDM Executive Board should
accredit facilitators.
In addition to verification, Parties that are both investors in and hosts of CDM projects should report on the progress of these projects and verified CERs in their national communications. Timely and transparent information should also be made available through appropriate public media to keep civil societies abreast of the progress of CDM projects.
Information pertaining to the progress of CDM projects should be included
in national communications of Parties to the FCCC and should be made available
in an accessible way to civil society in countries participating in the CDM.
Reporting should be based on verified CERs and project process monitoring.
3.4.1 Allocation of project benefits
Investors from Annex 1 countries will normally choose the cheapest GHG emissions reductions opportunities in non-Annex 1 countries, unless another interest such as technology transfer takes precedence. Assuming low-income countries accept GHG reductions targets sometime in the future, they would then be faced with the leftover, higher costs abatement measures. Early measures must be taken to allow non-Annex 1 countries to invest in future commitments now, or to allow them to gain access to CERs.
Article 12.3a and 12.3b contain a guideline that will contribute to the 'win-win' nature of the CDM. Under the Article, non-Annex 1, host countries will benefit from project activities and Annex 1 (investor) countries will benefit from the accrual of the Certified Emissions Reductions (CERs). This article does not specify the exclusivity of the benefits to the Parties. For example, the CERs could be shared between the Parties, with the non-Annex 1 country banking theirs for sale or transaction at a later date. Indeed, a number of countries, whether Annex 1 or non-Annex 1, could form consortia in undertaking CDM projects, similar to the concept of 'bubbles', that have been proposed for sharing risks, credits and other strategic interests.
Article 12.9 states that 'participation ...in the acquisition of emissions reductions, may involve private and/or public entities'. The range of entities and the types of partnerships therefore could be numerous. With the advent of emissions trading, this is likely to become the norm.
We propose that any project that has been appraised by the Executive Board as fitting the eligibility criteria should first be offered to in-country private or public entities. This would address host country concerns that early, least-cost opportunities to meet future commitments may be sacrificed.
In a conventional bidding process, it is anticipated that Parties from investor and host countries would elect to develop a project jointly. At this point, if the project were to be offered to another entity by the host country, it is unlikely that there would be a taker, because the incentive to invest in project development would be lacking, aside from any CDM funds. The project would thus only be viable for other entities if they were to tender the project collectively. In such a case, the host country Party may elect either to remain a sole investor in the project or to invite equity partners to participate. If there are no non-Annex 1 takers, the project may be returned to a CDM clearing-house and auctioned. This approach supports a number of other goals:
CDM projects should be offered to local public and/or private entities
in non-Annex 1 countries before being offered to Annex 1 countries. Should
the steps not be taken to realise the project within a given period, the project
could then be auctioned on the international emissions market.
Financial additionality has not been precisely defined, but has been used in two distinct applications, firstly in the context of additionality of projects and their finance, and secondly in the context of the financing of the CDM itself.
Financial additionality in projects refers to the difference between a project that arguably would have been undertaken in a business-as-usual scenario, and the proposed CDM project. To set a financial cut-off as a criterion would be costly and difficult to assess (see Criterion 4). In such instances, independent consultants could be engaged to investigate cost projections.
As one observer put it '…environmental additionality should be addressed through the definition of a reasonable baseline, involving judgement about what might have happened in the absence of the project: reductions from a realistic baseline are additional. Private funds could be considered additional and separate to contributions by parties to the GEF and to ODA. Private funds for CDM projects that meet the environmental additionality test would not need to demonstrate financial additionality. The environmental additionality test would root out commercially viable projects that would have happened anyway from those made possible only by the establishment of the CDM. '21
In order to receive CERs, CDM projects must be truly additional to
those that would have been implemented anyway, according to a realistic baseline.
This criterion can apply to interventions in business-as-usual projects that
show both environmental and financial additionality.
The second application of financial additionality relates to project funding. Should funding for CDM projects be additional to existing financial channels such as Official Development Assistance, Foreign Direct Investment or the Global Environment Facility funding? Evidence that financial leverage is being promoted through the allocation of genuinely 'new' sources of funding must be shown, otherwise CDM projects may potentially drain the existing resources available to recipient countries.
In the international market today, there is a flow of large capital resources to certain low-income countries seeking short-term profitable opportunities in financial applications. However, much of this capital is not geared to the large up-front costs and long payback periods and risks associated with investments in renewables, energy conservation and afforestation projects. ODA has decreased by 25 percent in the last four years and CDM projects may help plug this resource gap, but should not become a 'replacement ODA'. It would be extremely useful for Parties to fix a baseline for future ODA, detailing the public and private components, prior to the commencement of the CDM.
The investments for CDM projects must be additional to existing finance
and resource channels.
The costs of administering CDM projects will be at their highest at the outset of the CDM activities, while methodologies are being developed, tested and established in practice. Added to these costs will be levies for adaptation and capacity building of CDM in country, public and private entities as well as the cost of CDM project auditors and facilitators.
At the outset of the CDM, projects will most likely be low cost, at a time when transaction and administrative costs are at their most onerous.
The design of a standardised process approach that is easy to apply and replicate will be critical for the minimisation of transaction costs. A set of streamlined steps should be rigorously applied in establishing a CDM project. Frameworks and models need to be developed to assist entities in their approach to a transaction. It is likely that cross-subsidies from larger to smaller projects will be required.
CDM project cost overheads should be capped on a sliding scale proportional
to the full project costs and should reflect the performance of the CDM project
rather than being imposed as flat rates.
Since increased cost-effectiveness in achieving global benefits is one of the main reasons to promote CDM projects, it will have to be carefully appraised on a project-by-project basis. The resulting costs of GHG emissions avoided by CDM projects can be affected by a number of social, technical, economic and financial project performance factors, besides the uncertainties of baselines and leakages. There is always a risk of poor performance of a technology transferred to another context. In addition, the choices of discount rate and life-cycles for the project evaluations are always somewhat arbitrary.
In order to apply for credits and to establish appropriate sharing mechanisms of credits between the host and investor countries, CDM projects will have to be subjected to continuous monitoring and verification. The corresponding costs will add to other transaction costs and can increase the initial cost estimates substantially. It has been estimated that, given the complexity of the task, monitoring and verification of CDM projects for credit will involve additional costs at least as high as those involved in the reporting and review process for national communications under the FCCC. This will reduce their claimed cost-effectiveness significantly.
The general perception of lower abatement costs in developing countries can be reversed in some cases by the combined effect of CDM projects with larger costs (and lower emissions reductions) than initially expected, and different macro-economic settings. An example of this is the lower energy prices in developing countries compared with OECD countries. On the other hand, there are non-negligible low positive costs and even negative cost abatement options to be tapped in OECD countries. The adoption of 'no-regrets options' may also be hampered by non-economic barriers or by hidden costs of a cultural or political nature. These may prevent the implementation of otherwise inexpensive mitigation measures.
In order to achieve emissions reductions that have associated non-economic
barriers, costs associated with local environmental, cultural and other externalities
must be factored into CDM project budgets.