FOCUS - CARBON TRADERS LOOK TO 'PLAN B' AS CHINESE CDM RISKS MOUNT
Xinhua Financial News
August 12, 2008
BEIJING (XFN-ASIA) - The carbon trading sector has flourished in China over the last few years but investors are now concerned that the bubble might burst amid general economic gloom as well as regulatory uncertainties both here and overseas.
With the Kyoto Protocol also set to expire in 2012, the industry also needs to start looking at other options, they said. Alberto Manzone, China manager with the Italian renewables developer, Asja Ambiente, said that the world was now in the middle of a "carbon rush." At such an early stage in its development, the hype and fear was perfectly natural. "This industry is like the Wild West right now," he said, "and you might find Indians or you might find bears, but you might also find gold." Whether that rush continues will perhaps depend on the ability of the world's leaders to thrash out a replacement for Kyoto over the next year. A new global climate change deal needs to be unveiled at the summit in Copenhagen in late 2009. It will determine whether the clean development mechanism (CDM) - the lynchpin of the global carbon trading industry - will exist after 2012.
"If there is no international agreement, then there will be very little demand," said Josh Harris, China representative with the London-based Climate Group, a non-profit organization established by a number of big international firms. "The negotiations are providing some positive signals," he added. "But it isn't clear what the CDM will look like in four years time." Others are hoping that domestic and international regulators can come out with a "plan B" that will enable the carbon business to survive. In China, it could involve a domestic emissions trading platform, or even a voluntary arrangement.
Post-Kyoto prospects are not the only concern. According to a consultant with a Beijing-based clean energy company, almost everyone in the sector is also worried that the hot money that has been sustaining the sector for so long could easily flow away. With as much as 80 pct of Silicon Valley venture funds now focusing on renewable energy projects, including the CDM, overall sector risks and concerns about the global economy as a whole could also precipitate a mass migration of capital, the consultant suggested. While some believe that the clean tech and carbon craze is likely to be rather more resilient than the dotcom bubble or the late 1990s, 2012 remains the key issue. "No other commodity needs to consider whether it will exist after 2012," said Mark Meyrick, director of carbon origination at the US energy firm, Constellation, speaking at a recent industry conference.
Such has been the conflict that has run through the sector from the very beginning. Bringing the muscle and innovative flair of the world finance markets to bear on the problems of anthropogenic, or human caused, global warming was regarded as critical. From this came the clean development mechanism, a way of making sustainable projects in the developing world profitable for investors in developed countries.
The CDM allows a country like China to draw on funds from the West to pay for projects that lead to verifiable decreases in greenhouse gas emissions. This is done through the creation of "certified emission reductions." The mechanism is essentially a trading platform for a hypothetical commodity, and it requires high levels of bureaucratic support. Naturally, traders are worried that if Kyoto expires and the bureaucracy withers, there will be nothing left to trade. In order to prevent valuable funds from reaching projects that would have been built in any event, the CDM forces investors to choose marginal projects that depend on the sale of carbon credits in order to make a profit.
This concept - known as "additionality" - is perhaps the most controversial aspect of the CDM.
The key problem in China right now was the "lack of coordination between the various administrations involved," said Beatrice Schaffrath, a lawyer and CDM specialist with Baker & McKenzie LLP.
She said that "the lack of sufficient market information" was also affecting the way carbon dioxide reductions are measured, and therefore undermined the whole purpose of the clean development mechanism. The UN has been looking into these problems, and an army of assessors and verifiers has already been established in order to make sure that "additionality" is achieved for each and every project. But if the calculations depend on putative emission cuts that take place after 2012, the additionality concept might create fresh problems. "Project owners will now struggle to find additionality unless they can prove that something will exist beyond 2012," Constellation's Meyrick said.
China has been dominant in the sector so far, providing as much as 73 pct of global emission reductions last year. Its nearest rival, India, provided just 6 pct.
The reason why China has been so appealing is obvious, said Massimiliano Varrucciu, the chief representative of Italy's Enel Trade in Beijing. "The marginal cost of (carbon) abatement in China is much lower than in other parts of the world," he said. According to a research report released this week by the Climate Group, China had completed carbon credit transactions covering 900 mln metric tons of greenhouse gases and worth more than 10 bln usd by the end of 2007. Many of the projects have been less than successful, experts have said. In China, the best performing sector has been HFC abatement projects, which have delivered 100 pct of the cuts specified in the original project documents. Some have complained that in the early days of the CDM, refrigerant producers actually scaled up HFC output in order to earn more credits from the abatement process. The worst performing sector has been biomass, which has delivered only 20 pct of the expected CERs so far, and landfill gas utilization has done only slightly better. "It is the sectors with the lowest risks rather than the highest profits that are growing the most quickly," said Thomas Stetter, chief operating officer with First Climate, a German carbon trade consultancy.
China has already slapped a 65 pct tax on carbon credit revenues earned through HFC abatement, with the aim of encouraging investment in other sectors, but that might prove difficult in the current climate. "We are seeing an unwillingness by Chinese sellers to commit themselves to sales after 2012," said Schaffrath of Baker & McKenzie.
She said that it was likely that they were holding out for a domestic carbon trading system that would be freed from the uncertainties of the CDM.
While China is making preparations and setting up trial markets in other clean "commodities" - including chemical oxygen demand and sulfur dioxide permits - a nationwide carbon emission market is unlikely to emerge until next year at the very earliest. Globally, China's dominant role in the sector has been one of the main worries. "China has been playing such a big role that the CDM was originally referred to as the China development mechanism," said Dr. Naoki Matsuo, the chief executive officer of Climate Experts Ltd.
There are enduring concerns in the US and Japan that the country - which as a developing country has not itself been forced to make mandatory carbon cuts - has been getting a free ride out of the arrangement. Many reckon that it will be next to impossible to bring the US into any new arrangement without forcing countries like China to commit to targets. Some quid pro quo on China's part is likely to be crucial for the success of next year's negotiations. But China remains vehemently opposed to the idea of implementing mandatory carbon reductions as part of any new deal. Furthermore, it is also trying to press its advantage in the current round of negotiations, hoping to use "CDM II" to facilitate greater levels of technological transfer from the west to the east. The impasse might not be broken soon. A complete market collapse might seem unlikely. The question doesn't merely perturb investors and project owners. It also involves the world's most powerful governments all anxious to demonstrate that they are doing something in the fight against global warming.
Marcus Chee, director of the Malaysian Business Council for Sustainable Development in Kuala Lumpur said it would be difficult to come to an agreement capable of satisfying the different objectives of the EU, Japan, the US, India and China, but he said he expects something to survive after 2012. "It will be great to have a CDM II, but let's have a plan B and a plan C as well," he said.
That "Plan B" would be a "VER" or "voluntary emission reduction" scheme, and would build on existing markets. It could be just as effective, Chee said. In the end, there was far too much at stake to let the CDM disappear completely, said Matsuo of Climate Experts Ltd. "Even if the Kyoto Protocol dies - and I cannot imagine that happening - the CDM can survive," he said. david.stanway@xinhuafinance.com
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