Select Committee on Environmental Audit Sixth Report


THE COMPLIANCE MARKET: A BENCHMARK FOR VOLUNTARY MARKET CREDITS?

57. The Government's consultation shows a clear distrust of VERs and a strong preference for CERs from the CDM as the credit of choice for consumers in the voluntary carbon offset market. Indeed if the code is produced as proposed in the consultation, then offset providers will only be able to hold the Government quality mark for their sale of compliance market credits. The Government is clearly worried the about robustness and accountability of some VERs and sees CERs as a way around these problems.

58. The compliance market is strong where the voluntary market is not in several areas: it guarantees that its resulting credits have emerged from a project which has met stringent criteria for approval; the emissions savings or reductions have been calculated in a transparent manner according to a specified methodology and are certified by a Designated Operational Entity (DOE) which gives a level of independence and reliability to the process; and credits which result from this market are officially registered and retired, thus reducing the risk of double-counting.

59. However, throughout our inquiry we received persuasive evidence that pushing the market for voluntary offset credits towards CERs as the benchmark credit might not be the best solution and that it might actually cause more problems than it solves. Our predecessor Committee's report, The International Challenge of Climate Change: UK Leadership in the G8 and EU, noted concerns with the CDM, particularly in relation to the slow rate of project approval, the kinds of projects being approved, and the lack of expertise and resources in less developed countries to partake in the CDM.[62] The '2006 State of the CDM' report by the International Emissions Trading Association (IETA) again brought to the fore these problems and in doing so highlights that they are still prevalent within the CDM.[63]

60. One problem raised in evidence to us and in the IETA report is the lack of technical expertise within the CDM administration to understand and deal with new technologies, particularly with the 'Meth Panel' who are responsible for developing methodologies to calculate emissions savings and reductions from new projects:

    IETA's membership frequently expresses concern that requests for clarification from the Meth Panel reflect a lack of technical competence relative to the technology and processes associated with proposed new methodologies. These questions contribute to unnecessary delays and the creation of a lack of confidence between the regulator and those that it seeks to regulate.[64]

On a very basic level the solution to fix this problem seems clear: the IETA report suggests that simply by encouraging more dialogue by telephone and email between the regulator and those being regulated many technical questions could be answered easily and some technical questions could be "disposed of entirely". It also recommends that the Meth Panel in developing new methodologies should be required to draw upon experts at each stage of the review process.[65] The recommendations of the IETA Report on 2006 State of the CDM for resolving the issue of a lack of technical expertise in producing new methodologies for new technologies are clear and uncomplicated, yet would resolve an important problem. If the voluntary carbon offset market continues to grow at the rates predicted then the development of new methodologies for new technologies will become increasingly important as those projects considered to be 'low hanging fruit' are exhausted. We recommend that the Government press for immediate action to be taken to ensure that the Methodology Panel can draw upon the advice of experts quickly and easily and that regulators and those being regulated are encouraged to, and are given the means to, communicate in a direct and efficient manner.

61. The lack of technical expertise also relates to and serves to exaggerate two other significant problems with the CDM, namely the timely development of new technology and uneven distribution of projects in some of the least developed countries. The IETA report recognises that only 2% of the total number of projects registered are based in Africa and less than 1% of CERs generated originate from Africa. It explains that the delay in small-scale methodologies for non-renewable biomass significantly reduces the opportunity for Africa to benefit from the CDM. The Co-operative Group also raised this point in its memorandum: it sees providing a methodology for non-renewable biomass as a "critical" concept for projects in the least developed countries.[66] It is estimated that 2.4 billion people rely on biomass as their primary energy source for cooking and heating. The demand on non-renewable biomass resources could be greatly improved by the use of biogas digesters and improved stoves: although under development, there are not currently any approved methodologies for projects which would support this. Such problems were further acknowledged by DEFRA officials in their oral evidence to us:

    We have done things like encouraging the smaller scale projects to be subject to more simplified methodologies but that has not been entirely a success, and we have looked at particular methodologies where there has been a problem about small-scale cooking stoves and proposing solutions for these […] We have made a proposal for particular project types which have not been accepted, it is true.[67]

62. If Government is determined to encourage the voluntary carbon offset market to move towards the sole use of compliance market credits, then it is vital that this does not draw money away from the least developed regions such as Africa which currently benefit from the sale of VER credits, but which remain largely excluded from the compliance market, in part for methodological reasons. We recommend, therefore, that as a matter of urgency, the Government redoubles its efforts to address the proposals of the IETA report on the 2006 State of the CDM in relation to resolving the disproportionate regional and sectoral distribution of projects: it should help to identify the systematic or systemic barriers to equitable distribution of CDM project activities and promote more regular meetings between the Executive Board and designated national authorities of under-represented regions such as Africa. It should also make a priority its efforts to assist and influence the development of a simplified methodology for projects which support the switch from non-renewable to renewable biomass.

63. There are also wider problems with methodologies and processes within the CDM which apply to all and not just to those countries which are currently under-represented: one of these is the time that it takes for new methodologies to be approved. New projects and technologies can only create CER credits once a methodology for them has been developed and approved under the CDM. On this matter, the IETA report states:

    Unfortunately, the new methodology approval process is creating a serious bottleneck that is needlessly delaying or discouraging these new types of project activities. At present, approval of a new methodology can take two years or longer […] Continued delays of this magnitude will cause investors and developers to become disenchanted with the CDM process, and lead to quality projects, with significant sustainable development benefits to go undeveloped.[68]

Given that one of the stated aims of the CDM is to achieve sustainable development in developing countries, this is certainly a significant issue. By pushing the market for voluntary offsets towards CDM credits, the Government risk destroying the only opportunity that projects with other sustainable development benefits have to sell credits in the voluntary market. Furthermore, not only does it take a long time for such methodologies to be developed, but the flexibility to clarify or revise methodologies is also constricted and subject to delay. Again this causes considerable uncertainty and can cause a risk to project developers. We were encouraged by the work that Defra officials have done recently to improve this situation which they highlighted to us in their oral evidence.[69] This has included increases to the numbers of UNFCCC staff designing methodologies and more work undertaken to consolidate methodologies. This has been particularly important for small-scale renewable projects where 512 projects are now using the same methodology. We applaud the recent work that DEFRA has done to reduce time delays and methodological problems broadly in the CDM. However, still more needs to be done particularly in regard to developing new methodologies. We recommend that the Government take further steps to address the issue of the delay in developing new methodologies by putting pressure on the CDM Executive Board to expand and streamline its methodology development and revision process to make it easier to define and produce methodologies for projects with sustainable development benefits.

64. Another related issue highlighted to us was the heavy burden and administration costs, particularly for smaller-scale projects of obtaining CDM accreditation. Climate Care told us in their memorandum, that under the current rules of the CDM a modest project is often not viable in the CDM because of high transaction costs. Here, it highlighted the example of a South African low cost housing energy upgrade project which was only viable in the voluntary market where transaction and administration costs were lower.[70] On a positive note, DEFRA officials told us that registration is now free if a project is worth below 15,000 tonnes of carbon,[71] but we feel that this area is one in which much more can, and should, be done. The strength of the voluntary carbon offset market is its ability to support a diversity of projects: including those that are small; those that bring additional sustainable development benefits; and those found in countries which are currently under-represented in compliance market projects. Despite seeming to have done some work to try to improve the situation here, DEFRA, in its memorandum and in the consultation, fails to explain or even acknowledge that there are problems with these types of projects in the CDM. We recommend that in further stages of developing the code these problems are addressed in an open and transparent manner and that the code is adapted in light of them. Primarily however, we recommend that DEFRA continues and expedites its work on further reform of the CDM in order to break down the barriers that prevent these important project types from succeeding. It should press for reform of the CDM in these areas at every available opportunity at an international level.

65. A growing problem with the CDM is the uncertainty of its existence beyond 2012. Whilst many of our witnesses felt sure that the CDM would continue as part of any post 2012 framework agreement,[72] others felt that the lack of firm commitment caused problems which were solved only by the existence of the non-compliance offset market:

    The absence of a long term signal for commitments within the CDM has deterred investment and created substantial uncertainty for project developers. By providing reassurance of a market demand, the voluntary market can continue to stimulate project development past 2012.[73]

In their oral evidence to us DEFRA officials were optimistic that they thought that the CDM, would "definitely continue",[74] but at the same time they highlighted that this is not yet official and that widespread uncertainties in the international frameworks remain:

    Clearly, there are uncertainties about the period post-2012, and they relate not just to the CDM they relate to the whole international structure and to the EU Emissions Trade Scheme […][75]

66. If the Government is serious about making CERs the credit of choice in the voluntary carbon offset market, then firm decisions about the future of the CDM need to made, and made quickly if further investment in the CDM is not to trail off as 2012 approaches. Consumers need reassurance that investments that they make in projects that take several years to produce the expected carbon savings or reductions will be guaranteed past 2012. The Government needs to expedite decision-making at an international level to resolve officially the issue of a post-2012 CDM.

67. Another point of contention with the CDM, raised by the Energy Saving Trust, is with some of the types of the projects that the CDM supports.[76] In the CDM some of the approved projects and methodologies work towards reducing the carbon emissions from polluting companies. The Co-operative Group makes the point that many consumers in the voluntary market would not want to see their money going to the companies which are actually a cause of pollution.[77] The media has recently reported credits being sold from projects which eliminate the gas HFC-23, a by-product of a chemical used to make refrigerants. It has been suggested that some companies have actually started producing this gas deliberately in order to get money from the CDM which allows them to both destroy it and make a profit whilst doing this.[78] A report in the Guardian suggested that 53% of the existing CERs come from just six "monster projects", in India, China and South Korea, all of which engage in HFC-23 reduction.[79] Clearly such a situation is untenable and goes against the entire ethos of carbon trading. We recommend that the Government push for reform of the CDM to ensure that profiteering from polluting behaviour becomes impossible. Consumers need to be confident that their money is being spent on projects which meet the highest ethical standards. Until this is achieved we recommend that the Government should require offset providers selling compliance market credits in the voluntary market to list the types of the projects from which their credits derive. This should be done as soon as is practicable and regardless of whether it decides to proceed with the proposed code.

68. Another potential problem for private consumers being pushed into using compliance market credits arises from the EU Emissions Trading Scheme. The EU ETS was established to reduce emissions from EU countries. However, the EU ETS currently allows credits from the CDM to be used to meet part of its target. CDM credits, CERs, originate from projects all over the world, and so the reductions are not necessarily being made solely in the EU. As we have stressed in our report The EU Emissions Trading Scheme: Lessons for the Future[80] and as the RSPB explained in its memorandum, this has the effect of "inflating the EU cap—making the already weak targets even weaker."[81] The Co-operative Group explained further in their memorandum how this is detrimental to the voluntary offset market:

    […] using the EU ETS model will involve the transfer of money from individuals and households to the 12,000 or so industrial installations across Europe participating within the scheme. This would provide ample opportunity for the media to point out that, in effect, the well-intentioned charitable donations of UK working families were ending up in the coffers of big European companies who were selling pollution permits. Such developments would result in greater levels of cynicism over the benefits of offsetting and therefore significantly damage consumer confidence.[82]

69. It is unacceptable that private consumers in the voluntary carbon offset market be put in the position where their money is effectively being spent to purchase permits for large installations to pollute. Until the EU ETS cap is tightened up and becomes more efficient and effective, it is vital that offset providers are required to provide a 'health warning' to consumers about what could happen to their money if they invest in compliance market credits. The Government should take steps actively to dissuade offset providers from providing EUAs to private consumers given that, as we have concluded in previous reports, EUAs from phase I of the EU ETS are as good as worthless in carbon terms, but yet continue to be retailed.

70. The evidence we received revealed a difference of opinion about the precise effect that the voluntary market would have on the compliance market and vice versa. Some, such as the RSPB, thought that the voluntary market would have little impact on the compliance market and that eventually compliance market credits would dominate the market place as consumers, particularly businesses, sought to mitigate the reputational risk that buying a VER could bring in the absence of any formal standards.[83] The Energy Saving Trust told us that it thought the two markets could continue to co-exist, the compliance market supporting larger projects and the voluntary market supporting smaller projects with additional benefits.[84] Similarly, Energy for Sustainable Development told us that the voluntary market has an important role to play in enhancing and complementing the compliance market. It sees the role of the voluntary market as acting as a training and testing ground for projects before they enter the compliance market and that it plays a critical role in educating and engaging individuals in climate change.[85]

71. Given the many unresolved problems with the compliance market, particularly surrounding methodological issues and uneven distribution of projects, we urge the Government to take swift action to resolve these problems regardless of whether or not it chooses to it introduce its code. The CDM remains significantly flawed and this needs to be addressed. We recommend strongly that the Government think again about its proposed code: of the options set out by the Government in its consultation it must produce a voluntary code based on all credit types which will recognise the important role that the voluntary market has to play in counter-balancing the flaws of the compliance market.


62   The Environmental Audit Committee, Fourth Report of Session 2004-05 The International Challenge of Climate Change: UK Leadership in the G8 and EU, HC 105, para 70 Back

63   International Emissions Trading Association, 2006 State of the CDM Back

64   International Emissions Trading Association, 2006 State of the CDM, p 13 Back

65   International Emissions Trading Association, 2006 State of the CDM, p 13 Back

66   Ev90 Back

67   Qq 423-424 Back

68   International Emissions Trading Association, 2006 State of the CDM, p 17 Back

69   Q 425 Back

70   Ev75 Back

71   Q 425 Back

72   Q389 LCCS Back

73   Ev75 Back

74   Q248 Back

75   Q247 Back

76   Ev3 Back

77   Ev90 Back

78   "Producers and traders reap credits windfall", Financial Times, 27 April 2007 and "British 'carbon swap' is£300m of Indian hot air", The Sunday Times, 22 April 2007 Back

79   "Global warming: Truth about Kyoto: huge profits, little carbon saved", The Guardian, 2 June 2007 p 6 Back

80   The Environmental Audit Committee, Second Report of Session 2006-07, The EU Emissions Trading Scheme: Lessons for the Future, HC 70 para 19 Back

81   Ev4 Back

82   Ev89 Back

83   Ev6 Back

84   Ev3 Back

85   Ev87 Back


 
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Prepared 23 July 2007