Baptiste Raymond and Anaïs Delbosc

also describe the benefits of project-based

mechanisms, which are being adopted around

the world as complements to emissions tra-

ding schemes. Although everyone agrees on

the benefits of either a cap-and-trade or a

mandatory tax, their practical implementation

in the short term, as well as the coverage of all

sectors at once, would be difficult if not impos-

sible. Project-based mechanisms can help,

making these instruments more effective by

extending a price signal for carbon and by

indirectly linking different carbon markets.

On the international scale, the implemen-

tation of emissions abatement measures

comes in general with discussions on the

competitiveness of the economic players or

national economies affected. These discus-

sions have been exacerbated by the econo-

mic crisis: if financing emissions reductions

efforts halfway around the world becomes

more difficult to justify, financing investments

at home begins to look more attractive.

Therein lies the attraction of the domestic off-

set project mechanisms which are being

created in Europe, the US and Japan.

Our survey of project mechanisms would

ClimatSphereThe newslet ter on the economics of c l imate change

not be complete without mentioning the

agricultural and forestry sectors, for which,

in the medium term, project-based mecha-

nisms seem to be more effective. This is the

subject of the final article by Mariana

Deheza and Valentin Bellassen.

Three lessons can be drawn from this survey

of projects. First, projects make it possible to

identify new sources of emissions reductions.

Second, the perfect project-based mecha-

nism does not exist; we have to learn how to

live with imperfect mechanisms and improve

them as time goes on. Finally, project-based

mechanisms improve the effectiveness of

existing tools by broadening the scope of the

price signal sent to the players under a carbon

constraint. They can link two mechanisms and

supplement either a cap-and-trade system or

taxes. This latter point is important to remem-

ber, with the discussion on the French level

about the climate-energy contribution, on the

European level about the proposed introduc-

tion of a carbon tax, and also on the interna-

tional level regarding both the plans for federal

a cap-and-trade system in the US and the

upcoming Copenhagen conference. �

Benoît Leguetbenoit.leguet@caissedesdepots.frTel. : +33 1 58 50 98 18

Regardless of the outcome of the

Copenhagen negotiations, one thing is

certain: the post-Kyoto world will include

project-based mechanisms. Project-based

mechanisms, the best known of which is the

Clean Development Mechanism (CDM), are

frequently criticized for being difficult to

implement, letting host countries off the hook

because they are voluntary, and even for

being bad for the environment. Criticisms can

lead to improvements in such mechanisms.

However, they must be balanced by conside-

rations of the context, and their benefits.

This kind of critical and necessary analysis

has been offered by two project-based

mechanism specialists, Noriko Fujiwara, of the

Center for European Policy Studies (CEPS),

and Maria-Bernadete Sarmiento Gutierrez, of

the Brazilian Institute for Applied Economic

Research (IPEA). They describe the potential

evolution from project mechanisms to "pro-

grammatic" mechanisms, the purpose of

which is to accredit programs of activities that

reduce emissions, up to and including secto-

ral emissions reduction commitments. We

would like to take this opportunity to thank

them for agreeing to answer our questions.

Project mechanisms: Ancient history?

The role of projects in the futureinternational climate agreement

Beginning of negotiations on the Kyoto Protocol project mechanisms

Kyoto Protocol Marrakesh agreements on Kyoto projects

First recorded CDM project

1989 1995 1997 2001 2004 2007 2009 2012

Copenhagen Conference: expected reform of project mechanisms

Initial voluntary project mechanisms

Projects Directive linking the EU ETS to Kyoto project mechanismsImplementation of domestic offset projects in New Zealand

Implementation of domestic offset projects in France, Germany and Spain

Development of project mechanisms in the US and Australia

Introduction of the "programmatic" CDM

N°15 • 3rd quarter 2009

Including developing countries inthe future international agreementthrough project-based mechanisms

Insights from Noriko Fujiwara andMaria-Bernadete Sarmiento Gutierrez

A bull market for domestic offset projects

Benoît Leguet

Projects: a complement to the ETS

Baptiste Raymond and Anaïs Delbosc

Project mechanisms in figures

Antoine Samzun

and Raphaël Trotignon

Conciliating national caps andincentives for projects

Valentin Bellassen and Mariana Deheza

Content

E ditorial

Source: Mission Climat of Caisse des Dépôts.

The earliest projects, which were implemented on a voluntary basis, date back to 1989. Nevertheless, projectmechanisms were codified by the United Nations only in 2001 in Marrakesh. Since then, an increasing number of countries have been using them as a supplement to their national emissions reduction policies.

2

I nterview

Including developing countriesin the future international agreement through project-based mechanismsInsights from Noriko Fujiwara, Head of Climate Changeat the Centre for European Policy Studies (CEPS), and Maria-Bernadete Sarmiento Gutierrez, SeniorResearcher at the Institute of Applied Economic Research (IPEA) in Rio de Janeiro.

Could the cap-and-trade systemsdeveloped in industrialized countries(EU, USA, Australia, Japan…) beextended to the major emerging countries?

Noriko Fujiwara (N.F.) : Yes, as far as a

cap-and-trade system appeal to them as a

viable mitigation option. An international

framework could be created to reward

national mitigation actions by developing

countries in exchange for financial and

technical assistance. The governments

would then find an opportunity to benefit

from early additional domestic measures

such as a cap-and-trade system. Another

approach would be voluntary adoption of

binding sectoral targets supported by a

sectoral trading system.

Maria-Bernadete Sarmiento Gutierrez

(M-B.S.G.): The principle of “common but

differentiated responsibilities” has to be

adapted. Any effective international climate

change agreement will have to include

major emerging countries, so as to avoid

cross-border carbon leakages. There are no

major conceptual and logistical impedi-

ments to extending existing cap-and-trade

systems. The major one is of a political

nature: governments from emerging coun-

tries, by and large, refuse to take responsi-

bility for a net contribution to reduce GHG

gases on the basis of the historical respon-

sibility criterion.

How do you expect the KyotoProtocol’s project-based mechanismsto evolve in such a post-2012 frame-work?

M-B.S.G.: So far, the roles the Clean

Development Mechanism (CDM) and Joint

Implementation (JI) have played in finan-

cing sustainable development have been

limited by high transaction costs, policy

uncertainty, technology risk, etc. To be

more effective, these project mechanisms

will have to be streamlined through pro-

grammatic, sectoral, and/or policy-based

approaches, which will complement each

other. Reforms will be needed to provide

new methodologies for energy efficiency

projects, new ways of evaluating projects

with long pay-back periods, or to foster

strategic transfers of new technology.

N.F.: The main challenge is how to

transform the CDM from pure offsetting to

crediting. One approach could be sectoral

crediting based on no-lose targets.

Baselines could be gradually tightened

and translated into absolute caps for a

cap-and-trade system. An emerging

country could thus voluntarily adopt bin-

ding sectoral targets, operate sectoral JI,

and introduce a mandatory sectoral tra-

ding system. Least developed countries

should however remain eligible to the

CDM.

Are global sectoral agreementsrealistic for including major emergingcountries?

N.F.: Technology cooperation would

hold the key for global sectoral approaches

to evolve from a voluntary industry-driven

exercise to agreements endorsed by

governments of both industrialized and

major emerging countries. One interesting

example would be the Asia-Pacific

Partnership on Clean Development and

Climate aimed at enhancing incentives for

development, deployment and transfers of

clean technologies and built upon a public-

private joint effort.

M-B.S.G.: A definite positive response

has already been made by certain indus-

tries. The Cement Sustainability Initiative

illustrates this: major companies from

Annex and non-Annex I countries have

agreed to common standards for monito-

ring and reporting CO2 with the final objec-

tive of developing a trading scheme. For

other sectors not exposed to international

competition, governments will have to take

the lead, for example in the transportation

and energy sectors. �

Interview by Nicolas Stephannicolas.stephan@caissedesdepots.frTel.: +33 1 58 50 98 39

“The views expressed are attributable only to theauthors in a personal capacity and not to any institution with which they are associated”.

Emissions trends in developing countries: the contribution of the CDM

By 2012, the KyotoProtocol’s project-basedmechanisms are likely to generate significant emissions abatement indeveloping countries. Indeed in 2012, about 3 % of their emissions should beavoided. Renegotiating therules of project mechanismsand completing them withother mitigation instrumentsis necessary to further limitemissions growth in developing countries.

28

Estimated GHG emissions without CDM +116% Estimated GHG

emissions with CDM: +110%

26

Gre

enho

use

gas

emis

sion

s in

non

-Ann

ex I

coun

trie

s (G

tCO

2e/y

)

24

22

20

18

16

14

12

1990 1995 2000 2005 2008 201210

Source: estimates of Mission Climat of Caisse des Dépôts, from UNEP Risoe and World Resources Institute data.

P olicies and measures

A bull market for domesticoffset projects

Joint Implementation Created by the Kyoto Protocol, Joint

Implementation (JI) was the first mecha-

nism for "domestic offset projects", rewar-

ding emissions reductions in the countries

subject to a Kyoto commitment with carbon

credits. Four years after the JI was laun-

ched in late 2005, more than 200 projects

are in development with potential emissions

reductions of approximately 350 MtCO2 by

2012. The majority of these projects is loca-

ted in Russia and Ukraine and employs a

variety of technologies: flaring methane

with recovery of heat or electricity in the

power generation sector, incineration of

industrial greenhouse gases, power gene-

ration from renewable energy sources and

improvements in energy efficiency. The cre-

dits generated can be traded on the

European market, which de facto finances

most of these emissions reductions.

JI in Europe, the source of"domestic offset projects"

Joint Implementation projects in Europe

are ineligible for allowances if they reduce –

directly or indirectly – emissions that are

already covered by the European Union

Emissions Trading Scheme for CO2 (EU

ETS). In spite of this limitation, almost all of

the new Member States and several older

Member States have established proce-

dures to accept JI projects. In France, the

system of “domestic offset projects” took

shape in late 2007. The objective was to

promote the emergence of fifteen projects,

the majority of which have a strong territo-

rial basis. For example, a project developed

by alfalfa dehydration industry in

Champagne-Ardenne is introducing the

wood-energy generation model at the local

level. The project implemented by the

Urban Community of Lille will supply urban

transit buses with biogas produced from

the processing of municipal waste.

In these times of tight budgets, other

European countries are looking with inter-

est at these projects which are co-financed

by the market. In Germany, the Rhineland

Energy Agency in Nordrhein-Westfalen has

created a regional energy efficiency pro-

gram, a portion of the financing for which is

provided by the sale of JI credits. In Spain,

a regulatory framework has been created.

Even the Netherlands, which have been

historically cool to the idea of JI projects,

have displayed interest. A study submitted

to the Minister of the Environment in mid-

2009 concludes that these mechanisms are

advantageous means of financing emis-

sions reductions in the construction, trans-

portation and agriculture sectors.

A strategic advantage The United States has gotten the mes-

sage. Its current proposed federal cap-and-

trade system, which aims to cover 85% of

its emissions, also calls for domestic offset

projects, specifically in the agricultural and

forestry sectors . In Japan, credits origina-

ting from domestic offset projects can be

used in the voluntary test market in opera-

tion until 2012. In Europe, the adoption of

harmonized domestic offset projects is an

opportunity created by the EU ETS

Directive for the period 2013-2020. This

opportunity remains to be transformed into

reality.

At the moment, the international discussions

revolve to a great extent around ways to

improve the CDM. This is a strategic error.

The objective of the negotiations should be

to encourage countries to accept emissions

reductions commitments; the importance of

the CDM will decrease over time. On the

contrary, the implementation of a system

that provides sufficient incentives for JI and

"domestic offset" projects could help bring

the emerging countries on board for a future

international agreement. �

Benoît Leguetbenoit.leguet@caissedesdepots.frTel.: +33 1 58 50 98 18

Domestic offset projects under development in France

3

The fifteen domestic offset projects under development in France are projected to reduce emissions bythe equivalent of more than 5 MtCO2 by 2012. The incineration of industrial gases represents more thanhalf of the reduction by volume, although the number of these projects is limited. The majority of theprojects take place in the power generation sector.

Source: CDC-Climat, July 2009.

To date, the project mechanism par excellence hasbeen the Clean Development Mechanism (CDM), whichfinances emissions reductions in developing countries.The economic crisis has brought forward “domesticoffset” projects which finance investments in thedeveloped countries. This article focuses on theadvantages of this mechanism.

Type Number of projectsEmissions reductions projected

for the period 2008-2012 (in tCO2e)

Energy efficiency 3 600,000

Renewable heat generation 6 1,400,000

Fuel replacement 1 80,000

Cooling 1 16,000

Transportation 1 46,500

HFC 1 1,000,000

N2O 2 > 2,000,000

Total 15 > 5,000,000

E missions Trading Schemes

Projects: a complementto the ETS In emissions trading schemes, the use of credits originating from project mechanisms allows theissuers to reduce their compliance costs without compromising the overall environmental objective. This article surveys the principal existing and proposed emissions trading markets.

Emitters who are subject to the require-

ments of a carbon market must return car-

bon assets that match the level of their

greenhouse gas emissions. Emissions –

and emissions reductions – have the same

impact on the climate regardless of where

they originate. Hence the idea of issuing

credits originating from emissions reduc-

tion projects outside an individual market,

in other industrial sectors or geographic

areas. The cost of compliance can then be

minimized by juggling carbon assets,

depending on their relative prices, without

threatening the overall environmental

objective.

Limited importation of credits In general, there are limitations on the

importation of credits. Why? The creators

of the market want to realize a portion of

the reduction effort on the sites operated

by the industries that are subject to the

cap. For example, the European Union

Emissions Trading Scheme (EU ETS)

authorizes the use of Kyoto credits up to

an average of 13.5% of a company's allo-

cation between 2008 and 2012. The

European commitment is motivated by two

objectives: to support developing coun-

tries in accordance with international

agreements and to ensure European indus-

tries flexibility in reducing the cost of emis-

sions reductions. This possibility will

remain in place after 2012, although in

reduced proportions.

The ceiling on the importation of credits is

lower in the Regional Greenhouse Gas

Initiative (RGGI), which caps CO2 emissions

by electric power producers in the

Northeastern US: 3.3% of their allocation.

Indeed, the electric power generation sec-

tor is relatively sheltered from international

competition so the cost of emissions

reductions can be more easily shifted to

consumers, which limits the need for redu-

cing the compliance costs. Moreover, the

RGGI emissions constraint for 2018 is

considered relatively small.

Finally the US and Australian federal market

projects are distinguished by the need to

ensure the players flexibility in exchange for

the imposition of a cap on at least 85% of

their emissions, especially in the current

economic context. The importation of cre-

dits would therefore be a minimum of 15%

in the US and unlimited in Australia.

Protected Designation of Origin

The majority of the carbon markets

draw a distinction between domestic cre-

dits that originate from projects outside the

carbon market but within their national ter-

ritory and international credits such as

Kyoto credits. Currently, the most restricti-

ve market is the RGGI which allows only

domestic credits. The projected future US

federal system is expected to allow up to

2 billion credits originating in equal portions

from domestic and international projects, in

conformity with US standards. A similar

approach is planned in the European mar-

ket. Between 2008 and 2012, domestic off-

set projects will be implemented only on

the initiative of the Member States. After

2012, if efforts will focus on enlarging the

European market to new industries, a sys-

tem of domestic offset projects could also

complete it.

Toward a link between markets?

Project mechanisms could indirectly

link several emissions trading markets

which accept the same credits and therefo-

re represent an international carbon curren-

cy. That would increase the overall efficien-

cy of the markets. Given the reluctance of

the US to accept the standards of Kyoto

mechanisms, the question will be whether

the coexistence of several standards, at dif-

ferent qualities and prices, will allow a satis-

factory interconnection of carbon markets

on a worldwide level. �

Baptiste Raymondbaptiste.raymond@caissedesdepots.frTel.: +33 1 58 50 77 72

Anaïs Delboscanais.delbosc-e@caissedesdepots.frTel.: +33 1 58 50 99 28

Utilization of credits originating from project mechanisms in carbon markets

4Source: Mission Climat of Caisse des Dépôts.

Existing carbon markets Planned carbon markets

EU ETS (European Union)

RegionalGreenhouse Gas InitiativeRGGI (USA)

CPRS (Australia,

federal project)

US ETS (USA, Waxman-

Markey draftenergy bill)

Cap as a %of allocation

13.5% averageover 2008-2012.Sharp reductionbeginning in 2013.

3.3% Increase to 5% or 10% in case ofsudden price rises.

Unlimited15% in 2012,increasing to 33%in 2050.

Types of projects

All types of projects, exceptnuclear and forestation.

Forestry projectsand certain emissions ofmethane, CO2

and SF6.

All types of projects.

All types of projects.

Project framework Kyoto Projects(CDM and JI).

RGGI States andNorth Americanjurisdictionshaving an agreement with the RGGI

Domestic offsetprojects and Kyotoprojects.

Domestic offsetprojects (50%) and internationalprojects (50%)

5

K ey figures

Project mechanisms in figures12 countries currently account for 90% of the potential credit supply

The demand for credits originating from emissions reduction projects (CDM, JI and

domestic offset projects) is also very concentrated. Presently, it comes essentially from

Europe. Additional demand will soon come from the US, Australia and New Zealand. �

The CDM: Cap on energy Reductions of emissions of industrial gases (HFC and N2O) were the first CDM projects

because of their low cost. There has been since a sharp increase in energy efficiency and

renewable energy projects, for which the volume of credits issued is expected to exceed

that of the HFC and N2O projects in 2012, with approximately 370 Mt avoided. These rela-

tively small-scale projects should also be encouraged by the recent implementation of the

“programmatic” CDM projects, the purpose of which is to accredit program activities. �

Since 2004, credits haveaccounted for approximately30% of carbon assets’ transactions by volume and 25% by value

The secondary market has grown signi-

ficantly since 2005 (an average of +240%

annually), with the appearance of standar-

dized spot and futures contracts on the

principal European exchanges (BlueNext,

ECX, Nordpool). The primary CDM market

has simultaneously slowed in the face of

uncertainty about the post-2012 period.

Trades of primary credits decreased from

552 MtCO2e in 2007 to 259 MtCO2e in

2008. �

Antoine Samzun antoine.samzun@caissedesdepots.frTel.: +33 1 58 50 98 19

Raphaël Trotignon raphael.trotignon@caissedesdepots.frTel.: +33 1 58 50 96 04

CDM: Clean Development MechanismJI: Joint implementationAAU: Assigned Amount Unit, a State’s Kyoto assetsEU ETS: European Union

Emissions Trading Scheme

0%

20%

40%

60%

80%

100%

CERs issued by type of project

2006 2007 2008 … 2012

Renewable energies

Energy efficiency

Replacement among fossil fuels

Reduction of CH4 in the energy sector

Processes (agriculture, cement) and transportation

Reduction of HFC or N2O

Forestation/Reforestation

States that have established (or plan to) an ETS that allows credits originating from projectsMain States hosting CDM projects (90% of the potential supply of CDM credits)Secondary States hosting CDM projects (additional 9% of the potential supply of CDM credits)States hosting JI or domestic offset projects

Updated cumulative value of carbon assetssince 2004

(Total 156.6 billion €)

EU ETS116.1 billion €; 74%

CDM18.5 billion €; 12%

JI - 0.8 billion €; 1%

Voluntary market0.4 billion €; 0%

AAU 0 billion €; 0%

Cumulative value of carbon transactions since 2004

(Total 9,956 MtCO2)

EU ETS6,578 Mt; 66%

CDM - 1,786 Mt; 18%

Secondary CDM1,347 Mt; 14%

JI - 106 Mt; 1%

Voluntary market 120 Mt; 1%

AAU - 18 Mt; 0%

Source: World Bank, 2009

Source: Mission Climat of Caisse des Dépôts.

US MARKETS10% of worldwide emissions

Maximum 1,000 Mt/year of international credits (CER+ERU)

and 1,000 Mt/year of domestic credits, after 2012

EU ETS4% of worldwide emissions

Minimum 1,500 Mtover the period 2008-2020

(i.e. 115 Mt/year; 82 Mt already imported in 2008)

AUSTRALIAN AND

NEW ZEALAND MARKETSless than 1% of

worldwide emissions

On the order of 20 Mt/year, after 2012

Source: UNEP-Risoe, June 2009 and estimates by the Mission Climat of Caisse des Dépôts.

6

restation (see Climate Sphere n° 11 & 14).

To materialize this opportunity, countries

engaging in the REDD framework will be

confronted to the same quandary currently

faced by forestry projects in Annex I coun-

tries: how to transfer a national incentive to

the local level, where it actually results in a

change of practices?

Accounting rules under debate The complex accounting rules of forest

carbon in Annex 1 countries are defined in

Articles 3.3 – deforestation/reforestation

carbon balance – and 3.4 – carbon balance

of forest remaining forests – of the Kyoto

Protocol (see figure). The no-lose accoun-

ting of changes in forest cover under Article

3.3 has often complicated the transfer of

national forestry credits (Removal Units, or

RMUs) to the domestic project level: a fra-

mework for forestry domestic offset projects

is up and running in New Zealand, whose

carbon budget is likely to be positive; in

France where the carbon budget should

only be slightly positive, regulation is under-

way and may link the national budget to the

generation of carbon credits at project level.

Providing project-level incentives for impro-

ved forest management under Article 3.4

has proven even more challenging: no

country has yet managed a way around the

issue. In the meantime, project developers

could turn to voluntary markets if rigorous

methodologies are developed under the

existing quality labels.

On the road to Copenhagen, several propo-

sals to overhaul forestry accounting rules

have been put on the table. Under the “bar

accounting” proposed by the EU, carbon

credits would be credited above (or debited

below) a “bar” reference level. This bar

could be set equal to a historical level, and

adjusted for the age-class legacy effect: no

penalty for countries with old forests and no

“hot air” for countries with young forests.

Most Annex 1 countries are in the view that

only emissions and sinks coming from

human intervention should be accounted

for, factoring out major disturbances such

as exceptional storms or pest outbreaks.

Furthermore, many countries are pushing

for the accounting of harvested wood pro-

ducts, which has so far been left out of

national inventories.

One question will certainly be in the back

of negotiators’ minds for both REDD and

forestry in Annex 1 countries: how to devi-

se a national cap and its related accoun-

ting rules so that they are both environ-

mentally sound and inciting for project

developers? �

Valentin Bellassenvalentin.bellassen@caissedesdepots.frTel.: +33 1 58 50 19 75

Mariana Dehezamariana.deheza@caissedesdepots.frTel.: +33 1 58 50 99 85

Key negotiations issues onforestry

Eight years after the launch of the

Kyoto protocol project mechanisms in

Marrakesh, forestry mitigation projects are

still waiting to take off. The latest figures

released by the World Bank put their share

of transacted carbon credits below 1% in

2008. Close to nothing compared to the

17% of global emissions due to deforesta-

tion, and to the hundreds of millions of tons

of yearly mitigation potential through refo-

restation and sustainable management.

The current climate negotiations on

Reducing Emissions from Deforestation

and Degradation (REDD) could broaden

both supply and demand of forestry-based

offsets. A consensus is emerging on a

“REDD+” framework, a sectoral approach

that would reward countries whose forest

carbon ends up higher than expected,

either by reforestation or by avoided defo-

Forestry accounting: the example of France

The Mission Climat of Caisse des Dépôts is a research centre on climate change economics.It is part of CDC Climat, the department of Caisse des Dépôts in charge of carbon finance activities.Director of publication: Benoît Leguet, Tel.: +33 1 58 50 98 18Caisse des Dépôts – 16 rue Berthollet – 94113 Arcueil Cedex – ISSN : 1952-7659

Source: Mission Climat of Caisse des Dépôts, from the French National GHG Inventory (2007).

Under article 3.3, the balance between reforestation and deforestation activities leaves France with a smallnet sink. The uncertainty in the forest inventory combined with an unpredicted increase in deforestation couldstill tip the boat before 2012: in this case the deficit would be compensated by the surplus resulting fromarticle 3.4. This latter accounts on a voluntary basis for net emissions from forest management. France willreceive an additional maximum of 3.2 millions of carbon credits, far below the actual 80 million sink.Improving the sequestration of carbon through forest management projects will therefore not increase theamount of credits perceived.

Carbon balanceReforestation/Deforestation

Net sink(2,406 ktCO2eq)

Emissions (Deforestation)

Removals (Afforestation/Reforestation)

Emissions (Decomposition/Harvesting)

Removals (Growth)

Net sink(72,614 ktCO2eq)

Carbon balanceForest management

Article 3.3 Article 3.4

3.2 Mt ceiling

F orestry Projects

Conciliating national caps and incentives for projectsSome of the obstacles that have hindered the developmentof forest mitigation projects could be overcome in Copenhagen. One of the most challenging issues is to devise sectoral accounting rules that translate a national cap into project-level incentives.