Certified Emission Reduction (CERs) Trading with EU Emission Trading System (EU-ETS): Are Developing Countries in a Crisis?

By Chatura Rodrigo
IPS Researcher 

Emission Trading Systems (ETSs) allow economies to trade the Certified Emission Reductions (CERs) through an open market mechanism. Countries engaging in Clean Development Mechanisms (CDM) projects generate CERs and then trade them, allowing project implementers to make profits while reducing carbon dioxide (CO2) and other greenhouse gas emissions. The European Union’s Emission Trading System (EU-ETS) was the main market place to trade the CERs generated through these CDM projects.

However, in their 2013-2020 agenda, the EU-ETS decided to only allow the trading of CERs that are being generated through CDM projects implemented in Least Developing Countries (LDCs).  Currently China and India are the main traders at the EU-ETS, and will definitely be affected by this decision. The first part of the article will provide a glimpse of the history of CERs, and how that developed into a market mechanism.  Next section will briefly introduce the EU-ETS and its importance to developing countries as a means of trading CERs. The latter part of this article will look at two decisions that the EU-ETS had taken, and how they will affect developing countries that are engaged in CDM projects particularly from a Sri Lankan perspective, as a country that is increasingly encouraging CDM projects. 

Trading Certified Emission Reductions (CERs) from CDMs: Background 

The Annex B countries of Kyoto protocol, have committed to limit emissions of greenhouse gases within their borders.  The limits that these countries are allowed are identified as “Assign Amount Units (AAU)”. Initially these targets were set for 2008-2012, and new targets are being proposed for the 2013-2020 period. Countries exceeding their AAUs are allowed to trade these with other countries that are behind their AAU limits. In order to make this a working market mechanism, market commodities focused on CO2 (since it is a principle greenhouse gas) were created, and are referred to as CERs. In addition, there are other trading units such as Removable Units (RMUs) and Emission Reduction Units (ERUs). These units are created through land use change, forestry projects, and joint implementation projects.  The EU-ETS is the largest platform in operation in which countries can trade CERs. However, there are other places that CERs can be traded apart from EU-ETS, such as the European Climate Exchange, Chicago Climate Exchange, Commodity Exchange Bratislava, European Energy Exchange, NASDAQ OMX Commodities Europe, and PowerNext.

In CER trade, one trading unit is the equivalent of one metric ton of CO2 emissions. This in turn is equivalent to one CER unit, or one permit. Units can be traded between countries on a one-to-one basis or in a market system such as in the EU-ETS, which is the most favored method.  These transactions happen under the purview and regulation of the United Nations Framework Convention on Climate Change (UNFCCC). In addition, when these CERs are being traded under the EU-ETS, they will be validated separately by the European Union. In the EU-ETS, the price of a permit is quoted in Euros.

The EU’s Emission Trading Scheme (ETS)

EU-ETS is operational during certain trading periods. The first period of trade started in January 2005, and went up to December 2007. The next was from 2008-2012. The third and current trading period will start from 2013 and go up to 2020. Approximately 30 countries and around 12,000 installations are covered by the EU-ETS and it accounts for the trading of 41% of the EU’s CO2 emissions. The installations cover many areas such as steel plants, factories that manufacture cement, glass, lime, brick and ceramics, power and heat generators, and also combustion plants and oil refineries.

In their 2013-2020 agenda, EU-ETS expects to further reduce their emissions by 21%, which means that there will be more opportunities for CERs generated through CDM projects. However, among other changes, the EU-ETS has announced that these CERs should specifically come from LDCs. 

The argument put forth by the EU-ETS is that while majority of CDM projects were undertaken by fast developing countries, such as India and China, they prevented the LDCs from developing sustainable CDM portfolios. This was a heavily debated point of the 2013-2020 agenda of the EU-ETS, where they stressed upon the importance of providing equal access to LDCs. At this point, it is too early to settle on one camp of argument; however, it is not too early to begin the discussion on the consequences these changes will have on other developing countries, such as Sri Lanka.  

While the steps taken by the EU-ETS is a noble effort in creating equitable opportunities for LDCs, some have put forth a rather sinister alternative explanation. Critics of the new EU-ETS agenda argue that the new regulations are specifically to eliminate countries, such as India and China, with impressive growth rates, from the CDM equation altogether.

Impact of EU-ETS Decision: Future for Developing Countries

Almost all developing countries trade their CERs through EU-ETS.  Therefore, for developing countries like Sri Lanka, this poses a very real problem.

It is important to look at the situation in context. Almost 80% of CDM projects are located in India, Mexico, China, and Brazil. If we look at Africa, it is home only to 2.9% of the total CDM projects equal to roughly, 260 out of more than 4,000 projects. Of that number, more than 100 CDM projects are located in South Africa, Nigeria, Kenya, Egypt, and Morocco – and none of these countries qualify for LDC status. Therefore, for CDMs registered from January 2013, a new market place is needed.

Experts opine that the CER trade of developing countries will move on to other places, such as Australia and New Zealand. Some even argue that fast developing countries like China and India might open up their own markets. However, the fact remains that economies have failed to invent or create new markets. Therefore, the alternatives that economists are suggesting at the moment might not come to fruition in the near future. On a positive note though, China and India have already made some interesting progress. China is to establish a trading scheme, which could allow its own increasing greenhouse gas emission targets, based on emission intensity targets. Furthermore, India put forward an energy efficiency scheme that operates on Performance, Achievements and Trade (PAT) systems.  In addition, South Korea is also planning to establish a CER trading system which could be a potential market place for developing countries.

It is conceivable that China and India would not let the EU-ETS decision damage their market potential, and likely to provide developing countries, such as Sri Lanka a lifeline.  What was once a concept has now developed into a 100 billion Euro market, therefore the outlook for developing countries remains positive and optimistic.

Sri Lankan Scenario

At the moment, there are 7 registered CDM projects implemented in Sri Lanka. Five of them are mini-hydro projects, one is a biomass power generation project, and the other is a coconut shell charcoaling and power generation project. These projects are classified under the category of “small scale projects”. The amounts of reductions vary from 5000 metric tons of carbon dioxide to 45,000. The other parties involved in these projects are mainly Japan, Switzerland, and Netherlands. What is being generated is mainly being traded through the EU-ETS.

With regards to the recent changes in the EU-ETS, one possible argument is that as Sri Lanka’s CDM industry is still in its infancy – adaptation will come relatively painlessly. India and China will have established markets by the time the industry is fully grown, hence, Sri Lanka’s future CERs will have a trading platform. However, from an economic perspective it is difficult to find favour with this argument, mainly on the grounds of opportunity cost. What is the opportunity cost of a CDM implementer in Sri Lanka, to forgo the possibility of shutting down when the CERs were not traded as planned? Furthermore, what would be the risk premium of a new CDM implementer, who now has to look for a new market place to trade the CERs?

While our CDM industry is still at an infant stage, the investment costs are huge for us. There are more than 40 projects in the pipeline to be approved, which means that they will commence after January 2013 and will face the challenge of trading the CERs. Sri Lanka has already compiled an interim policy on CDM implementation. The Ministry of Environment and Renewable Resources of Sri Lanka has established a Climate Change Secretariat that is increasingly engaged in the CDM industry. The government has invested a great deal in terms of establishing a DNA (Designated National Authority) for CDM approvals with infrastructure and staff. Therefore, in terms of public spending, the government would not want these investments to be classified as a sunk cost.

Sri Lanka needs to worry about the possibility of losing a market place for CER trading and it needs to be proactive in avoiding losses. Possible negotiations and close contacts with potential economies that would start CER trading markets would be a good place to start. Further, a dialog has to be initiated among the policy makers as well as potential and current CDM implementers, to discuss these matters more deeply, and to formulate strategies collectively.

References

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