CDM for the Everyman Ecopreneur: Reforming the Carbon Credit Process

The Bureaucracy Requires Consultants to Navigate, Pricing Out Many Entrepreneurs

Sebastian Foot hadn't meant to create such a frustrating job for himself.

Last year, he founded a Clean Development Mechanism (CDM) project finance structuring firm called Frontier Advisors with the "intention to take equity" in the emerging green market space. Instead, he ended up in a constant tussle with an interminably slippery bureaucracy that is the UNFCCC CDM Executive Board.

Foot has watched the debate surrounding its reform, and, in his mind, it doesn't go far enough.

"I think the goal, aspirations, of the CDM really should be to engage people in developing countries to develop projects and to be able to seek approval themselves," Foot says.

He'd like to see the everyman ecopreneur in a developing economy empowered to benefit from what the CDM offers: a stake in the economic development of their country. Instead, Foot explains, the everyman ecopreneur faces a shifting qualification maze, rising costs, and an executive board that has lost the plot:

"The CDM creates a carbon market — which is fantastic — but it should have a lower barrier to entry, and instead it has a very complicated, high barrier to entry. And that doesn't make it efficient for what I think its goal is, which is sustainable development.

"It makes it efficient for consultants and it creates a group almost that understands how it works and therefore you tend to have to go through those sorts of entities in order to even get to the stage where you've got a project that is recognized that you can generate value."

The CDM was created so emissions-reduction projects, such as renewable energy projects, in developing countries could earn certified emission reduction credits, which could then be sold to industrialized countries to help them meet their emission reduction targets under the Kyoto Protocol. The executive board oversees the qualification process.

According to Samuel Frankhauser, senior research associate at LSE's Financial Markets Group, part of the problem in the CDM process is a result of asymmetric information.

"We have a regulator that doesn't know everything that industry knows, and therefore you build in industrial regulatory structures to reveal the information to make sure the industry reveals what they truly think," Frankhauser says.

"The whole CDM procedure is sort of its own dance between project developers and the executive board to make the elements reveal what they would have done."

Christopher Wright, a research fellow at the Centre for Development and Environment at the University of Oslo agrees that the scope of the CDM needs to be expanded, because, as it is, it allows for the preference of investors for "large projects in middle-income countries."

A plan for CDM reform was agreed to at the international climate conference in Copenhagen late last year that includes procedural "streamlining" and funding for countries with fewer than 10 approved CDM projects, a group that includes most of Latin America and Africa. But the reforms still fail to get at the heart of the matter.

Foot says the process has become politicized and unpredictable, which hurts the market. He uses the example of the 10 wind farms in China that were turned down by the CDM board last December, ostensibly rejected on the basis of an unacceptable tariff structure in China, a tariff structure that had existed when other projects of the same type were approved previously. Foot says it was a technicality over pricing of power, something that's outside the board's mandate.

"I think that the CDM Executive Board knows that it has to evolve, but it's becoming more and more involved in how CDM projects are structured, and actually its mandate isn't to do that at all, its mandate is to give guidance and to approve projects," he says. "But right now, we're dealing with something that is very unpredictable in its approach."

Unpredictability reduces the likelihood that investors will participate in the market on the demand side and on the supply side, it throws up barriers to entry for those with projects. Those barriers can be exorbitant for countries where middle classes with sufficient capital necessary to produce entrepreneurship are still nascent.

Ecopreneurs with projects that would qualify under the CDM require a complex understanding of how the mechanism works. Foot explains:

"Developers have a tough decision to make. The CDM and all this other stuff, it's not their core business, it's not what they deal with. They produce biofuels or they make widgets or they run wastewater treatment plants or they operate wind farms. ... If you're a little project developer, it would be hard for you to understand how much value you're giving away; quite frankly you'll have no idea."

What Foot says is consistent with a recent report from Frost and Sullivan consultancy. The consultants explain:

"Before they can take the plunge into the Asia Pacific market, participants will have to equip themselves to deal with the complex procedures and formalities involved in CDM. This is because the methodologies and baseline computation will vary from project to project. These challenges require participants to acquire the pertinent expertise to conduct and provide technical support for the project at all stages.

"In Southeast Asia, there are inadequate local consultants to support the process and CDM evaluation, causing the markets to depend heavily on international assistance. The implementation of CDM projects requires proper technical, financial, and governmental support."

A report from KFW Bankengruppe estimates that the cost of a consultant in India is anywhere from $6,000 to $55,000 not including consultant fees; partly this depends on the scale of the proposed CDM project, partly a market gap in supply of consulting services. And partly, according to Foot, because the process falls short of inspiring trust in the mechanism itself, "If two years ago I was developing a wind farm project in China, I could be confident I could get it approved under the CDM ... and now I'm not confident on that."

For Foot, it comes down to this:

"If you're building a wind farm in a developing country, even if you've got a fairly good return because you've got a good tariff, you're developing a wind farm in a developing country. This is new technology no matter how you look at it. No matter what financial return you get from that project, it's a huge step forward.

"If you have projects like that, you should just automatically qualify to generate carbon credits. You shouldn't have to haggle with the UN on what sort of energy tariff you have and whether that affects what you're doing in terms of sustainable development. A small change in energy tariff doesn't affect sustainable development."

Wright warns, though, that "it is important that the political goal of increasing investment in low-income countries does not undermine the environmental integrity of CDM projects."

Wright says that in order to make the mechanism more accessible, a strong support structure will be needed.

"Public financial institutions — for example, the World Bank and regional development banks, as well as bilateral donors and development institutions — can act as brokers between developers (including small-scale), governments and private investors, and provide seed financing and risk guarantees. And national governments should be supported to set up regulations and investment support structures that facilitate such projects. There has been some innovation here, but more is needed."

Foot has seen clients get poor prices for their CDM certified emission reduction credits, and that's one of the reasons he does what he does. A better way forward is possible and it will be up to negotiators to return to the table at Bonn in May to provide the capacity for the CDM to achieve sustainability.

 

See also:

Is China Still a Developing Country?

Public Financing or Offsets? How Best to Fund Clean Tech for Developing Nations

Friends of the Earth: Why It's 'Suicide to Base Our Future on Offsets'

 

(Map: UNFCCC, interactive version; Chart: UNEP Risoe Centre)

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