The Clean Development Mirage

Cutting down greenhouse gas emissions in developing nations using the Clean Development Mechanism is bedeviled by a host of problems.

A man cycles past cooling towers of the coal powered Fuxin Electricity Plant in Fuxin, in China's northeast Liaoning province Feb. 17, 2005. As the world grows warmer, poorer nations are helping the rich by reining un heat-trapping gasses, in a multibillion-dollar "carbon trade" that is outrunning its U.N. overseers and founding principles, and spawning conflicts of interest and possible abuse. Gareth Phillips, with the British Clean Development Mechanism developer Sindicatum Carbon Capital, protest that many projects are truly "green," such as his firm's plan to capture methane from Chinese coal mines to use as energy.

Peter Passell is a senior fellow at the Milken Institute and a consultant to the Legatum Institute's Prosperity Index Group.

On first look, it seems one of those terrific ideas every market-friendly economist wishes he'd thought of first. Here's the deal: Most developing countries have neither the cash nor the inclination to contain climate-changing emissions on their own. Yet many of the cheapest opportunities to pare greenhouse gases—everything from capturing methane from waste to switching to more efficient boilers—lie in these countries. Why not let companies in Europe, Australia, and Japan, which are legally obligated to reduce emissions, anyway, pay for these projects (directly or, more likely, by purchasing credits earned by others) to offset obligations back home?

Why not, indeed? The United Nations just announced the completion of its 5,000th emissions reduction project (a wind farm in the Dominican Republic) under the Kyoto Agreement's Clean Development Mechanism. According to the UN, investors have spent $215 billion on Clean Development Mechanism projects in return for one billion credits—each of which represents emissions reductions equivalent to a ton of CO2.

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But a closer look suggests that neither the past accomplishments of Clean Development Mechanism nor its future prospects are as rosy we'd like to believe. On the one hand, Clean Development Mechanism is bedeviled by a host of problems, conceptual and practical, making it far from clear that emissions-reduction per dollar spent on Development investments is higher than on projects foregone back home. On the other, the market value of the credits generated by Development projects have collapsed, sharply reducing incentives for investors to produce more and putting the long-term viability of Clean Development Mechanism in doubt.

There are plenty of relatively inexpensive ways to cut emissions in developing countries, and a UN bureaucracy in place to keep score and deter fraud. What could possibly go wrong?

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Way too many things. The most potent greenhouse gas is an industrial chemical called HFC-23, which is at least 11,000 times as potent as C02 and last hundreds of years in the atmosphere before it degrades. So a project that traps a ton of HFC-23 is (or was) eligible to receive at least 11,000 carbon credits. That, alas, made it so profitable to eliminate the gas that investors in China and India tripped over each other to build plants that actually produced HFC-23 (nominally, as a byproduct of making other chemicals) and then destroyed it in return for credits.

All told, 42 percent of all the credits ever issued under the Clean Development Mechanism have been for HFC-23 containment, while another 21 percent were for similar boondoggles involving the capture of nitrous oxide, another muscular greenhouse gas produced along with industrial chemicals. This perversion of the intent of Clean Development Mechanism is widely blamed for a flood of credits that has pushed the market price down by 70 percent in Europe.

[See a collection of political cartoons on the economy.]

Those near-scams are now history—Europe, which is the source of most of the demand for emissions credits, no longer accepts HFC-23 sourced projects. Accordingly, the market price of credits is likely to rebound from its recent lows. But the system faces a variety of other supply-side potholes. Among the deepest:   

  • The risks in investing and trading credits are viewed as so great (or the market is so inefficient) that only about 30 percent of the money spent on them goes toward the construction and operation of the containment projects, with the rest compensating brokers and investors.
  • The goal of the Clean Development Mechanism is to curb emissions that wouldn't otherwise be curbed. But how do you really know whether, say, the conversion of a power plant from coal to natural gas in China would have happened without the Clean Development Mechanism incentive? Just how great the slippage from the "addtionality" problem is anyone's guess.
  • Projects to avoid deforestation are not considered for credits, both because of the aforementioned additionality problem and because they are so hard to monitor. But they represent as much as 25 percent of plausible Clean Development Mechanism containment—and a far larger percentage than that in very poor countries.
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    Is the Clean Development Mechanism fixable? The UN's experts have a jillion-point program for cleaning up the mechanism, which would streamline the selection process and curb some abuses. But cutting through the bramble of interest group conflict, incentives for fraud, bureaucratic pettifoggery, and public mistrust will be a formidable challenge.

    It would be a pity to give up on the concept, though. By one plausible reckoning, an efficiently structured, efficiently managed version could cut the global cost of containing climate change by half. Probably the most sensible approach now is to tighten selection criteria and learn (rapidly, one hopes) by doing. As Lenin (or maybe it was Robespierre) put it in another context, you can't make an omelet without breaking eggs.

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