The clean development mechanism and the clean development fund – Background

3.1.1 Clean Development Mechanism

Since GHG are universally mixed pollutants, the location of abatement does not matter for climate change impacts. Based on this notion, GHG emission abatement should be conducted where it is cheapest so as to reduce the overall cost of abatement or conversely maximize abatement opportunities with a given budget. To reduce total abatement costs, countries can reduce emissions in another country and count these reductions against their own emission limits target. This is called an offset system, as emission decreases in one country are offset by increases in another.3

As developing countries do not have emission reduction targets under the Kyoto Protocol, emission reduction opportunities could be used to reduce abatement costs and avoid or slow down a lock-in of carbon-intensive infrastructure in developing countries (Heller, 1996). Emission increases in countries with an emission reduction obligation are counted against emission reductions in countries without emission reduction obligations. If the increases are completely offset by reductions, global emissions do not increase. The currency used in this transaction is CERs. Each CER is equivalent to one tonne of CO2- equivalent reduced and can be used to increase emissions elsewhere by the same amount.

3.1.2 Clean Development Fund

The CDF was part of a proposal put forward by Brazil in May 1997 (UNFCCC, 1997b). This submission had two parts. The first part suggested a mechanism to establish emission reduction targets for countries based on historical responsibility. Countries, which have emitted (historically) the most GHG emissions, should also bear the greatest reduction effort under this proposal. Cumulative emissions were counted as of 1850 in the proposal. Using available data at the time, Brazil’s submission projected that developing countries’ absolute emissions will take over those of industrialised countries approximately by 2037. In terms of historical cumulative emissions, developing countries would only over take industrialised countries emissions by 2162 (UNFCCC, 1997b). This justified, according to the proposal that only developed countries should be subject to an emission limitation, a so-called cap on emissions.

3

See for pioneering work on offsets Liroff (1980) and for a review of the literature on offsets in general (R. W. Hahn & Richards, 2010).

The second part suggested a compliance regime for achieving the emission targets established in the first part of the proposal. This proposal outlined the CDF. The proposal works as follows: According to the formula proposed in the first part of the Brazilian submission, industrialised countries would receive individual emission reduction limits, an individual cap. Developing countries would not have a cap on emissions. If a country emits more than its emission reduction limit allows, then it has to pay a penalty fee (F) for each tonne of GHG emitted in excess of the emission limitation. These penalty fees would be collected by a so-called Clean Development Fund (UNFCCC, 1997b, p. 5). The proposed penalty fee per tonne of CO2- equivalent in Brazil’s submission was US$ 10.

3.1.3 Similarities between the two instruments breaks initial opposition to CDM

The CDM explicitly allows achieving compliance with a reduction target through abatement in countries without a cap. The CDF in turn implicitly allows a country with a cap to emit more than the cap, if the country pays a penalty fee. Thus, both instruments allow a country with an emission limit to exceed this limit. Developing countries were at first strongly opposed to the idea that industrialised nations could exceed their cap and argued that rich countries could buy themselves out of the responsibility to reduce emissions domestically (Depledge, 2000).4 The CDF however allows exactly that: according to Olsen (2007) this similarity was picked up by the US negotiators and the proposal of the CDF changed into the CDM.

3.1.4 Institutional framework of the CDM

Chapter 2 introduced the goals and procedures of the CDM. These are in short: CDM projects should be cost-effective, contribute to sustainable development, and should be additional to any that would have occurred anyway. The project host country is responsible for ensuring that proposed projects meet the sustainability criteria of the respective country they are located in. Buyers and sellers of CERs generated by CDM projects aim to reduce emissions at lowest cost, i.e. cost-effectively. However, as host countries and CER buyers in the CDM market both have an incentive to overstate emission reductions, an institutional procedure (described in Chapter 2) has been established to avoid the registration of projects that would have happened anyway, i.e. also without CDM support. Projects and emission reductions that would have happened also without the CDM support are called non- additional.

4

This view is supported by Najam (2002), who argues that by using the low-cost abatement opportunities, low-hanging fruits in developing countries, future generations are only left with more costly options. See Castro (2010) for an empirical analysis refuting the claim that the low-hanging fruit issue hinders advanced developing economies to engage in mitigation.

3.1.5 Institutional framework of the Clean Development Fund

In contrast to the CDM, the CDF has no market for emission reductions. The price for exceeding the emission cap in industrialised countries is set by the level of a penalty fee (F). The proceeds from the penalty are transferred to developing countries, which then conduct abatement of emissions in their territory. Assuming the host country is interested in maximising emissions abatement, it would set up a national system similar to the one described in Chapter 2 for the CDM. The main difference is that the funds received by the developing country are dependent on the penalty fee and not the actual price to reduce emissions in the developing country.