Red tape and risk frustrate Kyoto’s CDM scheme

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One of the Kyoto Protocol’s main tools for curbing greenhouse gas emissions is struggling to take off as projects get bogged down in red tape and investors worry about risky deals with developing countries.

The Clean Development Mechanism (CDM)—which lets rich nations earn emissions-reduction credits toward Kyoto targets through investment in green projects in poor countries—has registered just three schemes since its launch in 2001.

Potential CDM investors are wary of credit risk, while the executive board charged with approving projects has been slow to process applications, market sources say.

“There is a huge backlog of work for an under-resourced executive board,” Moe Moe Oo of environmental trading company GT/SKM told a recent emissions trading conference.

A spokeswoman for the United Nations Framework Convention on Climate Change said there were no plans to expand the board, whose members answer to the Conference of Parties to Kyoto - the international pact on fighting climate change which kicked in last month.

Firms and governments can invest in CDM by buying emissions credits - Certified Emissions Reductions (CERs) - generated by pollution-curbing projects like wind farms and new forests in developing countries.

The projects registered so far are a landfill gas plant in Brazil, a small hydro-electric power plant in Honduras and a scheme to curb emissions at a chemicals plant in India.

India is among those touting itself as a potentially big seller of CERs. The government has approved over fifty CDM projects but only one has made its way onto the mechanism’s official register, said S.K. Joshi of the ministry of environment and forestry.

RISKY BUSINESS

Most proposed CDM deals involve buying CERs over several years, which means the financial risks involved can be high, analysts say. There are also risks that legal and tax regimes in the host country may change over the lifetime of the deal.

“It’s very important to do your homework at the outset, it’s important that these issues are resolved,” said Martijn Wilder of law firm Baker & McKenzie.

The ability to trade CERs in a spot market could help buyers to hedge some of the risk but dealers say liquid trading is some way off.

There needs to be a far higher volume of CERs in the market and a standard contract for trading them before a proper market can develop. “It is reasonable to assume that we won’t see a spot market until late 2007,” said Moe Moe Oo at GT/SKM.

The European Commission has said it does not expect CERs to start filtering into the EU’s emissions trading scheme until mid-2006.

Countries whose governments have adopted the necessary “linking directive” can use CERs to comply with the EU’s trading scheme, which limits CO2 emissions from factories and power stations.

For CERs to be fully transferable between EU countries a new transaction log will have to be in place. “You may find that CERs are not fully transferable in phase one of the EU trading scheme (2005-2007),” said European Commission administrator Olivia Hartridge.

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