China holds key to carbon trading

Euromoney, December 2009

Attention at the Copenhagen summit on climate change this month [DECEMBER] will mostly be focused on the US. But in terms of emissions trading the most influential place, and the one most likely to be affected by any change in a global framework for climate change, is Asia, and especially China.

The most important vehicle in carbon trading is the clean development mechanism, or CDM. This is the deal struck under the Kyoto protocol which allows industrialized countries, with commitments to reduce their greenhouse gas emissions, to invest in projects that reduce emissions in the developing world. This is the foundation of carbon trading: approved CDM projects generate credits, which can then be traded. The whole arrangement is overseen by a branch of the United Nations Framework Convention on Climate Change (UNFCCC), and according to that group’s data, the vast majority of eligible projects so far have come from Asia: 1398 out of 1890 registered projects, the bulk of them in China.

It’s been clear from the outset that this has been an imperfect process that needs streamlining, as Lex de Jonge, chair of the CDM Executive Board at the UNFCCC, readily admits to Euromoney: “The entire CDM development has been a massive learning-by-doing process, to be frank about it, and we are still not there yet.” So any changes that come out of Copenhagen will be closely watched in markets like China and India that have to date been the greatest beneficiaries of westerners hoping to offset their own pollution.

For de Jonge, the biggest challenge he faces is capacity. Already the UNFCCC doesn’t have as many staff as it needs: they are frequently poached by the private sector once trained. Getting a project from the drawing board to approval is a laborious process, and indeed has to be, in order to preserve the environmental sanctity of the whole market. He is confident with his agency handling 500 projects a year. But if a new climate deal in Copenhagen commits to bigger emission reductions and so creates a much greater demand for carbon credits and the requirement moves to 2,000 projects a year or so, “it’s too much.” Expecting this, there are moves towards shifting CDM approvals to a sectoral approach in certain countries big enough to organise themselves: power sector projects in China and India, for example. If those projects could then be evaluated in bulk, the UNFCCC is free to devote more time and attention to one-off projects in smaller states. This is something else that could get started in Copenhagen, and again it has a big impact in Asia: a sectoral approach ought, logically, to increase still further the dominance of China in particular as a source of tradable carbon credits, as it will be able to get still more projects through the approval process.

Another group watching closely is the Asian Development Bank, which to date is one of only a handful of institutions to have launched carbon trading funds that deal in credits post-2012, which is the date upon which the Kyoto protocol expires. The ADB, which already launched a more mainstream US$150 million carbon credit fund in 2007, noticed that uncertainty about the future of carbon credits was stopping development, so launched the new fund with a flexible clause allowing it to take into account future changes in the CDM, “as a price signal,” says Toru Kobu, senior clean energy and climate change specialist at the Asian Development Bank. “It’s basically an assumption by the investors, as well as ADB as a trustee, that the parties negotiating would not change any rules to have a retroactive effect,” he says. After Copenhagen, we may find out if they were right.

Alongside this, emissions trading exchanges are approaching readiness in Asia, from Singapore and Australia to two separate Chinese ventures, in Beijing in Tianjin. “It’s only natural,” says Harry Derwent, president of the International Emissions Trading Association in Geneva, “that when you have a major production line you start seeing points where people can buy or sell closer to the point of origin.”

Derwent is unapologetic about his industrial language: “This is essentially a production process, I don’t think anybody should be frightened of that perspective.” And his line of thinking is bound to strike a pragmatic chord in China, which having long enjoyed the benefit of foreigners paying to build up its renewable energy resources may yet go a step further and corner the consequent trading revenues too.