U.N.’s Application of the Clean Development Mechanism to China – Fair or Unfair?

As is customary for many over the Chinese New Year, I spent a lot of time cleaning up old junk in my house the last few weeks. As luck would have it, I happened to run over a December article in BusinessWeek reporting that the U.N. had stopped awarding carbon funding of green projects in China. An excerpt of the article (cnn copy) is provided here:

The United Nations body in charge of managing carbon trading has suspended approvals for dozens of Chinese wind farms amid questions over the country’s use of industrial policy to obtain money under the scheme.

China has been by far the biggest beneficiary of the so-called Clean Development Mechanism, a carbon trading system designed to direct funds from wealthy countries to developing nations to cut greenhouse gases.

China has earned 153m carbon credits, worth more than $1bn and making up almost half of the total issued under the UN-run programme in the past five years, according to a Financial Times analysis. The credits are currently trading at about $10-$15 each.

Industrial countries can meet part of their commitments under the 1997 Kyoto protocol to battle global warming by financing projects that mitigate emissions in developing nations. Projects only qualify for credits if the applicants prove they would not have been built anyway, a condition known as “additionality”.

The controversy over Chinese wind farms and other CDM projects will intensify calls for the system to be overhauled at the UN’s Copenhagen conference, which opens on Monday.

China-based consultants said the CDM’s board in Bonn began refusing approval for Chinese wind power projects in the middle of 2009, over concerns Beijing had deliberately lowered subsidies to make them eligible for funding.

“The board now suddenly says the projects are not additional, whereas in the past they found no fault with additionality,” said Yang Zhiliang, general manager of Accord Global Environment Technology, one of China’s leading CDM consultants. “They are blaming the Chinese government and its decision to lower subsidies.”

Ms Yang said Beijing had other aims, such as limiting overcapacity in the wind turbine sector, in setting subsidies. “The Chinese government wouldn’t adjust subsidies just to bag CDM money,” she said.

Industry officials said the CDM board had refused approval for about 50 wind power projects. Doubts over whether CDM funding will be available in the future has also prompted power companies to stall new wind power investments.

Lex de Jonge, head of the UN board, confirmed that “a handful of [Chinese] projects” had been suspended but declined to give reasons. Michael Wara, of Stanford University, said there were considerable problems in China with the CDM’s rules.

With the emphasis that Beijing is now placing on both smaller hydro-electric projects and wind power, the government would have supported at least some of the projects receiving money under the CDM scheme anyway.

“It is hard to believe that there is additionality in many of the energy projects in China right now,” he said.

Chinese government officials quoted in the local media defended the CDM process as an effective mechanism for helping developed countries cut emissions and the only one that gave poorer nations a role.

Chen Hongbo, of the Chinese Academy of Social Sciences, said although the system needed reform, it should be maintained. “I think that after 2012 [when Kyoto expires], the CDM cannot stop immediately,” he said.

This to me was a significant development. Just a few days later, a top U.S. government official to Copenhagen publicly announced that while developed countries may have a responsibility to help developing countries go green, he did “not envision public funds, certainly not from the US, going to China. We would intend to direct our public funds to the neediest countries.”

The new norm here seems to be that even if China can benefit from money from the world in developing green projects, China should not be helped.

Is China being unfairly treated?  Or is China not deserving of assistance?

I was initially shocked to hear both the U.N. and then the U.S. announcements last year. China is home to some 1/5 the world population. China is industrializing rapidly. From a purely climate and economic perspective, money spent in China – and at this specific juncture in time – may very well be the best thing money can buy in terms of cutting global carbon emissions.

I have since come to terms with why the U.S. might be defiant in helping China. Many in the U.S. see China as a strategic competitor. With the U.S. mired in a deep recession and government deficit at an all-time high, helping out China – even if it’s assistance that helps the rest of the world also – may simply be politically too hot a potato.

But the U.N. decision still puzzles me. The CDM is one incarnation of a Carbon Market (see here). The CDM allows developed nations to meet some of their carbon obligations by funding green projects in developing nations. Carbon credits created when projects that result in “real, measurable and verifiable emission reductions that are additional to what would have occurred without the project” are implemented in developing nation. These credits can then be purchased by developed nations as a cost effective way to help developed nations to meet their carbon limits. Developing countries receive valuable financial aid to kick start many of their green projects. It’s a win-win all around for everyone.

The key issue in controversy here centers on what “additionality” means.

A simple and straightforward interpretation of “addtionality” is to view additionality from the perspective of the environment. Emission reductions from a project would be considered “additional” if the project can be documented to lower emission above and beyond those produced by some standard baseline project. When China builds a wind turbine, for example, additional emissions reductions would be created if the wind turbine produce a net carbon savings over those produced by standard, non-green generators.

But the U.N. seems to be defining “additionality” in terms of emission reductions above and beyond what alternative local investment and financial resources would allow. This project in China should not receive green credits because the project would have come to fruition, in view of the U.N., with the support of the local businesses without any CDM funding help. That project in China should not receive green credits because the project would have come to fruition, in view of the U.N., with support from the local government without any CDM funding help.

Ignoring the fact that such “investment” and “financial” additionality requirements seem to have already been explicitly rejected in the “Marrakech Accords,” I believe this interpretation of additionality forces the U.N. to unwittingly replace a market-driven with a centralized planned process for promoting green technology growth around the world. By injecting its judgment of what would or would not have occurred in the marketplace, the U.N. inevitably imposes an unneeded centrally-coordinated approach to incentivizing global green development.

In an optimal market, resources are allocated to projects that make the most compelling use of the resources. If China currently presents the most compelling economics place for going green, if China truly presents the lowest fruit for cutting global emission, what is wrong with most of the resources of the CDM going to the economically most compelling projects in China at this time – regardless of whether other entities including Chinese government, local businesses, as well as international consortium are also pouring resources?

A better tact is for the U.N. to restrict itself to documenting and verifying carbon savings, not determining which countries “deserves” aid.

On the other hand, I do admit to seeing why some may feel China’s getting money as unfair. Why should cash-rich China receive funding for projects that would have been constructed even without CDM money? Couldn’t CDM resources be spent better in other projects – in projects in poorer countries for example?

I believe this is ultimately an issue for the market to decide. The price of carbon and the carbon savings created alone should dictate where CDM money go. But even from a political perspective, it’s simply not true that China cannot benefit from CDM type of funding for Green Energies. China is still overall a very poor country compared to the West, with a gdp per capita ranked behind Namibia and just ahead of Ukraine. Money going to China to help China reduce its dependence on oil will have a real, measurable effect on the environment.

In conclusion, from my perspective, if the goal of the CDM is to create a mechanism that efficiently allocates carbon money that produces the biggest bang for the buck for the environment, the U.N. should probably leave the market-oriented system mostly alone to do its job.

If on the other hand the goal is to create a politically-driven mechanism for distributing resources across the globe for developing green energy, the U.N. should at least drop any semblance of a market approach for the Clean Development Mechanism and openly anoint itself as the central command of a vast U.N. sponsored network of global green development efforts.

What are your thoughts?