The Good, the Bad and the Greedy

Developing countries are using the UN’s Clean Development Mechanism to give them a welcome boost, but the scheme has come under fire of late and is causing much controversy.

The news surrounding carbon trading these days is increasingly dominated by the EU ETS, the rapid growth of the industry along with a tidal wave of warnings, dire proclamations and opinion pieces about the effect Australia’s proposed carbon trading scheme will have on its economy. Meanwhile, the UN’s Clean Development Mechanism (CDM) has been quietly getting on with the business of incentivising the use of clean technologies in the developing world. It has now registered some 1170 projects in 49 countries.

The mechanism exists as an arrangement under the Kyoto Protocol and allows OECD countries which have committed to reducing their greenhouse gas (GHG) emissions (known as Annex 1 countries) to invest in projects in developing countries which have not signed up to any limitations on their emissions. The difference in GHG emissions can then be banked as Certified Emission Reductions (CERs) and can subsequently be sold to parties looking to offset their own emissions. The cost of mitigating GHG emissions via CDM projects is typically lower than attempting to make similar savings in developed countries for a variety of reasons. These include the cost of labour and the fact that many of the easy and relatively inexpensive measures to mitigate emissions have already been taken in Annex 1 countries. To prevent nations from relying completely on the CDM and CERs to meet their obligations, a provision in the Kyoto Protocol dictates that CDM can only be used to supplement domestic measures.

The CDM is overseen by the United Nations Framework Convention on Climate Change (UNFCCC) and the CDM Executive Board. The latter has the task of setting and revising the methodologies used to determine whether a proposed project qualifies for support under the scheme. All projects must demonstrate additionality. This is currently interpreted by the CDM Executive Board as meaning that the proponents of a project must show that in the absence of inclusion within the CDM, more polluting alternatives would be more favourable economically.

The process by which a project acquires approval is quite complex. First, a country in need of CERs (the applicant) obtains permission from the developing country that will host the project. The applicant must then establish the case for additionality and has to generate a baseline for future emissions in a scenario where the project does not go ahead. A third-party agency, known as the designated operational entity, then validates the project. The CDM Executive Board then decides whether it will register/approve the project.

The CDM is, to some extent, becoming a victim of its own success. The World Bank issued a report in June, highlighting that of the 3188 projects in the pipeline, 2022 were awaiting validation and that it took an average of 80 days to go from the project registration request stage to actual registration, while it also took participants up to six months to engage a designated operational entity. The UNFCC is therefore looking to further streamline the process by introducing an approach called programmatic CDM, which would clear a number of related projects at the same time.

Figure 1: A) CDM projects by sector. B) CDM projects by sectors expressed in terms of CERs issued. Source: UNEP Risø centre, October 1, 2008

As can be seen from Figure 1, there are many different types of CDM projects. Interestingly, although the majority (63 per cent) employ renewables, these result in only 13 per cent of the mitigated emissions. Yet at the same time, HFCs, PFC and N₂O reduction projects make up only two per cent of the projects currently registered by the CDM but are responsible for a massive 74 per cent of all CERS issued.

This phenomenon has attracted fierce criticism of the CDM. HFCs (hydrofluorocarbons) are extremely potent greenhouse gases and are a by-product of refrigerant factories. The issue is that destruction of HFCs is extremely cheap, and the costs pale in comparison to the potential profits from the sale of CERs, leading many to question as to whether the CDM is really providing value for money. The situation has also created a perverse incentive to open new refrigerant plants. Fortunately, the UNFCC amended the rules, so that only existing plants can benefit from the scheme. In terms of geography, four countries dominate the market in CDM generated CERS. These are China, India, Brazil and Mexico. At the start of the scheme, they accounted for around 50 per cent of all projects, but this figure has now risen to around 75 per cent. While China hosts slightly more projects than India, it supplies over three times as many CERs. This is for one very simple reason: the cost of mitigating emissions in China is lower than in any other country.

China’s dominance is demonstrated by the fact that all of the top 10 projects registered in the past year, in terms of GHG emissions mitigated, are located within its borders. They fall into two main categories: N₂O/HFC reduction and fuel switching from coal to natural gas. One of the quirks about the latter is that the CDM is thought to be one of the reasons why the Chinese government has not pressed for tighter environmental standards. However, this has still happened in other areas; coal bed methane being a prime example. Since the government introduced measures making the use of coal bed methane and gas from landfill mandatory, projects based on exploiting these resources can no longer fulfil the additionality clause as set out by the CDM Executive Board.

As far as the whole of the CDM is concerned, 2008 has see a large increase in coal to gas fuel switching. Over 4400MW of Asian power capacity was registered under the scheme in 1Q08, compared to 1741MW registered in the same period in 2007 and the 7538MW registered over the whole of last year. Of the 1Q08 total, more than 80 per cent was natural gas-firing.

Top 10 projects

1. PetroChina’s N₂O decomposition project, Liaoyang
Estimated GHG reductions: 10.017Mta
This is by far and away the largest CDM project registered this year. PetroChina is looking to install a catalytic decomposition facility to reduce the N₂O emissions generated from the production of adipic acid, which is used both as a food ingredient and in the production of polyurethane. The company argued in its application that given the lack of a market for N₂O and the absence of regulations governing its release in China, without CDM registration, there was no economic rationale for the development to proceed. Indeed, PetroChina calculated that without the ability to sell CERs, the net present value of the project would be -US$48.33m.

2. Changshu Haike HFC23 decomposition project
Estimated GHG reductions: 3.473Mta
Changshu Haike, a Sino-French joint venture, was looking to install a thermal oxidation facility from VICHEM, a French technology supplier, in order to reduce the HFC23 emissions from its HCFC22 production plant, in Changsu City, Jiangsu Province, which has been in operation since May 2000. The process requires heating to above 1200^oC, but as HFC23 is such a potent GHG, the emissions produced by fuelling the facility are more than outweighed by the elimination of HFC23. According to project documentation, 65 per cent of the revenues from the sale of CERs will go to the Chinese government to support its sustainable development facility.

3. Baotou Iron & Steel Blast Furnace combined cycle power plant project
Estimated GHG reductions: 1.871Mta
This 300MW power plant will run off blast furnace and coke oven gas. In the absence of the plant, 30 per cent of the gases from the blast furnace would be flared. By using them to produce electricity, less coal has to be burnt in existing power stations.

Also part of the rationale behind the inclusion of the project within the CDM, is that as an iron and steel company, Baotou’s investments typically have to generate a 13 per cent rate of return, compared to the eight per cent required by power generation projects and the 10.06 per cent projected for the project in the absence of CDM finance. This would rise to 16.46 per cent with CDM approval. In addition, the use of blast furnace gas poses significant technical barriers, which the company argued would be reduced by CDM registration. The resulting expertise could then be transferred to similar projects.

4. Beijing Taiyanggong CCGT trigeneration project
Estimated GHG reductions: 1.516Mta
Beijing Taiyanggong Gas-fired Thermal Power Co is seeking to install and operate a 780MW grid-connected natural gas CCGT power plant, which would supply power to Beijing’s electricity grid and provide waste steam for heating and cooling to the surrounding area, allowing the removal of 78 low-efficiency boilers. The major selling point was that it offered substantial savings in GHG and other pollutant emissions compared to a business-as-usual, coal-fired generation approach. As with the project at Baotou, the relatively poor internal rate of return (IRR) was also given as a reason for CDM assistance. The project document indicated that there were three other natural gas-fired power plants in the Beijing area applying for CDM registration and argued that this a sign that additional finance is needed for gas-fired generation in China.

5. Shanghai Baoshan grid-connected natural gas combined cycle power plant
Estimated GHG reductions: 1.43Mta
This project intends to build three 400MW CCGT units to boost Shanghai’s peak-load balancing capacity by 10 per cent. Again, the baseline scenario involved the building of a coal-fired power plant and the low IRR in the absence of CDM funding was highlighted. Estimates for the power station included a rated thermal efficiency of 57.21 per cent and a 92 per cent load factor. GE has been selected as the equipment supplier for the plant. The application made it clear that the Shanghai market is adequately supplied with gas currently and this is expected to remain the case for the foreseeable future.

6. Zhenhai Provincial Energy Group’s natural gas generation project
Estimated GHG reductions: 0.937Mta
and
7. Zhejiang Southeast Electric Power Co’s natural gas power plant in Xiaoshan
Estimated GHG reductions: 0.937Mta
Both these projects are for the construction of natural gas power plants to be owned by the Zhejiang Southeast Electric Power Co and will supply the East China Power Grid (ECPG), which provides electricity to the provincial grids of Shanghai, Jiangsu, Anhui and Fujian. The first project will install two CCGT units with a total rated capacity of 795.6MW, while the second is for two 403MW CCGT units.
In addition to reducing GHG emissions, the project’s backers made the case that they would also reduce the levels of other pollutants compared to a business-as-usual scenario, improve the peak-load balancing of the grid and provide employment for the local people. Again, coal-fired generation was used as the baseline and the poor IRR was used as the rationale for CDM financing, in both cases.

8. Liuzhou Chemical Industry Co’s N₂O abatement project
Estimated GHG reductions: 0.902Mta
The aim of this project is to reduce N₂O emissions from five nitric acid plants, which produce 454,080tpa of acid and currently emit around 3250tpa of N₂O. Liuzhou is looking to use equipment provided by Sumiko Eco-Engineering and NE Chemcat, to decompose over 90 per cent of the emissions. Their technology has yet to be fully commercialised, even in developed countries. The project is sponsored by another Japanese company, Mitsubishi Corp. Like project number two in our list, the Chinese government will receive 30 per cent of the CER revenues generated by this venture. Due to the low temperature of the tail gas, some additional heating is expected to be needed and this will come from burning purge gas (methane and hydrogen) from an ammonia plant within the factory.

9. Yuyao natural gas power project
Estimated GHG reductions: 0.805Mta
Zheijang Guohua Yayo Fuel Gas Power Generation Co, is also seeking to build more peaking capacity for the ECPG. According to the project documents, the ECPG is expected to install 40GW of capacity in order to meet the region’s rising demand for electricity.

The company is looking to do its part by installing and operating a 780MW CCGT, supplied by GE. This project, along with numbers 7 and 8 on our list, highlights that the area is unsuitable for stored hydropower due to the lack of water resources. In addition, what potential does exist in the region for economically viable hydro projects has already been utilised, while nuclear is not an option for peak demand-balancing plants.

10. Henan Zhengzho grid-connected natural gas combined cycle plant.
Estimated GHG reductions: 0.692Mta
This is another peak load-balancing gas-fired proposal. Zhenghzhou Combined Cycle Power Co intends to build two 390MW CCGT units, which will serve the Henan provincial grid and through it, the Central China Grid. The equipment is being provided with Siemens, which also has a maintenance service agreement to ensure that the plant achieves optimal performance during the project operation.

Value for money?

It is clear that as far as China is concerned, the CDM is working to encourage cleaner forms of power generation. However, its efficiency is somewhat questionable, given the fact that CDM financing propels power projects well above the benchmark set by the Chinese government (see Table 1). In addition, one can’t help but wonder how the situation would change if the government were to relax its control on electricity prices. There is also the problem that the CDM offers a compelling financial incentive for the government to not introduce tighter environmental regulations, such as a ban on the release of HFC23 and N₂O as this would eliminate the additionality required by the CDM. Such a move would, however, be by far the cheapest way to improve the environment in this arena.
As for the future of the CDM as a whole, a very great deal depends on the successor to the Kyoto Protocol, which expires at the end of 2012. The negotiations over what form it will take are likely to be extremely heated, with the US expected to press for China to commit to some form of hard target, a move which the Chinese government has bitterly opposed. The US itself is also important to the future of the CDM, as it could well become its biggest customer, if a cap-and-trade scheme is introduced by the next president.

The World Bank has predicted that the uncertainty regarding the future of the CDM will lead to slowing growth in a sector which has rapidly increased in value, doubling in the last year to US$13bn. It expects the number of projects under the scheme to barely grow in 2008, before reaching almost zero in 2010. Let’s hope then that the sequel will make up for any lull and at the same time overcome many of the more glaring problems from which it currently suffers.

For more information, consider visiting the following websites:
http://cdmpipeline.org/
http://cdm.unfccc.int/index.html
http://cdmbazzar.net/