Trading in the carbon market: leveling the playing field in sustainable investment.

• Author: Pulitzer, Philip S.

INTRODUCTION

Despite the rhetoric from the developed world touting goals of environmental protection, most nations have continued investing in carbon intensive energy sources and promoting trade agreements that merely pay lip service to sustainable development. (1) Behind these actions is the view that environmentally-sound policy is a roadblock to economic growth. (2) With the first phase (Phase I) of the Kyoto Protocol (Kyoto) underway, developed nations are using market based strategies and Kyoto's flexibility mechanisms to meet their initial carbon emission targets. (3) The United Nations Framework Convention on Climate Change (UNFCCC) and Kyoto create an opportunity to build environmentally sustainable economies and turn what some nations refer to as an economic hindrance into a growth opportunity. (4) Through Kyoto's cap and trade system and its flexible methods for meeting emission caps, developed nations are investing in carbon abatement projects in the developing world and creating new investment opportunities for host nations. (5) Unfortunately, no silver bullet exists for reaching the desired greenhouse gas (GHG) emission reductions, so any effort to truly tackle the problem involves analyzing the complex nature of the climate change issue. (6)

This note examines the environmental, economic, and security concerns of climate change and posits that regional cooperation in the developing world is the key to obtaining sustainable investment. (7) Part II of this note provides background on the international community's efforts to combat climate change and how this affects the developing world. (8) Part III discuses some of the issues Kyoto has encountered as Phase I begins as well as the environmental, economic, and security issues surrounding climate change. (9) Part IV, using the Caribbean as a case study, analyzes the developing world's potential to transition to sustainable economies while strengthening regional unity and increasing investment opportunities with the clean development mechanism (CDM). (10) Part V concludes with a look at what developing nations can expect in a post-Kyoto world following its 2012 expiration, focusing on why creating a sustainable economy now will be important to economic growth in the future. (11)

2. HISTORY: KYOTO, THE CDM AND THE DEVELOPING WORLD

   The international effort to combat climate change in a legal fashion began with the signing of the UNFCCC in 1992. (12) The UNFCCC established an institutional structure providing regular meetings between signatories referred to as Conferences of the Parties (COP). (13) In December 1997, in Kyoto, Japan, the third COP adopted the Kyoto Protocol, creating firm emission reduction commitments by the developed world. (14)

   1. The Kyoto Protocol

      Kyoto requires developed countries, which are listed in Annex 1 to the treaty and referred to as Annex 1 nations, to reduce their emissions during Phase I, 2008-2012, to specific targets below 1990 emission levels. (15) Kyoto offers flexible mechanisms that allow Annex 1 nations to meet their emission reduction targets using market-based strategies. (16) Kyoto also provides developing nations, non-Annex 1 parties, the opportunity to voluntarily limit their emissions, giving them the flexibility to choose their base year from which reductions will be calculated. (17) While some members have been critical of Kyoto, it has provided a framework for mitigating climate change. (18)

      The structure of the current carbon market established under Kyoto involves a cap and trade system, where each government is allotted steadily declining annual emission limits. (19) Each domestic industry is also given limits by its government, and it can meet its reductions either through increasing efficiency or purchasing carbon credits on the global carbon market. (20) A cap and trade system, which allows market forces to find the cheapest emission reductions, is ideal for combating climate change because it gives incentives to firms and industries that can reduce their emissions most cheaply to do so on behalf of others. (21)

   2. The Clean Development Mechanism

      1. CDM Overview

         The CDM provides incentives for Annex 1 parties to promote sustainable development through investing in carbon abatement projects in developing nations. (22) Building more efficient industrial and energy facilities in the developing world is a cheaper way to reduce emissions than retrofitting the developed world's infrastructure. (23) By allowing for the flow of money and technology to developing nations, the CDM aims to mitigate climate change through sustainable development. (24) An increased transfer of wealth and technology to the developing world allows those nations to continue to industrialize while emitting fewer GHGs than they would otherwise. (25)

         The CDM functions within the larger picture of Kyoto's cap and trade system. (26) It creates tradable carbon credits, or certified emission reductions (CERs), equivalent to the amount of carbon the project removes from the atmosphere. (27) The CERs are either used to help the Annex 1 nation meet its emissions reductions or sold on the international carbon market. (28) It is crucial to the success of the carbon market, as well as combating climate change, that CERs represent actual, quantitative reductions in GHGs that are additional to what would have occurred without the CDM. (29)

         Kyoto's ability to restrict emissions is limited to those Annex 1 parties that have ratified the treaty, leaving the United States, China, and the rest of the developing world free to emit as they please. (30) With the United States on the sidelines, developing countries have little incentive to cap their emissions because, according to former-President George W. Bush, any caps would result in a loss of jobs and money. (31) Further, the capital available for CDMs has been reduced significantly by the United States' refusal to ratify Kyoto. (32) Without the United States, the CDM market is more competitive and projects are unevenly dispersed. (33)

      2. Special Concerns of the CDM

         An investor and host nation must overcome a number of procedural hurdles before getting a project off the ground. (34) The parties must first submit a project development document (PDD) to a designated operational entity, which then validates the project and sends it to the CDM Executive Board for registration. (35) The PDD must contain information demonstrating that the project is additional to any other carbon reduction projects, the methodology from which such calculation is measured, and provide evidence the project is not causing leakage. (36)

         On March 30, 2006, the report from the COP meeting in Montreal was released with updated simplified procedural requirements for small-scale projects. (37) The simplified PDD still must contain its basic components. (38) It is now cheaper and easier to have small-scale projects approved. (39) Such procedures are available to projects smaller than fifteen megawatts and when multiple small projects are "bundled." (40)

         Small bundled projects can be a strong first step towards increasing the efficiency of regions, a must for transitioning to sustainable economies. (41) In Mexico, a new CDM project bundle that distributes compact fluorescent light bulbs (CFLs) illustrates the possibilities of bundled projects. (42) Bundled projects introduce new programs that would have been prohibitively expensive in the past because of the administration costs. (43) Introducing a large number of small energy efficiency projects to Mexico has the potential to be far-reaching and may lay the groundwork for projects in the future. (44)

   3. Caribbean's Efforts to Combat Climate Change

      1. CARICOM Overview

         The Treaty of Chaguaramas established the Caribbean Community (CARICOM) in 1973. (45) CARICOM's mission is to "provide dynamic leadership and service, in partnership with Community institutions and Groups, toward the attainment of a viable, internationally competitive and sustainable Community, with improved quality of life for all." (46) CARICOM has expanded its aims and undertaken its own efforts to combat climate change and promote sustainable development among member nations. (47) In 2004, the Caribbean Renewable Energy Development Programme (CREDP) became fully implemented with significant investment from the UN Development Programme Global Environment Facility. (48)

      2. CARICOM's Progress

         The Caribbean, a region Balkanized because of its geography and colonial history, presents both unique opportunities and challenges in creating a strong regional organization. (49) A number of Caribbean countries have begun the process of market unification, exemplified by the single market of CARICOM, and are inching closer to environmental unification. (50) Challenges to regional integration of environmental policy include lack of awareness, political will, investment, and the geographical dispersion of members. (51) Despite these issues, the Caribbean is a leading area for sustainable development because of the immense potential energy of the region. (52) Furthermore, CARICOM members share a universal aspiration for present and future generations to reap the benefits of a healthy environment, providing an incredible bond between member states with diverse interests. (53) While a number of CDM projects are registered in CARICOM member nations, the number is small compared to the significant amount of potential development and energy in the region. (54)

         CARICOM is unique among most regional organizations in that it seeks to establish not only a trade association but something more expansive, as illustrated in the centrality of the single economic market of the community. (55) The ambitious move toward a regional union requires members to give up rights to the central body in order to unify member policy, which may threaten the state's sovereignty. (56) Caribbean and developing nations are historically reluctant to cede...