law and economics of international climate change

LAW AND ECONOMICS OF INTERNATIONAL CLIMATE CHANGE POLICY by

Reimund Schwarze In Collaboration with John O. Niles and Eric Levy

With 26 Figures and 11Tables

KLUWER ACADEMIC PUBLISHERS Boston/Dordrecht/London

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CONTENTS Chapter 1 Introduction ...................................................................... 1 Chapter 2 ”Hot Air” in International Emission Trading How Much and How to Respond? Reimund Schwarze and Eric Levy............................................... 7 1. Introduction ................................................................................... 7 2. What is ”hot air”? .......................................................................... 8 3. How much ”hot air” exists in the first commitment period? ......... 9 4. Policies to address ”hot air”......................................................... 11 5. Economic analysis of the E.U. capping proposal ........................ 16 6. Conclusion ................................................................................... 18 Chapter 3 Accounting of Biological Sources and Sinks. Legal and Economic Considerations Reimund Schwarze .................................................................... 21 1. Introduction ................................................................................. 21 2. Climate change policy and forests............................................... 23 3. Can carbon accounting help save tropical forests?...................... 26 4. Biological sources and sinks under the Kyoto protocol .............. 28 4.1 Domestic accounting of biological sources and sinks.......... 28 4.1.1 Article 3.3 .................................................................. 29 4.1.2 Article 3.4 .................................................................. 30 4.1.3 Article 3.7 and the ”gross-net problem” .................... 31 4.2 Accounting of international LUCF activities....................... 35 4.2.1 Leakage and the need for national accounting........... 36 4.2.2 Baseline inflation....................................................... 37 4.3 Deforestation for reforestation? ........................................... 38 5. Experiences with AIJ forestry in Costa Rica ............................... 40 6. Conclusion ................................................................................... 44 Chapter 4 The Long-term Requirement for CDM Forestry and Economic Liability Reimund Schwarze and John O. Niles ...................................... 55 1. Introduction ................................................................................. 55 2. The long-term requirement of the CDM...................................... 58 3. Basic types of economic liability contracts ................................. 59 4. The efficiency advantage of seller liability ................................. 63 5. The CDM forest-secured escrow account.................................... 65

II 6. Conclusion ................................................................................... 69 Chapter 5 Increasing the Acceptability of CDM Forestry Through Bundling of Bioenergy and Forest Conservation John O. Niles and Reimund Schwarze ...................................... 75 1. Introduction ................................................................................. 75 2. Developing countries’ perspective .............................................. 77 3. Developed countries’ perspective................................................ 79 4. Synergies between bioenergy and forest conservation ................ 81 5. Conclusion ................................................................................... 85 Chapter 6 Activities Implemented Jointly: An Empirical Analysis Reimund Schwarze .................................................................... 89 1. Introduction ................................................................................. 89 2. The data ................................................................................... 90 3. The timing of AIJ ........................................................................ 91 4. Regional distribution of AIJ ........................................................ 92 5. Distribution of activity types ....................................................... 96 6. Private sector participation in AIJ ............................................. 100 7. On the baseline .......................................................................... 102 8. Cost of AIJ................................................................................. 105 9. Summary and implications ........................................................ 107 Chapter 7 Beyond COP6: The Need for Extended Flexibility ... 117 1. Introduction ............................................................................... 117 2. The road to COP6 ...................................................................... 118 3. The discussions at COP6 ........................................................... 121 4. The issue of additional sinks...................................................... 124 5. Lessons from COP6................................................................... 128 Chapter 8 Summary and Conclusion ........................................... 133 Chapter 9 Terms and Abbreviations ............................................ 139

III

FIGURES AND TABLES Figure 2.1: Surplus/Deficit carbon emissions (2008-2012)...................... 10 Figure 2.2: Economic effects of a sales cap ............................................. 13 Figure 2.3: Economic effects of a demand cap ........................................ 14 Figure 2.4: Earmarking of ”hot air”revenues ........................................... 15 Figure 3.1: Structure of sources and sinks of carbon................................ 24 Figure 3.2: Economics of long-term tropical forest conservation............ 27 Table 3.1: The gross-net problem............................................................. 32 Table 3.2: AIJ-forestry in Costa Rica....................................................... 41 Table 3.3: Implemented and planned AIJ forestry projects...................... 44 Figure 4.1: CDM contractual procedures ................................................. 60 Table 4.1: Basic contract types................................................................. 61 Table. 4.2: Present values of contract net benefits ................................... 63 Figure 4.2: Time distributions of contract benefits .................................. 66 Table 4.3: Numerical example of economic liability ............................... 68 Figure 5.1: The cycle of early mitigation and ratification ........................ 80 Figure 5.2: Synergies between bioenergy and forest protection............... 81 Table 5.1: Climate-related ecosystem services of tropical forests ........... 83 Figure 6.1: Activity starting date.............................................................. 91 Figure 6.2: Regional distribution of AIJ................................................... 93

IV Figure 6.3: Regional specific investment portfolios................................. 94 Figure 6.4: Regional specific investment portfolios................................. 95 Figure 6.5: Activity type........................................................................... 96 Figure 6.6: Average GHG reduction by activity types ............................. 97 Figure 6.7: Regional specific activity portfolios ...................................... 98 Figure 6.8: Share of GHG reduced by gas type........................................ 99 Figure 6.9: Private sector funding share................................................. 101 Figure 6.10: Regional specific funding portfolios.................................. 102 Figure 6.11: Baseline.............................................................................. 104 Figure 6.12: Gross average reduction cost by activity-type ................... 105 Figure 6.13: Net average reduction cost by activity-type....................... 106 Table 6.1: AIJ Projects (1995 – 1999).................................................... 108 Figure 7.1: The political frontlines at COP6 .......................................... 119 Table 7.1: Issue clusters at COP6........................................................... 121 Table 7.2: The Pronk proposal ............................................................... 122 Figure 7.2: The JUSC 3.4 proposal ........................................................ 124 Figure 7.3: The effect of Article 3.4 on Kyoto targets ........................... 126 Table 7.3: The effect of Article 3.4 on Kyoto targets............................. 127

Chapter 1 Introduction International climate change policy can be broadly divided into two periods: A first period, where a broad consensus was reached to tackle the risk of global warming in a coordinated global effort, and a second period, where this consensus was finally framed into a concrete policy. The first period started at the "Earth Summit" of Rio de Janeiro in 1992, where the United Nations Framework Convention on Climate Change (UNFCCC) was opened for signature. The UNFCCC was subsequently signed and ratified by 174 countries, making it one of the most accepted international treaties ever. The second period was initiated at the 3rd Conference of the Parties (COP3) to the UNFCCC in Kyoto in 1997, which produced the Kyoto Protocol (KP). Till now, eighty-four countries have signed the Kyoto Protocol, but only twelve ratified it. A major reason for this slow ratification is that most operational details of the Kyoto Protocol were not decided in Kyoto but deferred to following conferences. This deferral of the details, while probably appropriate to initially reach an agreement, is a major stepping stone for a speedy ratification of the protocol. National policy makers and their constituencies, who would ultimately bear the cost of Kyoto, are generally not prepared to ratify a treaty that could mean anything, from an unsustainable strict regime of international control of greenhouse gases (GHGs) to an "L-regime" of loopholes, or from a pure market-based international carbon trading to a regime of huge international carbon tax funds. The Kyoto Protocol, if ratified, will become effective in 2008. Some of its mechanisms may, however, be applicable as of 2000. The parties at Kyoto were overly optimistic to imagine that all open questions of the protocol could be resolved within such a short time span. Most observers agree that it will take longer. Indeed, last year’s climate summit at The Hague (COP6), which was supposed to finalise the rules of the Kyoto Protocol, ended without any agreement. But, borrowing a popular

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Introduction

phrase from U.S. Senator John McCain during the war in Kosovo, ”now that we're in, we have to win”. We have to double and triple our scientific and political efforts to get Kyoto operational, legally sound and politically acceptable. This study is a contribution to this much-needed effort. It will elaborate in six essays on some of the most pressing policy problems of the Kyoto Protocol. These are the problems of "hot air", the accounting of biological sources and sinks and the modalities of the Clean Development Mechanism. ”Hot air” is a phrase used to describe the fact that some economies in transition, particularly Russia and the Ukraine, are granted emission rights under the Kyoto Protocol, which exceed their projected emissions in the first commitment period 2008-2012. In my first essay, which was completed with the help of Stanford graduate student Eric Levy, I discuss the importance of ”hot air” in the first commitment period and potential policies to address this problem. Specifically, I show that there is no easy way out of the ”hot air” problem. Renegotiations of GHG emissions targets aimed at reducing ”hot air” seem politically infeasible, and a cap on emissions trading as proposed by the E.U. would be ineffective. Instead, I suggest putting no restrictions on ”hot air” trade. This would keep ”hot air” cheap compared to restricting trade, which in turn increases the political chances for a buy-out solution to the problem. This buy-out of ”hot air” could be an open market operation, where a group of concerned parties, e.g. the OECD, would buy assigned amounts from Russia and the Ukraine solely for the purpose of retiring them. Alternatively, it could be done through purchases of ”hot air”, which are paid in-kind with emission reduction equipment or where revenues are ”earmarked” for purchases of emission reduction investments in Russia and the Ukraine. The accounting of biological sources and sinks (BSS) is another highly disputed problem of the Kyoto Protocol. Some critics see it, next to ”hot air”, as the second largest ”loophole” of the Kyoto Protocol, which would lower the actually achieved rate of emission reduction by one-third. They suggest that, missing a major revision of the Kyoto protocol, the accounting of domestic BSS shall be minimized, and international activities in biological source protection and sink enhancement shall be put on hold for at least a decade or two. I address this critic in my second essay, where I discuss the main legal, economic and political issues of accounting of biological sources and sinks under the Kyoto protocol. Based on this discussion, I conclude that the Kyoto protocol, though in

Law and Economics of International Climate Change Policy

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many ways imperfect, is basically a good beginning. It provides a sound legal and political basis for the domestic accounting of biological sources and sinks and for forestry projects under the Clean Development Mechanism, which should be further developed to capture the unique potential of linking the issues of climate change and global sustainable forestry. The third essay is focused on policies to enforce the long-term requirement of the Clean Development Mechanism (CDM), particularly in the field of CDM-forestry. CDM-forests must be durable and long-term to offset long-living greenhouse gases in the atmosphere. The essay is a joint paper with Stanford graduate John O. Niles of the Center of Conservation Biology. In this paper, we show how the long-term requirement for CDMforestry can be enforced by a system of withholding of contract benefits for a pre-specified period of time, which we call ”economic liability”. Specifically, we propose a scheme of crediting of the interest and withholding of the principle payments of the donor (escrow). This ”CDM forest-secured escrow account” is more economical to potential CDM hosts than pure seller liability, while still providing sufficient incentives for long-term protection. The fourth essay is another joint paper with John O. Niles. It discusses the main political and ethical issues - from a developing and developed countries’ perspective - of including tropical forest conservation into the Clean Development Mechanism. Since some key developing countries fear that the CDM could be a form of ”carbon colonialism”, returning these countries into "giant forests", political and ethical reservations have become a major obstacle for forest conservation projects. We explore how synergies between forest conservation and bioenergy projects, if packaged into tandem, could increase the acceptability, the profitability and ecological integrity of forest-based emission reductions. Our main finding is that the bundling of bioenergy and forest conservation makes CDM projects more acceptable to local communities, more likely to succeed, more attractive to investors, and cheaper to site. This in turn may increase the political and economic support for the CDM and the Kyoto Protocol. In my fifth essay I study the experience with project-based mechanisms of international cooperation in the pilot phase Activities Implemented Jointly (AIJ). Though actually a Pre-Kyoto policy, AIJ provides a rich picture on the practical working of project-based mechanisms, which applies to the project-based mechanisms of the Kyoto

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Introduction

Protocol known as Joint Implementation (JI) and the Clean Development Mechanism (CDM). In this essay, I provide evidence for ”national preferences” of host and investor countries. These preferences influence the where, what and how of trading under project-based Kyoto mechanism. I discuss the efficiency implications of this finding and the role of transaction costs. The sixth and final essay is a joint paper with Axel Michaelowa of the Hamburg Institute for International Economics. It was written after the completion of this book and provides an update on several previously discussed issues as they appeared on the COP6 agenda. It also analyses, from a subjective standpoint, why the summit of The Hague failed and how this failure could be avoided at the subsequent meeting (COP6/II). The study concludes with a summary of main policy proposals and a discussion on the perspectives to get Kyoto finally ratified. This study has been completed, in its main part, during a research fellowship at the Center of Environmental Science and Policy (CESP) of Stanford University in 1998/1999. It is very much inspired by the unique interdisciplinary environment that Stanford provides for researchers in this (and other) fields. I have particularly gained from several talks with Ambassador Raoul Estrada, who chaired the Kyoto conference in 1997, and was the Payne-lecturer at the Institute for International Studies in 1999. I have also profited from discussions in a series of seminars on climate change policy, which were held at the CESP during this year. Personal discussions with Stanford faculty members and students also helped me to advance my study. Specifically I would like to thank Eric Levy, Ph.D. student at the Department of Biological Sciences of Stanford University, and John O. Niles of Stanford’s Center of Conservation Biology for their very thoughtful critique and their contributions to Chapters 2, 4 and 5 respectively. I also like to thank Professor Thomas Heller of the Stanford Law School, who provided me with invaluable ”insider knowledge” on international climate change law and policy. Discussions with Mike Toman and Rodger Sedjo of Resources for the Future, Washington D.C., and with Ed Vine of Lawrence Berkeley National Laboratories, Berkeley/CA, helped to improve my original writing on Activities Implemented Jointly and the CDM. I also received a thorough review of Chapter 3 from Bernhard Schlamadinger of Oak Ridge National Laboratories, Tennessee. The book as a whole was reviewed by Michael Dutschke and Axel Michaelowa of the Hamburg Institute for International Economics. I am very grateful to all these people helping me


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to advance this study. Of course, I retain the responsibility for any remaining errors. I also like to thank the Thyssen foundation, which generously funded my stay at Stanford and my travels throughout the U.S. Last but not least, I thank my beloved family who joined me during this stay. Reimund Schwarze

Chapter 2 ”Hot Air” in International Emission Trading How Much and How to Respond? Reimund Schwarze and Eric Levy

1.

INTRODUCTION

International Emission Trading (IET) is a ”flexibility mechanism” of the Kyoto Protocol (KP) to the United Nations Framework Convention on Climate Change. It is aimed at minimizing the cost of reducing greenhouse gases (GHG) on a global basis. For this purpose countries with quantified emission limitation and reduction objectives, listed in Annex B of the Kyoto Protocol, may purchase emission rights from other Annex B countries that are able to cut emissions below their assigned targets at lower cost. The details of how this regime will operate are still undecided, but may play a pivotal role in the ratification of the Protocol. 1 A major political obstacle to IET is the problem of ”hot air”. ”Hot air” is a term used to describe the fact that some economies in transition (EITs), particularly Russia and the Ukraine, were granted emission rights that exceed their projected emissions in the first commitment period of the Kyoto Protocol (2008-2012). This surplus assigned amounts could be as high as 1400 million metric tons of carbon (MtC) or 50% of the overall emission reduction of the Kyoto Protocol. ”Hot air” is viewed by critics from environmental groups as the major ”loophole” of the Kyoto Protocol. Partly in response to this critique, the European Union (E.U.) has decided to negotiate a concrete ceiling (”cap”) on the use of IET (European Council Permanent Representatives

8

Hot Air

Committee, 1999). This capping proposal could become a major obstacle for ratification of the Kyoto Protocol in the United States (U.S.). This paper discusses the importance of ”hot air” in the first commitment period and potential policies to address this problem. We show that there is no easy way out of the ”hot air” problem. Renegotiations of GHG emissions targets aimed at reducing ”hot air” seem politically infeasible, and a cap on emissions trading as proposed by the E.U. would be ineffective. Instead, we suggest putting no restrictions on ”hot air” trade. This would keep ”hot air” cheap compared to restricting trade, which in turn increases the political chances for a buyout solution to the problem. This buy-out of ”hot air” could be an open market operation, where a group of concerned parties, e.g. the OECD, would buy assigned amounts from Russia and the Ukraine solely for the purpose of retiring them. Alternatively, it could be done through purchases of ”hot air”, which are paid in-kind with emission reduction equipment or where revenues are ”earmarked” for purchases of emission reduction investments in Russia and the Ukraine.

2.

WHAT IS ”HOT AIR”?

The Kyoto Protocol sets quantified emission limitation or reduction objectives (QUELROs) for 38 countries and the E.U.. These targets, if the treaty is ratified, will reduce GHG emissions of these countries by an average of 5.2% below 1990 levels. Each country’s specific reduction varies. As outlined in Annex B of the Kyoto Protocol, most countries are assigned a reduction of 8% from their 1990 baseline. Differently, the U.S. must account for a 7% reduction, Japan 6%, and Canada 6%. Certain countries were given emission targets, which will allow these nations to maintain or emit more than their 1990 emission levels. For example, Australia can increase its emissions by 8% and Iceland by 10%. Emission reductions are required during the first commitment period (2008-2012), but the reductions are expressed relative to a 1990 baseline. Therefore, countries such as the U.S. that have dramatically increased their emissions since 1990 will actually need to reduce their emissions by an amount much greater than 7% of future levels. The common estimate for emission reductions in the U.S. is 30-35% below business as usual in 2010 (Energy Information Agency, 1998).


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While most countries have increased GHG emissions since 1990, countries such as the Russian Federation and the Ukraine, that suffered economic decline after the collapse of their centralized governments, are dramatically below their 1990 levels of emissions and will likely remain below these levels for the near future. The Kyoto Protocol requires Russia and the Ukraine to maintain 1990 levels of GHG emissions. Therefore, these countries will have surplus assigned amounts that they will be allowed to sell in a tradable permits market. This free surplus is what opponents have termed ”hot air”, because it will be treated as emission reductions in an emissions market while no ”true” abatement has occurred. Critics assert that emissions reductions that are caused by factors outside the realm of environmental policy are not purposeful emission reductions. Consequently, they can not be credited to the host country and must be banned from trading. Proponents of emissions trading have argued that ”hot air” does not affect the overall Kyoto target. Even if the full surplus of emission rights from Russia and the Ukraine were traded to the West, GHG emissions from Annex B-countries would still be on average 5.2% below 1990 levels. Both views reflect a totally different understanding on the nature of emissions trading. While the proponents of free trade think of it as a cap-and-trade regime, where only the overall emissions target counts, critics perceive it as a regime of emission reduction credits, where tradable permits result from a decrease of emissions compared to the business-as-usual. 2 Another interesting prospective of the political implication of ”hot air” was developed by Batruch (1998), who suggests that ”hot air” sets a legal precedent for developing countries. In her paper, Batruch argues that when developing countries establish their own emissions targets they could ask for a similar buffer to allow for future growth. In other words, they can ask for their own ”hot air”.

3.

HOW MUCH ”HOT AIR” EXISTS IN THE FIRST COMMITMENT PERIOD?

The actual amount of ”hot air” in the first commitment period is difficult to predict, because it depends on several factors - the pace and time of economic recovery in EITs, the availability of fossil versus non-

10

Hot Air

fossil fuels, and the stringency of environmental policies. The most comprehensive recent estimate of ”hot air” is based on scenarios developed at the International Institute for Applied Systems Analysis (IIASA) (Victor et al., 1998). The main results of this study are shown in figure 2.1. Figure 2.1 depicts the emission surpluses or deficits of different countries or groups of countries under different future scenarios. An emission surplus is defined in this study as a positive difference between the projected business-as-usual emissions (BAU) in the five-year period 2008-2012 and the Kyoto target for that period. An emission deficit, termed ”hot air”, is defined as a negative difference between BAU emissions and the Kyoto target. Figure 2.1: Surplus/Deficit carbon emissions (2008-2012)

5000 OECD Countries (incl. Japan) North America Western Europe Russia/Ukraine Economies in transition

4000

3000 2697 2000

1838

MtC 1000 731 0 -59

-190

-1000

-726

-1117

-1051

-1462 -2000 High Growth/ Coal

High Growth/ Gas

High Growth/ Non fossil fuel

Low Growth

Green Future

From the IIASA-study we display five possible future scenarios, three high-growth scenarios and two low-growth scenarios. The highgrowth scenarios reflect different assumptions on dominant fuels with rapid growth. The first sub-scenario predicts coal as the dominant fuel source due to scarcity of oil and gas. The second sub-scenario assumes oil and gas remain important fuel sources. In the third sub-scenario, improvements in non-fossil fuel technologies (renewables and nuclear)


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lead to economically competitive alternatives and long-term elimination of fossil fuels. The low-growth scenarios reflect different economic and environmental policy futures. The first sub-scenario captures the effect of a sluggish world economy and greater than expected difficulties in the economic recovery in Russia and the Ukraine. The ”green future” subscenario, on the other hand, predicts the effects of a broad, unprecedented national and international effort to protect the environment (e.g. international carbon tax with revenue recycling to developing countries) combined with technological improvements in energy use and renewables. Predicting the size of the ”hot air” emissions deficit is largely driven by assumption on economic growth in EITs. Economic recovery fueled by coal or natural gas, would shrink ”hot air” in EITs to a relatively negligible 59 MtC or 190 MtC respectively. 3 However, even with economic recovery there could be a sizeable emission deficit in EITs of 726 MtC, if these countries choose the non-fossil fuel/nuclear option. This result sheds some light on the difficult nature of ”hot air” because, in the latter case, the emission deficit stems from domestic technology choice, not from an overgenerous allocation of assigned amounts. The IIASA-study suggests that the low growth scenario is the most likely outcome. According to this prediction, the authors find that ”hot air” in the first commitment period could be as high as 1117 MtC in Russia and the Ukraine, and 1462 MtC in EITs as a whole. 4 This amount would not fully cover the need to reduce emissions in OECD-countries, which is estimated at 2700 MtC. However, depending on the no-regret potential and the amount of trade among OECD-countries, it could make up 50% of the future market for assigned amounts. 5

4.

POLICIES TO ADDRESS ”HOT AIR”

Allocating too many emission rights to Russia and the Ukraine essentially created the problem of ”hot air”. A straightforward correction to this problem would thus be to renegotiate this initial allocation so that fewer emission rights are assigned. One way would be to request that Russia and the Ukraine agree to reduction targets instead of the present stabilization targets. This policy could build upon an early proposal of Annex B targets of December, 9th, 1997, where Russia and the Ukraine had been allocated a 5% reduction target in a framework of a 6% overall Annex B reduction (Koch/Michaelowa, 1999). Another way would be to

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Hot Air

choose a base year other than 1990, e.g. 1995, where most of the emission reductions from the economic collapse would be discounted. Both ways, however, seem politically infeasible. Renegotiating the initial allocations of Russia and the Ukraine would most probably initiate a process of renegotiating all Kyoto targets, putting the greatest achievement of Kyoto – the move towards quantitative targets - seriously at risk. Shy of renegotiating Kyoto targets, there are essentially three ways to respond to the problem of ”hot air”: Restrict the sale, restrict demand, or collectively buy-out ”hot air” emissions. Each solution has severe shortcomings. • Restricting the sale of ”hot air” would only have a temporary effect, if banking of emissions for the future were allowed. With banking, assigned amounts that cannot be sold in the first commitment period will be saved for sale in future periods. A simple supply cap would thus only postpone the problem of ”hot air” into the future. Since banking is legal under Article 3 of the Kyoto Protocol and economically important to prevent market disturbances 6 , a supply cap would not be a viable solution to the problem of ”hot air”. The present wording of Kyoto Protocol would also not cover it, since "hot air" is a legitimate entitlement of Russia and the Ukraine (if the Protocol is ratified,) and there is nothing in the protocol that would restrict the sale (as opposed to the purchase) of assigned amounts. Moreover, a sales cap is not an economically efficient solution. This is shown in figure 2.2. Figure 2.2 depicts a simplified permit market in the first commitment period, where the demand curve (D) represents an aggregation of all nations willing to buy permits, while the supply curve (S) represents an aggregation of nations that are willing to sell their permits. S is the horizontal sum of the individual supply of two countries (S1 and S2). The supply of country 1 (S1) includes no-cost ”hot air” permits at quantity q1. Restricting the sale of permits, for example, to q* for all sellers 7 would decrease the aggregate supply to S (restricted) and, consequently, increase the equilibrium price of permits from P1 to P2. Higher prices imply higher costs; some parties (depicted as difference Q1Q2 in figure 2.2(b)) that would have acquired permits on an unrestricted market will now face inefficient spending for domestic abatement. A fact that is often overlooked is that a supply cap would also impose a hidden cost. Since it is practically impossible to distinguish ”hot air” from ”true” emission reductions, it would suppress all sales of permits, not just ”hot air” sales. Incentives for true low-cost emission


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reductions would thus be lost. This is indicated in figure 2.2 (b) by a decreasing amount of ”true” emission reductions (Q2 –q* as compared to Q1 -q1 ) in the restricted market.

Figure 2.2: Economic effects of a sales cap

P

(a) individual supply

(b) aggregate supply P

G ain w ith restriction cap

D

S (restricted)

S2

P2

S1

Π2 Π2

Π1

P1 q*

q1

q

q* ”hot air“

q1 Q 2

S (unrestricted) Q1

Q

”true E R s“

Not surprisingly, the permit price hike due to a supply cap may actually help ”hot air” sellers. Depending on supply and demand elasticity, the cap may increase their revenue in the first commitment period as illustrated in figure 2.2 (b) by higher profits Π2 than Π1. 8 Essentially, a sales cap allows sellers to skim some consumer surplus compared to an unrestricted market. Other winners would be suppliers that are not constrained by the cap. S2 in figure 2.2. (a) depicts such a case. Country 2 would gain from the restriction because it could sell permits at a higher price (P2), while the country 1 is constrained by the cap. Obvious losers of this policy would be the buyers, who have to pay the higher price for the permits and domestic abatement in the first commitment period. • Restricting the demand would be lawful but ineffective. A demand cap is legally supported by a provision of Article 17 KP, which

14

Hot Air

states that the use of this flexibility mechanism shall be ”supplemental to domestic actions.” This clause could imply that only a certain percentage of the reduction commitments can be achieved through purchases of assigned amounts. Such a concrete ceiling would apply to all flexibility mechanisms and to all potential sellers, not just Russia and the Ukraine. However, as such it will have no specific effect on the sale of ”hot air” and may even accelerate the problem. Since ”hot air” will be clearly the cheapest supply of emission rights (since it comes at zero cost to the supplier), a demand cap would primarily hurt the ”true” emission reductions from developing countries, which carries a positive price. Moreover, it may affect Annex B countries in an inequitable manner. Figure 2.3 depicts such a case. Figure 2.3: Economic effects of a demand cap

P

(b) aggregate demand

(a) individual demand P D

Gain with restriction (Π1)

D1

Cap S Loss with restriction (Π2)

P1 P2

(unrestricted) D2 q** q*

(restricted) q

q*

Q

Figure 2.3(a) represents two countries where demand is capped at q*.. Country 1 has a much larger demand (D1) for emission rights than country 2 (D2). If the same demand cap would apply to both countries 9 , there is a price-quantity region (shaded in figure 2.3(b)), where the demand cap constrains country 1 but not country 2. In this region, the lower price of emission rights (P2) – resulting from the demand constraint


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– would allow country 2 to purchase more permits at a lower price, while country 1 is already at its cap. Therefore, country 2 will benefit by the amount (∏2) and country 1 will lose out by the amount (∏1) created by higher domestic abatement costs. • A buy-out of ”hot air” could be done in different ways. One way would be an open market operation, where a group of concerned parties, e.g. the OECD, or a designated UN authority would buy assigned amounts from Russia and the Ukraine solely for the purpose of retiring them. Alternatively, it could be done through purchases of ”hot air”, which are paid in-kind with emission reduction equipment, or where revenues are ”earmarked” for purchases of emission reduction investments (Victor et al., 1998). In other words, Russia and Ukraine would get emission reduction equipment in exchange for ”hot air” credits, which would be consequently subtracted from their emission budgets. Industrialized countries could also pay for ”hot air” with non-quantifiable projects such as environmental education, emission monitoring devices, research, etc. (Koch/Michaelowa, 1999).

Emissions

Assigned Amount AA “hot air“ „hot air“

Business as Usual

C B

1990

2008

2012

Figure 2.4: Earmarking of ”hot air”revenues

Time

16

Hot Air

Paying in-kind with emission reduction equipment, however, does not avoid efforts of OECD countries to retire assigned amounts. As shown in figure 2.4, using buy-out income for purchasing emission reduction equipment would shift the business-as-usual emissions in Russia and the Ukraine further downward, creating additional emission deficits (B and C) in the future. These emission deficits can be sold in the carbon market in the second commitment period (2012-2016) or, if there are immediate effects from reinvestment, in the first commitment period (2008-2012). 10 Without a policy of retiring ”hot air”, these emission reductions would simply add to (instead of substitute) ”hot air” credits. 11 Each of these buy-out strategies faces severe political hurdles. Negotiators and politicians of industrialized countries, specifically from the E.U., object to the idea of an open market buy-out, because it would grant windfall profits for Russia and the Ukraine. Moreover, it would put a visible price on previous negotiation failures. Paying in-kind with emission reduction equipment or earmarking of revenues, on the other hand, faces strict opposition of the main proponents of emission trading, including Russia and the U.S..

5.

ECONOMIC ANALYSIS OF THE E.U. CAPPING PROPOSAL

In response to the ”hot air” problem, the E.U. Council at its meeting on May 17, 1999, decided to negotiate for a concrete ceiling on the use of the Kyoto mechanisms. The E.U. ministers proposed a combined supply and demand cap (E.U. Council Permanent Representatives Committee, 1999). Specifically they proposed that: a) Net acquisitions by an Annex B Party for all three Kyoto mechanisms together (IET, Clean Development Mechanism (CDM), and Joint Implementation (JI)) must not exceed the higher of the two following alternatives: 5 % of: its base year emissions multiplied by 5 plus its assigned amount 2

or


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50 % of: the difference between its annual actual emissions in any year of the period from 1994 to 2002, multiplied by 5, plus its assigned amount,

b) Net transfers by an Annex B Party for all three Kyoto mechanisms together must not exceed: 5 % of: its base year emissions multiplied by 5 plus its assigned amount 2

We will try to simplify this rather complicated formula. The two alternative demand caps (a) can be reduced to one – the 50% difference rule. The 50% difference rule will allow more trading than the 5% rule, because the rate of growth of emissions over the given period is higher than 5% in most potential buyer countries (Canada, U.S., Europe, and Japan). Common estimates are 15% for the U.S., 10% in Canada and Japan, and 5% in E.U.. 12 Similarly, the supply cap (b) can be simplified, because this restriction is aimed at countries with a stabilization target (Russia and the Ukraine). These countries have their assigned amounts based on 5 times their 1990 emissions, so the average of the two is just 5 times their 1990 emissions. In a quantitative analysis, the International Energy Agency (IEA) applied the E.U. capping formula to each Annex B country using data on energy-related CO2 (Baron et al., 1999). This study confirms that the 50% rule allows a higher quantity of acquisitions for most Annex I countries (potential buyers). It would restrict the total demand of Annex B countries to 576 MtC or 36% of the total Kyoto market (estimated as difference between expected 2010 emissions under business as usual and the Kyoto target). IEA is, however, inconclusive whether the demand cap or the supply cap is overall binding. Their estimate of the amount of permits available for sale from EITs under a supply cap (51 MtC) seems to indicate that the supply cap is more restrictive than the demand cap. However, since the E.U. supply cap does not apply to non-Annex B countries, excess demand could be met by CDM projects in developing countries. This would render the demand cap ultimately binding, since it applies to all three mechanisms, including JI and CDM. Missing a reliable estimate on the supply of emission reductions from CDM projects, the authors are unable to determine the price effect of the E.U. capping

18

Hot Air

proposal, which could be either a decrease or an increase of the price of permits. Nonetheless, IEA is very clear about the effect of the E.U. proposal on market efficiency. Regardless of the type of constraint that is binding, Annex B parties will spend more economic resources on domestic abatement than they would do in an unrestricted market, and more than what would be economically efficient.

6.

CONCLUSION

There is no easy solution to the ”hot air” problem, if we assume it is a problem. The currently proposed policies are either ineffective or politically infeasible. Renegotiating the initial allocations of the most important ”hot air” suppliers, Russia and Ukraine, would be a dangerous strategy. It would kick off a process of renegotiating all Kyoto targets, putting the great achievements of the Kyoto Protocol and its speedy ratification seriously at risk. A cap on trade, as proposed by the E.U., would be ineffective. As a demand cap, it would primarily increase cost for countries demanding permits, and as a supply cap, it would only postpone the problem, if banking were not prohibited. Since banking is essential for a functioning market, a supply cap does not help. A buy out of some kind, either through an open market operation or through in-kind transfers seems unavoidable. In this paper we have identified the problems of ”hot air” and its subsequent fixes. While we debate the details of the Kyoto Protocol, we can often lose sight of the greatest challenge to the success of this international agreement -- ratification. By reducing costs of emissions reductions, ”hot air” has the benefit of making ratification of the Kyoto Protocol more palatable to legislators. From this perspective, unrestricted trading of ”hot air” may actually aid the long-term goal of reducing global greenhouse gas emissions. In discussing the "hot air" problem, we should keep in mind that Kyoto is a minimalistic beginning -- more of a learning phase than a true effort to combat climate change. The overriding issue of Kyoto is not how much of an emission reduction will be actually achieved -- which will be in any case to little compared to the ultimate goal of the UNFCCC -- but the process of getting Kyoto ratified by the largest possible number of countries.


19

REFERENCES Baron, R., Bosi, M., Lanya, A., Pershing, J., 1999, A Preliminary Analysis of the E.U. Proposal on the Kyoto Mechanisms, International Energy Agency, Paris (unpublished). Batruch, C., 1998, ”Hot air” as Precedent for Developing Countries? Equity Considerations. Working paper W71, Climate Change in the Global Economy Programme. International Academy of the Environment, Geneva (unpublished). European Commission, 1999, Preparing for Implementation of the Kyoto Protocol, Document COM(1999)230, Bruxelles. European Council Permanent Representatives Committee, 1999, Community strategy on climate change - draft Council conclusions, Document 8226/99, Bruxelles. Energy Information Agency, 1998, Climate News, December, 1, 1998. Grubb, M., Michaelowa, A., Swift, B., Tietenberg, T., Zhang, Z.X., 1998, Greenhouse Gas Emissions Trading. Defining the Principles, Rules, Modalities and Guidelines for Verification, Reporting and Accountability. UNCTAD, Geneva (unpublished). Koch, T., Michaelowa, A., 1999, ”Hot air” reduction through non-quantifiable measures and early JI, Joint Implementation Quarterly, June 1999: 9-10. Tietenberg, T., 1985, Emissions Trading. An Exercise in Reforming Pollution Control, Washington, D.C. UNFCCC, 1998, Review of the Implementation of Commitments and the other Provisions of the Convention. National Communications from Parties included in Annex I to the Convention. Second compilation and synthesis of second national communications. Addendum. Tables of Inventories of Anthroprogenic Emissions and Removals of Greenhouse Gases for 1990-1995 and Projections up to 2020 (FCCC/CP/1998/11/Add.2). From: www.unfccc.de. Victor, D.G., Nakicenovic, N., Victor, N., 1998, The Kyoto Protocol Carbon Bubble: Implications for Russia, Ukraine and Emission Trading, International Institute for Applied Systems Analysis, IR-98-094, Laxenburg, Austria (forthcoming Climatic Change).

20

1 2

3 4

5 6 7

8

9

10

11

12

Hot Air

For a comprehensive survey on options of how to implement Article 17 KP see Grubb et al. (1998). Interestingly, the same critics object to the idea of measuring emission reduction commitments relative to business as usual in countries with increased emissions such as the U.S., because this would ”reward the laggards” (cp. Batruch, 1998, p. 18). For this reason, Russian and Ukrainian officials doesn’t consider to have been granted any windfall at Kyoto, as they predict economic recovery until 2020. Emission deficits in EITs other than Russia and the Ukraine are largely from four Eastern European nations (Bulgaria, Hungary, Poland and Romania), that were allowed to adjust their base years to dates prior to 1990 when their emissions were higher. Another recent study derives a much smaller estimate of ”hot air” (782 MtC) and, consequently, a much smaller market share of less than 20% (Baron et al., 1999). On the merits of banking for emission trading see Tietenberg, 1985. An absolute cap (q*) is superior to a relative cap, e.g. a percentage cap on actual trades, because it is not prone to strategic behavior. A relative cap would incite parties to claim excessive trades in order to expand their trade allowance. Their long-term revenues from "hot air" will, however, decline since sellers must sell banked assigned amounts in future commitment period at a reduced price (below the intertemporal profit-maximizing Hotelling price). A relative demand cap such as the 50% rule, which would allow a greater demand for bigger countries (large emitters), would not necessarily avoid the inequitable treatment described here. Given country 2 is capped at q*, any demand cap q** < q < q* for country 1 would produce the same gains and losses in our example as an undifferentiated demand cap (q*). Additional emissions deficits caused by in-kind payment for ”hot air” (A) are respectively shown as areas B and C in the first and second commitment period. For a somewhat similar reasoning on early JI in Russia and the Ukraine see Koch/Michaelowa, 1999. Estimates for the U.S., Canada and Japan for 2002/2003 are taken from the second national communications of these countries to the UNFCCC (FCCC/CP/1998/11/Add.2, tab. C.1). They are derived by averaging 2005 and 2000 projections of this source. The estimate for the E.U. is from a Post-Kyoto strategy paper of the European Commission (COM (1999)230), p.2.

Chapter 3 Accounting of Biological Sources and Sinks Legal and Economic Considerations Reimund Schwarze

1.

INTRODUCTION

A recently released newsletter of Climate Action Network, an international environmental pressure group, portrays Kyoto negotiators desperately seeking the truth of carbon uptake by measuring tree volumes in a forest (Singer, S., 1998). Another environmental publication depicts biological sources and sinks as the second largest ”loophole” of the Kyoto Protocol, nearly the size of ”hot air”, which would lower the actually achieved emission reductions by one-third (Institute for Global Communications, 1998). Yet another environmental release argues that the Kyoto protocol creates ”a significant new opportunity to capture the value of biodiversity, carbon storage and other ecosystem services of forests” (Frummhof, P.C. et al., 1998). Opinions couldn’t possibly differ more! Indeed, no other Kyoto issue has met such a mixed reception as the accounting of biological sources and sinks. The issue was also contentious among participants at the 3rd Conference of the Parties to the United Nations Framework Convention of Climate Change (UNFCCC) in Kyoto. Resulting from necessary political compromises the Kyoto Protocol’s treatment of this issue is complicated and confusing, which adds to pre-existing reservations. The Climate Change secretariat in Bonn responded to this unsatisfactory situation in 1998 by asking the Intergovernmental Panel on Climate Change (IPCC) to write a comprehensive special report on land use change and forestry (LUCF). This report, released in May 2000, elaborates on the scientific,

22

Biological Sources and Sinks

technical, socio-economic, and legal issues of the accounting of biological sources and sinks (BSS). 1 A speedy resolution of the BSS-accounting issue is needed because the Clean Development Mechanism (CDM) of the Kyoto could start immediately, once the treaty is ratified. The CDM would allow industrialized countries (Annex I-countries in the protocol) to promote projects of emission reduction in developing countries (Non Annex Icountries) and get emission reduction credits in return. This may include projects of tropical forest conservation and sink enhancement. Despite slim chances to get Kyoto ratified in the near future, several developing countries such as Costa Rica prepare to make use of the CDM as part of their national forestry policy. There are also a number of forestry projects in the actual pilot phase. Twenty-two Activities Implemented Jointly, covering investments in excess of US$ 57 million, were apparently initiated with the expectation that the CDM or an alternative mechanism of crediting will become effective during their lifetime (see Chapter 5). Continuing uncertainty about the legal status of BSS under the Kyoto Protocol would be a major setback for these and other institutional developments of ”Kyoto forestry” 2 such as specialized environmental brokerage firms and NGO networks. The German Council of Scientific Advisers on Global Change (WBGU) lately added to this uncertainty in a special report on "The accounting of biological sources and sinks under the Kyoto Protocol” (WBGU, 1998). This report ends with two rather gloomy conclusions. 3 It suggests that, if the Kyoto Protocol were not substantially revised, the accounting of domestic BSS should be minimized. It further argues that creditable international LUCF-activities shall not be pursued, if developing countries did not assume quantified emission limitation and reduction commitments. The latter condition would render international LUCF projects practically impossible because most developing countries are unwilling to adopt any binding emission limitations at present. WBGU’s call for caution is based on a perceived serious risk of abuse and severe legal problems in the accounting of the domestic BSS under the Kyoto Protocol. Specifically, the WBGU is concerned that primary natural forests might be cut in favor of fast-growing carbon plantations, if sink enhancement 4 would be creditable under Kyoto (WBGU, 1998, Sec. 7.1). But is BSS-accounting really such a Pandora’s box, or is it the opposite, a wonder-drug that could heal global warming and loss of


23

habitat at the same time, as others believe? This paper takes a law and economics-perspective to this question. It discusses the main legal, economic and political problems of accounting of biological sources and sinks under the Kyoto Protocol. I have organized the paper as follows: Section 2 weighs the basic political and economic pros and cons of including biological sources and sinks (BSS) in international climate change policy. Section 3 specifically examines whether carbon accouting can effectively help save tropical forests. Section 4 separates the legal issues surrounding BSS-accounting into issues of domestic BSS-accounting (Section 4.1) and issues of the accounting of international LUCF-activities (Section 4.2), which are subsequently discussed in detail. Section 5 analyzes the Costa Rican experience with LUCF-projects in the pilot phase of Activities Implemented Jointly (AIJ). Based on this multi-disciplinary multi-layer discussion the paper derives a different conclusion than the WBGU. I find that the Kyoto Protocol provides a basically sound legal and political foundation for the accounting of biological sources and sinks and for CDM-forestry. It should be embraced and further developed to capture the unique potential of linking the issues of climate change and global sustainable forestry.

2.

CLIMATE CHANGE POLICY AND FORESTS

The ultimate goal of the UNFCCC is to ”stabilize greenhouse gases in the atmosphere at a level that will prevent dangerous anthropogenic interference on the climate” (UNFCCC, 1992). This goal can not be achieved without drastic cuts in our current global usage of fossil fuels. Protecting biological sources (through forest conservation) or enhancing biological sinks (through afforestation and reforestation) 5 are important short- to medium-term strategies, but without meaningful reductions in fossil fuel use, biological sinks will not be sufficient in the long-term. This can be demonstrated by some rough calculations (cp. figure 3.1). In the short-run, i.e. in the next 20 years, the mitigation potential of stopping deforestation, specifically in the tropics, is huge. Tropical deforestation is currently causing an annual release of carbon into the atmosphere of between 1.2 to 2 billion metric tons (GtC), making it one of

24

Biological Sources and Sinks Figure 3.1: Structure of sources and sinks of carbon 12 Gigatonnes of carbon per year 10

Major DC emitter 3.0

8 Major DC emitter 1.2 Fossil fuels (Annex I) 7.7

6

4

Fossil fuels (Annex I) 5.1

2 Deforestation

Deforestation 1.6+/-0.4

0.3+/-0.1

0 Afforestation

Terrestrial sinks 1.8+/-1.6

Terrestrial sinks 2.8+/-2.0

1995

2040

-2

program 1.0+/-0.2

-4

Compiled from Houghton et al. (1996), OECD (eds.) (1995), Tab. A2.3, IPCC (2000), Tab. 2.

the leading sources of elevated CO2. But this short-term potential will decline rapidly over the next 50 years to an estimated annual average of 0.2 to 0.4 GtC per year (0.3 GtC+/- 0.1) simply because most of the tropical forests will be lost by that time. Currently tropical forest are lost at a rate of 15 million hectar per year, or 1-2%% of the remaining stand (FAO, 1999). Afforestation and reforestation could help provide a longrun contribution of Kyoto forestry. However, the sequestration potential of forests is also limited. Considering the availability of suitable lands and the maximum carbon uptake of forest ecosystems, the total contribution of afforestation and reforestation to the reduction of carbon emissions into the atmosphere has been estimated between 40 to 60 Gigatons of carbon (GtC) during the next 50 years (Brown et al., 1996, Tab. 24-5). This implies an annual average GHG reduction of 0.8 - 1.2 GtC (= 1+/- 0.2 GtC) over this period. The total long-term contribution of Kyoto forestry, i.e. from stopping deforestation and reforestation, to the ultimate goal of UNFCCC is thus limited to 1 - 1.6 GtC per year (on average). This is a considerable amount but clearly not sufficient. It compares to current


25

worldwide release of carbon from fossil fuels of 6.3 GtC, which will almost double to 10.7 GtC by 2040 under business as usual (OECD, 1995, Tab. A2.3). This increase of global carbon emissions is to a large extent driven by an expected steep rise of consumption of fossil fuels in major emitting developing countries such as China and India. Thus, while a powerful short- to medium-term strategy for the next 50 years, Kyoto forestry cannot replace action to reduce global fossil fuel usage. Kyoto forestry is an economical way to mitigate climate change. Existing estimates on the cost of carbon conservation and sequestration, despite using very different methodologies, fall within a relative narrow range of US$ 2 to US$ 69 per ton of carbon (Halsnaes, 1996, Tab. 9.3.5). Synthesizing these studies, IPCC reports that a substancial amount of carbon (50-70 GtC from afforestation and stopping of deforestation) can be supplied at low marginal cost of approximately US$ 10/tC (Halsnaes, 1996, Fig. 9.34). This figure compare to ”cost of Kyoto” estimates between US$ 14-23 (with full-blown emission trading) and US$ 67–348 (if the reductions must be achieved domestically in the U.S.). 6 From these figures, I conclude that Kyoto forestry could play an important role in the efficient blend of different mitigation options from different sectors. The most compelling argument for Kyoto forestry is, however, that it provides numerous additional environmental benefits such as preservation of biological diversity, stabilization of water sheds, soil erosion, etc.. These multiple ”ecosystem services” of forests are now well appreciated in the literature (Myers, 1995). Less appreciated and less understood are the effects that these forest services could have on climate change and our opportunity to respond. For example, the species rich environment of tropical forests may prove to be one of our most important natural resources to adapt to climate change. Should climate change occur, especially at a rapid rate, humanity will need novel genetic combinations to combat climate-related problems. New breeds of crops, drugs, and chemical applications will be needed to counter some of the negative impacts that a warmer planet has on human health, agriculture, and the economy. Currently, one in four commercial pharmaceuticals are at least partially derived from tropical plants (Ballick, 1996). Another example is the effect of clear-cutting. We only recently learned how changes in local temperature and humidity caused by extensive logging in South East Asia made forests in this area much more

26


vulnerable to natural fires. In Indonesia alone, natural fires in 1997 released more GHGs into the atmosphere than all sources in the E.U. combined during the same year (Sander, 1997). But deforestation will probably influence global weather conditions as well. It is after all, the export of heat and moisture from the tropics to higher latitudes that drives global circulation patterns. Disrupting these biomes will clearly have some impact, outside of the sphere of greenhouse gases, on our planet’s climate and weather patterns (Hastenrath, 1985).

3.

CAN CARBON ACCOUNTING HELP SAVE TROPICAL FORESTS?

Previous policies aimed at stabilizing these unique ecosystem services of tropical forests such as Debt-for-Nature Swaps (DNS) have largely failed to be effective. 7 Financial flows from DNS were small and declined in recent years. 8 The Convention of Biological Diversity, signed at the 1992 UN Earth Summit has also been unsuccessful in securing the resources necessary to prevent biodiversity loss, especially in tropical forests. Tropical deforestation has not appreciably declined in the 1990s (Myers, 1995). A UN report at the Rio Conference suggested that some $30 billion annually might be required to conserve tropical forests (IFF, 1999, 3). In 1996, the world fell far short of this goal and funneled only about US$ 1.3 billion toward forest and biodiversity conservation combined (IFF, 1999, 15). Carbon accounting could help fill this gap. Based on a possible price range for a ton of carbon of US$ 10-50 the Kyoto protocol could mobilize between US$ 2-11 billion annually for tropical forest conservation. 9 This would be a substantial contribution to the current need for financial resources to conserve tropical forests. The prospective of long-term diminishing effectiveness of forest conservation for GHG mitigation has spurred many foresters to reject a potential role of the CDM to conserve the world’s tropical forests. CDM funds are characterized as ”hot money”, which may be just another form of short-term cash crop. (Smith et al., 1998). Indeed, there is a limited amount of time to use forest conservation as legally acceptable mitigation under the Kyoto Protocol. After about 50 years -- when most tropical forests will no longer exist under a business as usual trajectory – there will


27

be no (or far fewer) emissions to reduce. And hence, there will be no credits to be bought and sold by slowing deforestation. However, there are clear indications, for example, in recent moves of Du Pont and other pharmaceutical giants, that the current undervaluation of genetic resources in tropical forests is only an intermediate problem (e.g. for the next 50 years). As computational power and DNA testing become faster it is possible that the next stage of the "information revolution" will increasingly rely on genetic material that is extant, yet undiscovered. Developing countries that are currently holding a substantial fraction of gene diversity may find this resource to be a critical financial resource as biotechnology and gene therapy becomes more widespread. This possible future trend may form a part of the new paradigm of a knowledge intensive growth, a vision of the future that sees a cleaner economy based on information technology (Chichilinsky, 1996a; 1996b). Genetic resources may thus ultimately be the "long-term" solution to tropical forest valuation. The CDM would be able to buy some time until these additional markets for forest resources develop. Figure 3.2: Economics of long-term tropical forest conservation

10 9 8 7 6 $ bill. 5 4 3 2 1 0 2000

need for carbon subsidy

2010

2020

2030

2040

2050

Economic benefits of carbon conservation Internalized economic benefits of biodiversity

Figure 3.2 depicts qualitatively how this long-term valuation of genetic resources and the diminishing contribution of tropical forest conservation for GHG mitigation could make a perfect economic fit. The

28


CDM money would precisely be the ”carbon subsidy” needed until the market for genetic resources develops. The Kyoto Protocol could effectively transcend the current uncertainties of valuing biodiversity by valuing the habitats of many species for their role in storing carbon.

4.

BIOLOGICAL SOURCES AND SINKS UNDER THE KYOTO PROTOCOL

The accounting of biological sources and sinks (BSS) under the Kyoto Protocol can appear complicated and confusing. The most important rules are contained in Article 3, Article 6 and Article 12 of the protocol. 10 Article 3 defines the accounting of domestic BSS as part of the national emission inventories and national assigned amounts of GHGs; Article 6 and Article 12 are to guide international LUCF projects. It is useful to separate the discussion of these rules.

4.1 Domestic accounting of biological sources and sinks The Kyoto Protocol specifies that Annex I-countries achieve country-specific greenhouse gas reduction targets. These targets are expressed as percentage reductions of emissions of six greenhouse gases (GHGs) 11 relative to a 1990 baseline, which must be achieved during the first commitment period (2008-2012). Implicitly, these targets define country-specific assigned amounts of GHG emissions. For example, the 7% reduction target of the U.S. translates into an assigned amount of 6250 million metric tons of carbon (MtC) during the five-year period 20082012, or an annual average of 1252 MtC, based on 1990 emissions of 1346 MtC. Assigned amounts and actual emissions during the commitment period are calculated from five sectors, which are listed in Annex A to the Kyoto Protocol (see Sec. A1). The LUCF sector does not appear on this list. However, some selected GHG fluxes from this sector are considered through special rules in the Kyoto Protocol. Article 3.3 allows the domestic accounting of selected LUCF-emissions from afforestation, reforestation and deforestation (ARD) during the commitment period. Article 3.4 rules how this selection can be expanded to other GHG fluxes such as nitrous oxides from agriculture. Article 3.7 finally admits some countries (”LUCF-net emitters”) to add LUCF-


29

emissions of 1990 to their baseline for the calculation of assigned amounts. Since the latter provision may be perceived as a response to an inequity established by the former rules, it will be described following a detailed discussion of Article 3.3 and Article 3.4. 4.1.1 Article 3.3 Article 3.3 states that "verifiable net changes in carbon stocks, which result from any direct human-induced LUCF-activities since 1990, limited to afforestation, reforestation and deforestation, shall be used to meet the commitments of Annex I countries". This essentially implies that GHG fluxes from these named activities must be accounted during the commitment period. Since these fluxes can be either positive (carbon emission) or negative (carbon uptake), the protocol’s interpretation of BSS accounting as useful ”to meet the commitments of Annex I countries” is somewhat misleading. Only if LUCF-emissions are negative (carbon uptake) during 2008-2012, the BSS accounting would be ”useful” for Annex I countries to meet their commitments. If, however, LUCFemissions were positive during the commitment period, they would increase the need to mitigate GHGs in other sectors of Annex I countries. This is a source of inequity that ultimately led to the introduction of article 3.7 (see below). The protocol does not define the precise meaning of afforestation, reforestation, and deforestation, the three selected LUCF-activities for BSS accounting. The IPCC-Guidelines for National GHG Inventories (IPCC, 1996) which are frequently cited in the protocol, can help define these terms. IPCC specifies that afforestation is ”the planting of new forests on lands which, historically, have not contained forests”. Reforestation is defined in the same source as ”planting of forests on lands, which have, historically, previously contained forests but which have been converted to some other use”. And deforestation is defined as ”conversion of forests to other land-use”, which could be pasture, cropland or abandoned lands (as explained there). In synthesis, these definitions exhibit a clear pattern of (positive or negative) sanctioning of land use changes: Biological sources and sinks are accountable only if they are caused by a change from one type of land use to another, e.g. from forestry to agriculture. Logging of forests with a consequent replanting of trees (to achieve or accelerate carbon uptake) would not be covered by this definition because it does not qualify as a land use change.

30


The GHG emissions from ARD are measured as changes in the net carbon stock of land. Measurement methods are kept simple and straightforward to achieve maximum verifiability under variable natural and economic conditions (for details see Schlamadinger/Marland, 1998). The carbon uptake of forests, for instance, is measured as change in aboveground-carbon stocks, which is essentially tree growth. Similarly, the carbon release from biological sources is measured as change in aboveground-carbon with an added focus on soil carbon losses following deforestation. These annual losses of ground-carbon stocks are estimated according to a simple linear decay function over a 20-year period. Carbon stocks embodied in long-living wood products are not accountable under the Kyoto protocol. 12 Resulting from this simplified methodology, deforestation is generally accounted as a complete release of carbon stock into the atmosphere. Concerns that deforestation, including clearcutting old-growth trees, with the aim of getting credits for a follow-up reforestation seems impossible under this scheme for two reasons. First, if deforestation happened after 1990, it will be counted as carbon emission to be deducted from any subsequent carbon uptake on the same lands. Second, the IPCC definition of reforestation and afforestation requires that reforested and afforested lands must have been used differently over a minimum period of 20 to 50 years respectively. Given this definition, deforestation must have occurred the latest in 1988 (2008 minus 20 years) to be counted as reforestation during the first commitment period. This timing generally precludes the notion of ”deforestation for reforestation” as a serious concern. A fallow period of 20 to 50 years is simply too long to make ”deforestation for reforestation” economically rewarding. 4.1.2 Article 3.4 Article 3.4 is another focus of critique. It states that ”the meeting of the Parties to this protocol shall, at its first session or as soon as practicable thereafter, decide upon modalities, rules and guidelines as to how, and which, additional human-induced activities 13 related to changes in greenhouse gases emission by sources and removals by sinks in the agricultural soils and the land-use change and forestry categories shall be added”. In addition, it stipulates that any such decision shall apply in the second and subsequent commitment periods, except that ”a party may choose to apply such a decision … for its first commitment period”. This


31

exception, to some critics, seems to indicate that the accounting of additional BSS during the first commitment period could be at the discretion of the parties. This could give rise to an adverse selection: Countries, which expect a net sink during 2008-2012 in, for example, agriculture would account this activity, whereas countries with a net emission from agriculture would choose to ignore this source (UNFCCC/SBSTA, 1998, 14; WBGU, 1998). As a result, the assigned amounts under Kyoto would increase since only sinks (negative emissions) would be added. This potential for negative selection exists indeed! However, it is important to notice that any decision of the COP to allow an individual member to account additional BSS during the first commitment period automatically applies to all parties in the second and all subsequent periods. Thus, the current approach of voluntary early crediting of additional sinks and sources is more of a carrot-and-stick mechanism. It incites countries, which benefit from the accounting of additional sinks and sources, to negotiate for a more comprehensive coverage of the Kyoto protocol in subsequent commitment periods. Prohibiting the accounting of additional sinks for individual countries, as the critics suggest (e.g. WBGU, 1998, Sec. 8.2.3), would inadvertently imply that some important human-induced biological sources and sinks would be disregarded for a long time. 4.1.3 Article 3.7 and the ”gross-net problem” Another major problem of the national accounting of biological sources and sinks is the so-called "gross-net problem" (Fuentes et al., 1998). It is essentially a problem of initial allocation of emission rights, which can be best explained by means of a simple numerical example (table 3.1). For this example we assume a sink country (S) with net emissions of 400 MtC in 1990, made up of 500 MtC from industrial emissions minus 100 MtC from carbon uptake. S has committed to reduce emissions by 5% compared to 1990. Following Article 3.1 (which excludes LUCFemissions), it was assigned an average annual emission of 475 MtC during the first commitment period (500 MtC – 5%). It shall however use LUCFemissions during this period, limited to land use changes (ARD) since 1990, to meet her commitment. Combined, this constitutes a ”gross-net approach” because it excludes LUCF-emissions from the baseline but includes them

32


(selectively) in the accounting of emissions during the commitment period. If we assume that carbon uptake from post-1990 ARD activities is on average 50 MtC per year in 2008-2012, accounting of sinks enables this country to emit 525 MtC, or 5% over 1990 levels (Table. 3.1). This increase in the emissions from energy use and industrial production is what critics have deemed a ”loophole” (Fuentes et al., 1998). However, this increase is clearly justified by the fact that S did actively increase her carbon uptake through ARD activities since 1990. The additional annual removal of 50 MtC in the commitment period exactly offsets the increase in annual E/I-emissions relative to the Kyoto goal (475 MtC). Table 3.1: The gross-net problem Year 1990

2008-

Emission [MtC]/ Reduction target Energy/Industry emission (gross) LUCF-emission

LUCF-net sink (S) 500

LUCF-net emitter (E) [Art. 3(3)/Art. 3(7)] 500

100

200

LUCF-uptake

-200

-100

LUCF-net emission

-100

100

Total emission (net)

400

600

Reduction target

-5%

-5%

Assigned amount

475

475/570

LUCF-emission*)

50

100

LUCF-uptake*)

-100

-50

LUCF-net emission*) Energy/industry (effectively) E/I reduction quota (effectively)

-50

50

525

425/520

+5%

-15%/+4%

2012 (∅)

*) Limited to afforestation, reforestation and deforestation since 1990.


33

A different situation arises in countries with net LUCF-emissions in 1990 (”LUCF-net emitters”). E is an example. He has total net emission of 600 MtC, made up of 500 MtC from energy and industry and 100 MtC net emissions (carbon release) from LUCF. Under a gross-net approach, E would be assigned 475 MtC allowed emissions. This implies that he has to increase his effort to reduce E/I emissions compared to S, if he continues to be a LUCF-net emitter in the commitment period. In our example, E would have to reduce E/I emissions effectively by 15 % instead of 5%. This seems unfair, particularly if he took action to reduce LUCF-net emissions during the commitment period. This case is demonstrated in tab. 1 by a decrease in the annual LUCF-emission from 200 MtC in 1990 to 100 MtC in 2008-2012 on average. Australian negotiators faced exactly this scenario in Kyoto. Australia’s first national GHG emission inventory (Commonwealth of Australia, 1994) showed LUCF-net emissions of 139 Mt CO2 (= 38 MtC), representing a share of 24% of Australia’s total emissions of 571 Mt CO2 (= 156 MtC). This large share of emissions from LUCF results from controlled bush fires, which is a common practice in this country to prevent natural fires. By continuing this practice, Australia would have to reduce emissions from fossil fuels by a double-digit number. This seemed inequitable. As a result, negotiations in Kyoto led to the introduction of a special rule (poignantly called ”Lex Australia”) in Article 3.7 KP. This rule allows countries, which are LUCF-net emitters in 1990, to include this emission (or a portion of it) in their 1990 baseline. 14 Article 3.7 thus constitutes a ”net-net approach”. It includes LUCF-emissions in the baseline and in the emission inventories during the commitment period. The difference between the gross-net approach and the net-net approach is essentially the treatment of LUCF-net emissions in the 1990 baseline for assigned amounts. The gross-net approach excludes LUCFnet emissions from the baseline whereas the net-net approach includes them. What are the merits of applying either approach? As for any problem of initial allocation, this question cannot be resolved scientifically because this would imply some notion of fairness (i.e., value-judgements). We can, however, highlight the political reasoning behind this decision and we can look at the environmental effects. The Kyoto Protocol’s accounting of LUCF applies two basically conflicting principles of initial allocation of emission rights, one is to hold parties responsible for the past action (”principle of accountability”) and

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the other is to assign emission rights according to the status quo (”principle of grandfathering”). Article 3.7 applies the principle of grandfathering. It assigns amounts of GHG emissions to LUCF-net emitters according to their total net emission of 1990 (reduced by a certain percentage to achieve the Kyoto target). Article 3.3, on the other hand, applies the principle of accountability. It considers the past environmental effort of countries to maintain sinks and, therefore, does not subtract the carbon uptake. To apply the principle of grandfathering to sink countries would mean to punish them for their good past environmental behavior, since they could have destroyed their forests (too). For example, applying a net-net approach to country S would have resulted in an assigned amount of 380 MtC instead of 475 MtC, which would be less than a comparable LUCF-net emitter (E) receives. A potentially disturbing environmental effect of the ”gross-net approach” is that this accounting procedure could lead to an increase of total carbon release into the atmosphere. Looking at tab. 1, we find that the net emission of S in 1990 is 400 MtC. Gross emission during the commitment period is 525 MtC annually. Subtracting the carbon uptake on afforested land (- 100 MtC) and adding the release of carbon caused by deforestation (50 MtC), we have an annual net emission of 475 MtC during the commitment period. However, this is not the actual release of carbon into the atmosphere during a year, because net emission from ARD (”land use changes”) is only a part of the total LUCF-net emission. The latter specifically includes carbon fluxes in existing forests. If the netuptake in existing forests would be lower in the commitment period, which is plausibly the case since some land has been deforested since 1990 and existing stocks are aging, we could have an increase of total net emissions as a result of the present accounting procedure. This is generally the case, if the net carbon uptake in existing managed forests decreased by more than the equivalent decrease in fossil fuel and industrial emissions that is required by the Kyoto target. For example, if the net carbon uptake in existing forests of S (-100 MtC) decreased by more than the amount of mitigated E/I-emissions (25 MtC), e.g. by 50 MtC, its annual net emission during the commitment period increases to 425 MtC. This disturbing result highlights a general short-coming of the current BSS-accounting approach of the Kyoto protocol - the disregard of changes in the carbon fluxes of existing managed forests.


35

We may halt at this point to establish an interim result: The Kyoto protocol’s accounting of domestic LUCF-emission is complicated and confusing. However, except for its disregard of changes in existing forests (forest degradation, aging forest etc.), it is basically sound. There is in particular no risk of abuse of BSS accounting to replace existing forests with fast growing carbon plantations. The applied principles of accounting seem reasonable and consistent.

4.2 Accounting of international LUCF activities The Kyoto Protocol defines four flexibility mechanisms to help industrialized countries meet their commitments to reduce emissions at minimal cost. Only the two project-based mechanisms, Joint Implementation (JI) and the Clean Development Mechanism (CDM) are presently important for international LUCF activities. Project-based mechanisms are subject to a range of potentially dismal incentives, the most important of which are ”leakage” and 15 ”baseline inflation” . CDM projects could easily be manipulated to simulate false or inflated environmental benefits, if analysis and verification are limited to the individual governments or firms involved in each project. One reason is that, for project-based mechanisms, the environmental benefits must be measured against a baseline, i.e. what would have occurred without the project. Governments or companies participating in projects have an incentive to inflate the baseline, attributing more reductions to their projects than is realistic, because it increases the amount of tradable emission reductions. For the same reason, participants have an incentive to deflate actual emissions, claiming a lower output of GHGs (i.e. more forest preserved) than they actually achieved. A related problem is ”leakage”. If a country or private party establishes a forest conservation project, and then increases deforestation in another area, the benefits of the CDM project could be neutralized. Both problems, baseline inflation and leakage, are not specific to forestry projects. They also frequently apply to energy-related project (Chomitz, 1998). These problems, while in principle applying to both JI and CDM, are potentially more acute in CDM projects. The essential difference between JI and CDM is that JI countries are committed to quantified emission limitation or reduction targets. JI host countries will, out of selfinterest, control their domestic sellers of emission reductions, since they ultimately have to make up for any faked emission reductions at the

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project level. They are obliged to subtract any vended emission reduction from their national assigned amount according to Article 3.11, and they must keep a complete record of carbon emissions in their country according to Article 3.7. As a result, faked emissions reductions will show up as a difference in their national emission budget, forcing them to buy emission reductions from other countries or increasing their emission reductions in other sectors. This is different for CDM host countries. NonAnnex I countries are not committed to any quantified emission limitation or reduction and they are not obliged to keep a full carbon inventory. Hence, they are less inclined to track their private party’s behavior in emission trading, since they are not liable for any overestimated or faked emission reductions of projects. They may even benefit from this behavior, e.g. through improved terms of trade. Several proposals have been made on how to solve these incentives to "cheat" within the legal framework of the CDM (for an overview see Michaelowa, 1998). One main solution to many of these problems is to apply national level accounting and involve independent third parties in the process of verification (discussed below). 4.2.1 Leakage and the need for national accounting National-level accounting, instead of individual project accounting, will largely remove the possibility of CDM participants to offset the reduction in deforestation through a project with increased deforestation outside the project area. National-level accounting is equivalent to increasing the ”system boundary” (i.e. the area covered by the project relative to the area, on which project effects could occur). It increases the likelihood that all impacts of a project will be accounted. This approach to leakage has been taken in recent AIJ, where single projects are bundled to regional or national ”umbrella projects” (see section 5 below). National accounting could also be applied at below-national level, i.e. community or private projects. In this case, national baselines and emissions would apply on a pro-rata basis (e.g. per ha of land), possibly differentiated according to land characteristics such as forest type, land tenure, etc. This approach has been suggested outside of the field of ”Kyoto forestry” for fossil fuel related projects, where it is labeled ”project matrix-based approach” (Jepma, 1997). The project-matrix


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approach limits the potential of ”cheating”, while reducing transaction cost for the verification of individual projects. Another reason to measure emission reductions at the national level is that many land-use policies and decisions are decided at the national level. The majority of land in tropical countries is publicly owned (FAO, 1982). Even on private lands, government policies may sanction or even encourage deforestation. Lands in private ownership are also manipulated by national and local government policies such as stumpage fees or subsidies for land clearing. To implement national accounting of avoided deforestation, Annex 1 parties must work holistically with a potential recipient nonAnnex 1 country. Only few developing countries have so far been able to establish such a scheme. However there are some valuable studies that have used a wide variety of methods to calculate historical carbon losses (Flint/Richards, 1991). 4.2.2 Baseline inflation For CDM projects to create emissions credits, the benefits of a CDM project must be measured against a baseline, i.e. what would have occurred without the CDM project. Participants in CDM projects have an incentive to inflate the baseline, because it increases the amount of tradable permits. Claiming a higher baseline than is realistic would be nearly impossible to refute, because completion of the CDM project will ensure that the baseline scenario never takes place (Michaelowa, 1998). To avoid countries claiming artificially high deforestation rates, historical deforestation trajectories must be used, because deviations from these trajectories can then serve as basis for CDM crediting. Deforestation rates for 1980-1990 have been determined by the FAO, but there is some debate about the accuracy of these findings (Myers, 1992). A critical distinction will also need to be made, not only about the rate of deforestation, but about the shape of the curve. Some historical data show that deforestation is accelerating (Myers, 1995). Others have suggested that deforestation rates are declining. Eventually, baselines will need to determine if deforestation is occurring in a linear, exponential or constant fashion. This will have an enormous impact on the amount of potential reductions under CDM and on models which project future emissions. Another safeguard to remove the potential of baseline inflation is independent verification by third parties. Article 12 acknowledges this

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need and stresses the crucial role of third parties for achieving accuracy and accountability. The modalities and procedures of verification and third party involvement are not yet decided; they are deferred to a later conference (CoP/MoP1). In general, verification could apply at three stages of a project, i.e. ex ante certification of projects, ex post certification of emission reductions, or as permanent or repeated auditing of project activities (Goldberg, 1998). All three modalities will be part of the verification procedure under article 12. Both, the certification of projects and emissions reductions, are delegated to an operational body of the UNFCCC, most probably the Climate Change Secretariat in Bonn. Independent private parties, e.g. specialized private auditing firms or nonprofit organizations with relevant expertise in this field, could do the auditing of project activities. Private and public procedures could be linked through a formal requirement of third party auditing for projects and emission reductions to be certified. Another, substantial means to increase accuracy and accountability of JI/CDM projects would be to require adjustable baselines. Baselines are said ”adjustable” if they are adjusted according to new information arising in the course of project implementation, and ”fixed” if they are determined in the beginning of the project and remain valid throughout the entire project lifetime. Adjustable baselines are important for LUCF-projects because forests are subject to several dynamic natural factors, e.g. fire, pest and disease. Moreover, they strongly respond to external factors such as beef prices. CDM investors are said to dislike adjustable baselines because they impose some measure of uncertainty and potential liability (Goldberg, 1998). However, poor accounting would not be in their long-term interest either, because it would ultimately destroy the value of emission reductions. Accepting scrutiny in the accounting should be in any case the price worth paying for the great financial opportunities offered by the CDM.

4.3 Deforestation for reforestation? Another critique of CDM-forestry is that it could be construed to cause deforestation with the aim to get credits for a follow-up reforestation. We have discussed the safeguards in the Kyoto Protocol against this potential abuse before in the case of domestic accounting. Most stop rules discussed there apply to the CDM as well. For example, the IPCC definition of reforestation also applies to potential CDM projects. As a result, CDM reforested lands must have been used


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differently over a minimum period of 20 years. Because of the long technical delay between the ”effort” (deforestation) and the ”reward” (credits for reforestation), deforestation for reforestation simply seems uneconomical. Another way to avoid this problem would be to enforce the CDM mandate for sustainable development (Article 12.2). This mandate is further defined in Article 2, where Kyoto forestry is specified as ”protection and enhancement of sinks and reservoirs of GHGs, taking into account commitments under relevant environmental agreements; (and) promotion of sustainable forestry, afforestation and reforestation”. Clearcutting of forests would violate this definition because, among other things, it would not accord to the Convention on Biological Diversity and the Declaration on Global Forests of the UNCED. Posed in this way, the CDM could even become an efficient tool to enforce these and related environmental agreements (Goldberg, 1998). Another immediate response would be to interpret the CDM such that it applies only to forest preservation, but not to sink enhancement. This is possible because of an legal ambiguity in article 12, which allows ”certified emission reductions”, omitting the words ”from projects aimed at reducing anthroprogenic emissions by sources or enhancing anthroprogenic removals by sinks” as in Article 6 (for a detailed discussion see Farhana, 1998, p. 59). The WBGU favors this approach as a hands-on alternative to binding commitments to emission limitations of developing countries (WBGU, 1998, section 8.4.). I would object this approach because it could result in a knockout of all LUCF-activities. Experience of AIJ forestry shows that integrated programs of forest protection, covering reforestation on destroyed spots, aided natural regeneration and sustainable forestry on adjacent lands (as an alternative to cattle grazing etc.), are most effective to relieve the biological and socio-economic pressure on natural forests (see Chapter 5). Excluding sinks from the CDM would artificially dissect this complex economicecological interaction. To summarize, CDM forestry can be sufficiently shielded against potential abuse without undue usage restrictions but this may be costly in terms of strict monitoring and verification. The question is, will this be too costly to be practicable? Experience in the pilot phase gives use some clues for an answer.

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5.


EXPERIENCES WITH AIJ FORESTRY IN COSTA RICA

Activities Implemented Jointly (AIJ) is a program of the first conference of the Parties to the UNFCCC in Berlin (UNFCCC, 1995). It allows greenhouse gas reduction and sequestration projects carried out through partnerships between an investor from a developed country and a host from a developing country or a country with an economy in transition. AIJ is conceptually similar to JI and CDM, except that, for AIJ, countries do not receive emission reduction credits. While this exemption of crediting clearly biases the actual results compared to what we could expect under the CDM, AIJ is still an important source for studying the CDM, specifically in field of LUCF. LUCF projects played an important role in the pilot phase. Though only 16 out of a total of 97 projects, they ranked first in emission reduction: 16 million out of a total of 46 million tons of carbon (MtC) reductions or 30% are achieved in LUCF projects (see Chapter 5 below). If we also consider projects that are still in planing stage (see table 3.3), this amount would increase considerably to 37-52 MtC. AIJ experience can teach us some lessons on the design and implementation of project-based mechanisms. In this section, we discuss the lessons from AIJ forestry projects in Costa Rica. Costa Rica has been labeled ”the world’s leader in developing AIJ” (Goldberg, 1998). Indeed, it is the biggest host to LUCF projects in the pilot phase. Eleven out of a total of sixteen projects worldwide are done in this country. It has also developed the most innovative solutions to incorporate AIJ projects into their national forestry policy. This solutions are widely hailed as a model to other developing countries (Dutschke/Michaelowa, 2000). The most comprehensive case study of AIJ forestry so far has been done at the Center for International Environmental Law (Chacon et al., 1998; Goldberg, 1998). The following discussion summarizes the main results of this study. Costa Rica’s AIJ fall into two classes, characterized by different types of projects (see table 3.2). First-phase projects are individual, privately planned and financed projects, in which the role of government is limited to review and approval. Second- and Third-phase projects are large-scale, nation-wide projects with a very active government involvement in the planning and implementation stage of the project. 16 They are called ”umbrella projects”. Funding of ”umbrella projects” is


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done through a system of ”Certified Tradeable Offsets” (CTOs), where each CTO guarantees one ton of carbon mitigated over a minimum period of 20 years. CTOs are sold to private buyers at a pre-specified (offer) price of presently US$ 10-20. The differences between these two classes of projects is visualized in table 3.2 (below) where we compare three prototype LUCF projects in Costa Rica. Table 3.2: AIJ-forestry in Costa Rica Project Project type Size

Ecoland 1st Phase Project

Private Forestry Project

Protected Area Project

2nd and 3rd Phase Umbrella Projects

2,500 ha

138,102 ha

530,498 ha

Total Cost

US$ 1.1 million

US$ 34 million

US$ 64.8 million

Funding

Private investors

CTOs and local taxes

Approval

Design and implementation

Not fully covered

Fully covered

Project-specific

National, sector-specific

Internal

External

Not addressed

Large system boundary

Role of government Long-term monitoring cost Baseline Verification Leakage

ECOLAND is an example of a first-phase project. This project preserves tropical forests through the purchase of 2500 ha privately owned forests located within the boundaries of a National Park. A U.S. utility company and two private foundations fund the project. The foundations are devoted to buying private forested land for conversion to public national parks worldwide. The total funding of this project amounts to US$ 1.1 million. A specialized U.S. brokerage firm (Trexler and Associates, Portland/OR) and two NGOs, a local and an international, manage the project. The Costa Rican government is, except for the general approval, not involved in the set up of this project. It only

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manages the lands after the purchase. The project has been recently (1997) completed and the area will soon be transferred to public ownership, where it will be ultimately managed under the national park regime of Costa Rica. ECOLAND is generally considered successful (Chacon et al., 1998). Some problems, however, that were encountered in this project (and similar projects) ultimately led to the creation of the new class of ”umbrella projects”. The first, most important problem of ECOLAND was that the area was not adequately protected after the purchase. The funding of US$ 40,000 for the interim management between the private purchase of lands and its conversion into public lands proved absolutely insufficient, given an unforeseen long (3 years) delay in the change of ownership to the government. During this period several persons residing in this area were still able to obtain harvesting permits. This is possible because a specific rule in the Costa Rican Forestry Law disapproves stateimposed harvesting restrictions on land, which is in private holding (Chacon et al., 1998). In addition, trespassing on these lands caused frequent (minor) damages. One of the lessons learned from this project is that long-term monitoring and control of land after the purchase must be adequately addressed in the project design to achieve an effective protection for forests. The second problem is the baseline of this project. ECOLAND is based on the assumption that historic deforestation continues over the entire project period (15 years) with the result that 100% of the forest cover will be ultimately lost. The actual deforestation in Costa Rica, however, is lower than expected due to lower beef prices, and due to the fact that private forest owners developed an interest in holding naturally forested, partly in anticipation of potential government buyouts (Chacon et al., 1998). Whether these national trends did actually affect ECOLAND is disputed. Project developers claim that specific circumstances at the project-site caused an exceptionally strong pressure to deforest. If, in contrast, a national baseline would have been applied to this project, fewer emission reductions would result. The third and final lesson concerns verification. Verification of ECOLAND has been done by project developers and parties of the project, i.e. internal. Independent external verification of the project was considered but not practiced. The problem of leakage was also not given much attention in this project. In summary, ECOLAND exhibits some weak points in the project design and implementation.


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The Costa Rican Office of JI (OCIC) reacted to these shortcomings by inventing a new approach to AIJ and new set of projects. These ”umbrella projects” are much bigger in terms of money and land, and they are integrated into a national program of forest protection. The government of Costa Rica itself has a very active role in the development and the implementation of these projects. An example is the Private Forestry Project (PFP). Under this project private landowners receive payments for (environmentally approved) tree plantations, sustainable forestry and forest conservation. PFP-projects are primarily located in buffer areas of the national parks of Costa Rica to relieve the biological and economical pressure on park areas. As of 1997/1998, the project covers an area of 138,102 ha which will be gradually expanded. The project financing is done through a combination of local taxes and sales of CTOs. The local tax on gasoline and payments of local hydroelectric companies for watershed restoration contributed US$ 32 million in FY 1997/1998; sales of CTOs amounted to US$2 million in the same period. An even more elaborate example of an ”umbrella project” is the Protected Area Project (PAP). PAP is a forest preservation project. It covers an area of 530,498 ha and costs US$ 64.8 million. In this project, the Government of Costa Rica contractually guarantees a duration of 25 years (on each CTO) and puts a large buffer stock (40% of the total CTOs created) aside to cover this warranty. Changes in the baseline or in the actual emission, e.g. due to natural fires, are covered by the warranty. The project applies a national sector-specific baseline, differentiated according to land characteristics (forest type, location, land tenure etc.). The verification of CTOs from this projects is done by a Swiss firm (SGS), which audits the contractor’s monitoring systems and supervises a sample of randomly selected projects on-site at least once a year. The problem of leakage is addressed in PAP by expanding the system boundary to a nationwide project. Bottom line: Switching from single AIJ to umbrella projects in Costa Rica allowed an increasingly sophisticated project design, which properly addresses the most important implementation problems of project-based Kyoto mechanisms, leakage and baseline inflation. This new approach is costly 17 , but not too costly. The current price of CTOs of US$ 10 - 20 is still far below the costs of domestic activities to mitigate GHGs in industrialized countries such as the U.S. which are estimated at US$67 to US$348/tC (Energy Information Agency, 1998).

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6.


CONCLUSION

The accounting of biological sources and sinks (BSS) in climate change policy is a matter of weighing opportunities against risks. The risks of BSS accounting seem manageable. The Kyoto Protocol's accounting of domestic BSS, although messy to read, provides a sound legal basis for implementation. It may contain some hasty last-minute mistakes in the legal wording, but it appears consistent and reasonable. Potentially disturbing is the Kyoto Protocol’s current disregard of changes in the carbon fluxes of existing managed forests. In the case of accounting of international LUCF-activities the main problem is not legal but economic. The CDM sufficiently shields against potential abuse, but this approach can prove too costly in terms of strict monitoring and verification. The question is, will it be too costly? Experience of recent LUCF-projects in Costa Rica, which apply sophisticated monitoring and verification methods, seems to indicate, that this is not the case. By increasing the scale of projects and bundling domestic and international efforts Costa Rica was apparently able to reduce the specific transaction costs per unit of carbon mitigated, thereby allowing a higher overall level of control. With manageable risks, we may turn to the opportunities. The opportunities of BSS accounting are tremendous - biologically, economically and politically. Biologically, forests are an important source and sink of GHGs and an invaluable natural asset. Economically, forestry is an important strategy within the optimal blend of options for mitigating climate change in the next 50 years. Politically, BSS-accounting can help developing countries to participate meaningfully in the global effort to combat climate change and at the same time achieve sustainable development - Costa Rica is an example of how this deal could work out. Table 3.3: Implemented and planned AIJ forestry projects Project / Partners / Components

Country

Carbon Sequestered Over the Lifetime of the Project

Cost

CARE/Guatemala Allied Energy Services Corp. (AES), CARE Agroforestry, reforestation, protection, silvo-pastoral

Guatemala

15,5-58 million tons

$14 million total


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Project / Partners / Components

Country


Cost

RIL Logging New England Electric (NEES), Innoprise, Rainforest Alliance, COPEC Reduced-impact logging

Malaysia

300.000-600.000 tons

$450.000

Paraguay Forest Protection AES, The Nature Conservancy, FMB Foundation, U.S. Agency for International Development Preservation, sustainable agroforestry

Paraguay

14.6 million tons

$3.4-4.5 million

Amazon Basin Forest Protection AES Corp., OXFAM Land tenure

Peru, Ecuador, and Bolivia

70 million tons

$2 million

RUSAFOR EPA, EDF, Oregon State University, Russian Federal Forest Service, International Forestry Institute Afforestation

Russia

200.000 tons

$500.000

Rio Bravo TNC, Wisconsin Electric Power Co., Program for Belize Conservation and forest management

Belize

5 million tons over 40 years

$2,6 million

CARFIX FUNDECOR, MERINEM, Wachovia Timberland Investment Management Sustainable forestry

Costa Rica

2 million tons

$2,73 per ton

46



Country


Cost

ECOLAND Tenaska Washington Partners, Trexler and Associates, National Fish and Wildlife Foundation, COMBOS, MIRENEM, Council of the OSA Conservation Area, and Rainforests of the Austrians Forest preservation

Costa Rica

1 million tons

$900.000

Noel Kempff M. Climate Action Forestry Project American Electric Power System (AEP), The Nature Conservancy, and Fundación Amigos de la Naturaleza (FAN)

Bolivia

6.794.000 tons

$1,25 per ton (estimated)

Halophyte Cultivation Project in Sonora Salt River Project, Halophyte Enterprises Inc., Econergy International Corporation and Mexican partner: Genesis, S.A. de C.V. Cultivation of salt-tolerant species

Mexico

1.650 tons

Confidential

Uganda Reforestation FACE

Uganda

7.172.550 tons

$5,6 million

Czech Republic Reforestation FACE Reforestation

Czech Republic

1,6 million tons

$5,9 million

Ecuador Reforestation Profafor/FACE Reforestation

Ecuador

9.578.250 tons

$5,6 million


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Country


Cost

Bottomland Hardwood Forest Restoration UtiliTree Carbon Co., Louisiana Tech University, Louisiana Dept. of Wildlife and Fisheries Reforestation of marginal farmland

United States

470.000 tons

$176.493

Reduced-Impact Logging UtiliTree Carbon Co., Rakyat Berjaya Sdn., Forest Rsearch Institute of Malaysia, Sabah Forestry Dept., Center of International Forestry Research , Rainforest Alliance Reduced-impact logging

Malaysia

379.000 tons

Less than $1,00

Pacific Forest Stewardship UtiliTree Carbon Co., Pacific Forest Trust, Oregon State University Improved forest management and conservation easements

United States

242.082 tons

Less than $1,00

Rio Bravo Carbon Sequestration Project UtiliTree Carbon Co., Programme for Belize, The Nature Conservancy, Wisconsin Electric Power Co., Cinergy Corp., Detroit Edison Co., Pacificorp Sustainable forest management and forest preservation

Belize

1.060.000 million

Less than $1.00

Reforestation in Eastern Washington Tenaska Inc., PacifiCorp, Trexler and Associates Reforestation

United States

250.000 tons

$2,00 per ton

Forest Resource Trush Carbon Offset Project PacifiCorp, Forest Resource Trust, Trexler and Associates

United States

45.000 tons

Less than $2.00 per ton

(Attributable to UtiliTree)

$75,000 total

48 Project / Partners / Components

Biological Sources and Sinks Country


Cost

Southern Oregon Reforestation PacifiCorp, Trexler and Associates Reforestation

United States

66.150 tons

$2.00-2.50 per ton

Salt Lake City Urban Tree Project Tree Utah, PacifiCorp, Trexler and Associates Urban forestry

United States

5.000 tons

$10-15 per ton

Western Oregon Carbon Sequestration Project UtiliTree carbon Co., Trexler and Associates, Oregon Woods, Inc., participating landowners Afforestation and sequestration

United States

564.000-747.000 tons

Less than $1,00

Reforestation

Source: WRI, 1998.


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REFERENCES Ballick, M.J., 1996, Tropical Forest Medical Resources and the Conservation of Biodiversity. Columbia University Press, New York. Brown, S., Sathaye, J., Cannell, M., and Kauppi, P.E., 1996, Management of Forests for Mitigation of Greenhouse Gas Emissions. in: Watson, R. et al. (eds.), Climate Change 1995 - Impacts, Adaptations and Mitigation of Climate Change: ScientificTechnical Analyses. Contribution of the Working Group II to the Second Assessment Report of the Intergovernmental Panel on Climate Change, Cambridge University Press, Cambridge/Mass., p. 775-797. Brown, P., Kete, N., 1998, Forest and Land Use Projects, in: UNDP (Hrsg.), Issues and Options. The Clean Development Mechanism, New York, 163-173. Chacon, C., Castro, R., Mack, S., 1998, Pilot Phase Joint Implementation Projects in Costa Rica. A Case Study, Center for International Environmental Law, Washington, D. C. (unpublished). Chichilnisky, G., 1996a, The economic value of the Earth's resources. Trends in Ecology and Evolution 11(3): 103-144. Chichilnisky, G., 1996b, Trade regimes and GATT: resource intensive vs. knowledge intensive growth. Journal of International and Comparative Economics 20: 147181. Chomitz, K. M., 1998, Baselines for Greenhouse Gas Reductions: Problems, Precedents, Solutions, Paper prepared for the Carbon Offsets Unit of the World Bank (unpublished). Commonwealth of Australia, 1994, Climate Change. Australia’s national report under the United Nations Framework Convention on Climate Change. greenhouse gas inventory, Canberra, From: www.unfccc.de/fccc/natcom/natcom.htm Dutschke, M., Michaelowa, A., 2000, Climate cooperation as development policy - the case of Costa Rica, International Journal of Sustainable Development 3: 63-94. Energy Information Agency, 1998, Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity. Released October 9, 1998. Farhana, Y., 1998, Operational and Institutional Challenges, in: UNDP (Ed.), Issues and Options. The Clean Development Mechanism, New York, p. 53-80. Food and Agricultural Organization (FAO). 1982. FAO Forestry Paper 30. FAO, Rome, Italy. Food and Agricultural Organization (FAO), 1999, State of the World's Forests, Rome, Italy.

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Flint, E.P., Richards, J.F., 1991, Historical analysis of changes in land use and carbon stock of vegetation in south and southeast Asia. Canadian Journal of Forestry Research 21: 91-110. Frummhoff, P. C., Goetze, D.C., Hardner, J., 1998, Linking Solutions to Climate Change and Biodiversity Loss through the Kyoto Protocol’s Clean Development Mechanism, Union of Concerned Scientists Reports 10—1998, Cambridge/Mass.. Fuentes, U., Mund, M., Busch, G., 1998, Die Anrechnung biologischer Quellen und Senken im Kyoto-Protokoll: Risiko für den globalen Umweltschutz. Unveröffentlichtes Manuskript (zit. n. WBGU, 1998, Sec. 3.1). Goldberg, D. M., 1998, Carbon Conservation. Climate Change, Forest and the Clean Development Mechanism, Center for International Environmental Law, Washington, D. C. (unpublished). Greenpeace, 2000, Should Forests and Other Land Use Change Activities be in the CDM? From: www.greenpeace.org/nclimate/politics/lyonsink.html. Hastenrath, S., 1985, Climate and Circulation in the Tropics. D. Reidel Publishing, Dordrecht/Holland. Halsnaes, K., Jaccard, M., Montgomery, W.D., Richels, R., Robinson, J., Shukla, P.R., Sturm, P., 1996. A Review of Mitigation Cost Studies. In: Bruce, J., Hoesung, L., Haites, E. (Eds.), Climate Change 1995. Economic and Social Dimensions of Climate Change. Contribution of WGIII to the Second Assessment Report of the Intergovernmental Panel on Climate Change. Cambridge University Press, Cambridge/Mass., p. 297-366. Houghton, J.T., Meira Filho, L.G., Callander, B.A., Harris, N., Kattenberg, A., Maskell, K., 1996. Climate Change 1995. The Science of Climate Change. Contribution of WGI to the Second Assessment Report of the Intergovernmental Panel on Climate Change. Cambridge University Press, Cambridge/Mass.. Hansen, S., 1989, Debt for Nature Swaps – Overview and Discussion of Key Issues, in: Ecological Economics 1: 77-93. Intergovernmental Panel on Climate Change (Ed.), 1996, The Revised 1996 IPCC Guidelines for National Greenhouse Gas Accounting. From: www.iea.org/ipcc.htm. Intergovernmental Panel on Climate Change (Ed.), 2000, IPCC Special Report. Land Use, Land Use Change and Forestry. Geneva. From: www.ipcc.ch/pub/SPM_SRLULUCF.pdf Intergovernmental Forum on Forests of the United Nations Economic and Social Council/ Commission on Sustainable Development (IFF), 1999, Matters left pending on the

Law and Economics of International Climate Change Policy Need for Financial Resources, Geneva www.un.org/esa/sustdev/forest/ifd99-4.pdf Institute for Global Communications www.igc.org/climate/eco4_0698.html.

(1998),

51

(E/CN.17/IFF/1999/4).

The

‘L’

Word.

From:

From:

Jepma, C., 1997, On the baseline, in: Joint Implementation Quarterly 3 (2): 1. Jepma, C.J., Munasinghe, M., 1998, Climate Change Policy. Facts, issues, and analyses, Cambridge/UK. Michaelowa, A., 1998, Joint Implementation - the baseline issue. Economic and political aspects, in: Global Environmental Change 8 (1): 81-92. Mulongoy, K.J.; Smith, J, Alirol, P.; Witthoft-Muehlmann, A., 1998, Are Joint Implementation and the Clean Development Mechanism Opportunities for Forest Sustainable Management through Carbon Sequestration Projects? Paper prepared for the Policy Dialogue organized by the International Academy of the Environment and the Center for International Forestry Research in Geneva, 1998, Geneva. From: www.iae.org/pd/forest-background.pdf. Myers, N., 1992. Future operational monitoring strategy of tropical forests: an alternate strategy. Proceedings from the World Forest Watch Conference. San Jose dos Campos, Brazil. May 27-29, 1992. Myers, N., 1995, The world's forests: need for a policy appraisal. Science 268: 823-824. Organization for Economic Cooperation and Development (OECD) (eds.), 1995, Global Warming. Economic Dimensions and Policy Responses, Paris. Pearce, D., B. Day, J. Newcombe, T. Brunello and T. Bello (1998), The Clean Development Mechanism: Benefits of the CDM for developing countries, CSERGE, London/UK. Rosebrock, J., Sondhof, H., 1991, Debt-for-Nature Swaps: A Review of the First Experiences, in: Intereconomics: 82-87. Sander, T., 1997, In Asia’s Big Haze, Man Made Battles - Man Made Disaster, Christian Science Monitor (October 28, 1997). Schlamadinger, B., Marland, G., 1998, The Kyoto Protocol: provisions and unresolved issues relevant to land-use change and forestry, Environmental Science and Policy 1: 313-327. Sedjo, R., Sohngen, B., Jagger, P., 1999, Carbon Sinks in the Post-Kyoto World, in: Weathervane-Feature 50. From: www.weathervan.rff.org/features/feature050.html.

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Singer, S., 1998, What do we sink about all this?, in: ECO4 – June 09, 1998. 1-2. From: www.igc.org/climate/eco4_0698.html. Smith, J.; Mulongoy, K.; Perrson, R.;, Sayer, J., 1998, Harnessing Carbon Markets for tropical Forest Conservation: Towards a More Realistic Assessment, International Academy of the Environment Working Paper, Geneva. United Nations Framework Convention on Climate Change/Subsidiary Body for Scientific and Technological Advice (UNFCCC/SBSTA), 1998, Methodological Issues. Issues related to land use change and forestry. Note by the secretariat, UNFCCC/SBSTA/1998.INF1. United Nations Framework Convention on Climate Change (UNFCCC, 1995), Report of the Conference of the Parties on its first session, held in Berlin from March 28 to 7 April 1995. Addendum. Part Two: Action taken by the Conference of the Parties at its first session, FCCC/CP/19995/7/Add.1. United Nations Framework Convention on Climate Change (UNFCCC, 1997), Kyoto Protocol to the United Nations Framework Convention on Climate Change, FCCC/CP/1997/L.7/Add.1. Wissenschaftlicher Beirat Globale Umweltveraenderungen (WBGU) (1998), The Accounting of Biological Sinks and Sources Under the Kyoto Protocol – A Step Forwards or Backwards for Global Environmental Protection. From: www.awibremerhaven.de/WGBU/wbgu_sn1998.html White House, 1998. The Kyoto Protocol and the President’s Policies to Address Climate Change. From: www.whitehouse.gov/WH/New/html/augnew98.html#Kyoto. World Resources Institute, 1998, Climate, Biodiversity, and Forests: Issues and Opportunities Emerging from the Kyoto-Protocol, Washington D.C. From: www.wri.org/ffi/climate. Victor, D.G., Nakicenovic, N., Victor, N., 1998. The Kyoto Protocol Carbon Bubble: Implications for Russia, Ukraine and Emission Trading, International Institute for Applied Systems Analysis, Laxenburg, Austria, IR-98-094 (forthcoming Climatic Change). Vine, E.; Sathaye, J., 1997, The Monitoring, Evaluation, Reporting, and Verification of Climate Change Mitigation Projects: Discussion of Issues and Methodologies and Review of Existing Protocols and Guidelines, Report prepared for the U.SEnvironmental Protection Agency, Berkeley (LBNL-40316).


1

2

3 4

5

6

7

8

9

10

11

12

53

Intergovernmental Panel on Climate Change, 2000, IPCC Special Report. Land Use, Land-Use Change and Forestry, Geneva. The term ”Kyoto forestry” describes the combined activities of afforestation, reforestation and deforestation, which are accountable under the Kyoto protocol (as explained below). Compare Sec. 8 and Sec. 8.4 of the WBGU report. Sink enhancement refers to any activity that increases the biospheric carbon uptake such as afforestation and reforestation. We restrict our discussion of biological sinks and sources to forest ecosystems because forests are worldwide the most import biological source and sink of carbon. It should be noted, however, that some other ecosystems such as wetlands have a much higher specific source potential (per ha) due to their very forceful methane and other trace gas emissions. These figures are taken from a much-cited White House 1998-estimate of the ”cost of Kyoto” and a related estimate of the Energy Information Agency of the same year. Debt-for-Nature-Swaps and some immediate results of this program are described in Hansen, 1989, and Rosebrock/Sondhof, 1991. The total face value of debt retired through this program amounts to only US$ 159 million (IFF, 1999, 9). Jepma and Munasinghe (1998) estimate the cost-effective combination of mitigation options for achieving a global emission reduction of 2.4 GtC. This is equivalent to a reduction of 55% below 1990 levels of Annex I countries. They estimate that 700 MtC (30%) would come from tropical forests. A 55% reduction in emissions is however more than Annex I countries need to reduce during the first commitment period, which amounts to around 15% compared to business as usual. Pearce et al. (1998) estimate the annual demand of Annex I countries during the first commitment period at around 730 MtC. If, as Jepma and Munasinghe suggest, about 30% of this amount is costeffectively produced in tropical forests, we obtain an effective market share of CDM forestry of about 220 MtC per year. Based on a price per ton of carbon of US$ 10-50 (from Victor et al., 1998) we derive a total annual contribution of between US$ 2.2-11 billion. Smith et al. (1998) present a much smaller estimate of the market share of US$ 0.3 - 0.5 billion assuming a lower price (5-23 $/tC) and a 10-20% cap on trade. Greenpeace, on the other hand arrives at a much higher estimate (US$ 7 billion) assuming 300 MtC per year as available credits from forest conservation and a price per ton of carbon of $ 23 (Greenpeace 2000, pp 17-18). If not stated otherwise, articles in this paper refer to articles of the Kyoto Protocol (UNFCCC, 1997). These gases are CO2 (carbon dioxide), CH4 (methane), N20 (nitrous oxide), and some industrial gases (SF6, PFCs and HFCs). The carbon equivalents of GHGs other than CO2 are calculated on the basis of global warming potentials calculated in the IPCC’s Second Assessment Report on Climate Change (Houghton et al., 1996). Since GHG emissions from extracting wood energy are also not counted, bioenergy is essentially a carbon-free fuel under the Kyoto Protocol.

54 13

14

15

16

17


Additional human-induced activities could selective logging, farming practices that lead to changes in soil carbon of agricultural land (for a comprehensive list of additional BSS see UNFCCC/SBSTA, 1998). It is actually not clear which LUCF-emissions from 1990 can be added to the baseline because Art. 3.7 allows the accounting of ”emissions by sources and removals by sinks in 1990 from land use changes”, omitting the words ”and forestry”. This gives rise to diverse interpretations, ranging from a pure and an inadvertent omission of the words ”and forestry” to a purposeful distinction to select specific carbon fluxes, i.e. deforestation in 1990 (Schlamadinger/Marland, 1998). We follow the former interpretation in this paper to simplify our exposition. Other problems associated with these instruments are short-term contracting, financial additionally and local benefits of projects. The problem of short-term contracting is analyzed in depth in Chapter 4 of this study; other problems are discussed in Goldberg, 1998; Mulongoy, K. et al., 1998; Sedjo, R. et al., 1999, Vine and Sathaye, 1997. Second and Third Phase Projects essentially differ in the targeted type of forestry. The Private forestry project (PFP) is directed at sequestration projects on private lands, whereas the protected area project (PAP) covers management of public natural parks and inclusion of private land into public natural parks. As a result, they differ in the degree of government involvement, which is greater in the case of PAP. We combine these project-types into one in this paper to bring out the difference between secondgeneration AIJ and first generation AIJ such as Ecoland. CTOs of PFP were sold (in the first-ever CTO-based contract) to the Government of Norway in 1997 at a price of US$ 10 per ton of carbon; CTOs from PAP has been offered in 1998 at a price of US$ 20 per ton of carbon on the Chicago Board of Trade.

Chapter 4 The Long-term Requirement for CDM Forestry and Economic Liability 1 Reimund Schwarze and John O. Niles

1.

INTRODUCTION

The Clean Development Mechanism (CDM) is an instrument of international cooperation under the Kyoto Protocol (KP) to the United Nations Framework Convention on Climate Change (UNFCCC). The primary purpose of the CDM is to assist developing countries (so-called Non-Annex I-countries in the Protocol) achieve sustainable development while helping stabilize greenhouse gas concentrations in the atmosphere. The CDM's second purpose is to assist industrialized countries (so called Annex I-countries) achieve the emission reduction commitments that they agreed to under the terms of the Protocol. Under the CDM, Annex Iparties may fund emission reduction projects in amenable Non-Annex Icountries and get credit for Certified Emission Reductions (CERs) from these projects. These CERs can then be used to meet the commitments of the Annex I-countries. Due to the "flexible" nature of the CDM, these CERs will probably cost less than domestic reductions in Annex I countries. As such, they will likely lower the per-unit cost of meeting the Protocol's target reductions. A major field of application for the CDM could be tropical forest conservation 2 . Tropical deforestation causes approximately 25% of worldwide greenhouse gas (GHG) emissions (Brown et al., 1996). Stopping or slowing the rate of deforestation compared to a business-asusual scenario will reduce emissions of GHGs into the atmosphere. Due to the relatively low cost of this carbon mitigation option (Halsnaes et al.,

56

CDM Forestry and Economic Liability

1996) and the abundance of opportunities for tropical forest conservation and regeneration in developing countries, CDM forestry projects are a topic of considerable debate. 3 One of the unique requirements of the CDM is that emission reduction projects must be shown to achieve ”real, measurable and longterm environmental benefits” (Article 12 (4) KP; UNFCCC, 1997). A problem arises, because CDM-parties may be reluctant to commit to protecting forests for long-term. This might be due to changes in national development priorities of a host or other events such as changes in prices, tenure, or social conditions. Unlike energy-based projects, a forest that is protected one year (over a baseline scenario) may easily be degraded the following year. Consequently, emissions would not be reduced per se, but only postponed. Long-term forest protection is particularly at risk if the CERs are granted early in the project. In this case neither party would have a substantial interest in sustained forest protection since credits and payments would already be transferred. And so an important issue of CDM-forestry is how to design contracts to reward long-term forest protection. 4 One solution is to allow the courts or other legal channels to decide the consequences of contract failure. If a project designed to protect a forest fails after a short period, then one party could sue the other, trade sanctions could be invoked, or other legal remedies taken to force compliance or invoke a fine. However, legal liability and sanctions are difficult to implement in global environmental regulation (Wiener, J.B., 1999). Additionally, legal liability potentially imposes some measure of lost decision making at the national level. Some countries have pointed out that the CDM could be construed in a way that limits the freedom of public or private entities’ future choices by forcing adherence to CDM contracts. While this is applicable to both technology-based CDM projects and land-use ones, the issue is potentially more acute in land-use projects. Thus, while both the host and the donor country must agree to a CDM project for it to be initiated, they may object to the idea of legal liability for long-term carbon conservation in forests. Moreover, a system of international legal liability could cause high transaction cost. Another way to encourage long-term conservation is to delay the payments to either the host or the sponsor country. By withholding benefits until "long-term protection" (however defined) has been achieved, a party would have an economic incentive to sustain forest conservation efforts. This can be either done through a certification


57

process or by stipulating crediting rules of CERs to the donor and/or CER proceeds to the host. We refer to the latter procedure as assigning economic liability, which is the focus of this paper. 5 Under economic liability, host countries have the flexibility to change their development priorities and also do not sacrifice any sovereignty. Delayed crediting simply is a way to encourage long-term participation while making the economic consequences of a broken contract transparent. In the case of economic seller liability, the payments from the sponsor to the Non-Annex I-host country would be delayed. The seller (host country) would only receive full payment for its participation at the completion of long-term protection. Alternatively, economic buyer liability delays the credits earned by the purchaser. The Annex I-Party or firm only receives CERs after the CDM requirement of long-term is met. 6 Economic liability conceptually resembles an assurance bonding system, which has been discussed as a flexible tool to enforce environmental liability (Perrings, 1989; Constanza/Perrings, 1990) and in the field of labor contracts (Becker/Stigler, 1974; Akerlof/Katz, 1989). In contrast to this general principal-agent literature, our paper is concerned with a specific enforcement problem – contract duration – in a specific legal-institutional environment, the CDM, where we have two agents - a buyer and a seller of CERs - and legal restrictions on borrowing. This gives rise to some unique new problems, in particular the placement of liability among buyer and seller and the question of timing of contract benefits, which have not been discussed previously. This paper has a dual aim: firstly, we suggest an a-priori economic advantage of seller liability compared to buyer liability. Secondly, we propose a specific impure system of seller liability (escrow), which is more acceptable to potential CDM hosts than a pure seller liability but still provides sufficient incentives for long-term contracts. Under this system, the principle payment of the donor is withheld in an escrow account to establish economic liability and interest in long-term contracting, and the interest on this principle is paid to the host. By its nature, the interest from the principle would be an increasing function with time since the fund, on which the interest is paid, is increasing. This hybrid schedule would resemble an escrow account, which is commonly used in the United States to enforce mortgage contracts. This paper is broken into six sections. In section 2, we develop the concept of a minimum contract period to implement the long-term requirement of the CDM. In section 3, we introduce three basic types of

58


economic liability contracts, i.e. buyer liability, seller liability and double liability, to enforce this requirement. In section 4, we establish the fundamental inequality of economic seller versus economic buyer liability with regard to the efficiency of contracting, and we discuss how this is caused by the ”no borrowing” provision of the CDM. In section 5, we propose a forest-secured escrow account. We show that this hybrid scheme of seller liability increases the internal rate of return to potential sellers without unduly diluting the incentive to have long-term contracts. Section 6 summarizes our results and discusses the institutional implications of applying an escrow account or other forms of economic seller liability to enforce the long-term requirement of the CDM.

2.

THE LONG-TERM REQUIREMENT OF THE CDM

Exactly how long is long-term in the case of CDM forestry projects? Article 12(4) of the Protocol only states that emission reductions under the CDM "shall be certified on the basis of real, measurable and long-term benefits to the mitigation of climate change". Thus, the Protocol does not provide any guidance for defining this requirement. Does the long-term requirement of the CDM imply permanence? As discussed in the introduction, permanent conservation could be unacceptable to many potential CDM host countries. The permanent protection of a forest could be perceived by developing countries as defacto expropriation or a forfeiture of control on the use of land. Several key developing countries, e.g. Brazil, have expressed exactly this objection to the CDM arguing it would limit their ability to make ”domestic decisions domestically” (MCT, 1999). From a scientific point of view the long-term requirement of the CDM should ideally cover the period of time that it takes for an emission to decay in the atmosphere, e.g. 50-200 years for carbon dioxide. Delaying emissions for any shorter time period would tend to postpone, rather than reduce emissions. Although financially advantageous for Annex I-countries (because they can use CERs to offset or postpone their duty to reduce emissions domestically), simply delaying emissions will not help stabilize greenhouse gas concentrations in the atmosphere. Less than permanence, however, could be sufficient, if we approach this question of duration from a socio-political point of view. If GHG emissions are reduced for a period of time while alternative


59

abatement strategies become widespread, delayed emissions will provide an important "bridge" to future atmospheric GHG stabilization. In this sense, the long-term requirement is justified and defined by the expectation that structural changes in the world economy and technology will arise at a later date. These changes could be the emergence of new technologies or an increased valuation of forests outside of their role in climate change mitigation. Widespread adoption of technologies such as solar power or storage of CO2 at some point in the future would imply that even semi-permanent reductions now will transition into more lasting reductions later. Alternatively, the value of tropical forests may rise in the future such that deforestation is no longer an attractive activity. This increase could either be in the form of domestic values (i.e., watershed protection) or external values (i.e., biodiversity) which develop a real market. Thus, forest conservation under the CDM could have a real effect on the climate by delaying emissions until the incentive to deforest is lost or alternative technologies develop. Practical experience with the long-term requirement was gained in the pilot phase of Activities Implemented Jointly (AIJ) under the Berlin Mandate of the UNFCCC (UNFCCC, 1995). According to our study, the average duration of AIJ forestry projects is 39 years with a median duration of 32.5 years. In several aspects AIJ resembles the CDM, both mandate the requirement of ”real, measurable and long term environmental benefits”. In the spirit of the Kyoto Protocol’s initial stepapproach and considering the experience of the pilot phase, it seems appropriate to apply a minimum period of 30-50 years as a practical rule for the CDM-requirement of long-term. 7

3.

BASIC TYPES OF ECONOMIC LIABILITY CONTRACTS

We can think of a CDM-project as having four distinct contractual procedures (see figure 4. 1). 1. The donor country ("buyer") funds a project according to some specified payment schedule. 2. The host country ("seller") receives payments from this fund according to a specified schedule.

60


3. In exchange for this payment, the host increases forest conservation 8 over a baseline rate, thus preventing the emission of greenhouse gases. 4. The donor country is credited for these emission reductions in the form of Certified Emission Reductions (CERs). Figure 4.1: CDM contractual procedures

$

$ 2

1

B uyer

S eller 3

4 CERs

C o nservation

For the purpose of establishing economic liability, any of these contractual procedures can be decoupled from one another and tied to a contract stipulation. We distinguish between four basic contract types (see table 4. 1). A service contract credits the host and the donor continuously. This "pay as you go"-scheme does not impose any kind of economic liability to keep to the contractual agreement long-term. In fact, under a ”pay as you go”-scheme, a long-term contract is separated into a sequence of single service contracts, each in the amount of annually reduced emissions. The other schemes impose some kind of economic liability on any one or both parties of the contract to make them adhere to long-term contracts. Buyer liability uncouples the payment of the donor to the host from the receipt of CERs. The donor country is held liable in order to influence the host to fulfill her promise to protect the forest on a long-term basis. She can do this either through direct control, e.g. by having an on-


61

the-ground monitoring task force, or indirectly by selecting only projects from hosts with a reputation of prudent contracting behavior. In any case, the donor country is credited the full amount of CERs only after the forest is protected for the agreed amount of time considered ”long-term”, e.g. 30-50 years. Table 4.1: Basic contract types Donor (Buyer)

Continuous crediting

Terminal crediting

Host (Seller) Continuous crediting Terminal crediting

No liability (service contract) Seller liability

Buyer liability Double liability

Under seller liability, rewards to the host party are withheld until the end of the contract. Since payments made by the donor are not immediately accessible by the host, a fund arises that would need to be managed. Presumably this fund would be managed by a third party, possibly the Global Environmental Facility at the World Bank or by some appointment of the executive board of the CDM. Double liability is an odd form of holding both parties responsible until the contract is fully performed. It foresees a continuous funding of tropical forestry by the donor and a continuous effort by the host to preserve forests. However, both countries are rewarded for their efforts only after the project is considered complete in the long-term. To illustrate the four basic contract types (outlined in table 4.1), we constructed a hypothetical numerical CDM forest preservation project. We used the following assumptions: 1. 2. 3. 4. 5. 6. 7.

Project area: 30 ha Baseline deforestation: 1ha/yr Deforestation rate under the CDM project: 0 ha/yr Project period: 30 yr Specific carbon stock: 150 tC/ha Donor’s Opportunity Cost ((i.e. cost of domestic action): 50 $/tC Host’s Opportunity Cost, (i.e. the revenue forgone if the forest is conserved): 1500 $/ha = 10 $/tC

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8. Market price of carbon rights: 30 $/tC 9. Discount rate: 3%. 9 In this example, the host country agrees to preserve an area of 30 ha primary forest which is under threat of being deforested. Deforestation is assumed to occur under business as usual over a period of 30 years at a rate of 1 ha per year. For this project, the host incurs opportunity costs as, for example, loss of income from timber harvest. This loss is assumed to be 1500 $/ha or 10$/tC. Naturally, for the host to agree to this project, he must be compensated at a value greater than this opportunity cost. This money would come from the reduced cost of compliance by the donor country. Her minimal cost of compliance are assumed to be $ 50/tC if done domestically. She can reduce this cost through purchases of certified emission reductions (CERs) from the host at a price of $ 30/tC. The price of $ 30/tC for CERs is chosen arbitrarily (without loss of generality) to depict the case of an equal sharing of benefits on a per unit basis. The total economic value (TEV) of this project is the difference between the opportunity cost to the donor ($ 50/tC) and to the host ($ 10/tC). It amounts to $ 180,000 over a period of 30 years (= $ 40/tC * 150tC/yr * 30 yrs). As a present value (PV) this stream of economic surplus is equal $ 117,602, based on an assumed 3% rate of discount. 10 This value represents the net gain by the world from ”where flexibility” or international trade in emission reductions. The value of the contract to the parties depends on the specification of the liability rule. In the case of buyer liability, the donor pays annually $ 4,500 in exchange for 150 tC conserved in tropical forests. Since this conservation effort is only credited after minimum period of 30 year, she actually pays for future CERs of the 31st year. These futures, as an investment, provide a net present value only worth $ 1,795 because of the imposed long delay. Similarly in the case of seller liability, where the host incurs a constant cost of $ 1,500 over a 30 years period to achieve a terminal payment of $ 135,000 after 30 years. As a net present value (= PV of benefits minus costs), this contract is valued at $ 24,598. Table 4.2 compares the net present value of the project to the parties under different liability rules including no liability.


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Table. 4.2: Present values of contract net benefits NPV (Buyer) NPV (Seller)

Buyer Pay Go

Liability

$ 58,801 Pay Go Seller

$ 58,801

$ 1,795 $ 58,801

$ 24,598 Liability

$ 58,801

$ 1,795 $ 24,598

From this table, we see that the introduction of economic liability (in the form of withholding contract benefits) substantially lowers the value of the project to the parties. The present value of net contract benefits, in the case of seller liability, is only 71% of the total economic value or $ 83,399 (= $ 24,598 + $ 58,801). The respective numbers for buyer liability and double liability are 51% ($ 60,596) and 22% ($ 26,393). The difference between economic seller and buyer liability stems from the fact, that the present value of the different liability contracts to parties is remarkably higher in the case of seller liability ($ 24,598) than in the case of buyer liability ($ 1,795). Given the equal sharing of contract benefits on a per unit basis in our example, this may come as a surprise. However only on first sight, because obviously the buyer incurs a higher annual cost (30 $/t) in the withholding period of an economic liability contract than the seller (10 $/t). This discrepancy in party costs consequently carries a higher weight as a stream of negative income for the purpose of PV-calculation.

4.

THE EFFICIENCY ADVANTAGE OF SELLER LIABILITY

The efficiency of liability regimes has been analyzed in depth in the law-and-economics literature. This literature, however, is only concerned with regimes of legal liability, i.e. legal sanctions attached to some kind of contract failure or general misbehavior. A general result of

64


this analysis in the context of contract law is that seller and buyer liability have identical efficiency properties in a world without transaction cost, e.g. cost of observation of contract performance, litigation cost etc. (see Polinsky, 1989). This result is basically an application of the CoaseTheorem to the field of contract law. A different result arises in our context of economic liability. The withholding of contract benefits is different from legal liability for contract failure, because it imposes an interruption of the contract in the withholding period. By contrast, legal liability does not interrupt contract performance, but only penalizes contract failures ex post. The interruption of contract performance under economic liability has a damaging effect in the case of buyer liability since the buyer (donor country) still has to fulfill his Kyoto commitments, i.e. reduce his emissions domestically. This comes at a higher cost than buying this service from the seller (host country). This economic loss does not arise under economic seller liability. The case of seller liability is different from buyer liability, because the interruption of contract procedures does not affect the actual behavior of the parties, but only their financial well being. The buyer is satisfying his needs at minimal cost, and the seller is providing the needed service. Of course, the seller is worse off in the withholding period compared to a noliability or a buyer-liability scheme, but the financial loss to the seller is exactly compensated by a financial gain, the accrual of interest, in the fund held by a third party. In fact, if these financial gains were to be distributed to the seller as a continuous payment, the seller would be equally well off under a liability contract as under a no-liability contract. 11 Thus, there is also no economic loss incurred under seller liability to the economy as a whole. As a result we find differences in the efficiency of economic seller versus economic buyer liability, assuming that there are no differences in the transaction costs between these two schemes. Differences in transaction cost between these schemes, which will exist in reality, could override the asymmetry described here. Yet, it is interesting to note this a-priori advantage for economic seller liability compared to economic buyer liability. An appropriate way to demonstrate the a-priori advantage of seller-liability is to compare the total economic value (TEV) of the different contracting schemes to the economy as a whole. The TEV is the present value (PV) of the difference of opportunity cost to the host and to the donor; it amounts to $ 117,602 in our example. In the case of buyer


65

liability, this figure is reduced to $ 60,596 as a result of the low economic value of the contract to the buyer ($ 1,795). In the case of seller liability, there is also a loss of contract value to the seller, expressed in a lower PV of contracting ($ 24,598) compared to the no-liability regime ($ 58,801). But this financial loss is exactly made up by the financial gains of the fund ($ 34,204). Thus, the TEV to the economy as a whole is $ 117,602 (= $ 58,801 + $ 24,598 + $ 34,204), which implies that no economic loss is incurred due to economic seller liability. This result seems to contradict the Coase-Theorem, but only on first sight. In fact, this asymmetry of economic seller versus economic buyer liability is due to a peculiarity in the legal setting of the CDM. The CDM does not allow Annex I countries to use future emission reductions to offset their actual Kyoto commitments. This provision is commonly referred to as ”no borrowing”. Thus, a liable buyer of CERs has to fulfill his actual duties during the withholding period by other means, e.g. domestic abatement. This missing ”when flexibility” of the CDM (and the other flexibility mechanism of the Kyoto Protocol) limits the efficiency of ”where flexibility". No borrowing, on top of asymmetrical requirements of the parties under the Protocol, results in different efficiencies for different types of contracting. These asymmetries do not exist in a Coasian world of pure liability. In this sense, our result does not contradict the Coase-Theorem.

5.

THE CDM FOREST-SECURED ESCROW ACCOUNT

In our above discussion we have been concerned with pure schemes of liability contracts to establish the general theoretical properties of economic liability. As mentioned earlier, there is an interesting "impure" seller-liability scheme that increases the internal rate of return of contracting to the seller, making it more acceptable to CDM host countries. This scheme resembles an escrow account, which is commonly used in the U.S. to enforce mortgage contracts. An escrow account is a special savings account that is established by a lender on behalf of a mortgager to cover future recurring costs, such as real estate tax, home insurance etc. Escrow accounts secure the lender's investment, not the mortgager, because the mortgager has to prepay all this cost. The mortgager, however, has a legal entitlement to the principle and the

66


interest on the principle in an escrow account. It is refunded to him, if he repays the loan or meets the conditions established to retrieve the escrow. Under the CDM, an escrow account is established by the buyer on behalf of the seller that is "secured" by the continued protection of a forest. In the case of this proposed forest-secured escrow account, the donor country establishes a savings account on behalf of the host country to secure interest in a long-term contract. The money, both the principle and the interest in this fund is a legal entitlement to the host and will be refunded to her if and when she fulfills the contract. Practically speaking, under CDM forestry projects, satellite measurements and ground-truthing could be used to verify that actual forest protection is occurring over a minimum period of 30-50 years. Only upon verification of emission reductions (i.e. forest conservation) at the end of the contract period would the principle in the account be dispersed to the seller. Meanwhile, the interest from the escrow account would be distributed to the host on a continuous annual or semi-continuous multi-year basis. Looking at the long-term incentives of a forest-secured escrow we find that it provides sound economic incentives for long-term contracting. A convenient way to do this is to analyze the time distribution of net benefits to contracting parties (s. Figure 4.2). Figure 4.2: Time distributions of contract benefits

100 90 80 70 60 50

Δ

40 30 20

δ

10 0

1

5

9

13

17 year

21

25

29

Service contract %

Escrow account Liability contracts


67

The time distribution of contract benefits measures the percentage of accessible contract benefits at any point in time during the contract period. It is obviously rather different for service contracts, which impose no liability, as compared to economic liability contracts. In the case of a service contract, the contract benefits are immediately accessible to both parties at any point in time. The donor is simply credited with CERs as he pays, and the host is credited this payments as he has done the service of protecting his forests (assuming there is no delay due to the certification procedure). Thus, the accessibility of contract benefits is strictly proportional to the contract duration, e.g. 50% of the benefits of a 30-year contract are accessible to both parties after 15 years of contract duration. In the case of pure buyer or seller liability, the full amount of contract benefits is withheld from one party until the contract is completed. Thus, in our example, no contract benefits are accessible in the years 1 to 29 to the liable party or parties (in the case of double liability), and full crediting will only occur at the end of year 30. The forest-secured escrow account is a hybrid between no-liability and pure seller liability. A major part of contract benefits – the principle – is withheld until after 30 years, however the interest can be accessed as it accrues. An established indicator to measure the skewedness of distribution functions is the Gini-coefficient (GC). 12 The GC is commonly used to compare the equality of income distributions. An almost equal distribution of benefits yields a low GC and an unequal distribution yields a high GC. In our paper, we use the GC to measure the incentives to adhere to long-term contracts. A low GC provides little or no incentives for long-term contracting, because there is little or no economic liability imposed to any party. Conversely, a high GC indicates a strong incentive to adhere to a long-term contract due to the imposition of economic liability. As is indicated in figure 4.2, liability versus no-liability contracts mark the most extreme values of the GC, i.e. GC=0 in the case of noliability, and GC=1 in the case of buyer or seller liability. Using the Ginicoefficients of pure seller liability (= 1) and no liability (= 0) as benchmarks, we find that the escrow account is closer to a pure economic seller liability than to a no-liability scheme; in our numerical example the Gini-coefficient of the escrow account is 0.74. This suggests a significant incentive to ensure contract durability. In fact, the escrow account establishes two independent economic incentives to fulfill a long-term contract. On the one hand, it is a form of economic seller liability, which withholds the principle payment (or some

68


portion thereof) from the host until she has fulfilled her obligations. On the other hand, the interest in that account is an increasing function in time, because the principle fund, on which the interest is paid, is increasing over time. Thus, even in the withholding period, contracting is more rewarding the longer it is sustained. As a type of seller liability, the forest-secured escrow account is efficient. The awarding of interest payments does not affect this property. As explained above, it is simply a redistribution of the gains of the escrow fund to the liable seller which has no effect on the efficiency of the contract. In essence, the forest-secured escrow account is simply a way to make some benefits (the interest) accessible to a host country while deferring others (the principle) to encourage long-term forest conservation. This accounting tool provides a higher internal rate of return to the seller (12% in our numerical example) compared to a pure seller liability (6% in our numerical example) 13 , which makes it more acceptable to potential sellers and would probably lead to increased rates of participation. Table 4.3: Numerical example of economic liability Buyer OC

Pay Go

Seller

Net-Benefits Pay Go

OC

Pay go Interest

Fund Net-Benefits

Pay Go

Fund

1

7500

-4500

3000

Buyer Liability -4500

-1500

4500

0

3000

Seller Escrow Liability -1500 -1500

2

7500

-4500

3000

-4500

-1500

4500

135

3000

-1500

-1365

4500

3

7500

-4500

3000

-4500

-1500

4500

270

3000

-1500

-1230

4500

4

7500

-4500

3000

-4500

-1500

4500

405

3000

-1500

-1095

4500

5

7500

-4500

3000

-4500

-1500

4500

540

3000

-1500

-960

4500

6

7500

-4500

3000

-4500

-1500

4500

675

3000

-1500

-825

4500

7

7500

-4500

3000

-4500

-1500

4500

810

3000

-1500

-690

4500

8

7500

-4500

3000

-4500

-1500

4500

945

3000

-1500

-555

4500

9

7500

-4500

3000

-4500

-1500

4500

1080

3000

-1500

-420

4500

10

7500

-4500

3000

-4500

-1500

4500

1215

3000

-1500

-285

4500

11

7500

-4500

3000

-4500

-1500

4500

1350

3000

-1500

-150

4500

12

7500

-4500

3000

-4500

-1500

4500

1485

3000

-1500

-15

4500

13

7500

-4500

3000

-4500

-1500

4500

1620

3000

-1500

120

4500

14

7500

-4500

3000

-4500

-1500

4500

1755

3000

-1500

255

4500

15

7500

-4500

3000

-4500

-1500

4500

1890

3000

-1500

390

4500

16

7500

-4500

3000

-4500

-1500

4500

2025

3000

-1500

525

4500

4500

Law and Economics of International Climate Change Policy Buyer OC

Pay Go

Seller

Net-Benefits Pay Go

69

OC

Pay go Interest

Fund Net-Benefits

17

7500

-4500

3000

-1500

4500

2160

3000

Seller Escrow Liability -1500 660

18

7500

-4500

3000

-4500

-1500

4500

2295

3000

-1500

795

4500

19

7500

-4500

3000

-4500

-1500

4500

2430

3000

-1500

930

4500

20

7500

-4500

3000

-4500

-1500

4500

2565

3000

-1500

1065

4500

21

7500

-4500

3000

-4500

-1500

4500

2700

3000

-1500

1200

4500

22

7500

-4500

3000

-4500

-1500

4500

2835

3000

-1500

1335

4500

23

7500

-4500

3000

-4500

-1500

4500

2970

3000

-1500

1470

4500

24

7500

-4500

3000

-4500

-1500

4500

3105

3000

-1500

1605

4500

25

7500

-4500

3000

-4500

-1500

4500

3240

3000

-1500

1740

4500

26

7500

-4500

3000

-4500

-1500

4500

3375

3000

-1500

1875

4500

27

7500

-4500

3000

-4500

-1500

4500

3510

3000

-1500

2010

4500

28

7500

-4500

3000

-4500

-1500

4500

3645

3000

-1500

2145

4500

29

7500

-4500

3000

-4500

-1500

4500

3780

3000

-1500

2280

4500

30

7500

-4500

3000

-4500

-1500

4500

3915

3000

-1500

2415

31

Pay Go

Fund

Buyer Liability -4500

225000

4050

Sum

225000 -135000 90000

90000

-45000 135000

NPV IRR

147003 -88202

1795 3%

-29401

6.

58801 infinite

88202

62775

135000 139050

4500

4500 -135000

90000

90000

152775

0

58801 infinite

24598 6%

58801 12%

34204

CONCLUSION

In this paper, we have established an a-priori economic advantage of seller liability compared to buyer liability. This asymmetry derives from the prohibition of borrowing under the Kyoto Protocol. In addition, we proposed a hybrid scheme of seller liability, an escrow account that is secured by long-term forest conservation. This hybrid accounting method would be more acceptable to potential CDM hosts than a pure economic seller liability while still providing incentives for long-term contracts. Given the reluctance of some developing countries towards the CDM, the escrow approach represents a compromise between long-term liability and the economic incentives to engage in CDM forestry. Other modifications of a pure economic seller liability that also delay contract benefits could be suitable as well. One example of this would be to release portions of the principle as a function of time.

70


The institutional implications of applying a scheme of economic seller liability (in a pure or an impure form) to CDM projects could be profound. There are two distinctive new features of this scheme: 1. Economic seller liability would stipulate a crediting schedule that provides an efficient resolution to the long-term requirement of the CDM. 2. The resolution of accounting details to ensure long-term emission reductions under the CDM could give rise to a substantial worldwide fund. The first feature would considerably restrict the present freedom of contracting of CDM parties and must be proceeded by a clear definition of the conference of the parties on the meaning of the long-term requirement of Art. 12(4). A minimum period for CDM forestry contracts of 30-50 years seems to us an appropriate practical rule. The second feature would require an international economic body with special skills for managing large international funds and experiences in handling international projects. This body could be located at the Global Environmental Facility of the World Bank or under the guidance of the CDM executive board. It would act as trustee comparable to the trustee holder of an escrow account. Moreover, it could act as a clearinghouse for bids and offers of CDM projects, and generally guide interested parties in establishing CDM contracts. The fund manager could also serve as an authority to tax the proceeds of CDM activities in accordance with Art. 12 (8). Art. 12(8) of the Kyoto Protocol (KP) stipulates that developing countries, which are particularly vulnerable to the adverse effects of climate change, shall be assisted in meeting the cost of adaptation based on a tax on CDM activities. Our resolution of the accounting to ensure long-term emissions reductions under the CDM could also bridge the two divergent views on the institutional character of the CDM (Farhana, 1998, 53). One view stresses the market-based character of the CDM, similar to AIJ. It is shared by many Annex I-countries. The other view emphasizes the multilateral character of the CDM as a fund fed by CER proceeds and proceeds from the adaptation tax of Article 12(8) KP. This feature is proposed by many developing countries. The forest-secured escrow account is essentially a ”bilateral approach”, market-based and on a project-by-project, similar to AIJ. At the same time it establishes a


71

multilateral CDM fund acting as a trustee holder of an escrow account. Such a scenario would be a hybrid between the opposing ”bilateral approach” and the ”portfolio approach”. Although there are numerous disagreements and discussions about the ultimate shape of the CDM, we believe that a form of sellerliability has some intrinsic advantages that must be considered. Furthermore, we suggest that if the CDM is structured in this manner, it may allow the resolution of other important differences, namely how to encourage long-term emission reductions and what form the CDM's executive board should take.

72


REFERENCES Akerlof, G.A., Katz, L., 1989, Worker’s trust funds and the logic of wage profiles, Quarterly Journal of Economics 104: 525-536. Becker, S., Stigler, G., 1974, Law enforcement, malfeasance, and compensation of enforcers, Journal of Legal Studies 3: 1-18. Brown, P., Kete, N., 1998, Forest and Land Use Projects, in: UNDP (Ed.), Issues and Options. The Clean Development Mechanism, New York, p. 163-173. Brown, S., Sathaye, J., Cannell, M., Kauppi, P.E., 1996, Management of Forests for Mitigation of Greenhouse Gas Emissions. In: Watson, R.T. et al. (eds.), Climate Change 1995. Impacts, Adaptations, and Mitigation of Climate Change. Contribution of Working Group II to the Second Assessment Report of the Intergovernmental Panel on Climate Change, Cambridge University Press, Cambridge/Mass., p. 775-797. Constanza, R., Perrings, C., 1990, A flexible assurance bonding system for improved environmental management, Ecological Economics 2: 57-75. Cullet, P., Kameri-Mbote, P., 1998, Joint Implementation and forestry projects: conceptual and operational fallacies. Journal of International Affairs 74(2): 393-408. Farhana, Y., 1998, Operational and Institutional Challenges, in: UNEP (ed.), The Clean Development Mechanism. Issues and Options, New York, p. 53-80. Goldberg, D., 1998, Carbon Conservation. Climate Change, Forests and the Clean Development Mechanism. Center for International Environmental Law, Washington, D.C. Halsnaes, K., Jaccard, M., Montgomery, W.D., Richels, R., Robinson, J., Shukla, P.R., Sturm, P., 1996, A Review of Mitigation Cost Studies, in: Bruce, J.P. et al. (eds.), Climate Change 1995. Economic and Social Dimensions of Climate Change. Contribution of Working Group III to the Second Assessment Report of the Intergovernmental Panel on Climate Change, Cambridge University Press, Cambridge/Mass., p. 297-366. Ministério da Ciência e Tecnologia (MCT), 1999, Atividades Implementadas Conjuntamente - Posição do Brasil (Activities Implemented Jointly – Brazilian Position). From: www.mct.gov.br/clima/brasil/ativcon.htm. Mulongoy, K.J., Smith, J., Alirol, P., Witthoft-Muehlmann, A., 1998, Are Joint Implementation and the Clean Development Mechanism Opportunities for Forest Sustainable Management through Carbon Sequestration Projects? Paper prepared for the Policy Dialogue organized by the International Academy of the Environment and the Center for International Forestry Research in Geneva, Geneva, 1998 (unpublished). From: www.iae.org/pd/forest-background.pdf.


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Niles, J.O., Schwarze, R. 2000, The long-term requirement for CDM forestry and economic liability, Journal of Environment and Development 9:4: 384-404. Perrings, C.A., 1989, Environmental bonds and environmental research in innovative activities, Ecological Economics 1: 95-115. Polinsky, M. A., 1989, An Introduction to Law and Economics, Boston, 2. ed. United Nations Framework Convention on Climate Change (UNFCCC), 1995, Report of the Conference of the Parties on its first session, held in Berlin from March 28 to 7 April 1995. Addendum. Part Two: Action taken by the Conference of the Parties at its first session, FCCC/CP/19995/7/Add.1. United Nations Framework Convention on Climate Change (UNFCCC), 1997, Kyoto Protocol to the United Nations Framework Convention on Climate Change, FCCC/CP/1997/L.7/Add.1. Vine, E., Sathaye J., 1997, The monitoring, evaluation, reporting and verification of climate change mitigation projects: discussion of issues and methodologies and review of existing protocols and guidelines, LBNL-40316 - U.S. Environmental Protection Agency, Berkeley/CA (unpublished) Wiener, J.B., 1999. Global environmental regulation: instrument choice in legal context. The Yale Law Journal 108:4: 679-800.

74

1

2

3

4

5

6

7

8

9 10

11

12

13


Revised version of a paper originally published in the Journal of Environment and Development (Niles/Schwarze 2000). Unfortunately, in a surprising negotiation swoop at the recent COP6, negotiators tentatively excluded forest conservation from eligibility under the CDM, before the talks ended without agreement. A positive decision on this matter will be taken at the follow up meeting (COP6/II). In addition to the accounting-based issues discussed here, there are considerable ethical and legal issues that are discussed elsewhere. See Vine/Sathaye, 1997, Brown/Kete, 1998, Cullet/Kameri-Mbote, 1998, Goldberg, 1998, Mulongoy et al., 1998. The problem of achieving lasting emission reductions from CDM projects is actually not a specific problem of CDM forestry but applies to other mitigation activities as well, e.g. energy efficiency projects. The reasoning in this paper could be easily generalized to these cases if the long-term requirement of Art. 12 KP is interpreted in the way as it is done in this paper, i.e. as a minimum period of contract duration. Most of our results also apply to an accounting procedure based on certification. Certification rules, however, are less suitable as an incentive scheme compared to crediting rules because they can not be easily disintegrated to have a piece-meal approach as in the case of crediting rules. From a principal-agent theoretical point of view, this terminal crediting assures that the contract is "coalition proof" in the sense that there is no opportunity for the liable party, e.g. the buyer, to bribe the not liable party, e.g. the seller, for a breach of contract and still claim long-term protection vis-a-vis the UNFCCC (as principal). For the purpose of this paper it actually does not matter what minimum period applies as long as the law requires any minimum period (longer than a year). While both source prevention (i.e. stopping deforestation) and sink enhancement (growing new forests or increasing the biomass of existing forests) achieve the same net result on the balance of GHGs, we discuss only source prevention. We do this in part due to the language of article 12 KP (”certified emission reductions”) as well as to avoid the ethical issue of Annex I countries buying entitlements to pollute by growing large plantations in developing countries. A spread sheet for this example is provided in table 4.3. Alternatively, the TEV could be calculated as the difference of the present value of opportunity cost to the donor ($ 147,003) and to the host ($29,041). Under seller liability the total gain of the fund is credited to the seller at the termination date of the contract but not continuously. Seller liability is thus a kind of ”forced longterm saving”. The Gini-coefficient is defined as ratio of the area (Δ) between the line of perfect equity (= cumulative income of a no liability contract) and the factual income distribution (= cumulative income of liability contracts, e.g. an escrow account), and the total area (Δ+ δ) below the line of perfect equity. The internal rates of return (IRRs) for our numerical example of the basic economic iability contracts are given in table 4.3 (last row).

Chapter 5 Increasing the Acceptability of CDM Forestry Through Bundling of Bioenergy and Forest Conservation 1 John O. Niles and Reimund Schwarze

1.

INTRODUCTION

Tropical deforestation and climate change are two of the most urgent global environmental problems. In developed countries, climate change may damage valuable ecosystems and has the potential to cause significant economic and health costs. In developing countries, climate change and tropical deforestation, combined with other local and regional environmental problems, are threatening the ability of many countries to meet basic human needs. The Kyoto Protocol could mobilize between US$ 2 - 11 billion annually for tropical forest conservation for several decades (as explained in Chap. 3.3 above). A critical issue for incorporating tropical forest conservation into the Kyoto Protocol is timing. Primary tropical forests are currently being lost at a rate of roughly one-percent per year (FAO 1998). Large tracts of these forests will disappear in the next few decades if no new powerful political actions are initiated rapidly. Article 12 of the Protocol, the Clean Development Mechanism (CDM), could be such a powerful new tool for protecting tropical forests. The CDM allows industrialized countries to pay for sustainable development projects that reduce greenhouse gases (GHGs) in willing developing countries. A joint bioenergy and forest conservation project would involve a host country (a Non-Annex I country) and an investor country (or a subnational player). The amenable host country negotiates with the investor

76

Bundling of CDM-Forestry and Bioenergy

to protect a core forest and to manage a nearby forest for the production of biomass fuel. The host country would receive a payment for the Certified Emission Reductions (CERs) that presumably equals or exceeds the net present value of the opportunity costs of the land. These CERs would derive from carbon protected in the core forest and carbon-neutral fuel produced in the bioenergy forest replacing fossil fuel. The investor is assumed to pay a price per ton of carbon that is below her or his current carbon risk. Carbon risk, also called exposure or sometimes liability (not to be confused with the liability for long-term contracts discussed in Chapter 4) is assumed to be a function of the appropriately discounted probability of passage of a treaty, multiplied by the anticipated cost of compliance under ratification. For example, if a firm perceives that the probability of ratification of the Kyoto Protocol (or an equivalent treaty) is 20% and that under this regime, a ton of carbon will have an additional cost of $50/tC, it faces an (undiscounted) existing carbon risk of $10/tC. If this same firm could operate a successful forest conservation and bioenergy project in a developing country for less than $10/tC, it would do so assuming it is riskneutral. As the only form of early credits, the CDM offers Annex I Parties or sub-national players such as firms or states a way to hedge their carbon risk. In addition to the legal and technical difficulties (discussed in Chapter 3) there is an intense debate about the political and ethical issues of CDM forestry. Some developed countries (Annex I countries in the protocol), particularly the United States, see stopping or slowing tropical deforestation as a relatively inexpensive way to meet their commitments to reduce emissions under the Kyoto Protocol. Meanwhile, some key developing countries (Non-Annex I countries) view the CDM as a way for wealthy countries to buy their way out of a problem they created. Some Non-Annex I countries fear that the CDM is a form of ”carbon colonialism” (Cullet and Kameri-Mbote 1998). These countries see the discussion of forest management as an attempt by Annex I countries to return Non-Annex I countries to ”giant forests”. Political and ethical reservations of this kind will probably be more important in the decision to include the forestry sector in the CDM than any biological and economic advantages. In this paper, we discuss the main political issues -- from a developing and developed countries’ perspective -- of including tropical forest conservation into the Clean Development Mechanism. Moreover,


77

we explore how synergies between forest conservation and bio-energy projects, if packaged into tandem, could increase the profitability, acceptability and ecological integrity of forest-based emission reduction. Our main finding is that the bundling of bioenergy and forest conservation makes CDM projects more acceptable to local communities, more likely to succeed, more attractive to investors, and cheaper to site. This in turn may increase the political and economic support for the CDM and the Kyoto Protocol.

2.

DEVELOPING COUNTRIES’ PERSPECTIVE

At Kyoto, Non-Annex I countries did not commit to specific emissions reductions. A major objection was the belief that Annex I countries should ”clean up their own mess.” Furthermore, Non-Annex I countries held the position that new and additional funds, over and above the normal aid package, must be offered in order to obtain their participation. Furthermore, many Non-Annex I countries expressed concern about the CDM, fearing that heavy-handed investors would negotiate unfair contracts. Another factor that pre-disposed some developing countries against the CDM is the perception that having forests could become a potential liability. Logically, this notion must be predicated on the idea that eventually Non-Annex I countries will adopt binding commitments. Should Non-Annex I countries eventually agree to binding reduction targets, deforestation of these forests, which most likely will continue, would add to countries’ emissions sources. Non-Annex I countries generally fear that Annex I countries would exploit the CDM to make only trivial domestic reductions and would perpetuate inequality between Annex I and Non-Annex I countries, especially if forest management project could replace ”technology transfer” projects. However, CDM projects in the forest sector will not necessarily preclude other technology transfers such as improvements in energy efficiency or in the transportation sector. Secondly, no Non-Annex I country is obligated to agree to CDM projects. It is a purely voluntary opportunity and both parties must find it in their self-interest to join together in an agreement. Understandably, many Non-Annex I countries are more interested in assistance with industrial efficiency projects and

78


other technology transfers. The bundling of bioenergy and forest conservation could be a key factor to match developing countries’ and developed countries' needs in this respect, specifically if we assume a grass-roots perspective of development. The concern by some indigenous communities that conservation is not in their best interest is a real concern in many areas. Recent research on conservation and sustainable use of forests in Madagascar suggests that local and national benefits from conservation do occur and that the 'failure' of markets is to provide income to national interests (Kremen et al. 1999). Nonetheless, perceptions and case-by-case situations are what matters to local people. A bioenergy component would diversify local employment opportunities. While forest protection often can create jobs such as rangers, guards, or ecotourist operators, some bioenergy facilities would create industrial jobs. Finally, certain public opinion polls show more concern for tropical forests than for climate change in both developing and industrialized countries (Bloom 1995). Since bioenergy will be largely perceived as a climate change tool, grouping may make the project more acceptable to constituents in both investor and host countries. It is likely that some of the motivation for investors sponsoring forest projects in developing countries is related to their public relations efforts. If this is the case, a rather 'mundane' bioenergy project could piggyback on the investment potential generated by more alluring tropical forest conservation. This is especially true given that during the AIJ pilot phase, most of the U.S. projects were privately financed forestry projects (see Chapter 6 below). If investors have a range of options to explore and finance, then more participation will occur with a greater diversity of options. If a forest-protection CDM brings in investors who would otherwise not necessarily engage in CDM, then through institutional learning and portfolio diversification, more CDM projects will be initiated. This should actually bring more technology-based projects into action. In turn, this will also generate additional financial resources for countries vulnerable to climate change. 2 The CDM may also be its own best advocate. If the CDM were operationalized early by the negotiating parties, countries that welcome financial assistance in meeting stated sustainable development goals might realize substantial gain under the CDM. At that point, they will be able to


79

determine, based on experience and not mistrust, the potential pitfalls and opportunities of this unique instrument.

3.

DEVELOPED COUNTRIES’ PERSPECTIVE

Annex I parties have differing views on the role of forestry as a tool to mitigate climate change. The E.U. declared that LUCF-activities, domestic or abroad, are not a priority for meeting its Kyoto target (Commission of the European Communities 1998). Differently, the U.S. Initiative on Joint Implementation encourages tropical forest conservation as a mitigation tool (USIJI, 1995). The U.S. is a key developed country in this debate. The Protocol will only enter into effect on the date on which ”not less than 55 Parties to the Convention, incorporating Parties included in Annex I which accounted in total for at least 55 per cent of the total carbon dioxide emissions for 1990 of the Parties included in Annex I, have deposited their instruments of ratification, acceptance, approval or accession” (Article 25). Given the fact that almost 25% of the total global carbon emissions are released in the U.S., this country has effectively a veto on the Kyoto Protocol. In an unanimous vote the U.S. senate demanded some ”meaningful participation” of developing countries as a prerequisite for ratification. 3 Additionally, the senate resolution indicated that the Protocol would not be ratified in the Senate if it imposed intolerable costs on the U.S. economy. As we examined earlier (in Chapter 3.2), CDM activities, especially those of forest conservation, appear to be one of the cheapest forms of abatement currently available. 4 The CDM could thus help build support for the eventual ratification of the Protocol by the U.S. senate. The CDM also has an intrinsic political consequence as a result of its early credit nature. Figure 5.1 illustrates how an early inclusion of forest conservation in the CDM could effect the chance of the Protocol’s ratification in the U.S. Senate. Faced with the possibility that the Kyoto Protocol could be ratified (1), firms perceive a carbon risk (2). Some firms may then engage in projects that conserve tropical forest (3), one of the few early, relatively inexpensive actions available. By demonstrating achievable, low-cost reductions in developing countries, these firms would help dispel the two primary objections to the Protocol by the U.S. senate. Additionally, these

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early actors would then have a competitive advantage with ratification, since they would have sunk costs with a return only possible under ratification.

Figure 5.1: The Cycle of Early Mitigation and Ratification

1. Probability of

ratification

2. Perceived carbon risk by firms

4. Economic and political support

3. Early mitigation via forest conservation

These actors might then raise political and economic support for ratification (4), increasing its probability of ratification (1). This would then raise the carbon risk faced by other firms who might then undertake additional mitigation. Thus, early mitigation via forest conservation (in addition to other CDM activities) could conceivably trigger support that makes the Kyoto Protocol more likely to be ratified by the U.S. Senate. Interestingly, there is a demonstrated preference by some U.S. private investors for forestry as a tool for jointly implemented climate change activities (see Chapter 6 below). By extension, the amount of CDM projects would be expected to be greater if there are viable options in the forestry sector under Article 12. In conclusion, we anticipate the greater the role of forestry under Article 12, the greater the chance of the Protocol's coming into force.


4.

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SYNERGIES BETWEEN BIOENERGY AND FOREST CONSERVATION

Since bioenergy and forest protection measures are politically important, what strategy could help in their deployment? We suggest that integrating these two techniques may produce valuable synergies. To explore this further, we envision a hypothetical land area in a developing country. Below is a diagram (Figure 5.2) that shows potential synergies from a combined bioenergy/forest conservation project. In our example, we assume that the core forest would otherwise have been cut down. We also assume that the bioenergy forest will be managed sustainably in perpetuity and would replace fossil fuels. Figure 5.2: Synergies between Bioenergy and Forest Protection

Bioenergy Forest

Less core pressure Less edge effects Long term income Increase in hosts

Protected Forest

Natural biocontrols Climate-stability Natural seed bank Short term income Increase in sponsors

SILVICULTURAL SYNERGIES There may be silvicultural advantages to a combined project (IUCN/UNEP 1986). The seed bank in the natural forest could provide the bioenergy forest with locally available varieties of fast-growing timber. Local tree populations may also have evolved resistances to diseases that

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could threaten the more vulnerable bioenergy forests. It is also possible that by employing professional foresters in the bioenergy area, these experts may be able to repair or prevent anthropogenic damage in the protected area.

BIOLOGICAL SYNERGIES The natural core area will maintain a greater biological diversity in the project vicinity (Szaro and Johnston 1996). This diversity will include indigenous biocontrols that should have a spillover effect on the managed bioenergy forest. Natural predators, microorganisms, and a more diversified ecosystem in general may buffer against outbreaks of disease, fire and pests in the more simplified bioenergy forest. Diverse ecosystems are generally considered to be more resilient and biogeochemically more stable (Tilman et al. 1996, Naeem et al. 1994, Naeem and Li 1997, McGrady-Steed et al. 1997). This resilience may have some positive impact on the perseverance and health of the bioenergy forest. Both of these factors would be reflected in the profitability of the bioenergy forest. As opposed to a surrounding field or a pasture, a managed forest on the periphery will also supply some biological benefits to a core area forest. For example, the microbial community under a managed forest will probably be more advantageous to a natural forest than would be a field or pasture microbe population.

CLIMATE-RELATED SYNERGIES Tropical forest conservation secures secondary climate benefits that fossil fuel mitigation alone can not provide. Apart from their role as regulators, reservoirs and sources of GHGs, tropical forests provide numerous climate-stabilizing properties (Myers 1996, Myers 1997). We call these properties "climate-related ecosystem services". These are ecosystem services that directly or indirectly influence climate. In the tropics, where the majority of CDM projects will occur, forests are important stabilizers of local climatic conditions (Gash et al. 1996, Hastenrath 1985). While difficult to predict precisely, it is generally believed that a mature tropical forest will help maintain historic local


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climatic variables. Some of the climate-related ecosystem services that tropical forests maintain are listed in table 5.1. The microclimate maintained by a more resilient natural core forest might lessen the severity and/or frequency of fires or droughts in the bioenergy section. It is also possible that natural forests will maintain evolved micro-climatic conditions (such as increased humidity) that support growth in the bioenergy section. Going the other way, a bioenergy forest on the periphery may reduce edge effects such as wind, sunlight penetration and desiccation in the core forest.

Table 5.1: Climate-Related Ecosystem Services of Tropical Forests

As opposed to agricultural or pastural land uses, natural tropical forests maintain an evolved microclimate. In general, tropical forests: • • • • • • • • • • • • • • •

influence the planetary boundary layer’s height, alter sensible and latent heat fluxes maintain a lower albedo, influence heat, momentum and water vapor exchange with the atmosphere, buffer soil temperatures, elevate soil moisture, provide heat storage, elevate surface humidity, reduce sunlight penetration to the surface, increase surface roughness and mixing, slow and elevate winds, cool riparian waters, moderate evapotranspiration (especially losses in dry seasons), maintain relatively vigorous convection and precipitation rates, and inhibit anaerobic soil conditions.

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SOCIAL SYNERGIES A sustained-yield forest on the perimeter of a protected forest should diminish the pressures on natural forests. Local people that fear an outright protection scheme would deprive them of this essential resource might oppose a forest protection project. Any project sustainably maintaining this resource would benefit local communities. Furthermore, if sustainable fuelwood supplies also lead to a reduction in the use of fossil fuels, this could qualify for bioenergy credits. In any case, fuelwood shortages in many countries contribute to deforestation (Mercer and Soussan 1992). Any effort that reduces the cause of deforestation will be a valuable component of some CDM forestry projects. This decreased corepressure may have financial as well as social value. If a potential investor can demonstrate that fuelwood is still available in the vicinity of a CDM forest protection effort, she may be able to lower her insurance costs.

FINANCIAL SYNERGIES Bioenergy systems that rely on replanting or recovery before harvesting will have delayed income streams. By providing immediate protection of the core forest, an investor may be able to qualify for immediate emission reduction credits (CERs). These credits will probably not be assigned the entire annual amount up front since some form of liability will need to be imposed on the CDM parties (see Chapter 4). Nonetheless, some portion of the annual carbon that is conserved in natural forests should be accessible as an income stream (in the case of our proposed forest-secured escrow account, this immediate income stream would be the interest from the principal). Similarly, as the deviation from a baseline deforestation rate in the core area diminishes with time, the bioenergy component will provide a more durable income stream. The diversification of a CDM forest portfolio may strengthen the financial prospective of either project viewed independently. Additionally, by grouping the two processes together, social requirements such as the permit and citing processes will benefit from economies of scale. The other synergies discussed previously (i.e., decreased pests) should also increase the profitability of the combined project. Finally, a joint project could increase levels of local and foreign support for sustainable forest management. This may increase the overall


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level of investment in projects that must simultaneously garner local support and international financing. In doing so, early mitigation of climate change will increase. Increased early action in this manner will not only impact atmospheric greenhouse gas levels. It may also help persuade reluctant bodies that climate change can be mitigated with low cost sustainable development projects in developing countries.

5.

CONCLUSION

Bioenergy and forest conservation are separate processes, each reducing emissions through the use of sustainable forest management. Combining these two efforts in CDM projects may make the project more acceptable to local communities, more likely to succeed, more attractive to investors, and cheaper to site. This in turn may raise the overall level of early mitigation, since forestry projects have been the preferred bilateral way of offsetting carbon emissions by some industrialized countries. If the level of early mitigation in the years 2000-2008 is enhanced, this may increase the political and economic support for an international climate change policy such as the Kyoto Protocol. Unfortunately, positions at the recent COP6 negotiations did not nurture this type of support. Forest conservation was tentatively excluded from eligibility under the CDM before the talks ended without agreement. This precedent could unfortunately move climate policy away from learning about sustainable forestry and the CDM, which in turn would reduce carbon risk and the chance of getting Kyoto ratified. Acknowledging the sobering realities of implementation at the domestic level, we urge negotiators in Bonn (COP6/II) to rethink this surprising negotiation swoop as part of our suggested “extended flexibility”-approach (see Chapter 7).

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REFERENCES Bloom, D.E., 1995, International Public Opinion on the Environment, Science 269: 354358. Cullet, P., Kameri-Mbote, P., 1998, Joint implementation and forestry projects: conceptual and operational fallacies. Journal of International Affairs 74 (2): 393-408. Commission of the European Communities, 1998, Climate Change - Toward an EU-PostKyoto Strategy. Communication from the Commission and the European Parliament (COM98-353), Bruxelles. Food and Agricultural Organization (FAO), 1999, State of the World's Forests. FAO, Rome/Italy. Gash, J.H.C., Nobre, C.A., Roberts, J.M., Victoria, R.L., 1996, Amazonian Deforestation and Climate, New York. Hastenrath, S., 1985, Climate and Circulation in the Tropics, Dordrecht/Holland. IUCN/UNEP, 1986, Managing Protected Areas in the Tropics, IUCN, Gland/Switzerland. Jepma, C.J., Munasinghe, M., 1998, Climate change policy. Facts, issues, and analysis, Cambridge/UK. Kremen, C., Niles, J., Dalton, M., Daily, G., Ehrlich, P., Fay, J., Grewal, D., Guilery, R.P., 2000, Economic Incentives for Rainforest Conservation Across Scales, Science 288: 1828-1832. McGrady-Steed, J., Harris, P.M., Morin, P.J., 1997, Biodiversity regulates ecosystem predictability, Nature 390: 162-165. Mercer, D.E., Soussan, J., 1992, Fuelwood Problems and Solutions, Chapter 8 in Sharma, N.P. (ed.), Managing the World's Forests: Looking for Balance Between Conservation and Development, Dubuque, IO. Myers, N., 1997, The world’s forests and their ecosystem services. Chapter 12 in, Daily, G.C. (ed.), Nature’s Services: Societal Dependence on Natural Ecosystems, Washington, D.C. Myers, N., 1996, Environmental services of biodiversity. Proceedings of the National Academy of Sciences 93: 2764-2769. Naeem, S., Li, S., 1997, Biodiversity enhances ecosystem reliability, Nature 390: 507-509. Naeem, S., Thompson, L.J., Lawler, S.P., Lawton, H., Woodfin, R.M., 1994, Declining biodiversity can alter the performance of ecosystems, Nature 368: 734-737.


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Niles, J., Schwarze, R., 2000, Long-term Forest Sector Emission Reductions and Article 12, in: Robertson, K.A., Schlamadinger, B. (eds.), Bioenergy for mitigation of CO2 emissions: the power, trnasportation, and industrial sectors, Proceeedings of the IEA Bioenergy Task 25 Workshop in Gatlinburg/TN, September 27-30, 1999, Joanneum, Graz/Austria. Pearce, D., Day, B., Newcombe, J., Brunello, T., Bello, T., 1998, The Clean Development Mechanism: Benefits of the CDM for developing countries, CSERGE/UC London. Smith, J.; Mulongoy, K.; Perrson, R.;, Sayer, J., 1998, Harnessing Carbon Markets for Tropical Forest Conservation: Towards a More Realistic Assessment, International Academy of the Environment Working Paper, Geneva. Szaro, R.C., Johnston, D.W. (eds.), 1996, Biodiversity in Managed Landscapes: Theory and Practice. Oxford University Press, Oxford/UK. Tilman, D., Wedin, D., Knops, J., 1996, Productivity and sustainability influenced by biodiversity in grassland ecosystems, Nature 379: 718-720. USIJI, 1998, Unique Aspects of U.S. Initiative on Joint Implementation Projects. From: www.ji.org.usiji/unique.html. Victor, D.G., Nakicenovic, N., Victor, N., 1998. The Kyoto Protocol Carbon Bubble: Implications for Russia, Ukraine and Emission Trading, International Institute for Applied Systems Analysis, Laxenburg/Austria (forthcoming Climatic Change).

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1

2

3

4


Revised and extended version of a paper presented at the IEA Bioenergy Task 25 workshop "Bioenergy for mitigation of CO2 emissions" on September, 27-30, 1999, in Gatlinburg/Tennessee (Niles/Schwarze, 2000). A tax on CDM activities to finance mitigation in developing countries was included in Article 12. In 1997, by a vote of 95-0, the U.S. Senate passed the Byrd-Hagel Resolution. This resolution stated that the senate would not ratify any climate change treaty if it 1) did not involve developing countries, nor 2) if it was unreasonably expensive. Cp. Halsnaes et al., 1996, Tab. 9.3.5.

Chapter 6 Activities Implemented Jointly: An Empirical Analysis 1 Reimund Schwarze

1.

INTRODUCTION

The first Conference of the Parties (CP.1) to the United Nations Framework Convention on Climate Change (UNFCCC) in Berlin (1995) established a program of so-called Activities Implemented Jointly (AIJ). Under this program, greenhouse gas reduction and sequestration projects can be carried out through partnerships between an investor from a developed country and a host from a developing country or a country with an economy in transition. 2 The purpose of this program is to enhance the transfer of technology and know-how on global warming protection from developed to developing countries and to gather experience on the opportunities and obstacles for the joint implementation of policies and measures to avert climate change. The AIJ experience will help to elaborate the design of project-based mechanisms outlined in Article 6 and Article 12 of the Kyoto Protocol (UNFCCC, 1997a), which are respectively known as Joint Implementation (JI) and the Clean Development Mechanism (CDM). The Subsidiary Body for Scientific and Technological Advice (SBSTA) of the UNFCCC was asked to review the experience of AIJ and, with the assistance of the UNFCCC Climate Secretariat in Bonn, to prepare a synthesis report on AIJ to the Conference of the Parties on a regular basis. At the time of writing of this article the second report has been published (UNFCCC, 1998). This report as well as the first report (UNFCCC, 1997b) takes a descriptive and predominantly institutional

90

Activities Implemented Jointly

look at the facts. It addresses mainly questions of reporting, assessment methods and procedures. This led me to do an independent study, which takes a more analytical approach. In this study, I identify some additional information, e.g. on GHG mitigation cost. And I correct some false general beliefs on AIJ, e.g. the belief in a lack of private participation. As another new result, I discover a pattern of regional-specific investment portfolios, which differ significantly between the U.S., Japan and European countries. These investment patterns can be traced back to differences in the national AIJ programs of investor and host countries (UNFCCC, 1997c). These national programs set out the objectives and criteria for the government approval of AIJ projects. 3 Another influence comes from the established national links of trade and general development aid. Other issues discussed in this paper are the baseline issue and transaction cost.

2.

THE DATA

This study is based on AIJ projects that have been reported to the UNFCCC by designated national authorities (DNA) and presented by the UNFCCC on its web-site as of 04/30/99. 4 The source for the AIJ of Japan is a detailed report of the New Energy and Industrial Technology Development Organization (NEDO) on 7 mutually agreed AIJ projects (NEDO, 1998). Combined, this study consists of 103 activity reports 5 on 143 projects 6 from 36 countries (27 host and 9 investor countries) with a total of approximately 170 million tons (Mt) of emissions reduced. 7 Except for the Japanese projects, the data were taken as found in the standardized reporting formats (URF or USIJI-URD). No adjustments were made to this data even though there are numerous deficits in the current DNA reports, e.g. great differences in the quality and the methods of reporting (Ellis, 1999). The ”take it as you find it”-approach of this study can be justified on two grounds. Firstly, any adjustments of the original data would have implied arbitrary reporting requirements and methods beyond the ones established by the Berlin Mandate. Secondly, the results presented in this paper proved to be robust in two sampling experiments, one in which I omitted 25 projects in the planning stage, and another based on a smaller sample of 96 projects (Schwarze, 1998). Based on the analysis of these data I have been able to identify six major issues on AIJ:

Law and Economics of International Climate Change Policy • • • • • •

91

the timing of AIJ the regional distribution of AIJ the distribution of activity types the private sector participation in AIJ the baseline issue the cost of AIJ. The results will be presented in this order.

3.

THE TIMING OF AIJ Figure 6.1: Activity starting date

50 46 45 40

number of projects

35 30 25 25

22

20

18 16

15 10

8 5

5

2

1

0 1992

1993

1994

1995

1996

1997

1998

1999

n.a.

Decision 5/CP.1 stipulates that the pilot phase for AIJ begins in 1995 and ends at the latest in 1999 (UNFCCC, 1995). It was only in late 1999 that the parties to the UNFCCC in Bonn decided to prolong the pilot

92


phase beyond 1999 for a yet undetermined period (UNFCCC, 1999). Given this schedule, one might expect that AIJ would be mainly pursued during the five-year period 1995 to 1999. As Fig. 6.1 reveals, a great number of projects do not conform to this expectation. Looking at the project starting date, we find that 29 projects were initiated before the program was introduced in 1995, and 16 projects have not been implemented by now, which implies that they will start on a date later than 1999. Only 98 projects (or 69%) were taken up during the AIJ period of the Berlin Mandate. 8 This picture becomes even more pronounced if we look at the project ending date. Here we find that virtually all projects have a lifetime exceeding 1999. In fact, the average duration of projects is 21 years. Thus, the true effects of AIJ are largely realized outside the stipulated AIJ program period. This evidence suggests that AIJ projects have been undertaken to a great extent independent of the AIJ program and largely with the expectation that the pilot phase would be prolonged beyond 2000 or transferred into a program with crediting. 9

4.

REGIONAL DISTRIBUTION OF AIJ

The 1998-report on AIJ by the UNFCCC (UNFCCC, 1998) points out that "the geographical distribution of activities ... shows a marked imbalance". This analysis confirms this view (see Fig. 6.2): Out of 139 projects 10 , 95 projects (68 %) were located in Economies in Transition. Only 32% of the projects were located elsewhere, mainly in Latin America (19%). Considering the amount of GHG reduced, however, a more balanced picture emerges. The greatest effect of GHG reduction will be achieved in Latin American countries with 44% of all GHG reduced or sequestered located there as compared to only 30% in Economies in Transition. This contradicting evidence on the regional distribution of AIJ can be traced back to a general heterogeneity of AIJ projects: the average amount of GHG reduced by project is five times larger in Latin America than in Central and Eastern Europe. The respective values of the average project size are 3.2 Mt CO2 for Latin America and 0.6 Mt CO2 for Economies in Transition. This is due to the fact that some European investor countries (e.g. Sweden) with a large number of investments in EITs (e.g. 50 projects) have stipulated in their national programs that AIJ


93

shall be "small to allow for quick implementation" (www.unfccc.de/ program/aij/aijprog/aij_pswe.html). 11 Figure 6.2: Regional distribution of AIJ

12% 10%

APC

30%

EIT

68%

44%

LAC

19% Percentage of GHG reduced Share of Projects

14%

AFR

3% 0

10

20

30

40

50

60

70

APC= Asian Pacific Countries; EIT= Economies in Transition; LAC= Latin American Countries; AFR= African Countries

Looking at the share of projects in Fig. 6.2, we can also confirm the view of the UNFCCC that "the bulk of current AIJ is between Annex I Parties” 12 (UNFCCC, 1997b, 4, reaffirmed in UNFCCC, 1998, 4). Since only EIT hosts and all investor countries are in Annex I, we can easily figure out that 68 % of all projects (i.e. the EIT share) has been between Annex I-Parties. Only 32% (the remaining share) has taken place between Annex I- and the Non-Annex I-Countries of Latin America, Africa and the Asia Pacific region. There is one plausible explanation for this pattern of cooperation. Most projects were initiated before the Kyoto-Conference in 1997 which implies that they were done under the reasonable expectation that AIJ projects would (if at all) be incorporated after 2000 into a program of joint implementation between Annex I-Countries only. Before the Clean Development Mechanism (CDM) was introduced in Kyoto it was rather unsure whether AIJ with Non-Annex I-Countries could ever be used to support Annex I countries fulfill their emission reduction

94


commitments. Thus it was much more attractive for Annex I-Countries to invest in the Annex I-Countries of Central and Eastern Europe rather than in Non-Annex I-Countries elsewhere in the world. However, this is only one explanation for the observed pattern of cooperation in AIJ. Looking at the regional investment portfolios in Fig. 6.3, another reason emerges, which I will call the "neighborhood trading"-hypothesis. Figure 6.3: Regional specific investment portfolios (number and share of projects)

9

APC

3

NAC

23

7

EUR 2

0%

AFR LAC EIT APC

4 4

91

20%

χ2 = 165.3*

40%

60%

CC = 0.732*

80%

100%

τ = 0.511*

Reviewing the investment portfolio of Asia-Pacific investor countries (APC), i.e. Australia and Japan, we find that all nine projects take place within neighboring Asian-Pacific economies, predominantly in China. In the case of Europe (EUR), projects in EITs dominates the AIJ portfolio by almost 90% (91 of 101 projects). In the U.S. (NAC) 23 of a total of 35 projects (66%) are located in Latin American Countries (LAC). This pattern of intra-Asian, intra-European and intra-American cooperation ("neighborhood trading") is significant according to 13 contingency analysis indicators. It can be explained by reference to the established institutional links of development cooperation. Examples are the hemisphere


95

partnership for development of the 1994 Summit of the Americas (U.S. Department of State, 1995), and the Baltic Sea Region Initiative of the Nordic States and the EU (Baltic Sea States Summit, 1996; Commission of the European Communities, 1996). Figure 6.4: Regional specific investment portfolios (amount in $ mill. and share of investor funding)

APC

27

APC NAC

EIT

47

2

LAC AFR

EUR

5

0%

χ2 = 262.2*

5 2

77

20%

40%

60%

CC = 0.784*

80%

100%

τ = 0.755*

In the case of Australia and Japan, the focus on neighboring AsiaPacific economies is a stated, trade and development policy-related objective of the national AIJ programs. The International Greenhouse Partnerships Office (1997) of Australia states as one main objective of AIJ ”to enhance Australian trade and investment links in environmental technology and services… particularly in the Asia-Pacific region”. This view is reaffirmed in an interview with Hugh Withycombe (1997), project officer of the AIJ Australia office. The Government of Japan is cited to believe ”that the role of Japan is to share technologies with other countries, especially with Asian economies” (Matsuo, 1996). Recently the Government of Japan initiated an effort to cooperate with Russia to

96


broaden its regional scope of AIJ (Matsuo, 1998), but this effort has not yet led to actual projects between these countries. This result becomes even more pronounced if we look at the flows of AIJ investment in Fig. 6.4. Based on a study of 117 projects with a declared composition of funding, we find that US$ 77 million (89%) of the total European AIJ funding went to neighboring EITs. US$ 47 million of a total U.S.-funding of US$ 49 million went to LACs. Stemming from their regional focus on the Asia-Pacific region, the AIJ investment of Japan and Australia (US$ 27 million) remains entirely within that region.

5.

DISTRIBUTION OF ACTIVITY TYPES

Climate change mitigation activities can be classified as related to energy efficiency (EEF), renewables (REN), fuel switching (FUE), fugitive gas capture (FGC), land use change and forestry (LUCF) 14 ,

Figure 6.5: Activity type

31%

REN

16%

32%

EEF

FUE

25% 16% 2%

Share of project s Share of GHG reduced

4%

FGC

19% 17%

LUCF

38%

0%

5%

10%

15 %

20%

25 %

30%

35%

40%

REN= Renewables, EEF= Energy efficiency, FUE= Fuel substitution, FGC= Fugitive gas capture, LUCF = Land use change and forestry


97

agriculture, industrial processes, solvents, waste disposal and bunker fuels. Only the first five indicated activity types have been implemented in AIJ (see Fig. 6.5). 15 The majority of projects (83%) have been technical by nature, in energy-related activities (EEF, FUE, REN or FGC). Only 17% of the projects have been related to LUCF activities (forest preservation, reforestation and afforestation). Looking at the share of GHG reduced or sequestered a rather different picture emerges. LUCFprojects account for more than 38% of the GHG reductions as compared to a remainder of 62% for all other emission mitigation activities. This result is largely due to the fact that LUCF projects exhibit a much longer lifetime (39 years on average) than average AIJs (21 years). Again, this contradicting evidence can be traced back to the great heterogeneity of the projects. As can be seen in Fig. 6.6, the average GHG reduction per project is much greater in LUCF-related activities compared to fossil fuel-related activities. A very notable exception to this is fugitive gas capture, which shows the largest GHG reduction per project. Figure 6.6: Average GHG reduction by activity types (Mt CO2)

7 6

5 .5

5 4 2 .8

3 2 1

0 .6

1 .0 0 .1

0 REN

EEF

FUE

FGC

LUCF


98


It is of some interest to look at the regional distribution of investment on different activities (Fig. 6.7). Europe, Japan and Australia focus on technological mitigation activities (EEF, FUE, FGC, and REN) while the United States displays a much greater involvement in forestry projects (LUCF). These regional specific investment portfolios can be traced back to the provisions from national AIJ programs. Several European national AIJ programs exhibit preferences for fuel switching and energy efficiency related projects (e.g. in Germany and Switzerland) or for quickly implementable small investments (in Sweden), whereas in the United States no particular focus on project type and size can be found in the national AIJ program. In the case of Japan and Australia again, we find a consistent priority of ”sharing of environmental technology and services” in both national AIJ programs (see above section 3.2). Figure 6.7: Regional specific activity portfolios (number and share of projects)

1

APC

1

7

LUCF NAC

10

3

FGC

18

2

EEF/ FUE REN

EUR

33

0%

20%

χ2 = 56.99*

3 5

60

40%

60%

CC = 0.534*

80%

100%

τ = 0.153*

Another influence on the observed distribution of activity types stems from national AIJ priorities of host countries. For example, the government of Poland, who is host of twenty-one projects of coal-to-gas


99

conversion and four projects of energy efficiency enhancement, selected this portfolio with the aim ”to achieve technological development and upgrade equipment in activities that directly reduce the generation of GHG in production of goods and services”. On the other hand, the government of Costa Rica promoted projects in the forestry sector ”to claim the cost of environmental services executed by private forest owners at international level”. Costa Rica hosts fifteen AIJ projects, eleven of which are LUCF-related, i.e. in sustainable forestry, reforestation and forest preservation. 16 There is a suggestive link between the observed regional pattern of AIJ (“neighborhood trading”) and the sectoral pattern of AIJ. Private U.S.-investors, looking for AIJ in their neighborhood, find hosts who favor forestry projects, which confirm to the USIJI-criteria of project diversity and cost-effectiveness. Public or publicly co-financed private investors in Europe and Japan find hosts in their neighborhood (EIT and China), who share the goals of energy efficiency and fuel substitution. Of course, the actual reasoning for each AIJ project may have been quite different, but this is the typical reasoning that the aggregate data suggest. Figure 6.8: Share of GHG reduced by gas type

N 2O 4% CH 4 19%

`

CO 2 77%

100


Another general result is the dominance of CO2-related projects (see Fig. 6.8): 77% of all GHG reductions from AIJ are occurring as CO2 reductions. Of the remainder 4% is going to N20 and 19% to CH4. The share of these gases is still remarkably high because it results from very few projects. The share of CH4 comes from only six projects of fugitive gas capture with an average GHG reduction per project of 5.5 Mt CO2 equivalents (see Fig. 6.5). The N20 reductions are virtually all from one Integrated Agricultural Demand Side Management project in India (indnor01-98). The higher global warming potentials 17 of these gases largely contribute to the high efficiency of projects in this field on the per project basis (Fig. 6.6) and on the per dollar basis (Fig. 6.12).

6.

PRIVATE SECTOR PARTICIPATION IN AIJ

AIJ is conceptually a program of bilateral cooperation between countries. Private sector involvement is not a formal part of the program. It has been delegated to the Parties to the Convention to induce private sector participation and funding, e.g. by crediting emission reductions from AIJ against national CO2 tax duties or voluntary commitments by national industrial sectors. However, such incentives are not existing in any national program. On the contrary, most countries have explicitly foreclosed the opportunity to credit AIJs at the national level (see UNFCCC, 1997c). Thus we should expect that private investment in AIJ is insignificant. Looking at the share of private funding in Fig. 6.9, however, we find a surprisingly large amount of private investment of $ 140 million, which compares to $ 47 million of public investor AIJ funds. There is also a remarkable large share of public non-AIJ related funding, e.g. from the Global Environmental Facility of the World Bank or bilateral direct aid. This result is based on a study of the investor country funding in 131 projects, for which funding data were available. Extending our analysis to the reports with non-available investor funding, we can identify an even larger degree of private sector participation in AIJ. Of the missing 12 projects with total cost of $ 96 million at least 50% will be privately financed because these projects are initiated exclusively by private sector entities.


101

Figure 6.9: Private sector funding share

Public 46 Mio. US $

Private 140 Mio. US $

Public (NonAIJ) 56 Mio. US $

Most of the private funding is from U.S.-investors as can be seen in Fig. 6.10. In this figure, AIJ projects were classified as private, public or mixed according to their funding composition. In the case of nonavailable funding data, projects were classified according to an exclusive private, public or a mixed institutional participation in the financing of the projects. Looking at the share of private projects, we find that private U.S.-investors funded 31 out of the 38 private projects, whereas only 6 private European projects and one private Australian project were reported. This result can be related to the fact that the U.S. Initiative on Joint Implementation explicitly encourages privately initiated projects (USIJI, 1998). We may halt at this point to establish an interim result: AIJ investment exhibits regional specificity. It greatly differs between the U.S., Asian and European investor countries. U.S.-projects are typically (i) large in cost and effects, (ii) not particularly focused on technologies, and (iii) privately initiated. They are overwhelmingly implemented in Latin American countries. European projects, on the other hand, are typically small, publicly funded and related to energy efficiency and fuel substitution. They are predominantly located in EITs. Asian projects are somewhat similar to European projects, i.e. they are small and publicly co-financed, however, they are exclusively

102


focused on the Asia-Pacific region. The public funding of AIJ projects is much smaller in Japan than in Europe. In Japan, we find government support for five projects in an amount of US$ 0.9 million. This compares to government support for AIJ of US$ 42 million in the Netherlands (FY 1996-1999, 12 projects), US$ 40 million in Sweden (FY 1993-1997, 42 projects) or US$ 18 million in Norway (FY 1995-1999, 32 projects). Figure 6.10: Regional specific funding portfolios (number and share of projects)

APC

1

8

private NAC

31

02 public mixed

EUR

6

0%

91

20%

χ2 = 172.7*

7.

40%

4

60%

CC = 0.740*

80%

100%

τ = 0.673*

ON THE BASELINE

The determination of a reference case of emissions ("baseline") to be compared to the projected or actual emissions of an activity is a crucial issue in emission reductions crediting. While AIJ is formally not a crediting approach, it still calls for a comparison of a reference case and a projected or actual emission scenario to establish the amount of GHG reductions from a project to be reported to the UNFCCC. Experience with


103

AIJ can thus help to identify a practicable and acceptable method for baseline determination. Several methods and procedures for baseline determination have been proposed in the literature on joint implementation (see Chomitz, 1998; Michaelowa, 1998; Ellis, 1999; or, for a brief overview, Jepma, 1997). For the purpose of this study, I have developed a simplified scheme of four indicators taken from the designated national authorities’ reports to characterize observed patterns of baseline assessment. The first two of these indicators are related to the method of defining the reference scenario, where I distinguish between a static and a dynamic baseline (S/D) on the one hand, and between a fixed and an adjustable baseline (F/A) on the other. In a stylized way we may define a static baseline as resulting from an extrapolation of the status quo over the entire lifetime of a project, whereas a dynamic baseline is established by considering changing trends of technology, economic policy, behavior etc. The keywords to identify a static approach in the DNA-reports is "unchanged over lifetime of the project" which may apply to deforestation rates, energy efficiency or energy demand. A dynamic approach, on the other hand, can be identified in the DNA-reports either by models on future energy and environmental trends or simply by a reference to new domestic technologies (common in the host country) instead of existing technology. A fixed baseline can be defined in a stylized way as a "once and for all"-approach: Once defined, the baseline will be valid over the entire project duration. It will not be adjusted according to new information arising in the course of project implementation. An adjustable baseline, on the other hand, will account for unforeseen outside developments that affect the reference scenario. Under an adjustable baseline such developments would lead to re-accounting of emission reductions. A reaccounting of emission reductions during the implementation of a project may either result from a changed reference scenario, e.g. due to a decreasing energy demand, or from a changing project scenario, e.g. from unexpected technical problems and thus increasing emissions of the project. The reader should be aware that adjustability as defined above is applying to a changed reference scenario, not to changed project emissions. Another important characteristic of determining emission reductions from projects is the choice of the scope of the project or system boundary. Two methods of accounting can be distinguished in this

104


respect: an accounting of direct or primary effects (Di), and an accounting of indirect or secondary effects (Id). Typical secondary effects of AIJ are leakage from shifting deforestation, or an increased energy demand in the course of an increased efficiency of usage - the so-called "snapback effect". A final characteristic of baseline assessment is the verification procedure, which can either be, performed internally (I) or externally (E) by third parties, e.g. Non Governmental Organizations. 18 Figure 6.11: Baseline 160

number of projects

137

133

140 120 100

97

93

80 60

48

43

S = Static D = Dynamic F = Fixed A = Adjusted Di = Direct Id = Indirect I = Internal E = External

40 20

8

4

0 S/D

F/A

Di/Id

I/E

Fig. 6.11 depicts a dominating S-F-Di-E-pattern of baseline assessment, i.e. a predominant static, once-and-for-all-approach in determining the baseline, which is concentrated on direct effects and verified externally. Compared to possible alternative approaches this is a rather simple and straightforward approach, which is only complicated by the involvement of third parties in the process of verification. This pattern is plausible since AIJ are not eligible for real credits. The wide use of expensive external verification, on the other hand, can be attributed to the strong support given to this procedure in several national AIJ programs, e.g. in the U.S. or Costa Rica (see UNFCCC, 1997c).


8.

105

COST OF AIJ

The costs of AIJ projects has not been reported in the UNFCCC’s synthesis reports because of the patchy and partly inconsistent cost data in the original DNA-reports (see UNFCCC (1998), 5, 12). Looking at aggregate data (where some failures cancel out), we can establish a credible and consistent picture of AIJ cost. In Fig. 6.12 the reader finds the average total cost per ton of CO2 equivalent reduced by activity type. Total cost includes investment cost, operating cost (if available), project development cost as well as transaction cost for monitoring, verification and general project administration. Looking at these figures, we find that fugitive gas capture (FGC) is by far the cheapest way to reduce GHG, closely followed by LUCF-activities and activities related to energy efficiency (EEF). Each of these options is costing less than $ 4 per ton of CO2 equivalent reduced. Figure 6.12: Gross average reduction cost by activity-type ($/t CO2) 18 15.4

16 14.0 14 12 10 8 6 3.2

4

2.6

2 0.1 0 REN

EEF

FUE

FGC

LUCF


Given our gross total cost-approach, this is an absolute rockbottom figure. It compares to a UNEP estimate of US$ 14 per ton of CO2,

106


which is based on a Non-Annex I multi-country study (UNEP, 1994). It is also well below the recent, very optimistic estimate of the price of CO2permits on an international emission trading market of the Clinton Administration. 19 Figure 6.13: Net average reduction cost by activity-type ($/t CO2)

18 15,3

13 8 3

FGC

-2 -7

FUE

REN -3,2

EEF -2,4

-7,7

LUCF -1,8

-12 REN= Renewables, EEF= Energy efficiency, FUE= Fuel substitution, FGC= Fugitive gas capture, LUCF = Land use change and forestry

Furthermore, if we take into account that most AIJ are generating revenues from fuel savings or selling of forest products and services (the amount of which can not be easily extracted from available data), these AIJ options are clearly "no regrets", i.e. options with negative cost. Based on a sub-sample of 63 projects (44%) with declared project revenues, we find that all AIJ, except for coal-to-gas fuel-substitution projects, provide revenues higher than costs (see Fig. 6.13). 20 Cost savings are highest for fugitive gas capture (FGC), and of similar size for renewables (REN), energy-efficiency (EEF) and LUCF-activities. These results are compatible with the results of previous cost studies on early mitigation activities (e.g. Halsnaes, 1996; Ridley, 1998).


9.

107

SUMMARY AND IMPLICATIONS

The UNFCCC-reported projects give a rich but rather patchy picture of AIJ. Projects are unevenly distributed by region, size and activity type; emission reductions and cost figures are based on rather different accounting methods, and figures on project revenues are largely missing. In this study, I have attempted to sort out these figures without making any changes to the original data. From these data I find that AIJ is very much influenced by regional factors, particularly by national AIJ programs. Specifically I find that regional investment portfolios in the United States on the one hand, and Europe and Japan on the other are rather different. U.S.-projects are typically large in cost and environmental effects, privately initiated and located in the Latin American countries. European and Japanese projects are typically small, publicly funded and located in Economies in Transition and China. This regional pattern of AIJ can be related to proximity (”neighborhood trading”) and to the established institutions of trade and development aid (lower transaction cost). Another general result of this analysis is the cost minimizing feature of AIJ. AIJs are overwhelmingly no regret-measures with zero or negative cost. Applying simple and straightforward methods of baseline determination has minimized transaction costs. The exception to this is the verification procedure where expensive external verification prevails. This general result is consistent with a program design that prohibits the opportunity of crediting of emission reductions at the international and to a large extent at the national level, too. How does this finding of ”national preferences” affect the efficiency of project-based ”Kyoto mechanisms” such as CDM and JI? Since these Kyoto mechanisms clearly resemble AIJ in the need for government approval we expect that future Jl and CDM national programs will influence the amount and structure of trading as in AIJ. Basic economic reasoning then tells us that regulatory preferences diminish the efficiency of trade compared to a free market, because marginal costs are not equal among participants. However, based on our empiricism this result needs to be qualified. As long as we are talking ”no regrets” (i.e. as long as mitigation projects come at zero or negative cost), national preferences only diminish the amount of cost savings that will be exploited. This may be the price worth paying to achieve sustainable

108


development in Non–Annex I countries and meaningful participation of these countries in the early phase of international climate change policy. Table 6.1: AIJ Projects (1995 – 1999) R eport

H os t

aus fij01-98 F iji belc ro01-98 C roatia bfanor01-98 B urkina F as o bhundl01 B hutan blzus a01-98 B elize c rinld01-98n C os ta R ic a c rinor01-98 C os ta R ic a c rius a01-98 C os ta R ic a c rius a02 C os ta R ic a c rius a03 C os ta R ic a c rius a04 C os ta R ic a c rius a05 C os ta R ic a c rius a06 C os ta R ic a c rius a07a C os ta R ic a c rius a08-98 C os ta R ic a c zefra01-98 C zec k R e p. c zendl01-98 C zec h R ep. c zeus a01-98 C zec h R ep. deul va01 Latvia deurus 01 R us s ia ec uus a01-98 E c uador es ts w e01 E s tonia es ts w e02-98 E s tonia es ts w e03 E s tonia es ts w e04 E s tonia es ts w e05 E s tonia es ts w e06 E s tonia es ts w e07 E s tonia es ts w e08 E s tonia es ts w e09 E s tonia es ts w e10 E s tonia es ts w e11 E s tonia es ts w e12-98 E s tonia es ts w e13 E s tonia es ts w e14 E s tonia es ts w e15-98 E s tonia es ts w e16 E s tonia es ts w e17-98n E s tonia es ts w e18-98n E s tonia es ts w e19-98n E s tonia hndus a01-98 H onduras hndus a02 H onduras hndus a03 H onduras hunndl01 H ungaria hunndl02 H ungaria

In ves tor Aus tralia Belgium N orw a y N etherlands USA N etherlands N orw a y USA USA USA USA USA USA USA USA F ranc e N etherlands USA G erm any G erm any USA Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden Sw eden USA USA USA N etherlands N etherlands

Subprojec ts S tarting date G H G reduc ed [t C O 2] 1 1997 265 1 1997 50250 4 1997 251690 00 1 1996 25 2 1995 602399 2 1 1998 3687,27 2 1997 846405 1 1995 128469 0 1 1995 222817 4 1996 217767 49 1 1996 36194 2 n.a. 184800 00 1 1996 210796 1 1997 n.a. 1 1997 57203 1 n.a. 168000 2 1992 101980 00 2 1995 607150 1 1995 7073 1 1997 225000 1 n.a. 117010 8 1 1994 85000 1 1995 2712 1 1994 2000 1 1997 3900 1 1994 48600 1 1996 8500 1 1994 32250 1 1996 9100 1 1993 53000 1 1994 7000 1 1994 2200 1 1994 147000 1 1994 40000 1 1994 3000 1 1993 85000 1 1994 101000 1 1996 n.a. 1 1997 291250 1 1997 97357 1 1997 34398 1 1997 237394 0 1 1997 237394 0 1 1995 7400 1 1994 240000

Law and Economics of International Climate Change Policy R eport

H ost

idnusa01-98 Indonesia indnor01-98 India lk ausa01-98 S ri Lank a ltusw e01 Lithuania ltusw e02 Lithuania ltusw e03 Lithuania ltusw e04 Lithuania ltusw e05 Lithuania ltusw e06 Lithuania ltusw e07 Lithuania ltusw e08-98 Lithuania ltusw e09-98n Lithuania lvanld01-98 Latvia lvasw e01 Latvia lvasw e02 Latvia lvasw e03 Latvia lvasw e04 Latvia lvasw e05 Latvia lvasw e06 Latvia lvasw e07 Latvia lvasw e08 Latvia lvasw e09-98 Latvia lvasw e10 Latvia lvasw e11 Latvia lvasw e12 Latvia lvasw e13 Latvia lvasw e14 Latvia lvasw e15 Latvia lvasw e16 Latvia lvasw e17 Latvia lvasw e18 Latvia lvasw e19-98n Latvia lvasw e20-98n Latvia lvasw e21-98n Latvia lvasw e22-98n Latvia m exnow 01 M exico m exusa01-98 M exico m exusa03-98nM exico m exusa04-98nM exico NEDO C hina NEDO C hina NEDO C hina NEDO Indonesia NEDO Indonesia NEDO T hailand

Investor USA N orw ay USA S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden N etherlands S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden S w eden N orw ay USA USA USA Japan Japan Japan Japan Japan Japan

109

S ubprojects S tarting date G H G reduced [t C O 2] 2 n.a. 134379 1 1998 8115660 1 1998 5684448 1 1995 72700 1 1994 22000 1 1996 36500 1 1995 194690 1 1995 147000 1 1996 3300 1 1994 16350 1 1993 127254 1 1998 n.a. 2 1997 n.a. 1 1995 58250 1 1994 4120 1 1995 17000 1 1996 45000 1 1995 31250 1 1994 30750 1 1996 19000 1 1994 31000 1 1995 195000 1 1993 65670 1 1994 159500 1 1996 46700 1 1995 2100 1 1996 3350 1 1995 800 1 1994 40000 1 1996 30850 1 1995 17000 1 1997 62928 1 1997 142100 1 1997 1980 1 1997 4640 1 1994 727130 1 1996 1080 1 n.a. 3065333 1 1998 7415 1 n.a. 1360000 1 n.a. 510000 1 n.a. 1440000 1 n.a. 1820000 1 n.a. 1040000 1 n.a. 62000

110


R e p o rt

H ost

In v e s to r

NEDO n ic u s a 0 1 n ld ro m 0 1 n ld ru s 0 1 n ld ru s 0 2 n o rp o l0 1 a n o rp o l0 1 b n o rs v k 0 1 -9 8 n panusa01 ru s u s a 0 1 ru s u s a 0 2 ru s u s a 0 3 ru s u s a 0 4 s lb a u s 0 1 Sum

V ie tn a m N ic a ra g u a R u m a n ia R u s s ia R u s s ia P o la n d P o la n d S lo v a k ia Panam a R u s s ia R u s s ia R u s s ia R u s s ia S o lo m o n

Japan USA N e th e rla n d s N e th e rla n d s N e th e rla n d s N o rw a y N o rw a y N o rw a y USA USA USA USA USA A u s tra lia

S u b p ro je c ts S ta rtin g d a te G H G re d u c e d [t C O 2 ] 1 n .a . 286000 1 1999 14119470 1 1997 1093000 2 1994 296596 1 1994 315 21 1995 2989858 4 1995 7600 2 1998 50000 1 1998 57640 1 1993 292728 2 1995 30955750 1 n .a . 1575840 1 n .a . 858000 1 1997 13850 143 170778825


111

REFERENCES International Greenhouse Partnerships Office, 1998, International Greenhouse Partnerships. Project Guidelines and Priorities. From: www.dist.gov.au/resources/energy_greenhouse/2nd_round.pdf. Baltic Sea States Summit, 1996, Presidency Declaration, Visby 3-4 May 1996. From: www.baltinfo.org/Docs/headsofgov/2/summit.htm. Chomitz, K. M., 1998, Baselines for Greenhouse Gas Reductions: Problems, Precedents, Solutions, Paper prepared for the Carbon Offsets Unit of the World Bank (unpublished). Commission of the European Communities, 1996, Final Communication from the Commissions Baltic Sea Region Initative, Brussels, 10.04.1996, SEC (96) 608. From: www.baltinfo.org/Docs/eu/communi.htm. Ellis, J., 1999, Experience with emission baselines under the AIJ pilot phase, OECD Information Paper ENV/EPOC(99)23/FINAL (unpublished). From: www.oecd.org/env/docs/cc/epoc9923.pdf. Halsnaes, K., Jaccard, M., Montgomery, W.D., Richels, R., Robinson, J., Shukla, P.R., Sturm, P., 1996, A Review of Mitigation Cost Studies. In: Bruce, J. et al. (Eds.), Climate Change 1995. Economic and Social Dimensions of Climate Change. Contribution of WGIII to the Second Assessment Report of the Intergovernmental Panel on Climate Change. Cambridge University Press, Cambridge/Mass., p. 297366. Houghton, J.T., Meira Filho, L.G., Callander, B.A., Harris, N., Kattenberg, A., Maskell, K., 1996, Climate Change 1995. The Science of Climate Change. Contribution of WGI to the Second Assessment Report of the Intergovernmental Panel on Climate Change. Cambridge University Press, Cambridge/Mass.. Intergovernmental Panel on Climate Change, 1996, The Revised 1996 IPCC Guidelines for National Greenhouse Gas Accounting. From: www.iea.org/ipcc.htm. Jepma, C., 1997, On the baseline. Joint Implementation Quarterly, 3 (2): 1. Matsuo, N., 1996, AIJ Japan Program Update. From: www.northsea.nl/jiq/japan.htm. Matsuo, N., 1998, MITI supports 37 new projects. Joint Implementation Quarterly, 4 (3): 6. Michaelowa, A., 1998, Joint Implementation - the baseline issue. Economic and political aspects. Global Environmental Change, 8 (1): 81-92. NEDO, 1998, New Energy and Industrial Technology Development Organization, NEDO’s AIJ Projects (unpublished).

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Ridley, M.A., 1998, Lowering the Cost of Emission Reduction: Joint Implementation in the Framework Convention on Climate Change. Kluwer Academic Publishers, Dordecht/Boston/London. Schwarze, R., 1998, Activities Implemented Jointly: Another look at the facts. Diskussionspapier der Wirtschaftswissenschaftlichen Dokumentation der TU Berlin 98-18 (unpublished). Schwarze, R., 2000, Activities Implemented Jointly: Another look at the facts. Ecological Economics 32: 255-267. UNEP, 1994, UNEP greenhouse gas abatement costing studies, Phase Two Report, Part 1: Main Report, UNEP Collaborating Centre on Energy and Environment, Riso National Laboratory, Denmark. United Nations Framework Convention on Climate Change (UNFCCC), 1995, Report of the Conference of the Parties on its first session, held in Berlin from March 28 to 7 April 1995. Addendum. Part Two: Action taken by the Conference of the Parties at its first session, FCCC/CP/1995/7/Add.1. United Nations Framework Convention on Climate Change (UNFCCC), 1997a, United Nations Framework Convention on Climate Change, Kyoto Protocol to the United Nations Framework Convention on Climate Change, FCCC/CP/1997/L.7/Add.1. United Nations Framework Convention on Climate Change (UNFCCC), 1997b, United Nations Framework Convention on Climate Change/ Subsidiary Body for Scientific and Technological Advice, Activities implemented jointly under the pilot phase. Synthesis report on activities implemented jointly, FCCC/SBSTA/1997/12. United Nations Framework Convention on Climate Change/Subsidiary Body for Scientific and Technological Advice (UNFCCC/SBSTA), 1997c, Activities implemented jointly under the pilot phase. Synthesis report on activities implemented jointly. Addendum, FCCC/SBSTA/1997/12/Add.1 United Nations Framework Convention on Climate Change (UNFCCC), 1998, Review of the Implementation of Commitments and of Other Provisions of the Convention. Activities implemented jointly: Review of Progress under the Pilot Phase (Decision 5/CP.1). Second synthesis report on activities implemented jointly. Note by the secretariat, FCCC/CP/1998/2. United Nations Framework Convention on Climate Change/ Subsidiary Body for Scientific and Technological Advice/ Subsidiary Body for Implementation (UNFCCC/SBSTA/SBI), 1999, Activities implemented jointly under the Pilot Phase. Draft conclusion by the Chairmen, FCCC/SB/1999/CRP.5.


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U.S. Department of State, 1995, Summit of the Americas Action Plan. Implementation of the Summit Action Plan. From: americas.fiu.edu/state. USIJI, 1998, Unique Aspects of U.S. Initiative on Joint Implementation Projects. From: www.ji.org.usiji/unique.html. Victor, D.G., Nakicenovic, N., Victor, N., 1998, The Kyoto Protocol Carbon Bubble: Implications for Russia, Ukraine and Emission Trading, International Institute for Applied Systems Analysis, Laxenburg, Austria, IR-98-094 (forthcoming Climatic Change). White House, 1998, The Kyoto Protocol and the President’s Policies to Address Climate Change. From: www.whitehouse.gov/WH/New/html/augnew98.html#Kyoto. Withycombe, H., 1997, Australia relies purely on private investments AIJ financing. From: www.northsea.nl/JIQ/austra.htm. Wirl, F., Huber, C., Walker, I.O., 1998, Joint Implementation: Strategic Reactions and Possible Remedies. Environmental and Resource Economics, 12: 203-224.

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1

2

3

4 5

6

7

8

9

10

11

12

13


Revised version of a paper originally published in Ecological Economics (Schwarze, 2000). Economies in Transition (EIT) are central and eastern European countries and states of the Former Soviet Union that are in transition to a market economy. Government approval is a legal prerequisite for AIJ under the Berlin Mandate (UNFCCC, 1995). AIJ must be backed by a mutual agreement between the host and the investor country known as ”letter of intent”. www.unfccc.de/program/aij/aijact and www.unfccc.de/program/aij/aijact98. A full list of the projects considered and their general characteristics is given in the appendix to this section (table 6.14). Several UNFCCC-reports are on more than one project, e.g. the AIJ between Norway and Poland (norpol01a, see App. 1) is on 21 projects of coal-to-gas boiler conversion. To make this information compatible with other more disaggregated reports, e.g. on boiler conversion between Sweden and Estonia (estswe01-estswe16, see App. 1), I have changed the UNFCCC-definition of projects ("activities") in this study to "projects as declared in the DNA-reports". Resulting from this new definition of projects, my set of data contains 143 projects as compared to 96 projects considered by the UNFCCC. This figures compare to an expected five-year (2008-2012) Kyoto market of approximately 10000 Mt CO2, which is derived from IIASA’s ”most likely” estimate of emission surpluses for Western Europe, North America and the Pacific OECD in 20082012 (= 2697 MtC). See Victor, D.G., Nakicenovic, N., Victor, N., 1998, table 2. There is some confusion in the current DNA-reports with respect to the meaning of the activity starting date. Several projects (25) were reported with a starting date but actually have not started in a technical sense, e.g. because of a lack of funding. According to the UNFCCC classification they are ”mutually agreed” but not ”in progress”. Omitting these projects would, however, not change the general results presented in this study. The crediting of emission reductions to investor countries is specifically excluded during the pilot phase created by the Berlin Mandate (UNFCCC, 1995), but it is possible under Article 6 and Article 12 of the Kyoto protocol (CDM and JI), which could become effective as early as 2000 and 2008 respectively. Four projects in EITs (criusa07a, ltuswe09-98, lvandl01-98 and estswe17-98) were omitted from this comparison because the emission reductions of these projects were not available on the UNFCCC’s website as of 04/30/99. A detailed list of national AIJ programs can be found in UNFCCC (1997c). An example of a national AIJ program is the United States Initiative on Joint Implementation (USIJI). The term Annex I-Countries refers to Annex I of the United Nations Framework Convention on Climate Change. This list of countries includes the 24 original OECD member countries and 11 former states of the Soviet bloc as well as the European Community as a regional economic integration organization. Throughout this study we applied contingency analysis to test the existence (Pearson’s χ2), the strength (Contingency Coefficient) and the direction (Goodman and Kruskal’s


14

15

16

17

18

19

20

115

τ) of the claimed contingencies. Values of these parameters with an asterisk are significant, which implies that the Null-hypothesis of non-existence, weak or opposite contingencies must be rejected. The IPCC (1996) actually distinguishes between three different LUCF activities, i.e. afforestation, reforestation and deforestation. Experience in the pilot phase shows that this systematically important distinction is not very useful to classify AIJ projects in this field, since most of these projects combine measures to protect existing forest and activities to reforest non-forest lands (e.g. abandoned pasture). Following this, USIJI has classified its latest projects in this sector as ”LUCF” (e.g. www.unfccc.de/program/aij/aijact99/criusa04-99.html). Arguably, two projects of fugitive gas capture (nldrus01) could also be classified as related to waste disposal because they are on sanitary landfilling with energy recovery. In this study, I follow the classification of these projects as FGC by the UNFCCC. The mentioned host country priorities in the AIJ pilotphase are drawn from www.unfccc.de/program/ aij/aijprog/aij_ppol.html (Poland) and www.unfccc.de/program/aij/aijprog/aij_pcri.html (Costa Rica). The global warming potential (GWP) measures the CO2 equivalent contribution to global warming of other greenhouse gases, e.g. CH4 and N20. It is established by reference to the IPCC model on global warming (Houghton, J.T. et al., 1996, Tab. 3), and is conventionally based on a 100-year time horizon. The pertinent GWPs of CH4 and N20 are 24.5 and 310 respectively. External verification of the baseline by an independent third party has been widely recommended for Joint Implementation because of a supposed incentive to "inflate" the baseline (Michaelowa, 1998; Wirl et al., 1998). The Clinton Administration’s ”Cost of Kyoto”-estimate is $14 - $23 per ton of carbon (White House, 1998, 53). It translates into $ 4-6 per ton of CO2. Negative cost does not necessarily imply that these projects are economically viable, for most AIJ does not factor the opportunity cost of capital (interest on investment). Because of this general flaw in the costing of AIJ we may assume that the rate of return for most AIJ will be below the market rate of return. I am grateful to Mike Toman, Resources for the Future, for this important qualification.

Chapter 7 Beyond COP6: The Need for Extended Flexibility Axel Michaelowa and Reimund Schwarze

1.

INTRODUCTION

The climate summit at The Hague ended without any agreement and thus disappointed hopes that it could give a clear start for international activities to reduce greenhouse gas emissions. Still many observers believe - with some distance - that there was progress, and that a deal was only missed because of lack of time and diplomatic failure (Jepma, 2000). We share this view and explain in this paper where, from our point of view, COP6 failed and where it succeeded, and how the failures of COP6 can be avoided at the follow-up meeting in mid-2001 (COP6/II). Specifically, we propose that European negotiators assume a more flexible approach to the "crunch issues" of The Hague (supplementarity and sinks) while standing firm on rules and modalities for the use of the Kyoto mechanisms. To give this strategy a chance of success, and to build confidence with the new negotiators of the Bush administration and to search new allies among the developing countries and countries in transition, the E.U. should initiate high-level political meetings to explore common ground before the meeting. The paper is organised as follows: In Section 2 we explain the role of COP6 within the Post-Kyoto process and discuss how the previous COPs and subsidiary bodies' meetings affected the discussions at The Hague. In Section 3, we provide an overview on the debate at COP6 and analyse President Pronk's proposal for a compromise, which was delivered two days before the break down of the conference. In Section 4, we draw some general lessons from the failure of COP6 and speculate how this failure could be avoided at COP6/II through extended flexibility and prior exploratory political meetings.

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2.

Beyond COP6

THE ROAD TO COP6

Compared to the previous two conferences of the parties, COP6 was met with great expectations. It was intended to finalise the deal struck at Kyoto in 1997. The Kyoto Protocol sets legally binding emission targets for industrialised countries but allows them in principle to use carbon sinks (forests and possibly soils), trade emission permits among themselves and to invest in emission reduction projects in other industrialised countries (Joint Implementation, JI) and developing countries (Clean Development Mechanism, CDM). However, the rules had not been defined in Kyoto. This consequently lead to a wide-spread resistance among major emitters to ratify the Protocol. To speed up this process, the climate summit of Buenos Aires (COP4) decided that all outstanding rules of the Kyoto Protocol should be finalised at COP6. To prepare this groundbreaking event, the UNFCCC Subsidiary Bodies (SBSTA and SBI) held four major sessions, and political negotiators met once in Bonn in 1999 (COP5). These rounds of talks did not produce many results. Instead they confirmed a deep political divide between the Parties on a number of technical issues. Figure 7.1 depicts the strategic frontlines of this divide. Major players in this debate were the U.S. who, along with some non-European OECD countries such as Japan, Canada and Australia, form the so-called Umbrella Group. Its main opponent was the European Union (E.U.). Other players were the Economies in Transition (Russia, the Ukraine and some Central and Eastern European Countries, that formed a new negotiating group “CG 11”) and the developing countries (G77 and China). Within the latter groups however, there were strong differences on some positions. The Umbrella Group pushed for maximum flexibility in the design of the Kyoto mechanisms as well as for some creative accounting of sinks - domestically and as part of the CDM - in order to reduce their perceived economic burden. The E.U., on the other hand, assumed the role of a "watchdog" for environmental integrity. It strongly pushed for domestic efforts to reduce energy consumption ("supplementarity") and limited accounting of sinks, both as part of the Kyoto mechanisms and domestic GHG accounting. The Economies in Transition, particularly Russia and the Ukraine, supported the Umbrella Group in their desire for unrestricted emissions trading, but the subgroup of Central and Eastern European Countries (notably Poland) joint the E.U. in their demand to


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restrict "hot air" trading and to focus the CDM and JI on technology transfer (energy efficiency and renewables). Figure 7.1: The political frontlines at COP6

aximumFlexibility flexibility MaM ximum

conomies Economies in Transition CG11 C G11 TrEansition

CalCculable alculablePenalitie penaltiess

echnology transfe transfer r TeTchnology

(Russia/Ukr aine) (Russia/Ukraine)

Two track approach to JI

Two track approach to JI

Umbrella Group

Supplementarity

Umbrella Group

Supplementarity

EU

E.U.

Non-compliance

Non-compliance

Additional Sinks Additional Sinks and CDM EEquality quality of ofJIJI/CDM Funding for Funding forDeveloping Countries’ Activities Developing Countries

Technology transfer CDM Sinks CDM sinks

Developing

Technology transfer

Countries

Limited flexibility

Some Developing Countries Some

LACs

LACs

(G77 and China)

(G77/China)

Limited flexibility

Stiff penalties

Stiff penalities

Many developing countries had changed their previously hostile attitude towards the CDM and other Kyoto mechanisms during the AIJ pilot phase. Especially many countries from Latin America (with the

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Beyond COP6

notable exception of Brazil) and forest-rich African and Asian countries recognised that they could benefit from the joint mitigation projects including projects of sink enhancement (afforestation and reforestation). Yet they agreed with the E.U. that the use of flexibility mechanisms should be somewhat limited. They also urged to have strict rules for compliance, specifically stiff penalties for non-compliance of Annex I countries. The Umbrella Group instead argued for calculable penalty schemes such as a cost cap (explained in Kopp/Morgenstern/Pizer 1997). Astonishingly, Russia argued against strong non-compliance rules. Developing countries also insisted on an equal treatment of JI and the CDM, specifically with regard to the adaptation tax of the Kyoto protocol, and demanded larger funding of developing countries’s climate change activities. Industrialised countries, on the other hand, argued that the CDM has already been given a competitive advantage over JI in that certified emission reductions (CERs) from CDM projects can, contrary to JI, be banked as of 2000. They also agreed to have a two track-approach according to which JI projects would be eligible to a simplified verification procedure as long as the host countries comply with their reporting and inventory commitments. The issue of domestic accounting of “additional sinks” (agricultural soils and forest management) was mainly pushed by the U.S., but met resistance by the E.U. and most other major players (except Russia). However, the whole issue of sinks remained largely undebated during the preparative sessions because of its difficult-to-understand technicalities and the expectation that these technicalities would be clarified by the IPCC special report on Land Use, Land Use Change and Forestry (LUCF) that was released shortly before COP6 (May 2000). This report does, however, not give clear political guidance on this issue (it was actually never intended to do so! 1 ), but identifies "a range of options and discusses implications and interrelationships among options" (IPCC, 2000, p.3). Missing any pressure to compromise on those issues, these sessions produced a "hotch potch" of proposals. Indeed, the final proposals submitted to COP6 negotiators were packed with mutually exclusive proposals (set in brackets) and covered 340 pages of legal text. 2 Thus, as a result of several years of in-the-air debate, COP6 did start with an untractable documentary basis for negotiations.


3.

121

THE DISCUSSIONS AT COP6

The discussions at The Hague continued along the lines described above. After more than a week without significant progress, the President of COP6, Jan Pronk, finally but unfortunately too late 3 took the lead and did away with the previous negotiation documents. He declared: "The documents before us are to long and littered with brackets. To facilitate our negotiations this week, we must distinguish between outstanding issues of differing characters. Some are "crunch issues", i.e. questions on which clear political choices are needed for negotiations to advance. Others are more technical issues with political implications, which would fall into place when decisions on the "crunch issues" are made. There are also technical issues that require further negotiation, but not at a ministerial level. Finally, there are certain technical questions that could be set aside until after COP6. While recognizing the importance of all these issues before us, I focus on the "crunch issues" - those ripe for highlevel decision making". (The President of COP6, 2000a) Instead, he proposed a few "issue clusters" (depicted as boxes) to be discussed in informal groups that contained the following topics (see table 7.1): Table 7.1: Issue clusters at COP6

Box B

Capacity building, technology transfer, implementation of Articles 4.8./4.9, 3.14 of the Kyoto Protocol and finance Kyoto Mechanisms

Box C

Land Use, Land Use Change and Forestry

Box D

Policies and Measures, Compliance, Accounting, Reporting and Review

Box A

Within this clustered approach negotiators achieved some progress. They agreed, for instance, on a fast-track approach for smallscale/renewables CDM projects. According to this approach, these projects would be subject to less stringent rules in terms of baseline determination (standardised baselines) and less institutional oversight. The political goal behind this decision was to jump-start the CDM with

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Beyond COP6

relatively uncontroversial projects at low transactions cost. Reconciliation seemed also feasible on the issue of supplementarity. The E.U. signalled (according to Environmental Minister Kawaguchi of Japan, who cofacilitated the informal discussion group 4 ) that it could settle on a qualitative formula rather than a quantitative ceiling if other technicalities could be resolved satisfactorily. Table 7.2: The Pronk proposal Box A contained a provision for additional funding of a very diverse bunch of developing country activities related to climate change such as capacity building, adaptation, emission reduction projects, forest protection, conversion of fossil fuel extraction-oriented economies. As part of this funding proposal it suggested an in-kind emissions tax based on emissions targets of the core industrialised countries (which could raise enormous revenues!). Another innovative proposal was the automatic kick-in of a (non-specified) tax on emissions trading and JI if less than one billion $ of additional funding would be reached by 2005. On the other hand, it limited the adaptation tax on CDM projects to 2% which, according to some estimates would amount to a few hundred million $ per year only. Box B suggested a purely political Executive Board of the CDM to be elected in June 2001 that should be ruled by majority vote (which would slow down the decision process considerably!). It also proposed a prompt start for small scale and renewable CDM projects that can use standardised baselines. No cap was proposed for CDM, JI and emissions trading, but a 70% reserve requirement to prevent overselling of permits. A traffic light approach to JI would have established strong verification rules if the host country does not fulfil its reporting requirements (very much in line with the previously described two track approach). Box C allowed a broad range of additional sinks (agricultural land and forest management) for domestic accounting, but limited to 3% of the 1990 emissions of Annex I countries. Afforestation and reforestation were eligible CDM projects, but not forest conservation (which would have been funded as part of the adaptation fund!). Box D stipulated a 50% penalty on any emissions above the target and an additional 25% for each target period in which the “debt” is not repaid.


123

To speed up this process and facilitate an agreement, President Pronk finally came forward with a proposal of his own - two days before the official closing of COP6. This proposal contained some bold suggestions (depicted in table 7.2) that reflected his personal view on the matters at hand (The President of COP6, 2000b). Indeed, the Pronk proposal would have been a relatively sensible comprise: • • •

• •

The non-compliance penalties would have given a strong incentive to comply with emission targets (as the implicit interest rates are above 8% per annum!). Full international flexibility would have kept the cost of Kyoto low. Letting a limited amount of additional sinks in and allowing afforestation in the CDM would have led to a diversification of mitigation activity while incentives for avoidance of deforestation would have been provided by the adaptation fund. The quick start with small scale projects in the CDM could have allowed institutional learning while not unduly risking environmental integrity. The reluctance of industrialised countries to commit funds for developing countries would have been overcome by the threat of taxing emissions trading and JI alongside the CDM.

On the negative side, the proposal was lacking decisions on some critical CDM issues such as • • • •

the distribution formulae for the funds for adaptation and other issues, the groundrules and institutional processes to derive baseline methodologies for CDM projects, the rules to prevent business-as-usual CDM projects (“investment additionality”), the participation of stakeholders in the CDM project pipeline.

The proposal was greeted by considerable scepticism from all interest groups, but particularly by the E.U.. The issue that finally lead to the deadlock of The Hague was the threshold for additional sinks.

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4.

Beyond COP6

THE ISSUE OF ADDITIONAL SINKS

The issue of additional sinks came to the forefront of political debate as parties arrived at some definitional arrangements under Article 3.3 of the Kyoto Protocol. This article allows Annex I Parties to take account of certain human-induced activities in the land-use, land-use change and forestry sector (LUCF) that remove greenhouse gases from the atmosphere, namely afforestation, reforestation and reduced deforestation. Conversely, it stipulates that any changes in these activities that lead to a increase of greenhouse gases in the atmosphere (e.g. an increase in deforestation) will be subtracted from the assigned amounts of Annex I parties. Article 3.3, however, does not define exactly what "afforestation, reforestation and deforestation" means, and Parties could not agree on a common definition for these three terms. As these definitional problems could be partly resolved by the IPCC’s Special Report of LUCF (IPCC, 2000), and Parties at SBSTA 13 (Lyon) seemed to compromise on the IPCC Definitional Scenario (according to which only non forest to forest conversion, i.e. land use change, triggers accounting under Article 3.3), it became clear that forest management activities (which increase the carbon uptake of existing stands), if at all, had to be included as additional activities under Article 3.4. Figure 7.2: The JUSC 3.4 proposal

100% Open ended interval

Initial interval

33% Medium interval 20 MtC/yr.

Z


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Several Umbrella Group countries, particularly the U.S., could generate heavy credits by including forest management. Some might have well been able to meet their Kyoto commitments without any action whatsoever. At the same time these countries faced considerable problems to get the Kyoto Protocol ratified at their domestic constituencies. Consequently, they fought for an extensive list of additional sinks, including forest management, to release the economic burden of Kyoto and smoothen the process of ratification. In the first week of COP6, Japan, the U.S. and Canada proposed a concrete scheme for computing forest management carbon credits, which became known as the JUSC 3.4 proposal. This scheme consists of three different crediting intervals (see figure 7.2, adapted from Greenpeace, 2000, p. 9). The initial interval offers full credits for net carbon removals from forest management for a portion up to 20 MtC/year. In the second interval, parties are offered credit up to an unspecified threshold (Z in figure 1) which will be discounted by a factor of 1/3. For those parties with a remaining sequestration potential (beyond Z) full credit will be given. As most countries net removals from forest management are less than 20 MtC/year, this proposal would have implied full crediting for all their carbon removals due to forest management. The following graph (figure 7.3) illustrates the effect of the JUSC 3.4 proposal on Kyoto targets, assuming a scenario with no threshold so that all credits beyond 20 MtC would be discounted by 2/3. The white and black bars in this graph depict the percentage target changes for several Annex B countries and Annex B as a whole. While the proposal seems to offer big target changes for some European countries, notably Sweden and Finland, the actual credits from forest management for these countries are comparatively small (i.e., - 4.5 MtC/yr and – 2.2 MtC/yr respectively). Massive gains, however, would result for the U.S. (-132.5 MtC/yr) , Russia (-71.3 MtC/yr), Canada (- 13.7 MtC/yr) and Japan (- 11.4 MtC/yr). The overall Article 3.4 credits for Annex I countries from this proposal adds up to approximately 250 MtC/year, which would effectively wipe out the Annex B target of an overall reduction of 5,2% to an insignificant decrease of –0.1 % below 1990 levels. This proposal met stiff opposition from the NGO community and the E.U.. The E.U., at a Council meeting in Luxembourg June 22, had adopted a negotiating position that no additional sinks should be included until after the first commitment period of 2008-2012. As such differences

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Beyond COP6

between the Umbrella Group and the European Union began to dominate political discussions during the second week of COP6, President Pronk released a compromise plan of his own. The President’s plan included a broad definition of additional activities (including forest management and agricultural soils), but curtailed the amount of credits under Article 3.4 to an upper limit of 3% of 1990 emissions. Furthermore, it stipulated a discounting of credits for forest management of 85% and for cropland/grazing land management of 30% exceeding a threshold of 30 MtC/yr. Figure 7.3: The effect of Article 3.4 on Kyoto targets

Annex B Australia Canada Finland France Germany Iceland

Pronk target Japan

JUSC 3.4 target Kyoto target

Netherlands Norway Russian Fed. Sweden Switzerland U.K. USA -30%

-20%

-10%

0%

10%

20%


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Table 7.3: The effect of Article 3.4 on Kyoto targets Party

Kyoto target

JUSC-3.4 proposal (MtC/yr)

% of Pronk 1990 proposal emissions (MtC/yr)

% of JUSC 3.4 Pronk 1990 target target emissions

Annex B

-5.2%

242.55

5.1%

105.80

2.1%

-0.1%

Australia

8%

2.18

1.5%

0.33

0.3%

9.5%

8.3%

Canada

-6%

13.73

8.2%

5.79

3.5%

2.2%

-2.5%

Finland

0%

2.20

10.7%

0.61

3.0%

10.7%

3.0%

France

0%

2.70

1.8%

0.39

0.3%

1.8%

0.3%

-25%

8.45

2.6%

1.50

0.5%

-22.4% -24.5%

10%

0.05

7.5%

0.01

1.4%

17.5% 11.4%

-6%

11.44

3.5%

2.46

0.7%

-10%

-0.69

-1.2%

0

0.0%

Germany Iceland Japan Netherlands

-2.5%

-3.1%

-5.3%

-11.2% -10.0%

Norway

1%

0.15

1.0%

0.02

0.1%

2.0%

1.1%

Russia.

0%

71.30

8-6%

33.00

4.0%

8.6%

4.0%

Sweden

-8%

4.55

24.1%

0.77

4.1%

16.1%

-3.9%

Switzerland

-8%

0.34

2.4%

0.09

0.5%

-5.6%

-7.5%

U.K.

-10%

2.71

1.3%

0.54

0.3%

-8.7%

-9.7%

USA

-7%

132.48

8.1%

56.70

3.4%

1.1%

-3.6%

Source: JUSC-3.4 proposal according to Kevin Gurney (personal email-communication of May, 7th, 2001), Pronk proposal according to WWF (2000). All values are derived from the submissions made by parties in August, 2000, except Russia which is based on K. Gurney and J. Neff (2000). Potential credits may be higher by 10-15% due to missing reports from some other countries.

The grey bars in figure 7.3 indicate how this proposal would affect the Kyoto targets and how it compares the JUSC 3.4. proposal. Obviously, Pronk's plan would have significantly undercut the JUSC 3.4 proposal. The total Article 3.4 credits for Annex B countries would have been limited to 150 MtC/yr instead of 250 MtC/yr of the JUSC 3.4. proposal. Yet, it served the need of Umbrella Group for ‘additional flexibility' by lowering the required reductions for the U.S. by 56.7 MtC/yr, for Canada by 5.8 MtC/yr and for Japan by 2.5 MtC/yr. More importantly, it helped to shift the focus of the debate from narrow technical matters (definitions, accounting procedures etc.) to a political level of bargaining on targets. Thus it levelled the ground for a series of last minute high-level political bargains.

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Beyond COP6

The most prominent bargain had been hatched, according to U.S. and British sources 5 , by a lengthy telephone discussion between U.S. President Clinton and British Prime Minister Tony Blair in the night before the closing of COP6. Britain's deputy prime minister, John Prescott, stepped forward on November, 25th, with a compromise that called on the United States to restrict its use of the emissions trading scheme and reduce carbon credits from its forests and farmlands to 50 MtC (below the 56.7 MtC/yr of the Pronk proposal), and he got the U.S. delegation to agree to this compromise. However, he did not find approval for this proposal by the E.U.. Germany and Denmark said the it was intolerable and stood firm to their previous offer of 20 MtC/yr for the U.S. This led to the ultimate break-down of negotiations at COP6.

5.

LESSONS FROM COP6

What can be learned from the failure of COP6? At this early stage, we can only provide our very subjective judgement. What we learned from COP6 was, firstly, that every conference has its own dynamics. If time pressure and late-night discussions helped to settle in Kyoto (as some commentators, e.g. Ott/Oberthür, 2000, suggested), it did not help in The Hague. In fact, we believe that COP6 could have been successful if negotiations on "crunch issues" would have started earlier at a political level. Given the range of issues and the potential for multiple settlements among parties, we conclude that a political deal would have been possible. Previous strategy talks and highlevel political negotiations would in any case have reduced the bargaining agenda to "crunch issues" at which negotiators in The Hague arrived only at the end of their talks. Specifically, the "killing issue" of additional sinks could have been disarmed if packaged into an overall political deal, instead of assuming ad hoc positions during the closing days of the negotiations. Waiting for an expert solution to the problem, as most Parties did before, was a flawed approach since there is no scientific solution to this essentially political problem - the IPCC special report is utterly clear on that from the outset! Thus to avoid repeated failure, we need high-ranking talks between all major players on all Kyoto issues before negotiators meet for the second part of COP 6. The meeting of environmental ministers in Ottawa (in December 2000) was an event in


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this spirit which needs to be followed by other such talks. The E.U. is in a perfect position to kick off such an initiative. Secondly, we learned about the importance of the "principle of enhanced flexibility backed by transparency and responsibility" (Sugiyama/Michaelowa, 2000) for the current Kyoto process. COP6 ultimately proved that the Kyoto protocol is different from all previous multinational environmental agreements in that it requires, at least for several countries, fundamental changes in energy consumption and lifestyles that imply high costs. In these countries powerful interest groups fight against the Kyoto Protocol. International negotiations have to acknowledge these sobering realities of political implementation at the domestic level. The slow process of ratification of the Kyoto Protocol and the failure at The Hague demonstrate that ambitious quantified targets do not survive the fight. The U.S. government needed the additional support of the influential groups of farmers and foresters. Thus, in order to prevent that such domestic backlashes destroy the whole Kyoto regime, we need “extended flexibility. 6 Extended flexibility implies to boil down the ambitious targets to symbolic, still important, hardcore issues ("crunch issues") and allow for political "horsetrading". Any deal should be possible such as: "If you accept x% of additional domestic sinks, I will agree on a de facto y%-cap on flexibility mechanisms or a maximum penalty for non-compliance of z $/t" (in this respect we fully agree with Jepma, 2000). However, we should strive for consistency to avoid distortionary incentives. The only non-negotiables are transparency and accountability both at the level of policy making and at the level of implementation. We believe that public pressure can be the ultimate force to make countries adhere to the goals of the UNFCCC, but it requires transparency and accountability. Striving for perfectionism at an early stage instead produces negotiation deadlock such as the one at The Hague. The failure of COP6 is neither dramatic, nor unique. It fits neatly into high-level summit failures such as the WTO summit in Seattle in 1999 or the temporary break down of discussions under the UN Convention on Biological Diversity in 1999 (Cartagena). It will have the greatest impact on the business community. Companies that have already started implementing climate change strategies may now scale back their activities and release their pressure on their respective government to provide a legal framework for early action. Business that had hoped for clarity concerning climate policy now faces even more uncertainty. In this situation, a lot depends on the willingness of some countries to take the

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Beyond COP6

lead, promote bilateral or regional agreements on climate change policy and shape the negotiation process at COP6/II. The E.U. is in also in perfect position to assume this leading role, especially if it teams up with Russia and the developing world.


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REFERENCES Anonymous, Special JIQ Report on COP6, The Hague, Netherlands, 13-25 November 2000, Joint Implementation Quarterly, Vol. 6(4): 7-12.. Greenpeace, 2000, In Depth Analysis of the USA/CANADA/JAPAN Proposal for Sinks under Article 3.4, released on November, 22nd, 2000 at COP6. Gurney, K.R. and Neff,J., 2000, Carbon Sequestration Potential in Canada, Russia, and the United States Under Article 3.4 of the Kyoto Protocol, World Wildlife Fund, June 2000. Intergovernmental Panel on Climate Change, 2000, IPCC Special Report: Land Use, Land Use Change and Forestry, Geneva. From: www.ipcc.ch/pub/SPM_SRLULUCF.pdf. Jepma, C., 2000, A Break in The Hague? Joint Implementation Quarterly, Vol. 6(4): 1. Kopp, R., Morgenstern, R., Pitzer, W., 1997, Something for Everyone: A Climate Policy that Both Environmentalists and Industry Can Live With, Resources for the Future, Washington D.C. Sugiyama, T., Michaelowa, A., 2000, What must and can COP6 decide? Extended flexibility backed by transparency and responsibility, Energy Policy 28, 571-574. The President of COP6, 2000a, Informal Note by the President of COP6, Submitted to COP6 participants on Monday, 20 November 2000, The Hague. The President of COP6, 2000b, Note by the President of COP6, Submitted to COP6 participants on Thursday, 23 November 2000, The Hague. WWF, 2000, Implications of the Pronk Package on Article 3.4, released on November, 23rd, at COP6 (Analysis by Kevin Gurney, Dept. of Atmospheric Science, Colorado State University, for WWF)

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1

2

3

4 5 6

Beyond COP6

As Robert Watson, the chairman of the LULUCF Special Report, made utterly clear in his outline: „This Special Report will be policy relevant, but will not be policy prescriptive“ (FCCC/CP/1998/INF.4) All In Session Documents” from www.unfccc.de (encompassing FCCC/CP/2000.CRP01-13 and FCCC/SB/ 2000/CRP.15 to CRP.23). Some negotiators felt bored at the beginning of the second week as nothing was moving. Cited in Joint Implementation Quarterly, Vol. 6(4), p. 9. Cited from Washington Post as of November, 26th, 2000. Extended flexibility corresponds conceptually to ordinary "flexibility" in others MEAs. We applied a new term since "flexibility", in the Kyoto discussion, often relates to the Kyoto mechanisms.

Chapter 8 Summary and Conclusion The Kyoto Protocol is the first serious international attempt to reverse the current global trend of rising greenhouse gas emissions. The ultimate challenge is to get it ratified. Without ratification, the world’s efforts to combat climate change will be significantly - perhaps irreversibly - set back. Due to the failure to reach an agreement at The Hague, many pundits are already wondering what the next protocol will look like. Alongside of this, many conservationists have assumed that the Protocol has too many ”loopholes” to be effective. I feel that this is a mistaken view. The Kyoto Protocol, despite many flaws, provides a sound legal and political basis for developing an effective future climate regime. In this study, I have discussed some of the most pressing policy problems of the Kyoto Protocol – ”hot air”, the accounting of biological sources and sinks, and the long-term requirement for the Clean Development Mechanism. For each of these problems, I have identified subsequent fixes. As for ”hot air”, I suggest a buy out-solution. The best response to surplus assigned amounts in Russia and the Ukraine, if any, is that a group of concerned countries buys and retires ”hot air”. Compared to the much favored alternative of a cap on trade, this would keep ”hot air” cheap, which in turn increases the chance to get Kyoto ratified in countries that bear the highest cost of Kyoto such as the U.S.. The accounting of biological sources and sinks is another heated debate. The Kyoto protocol’s complicated and confusing treatment of this issue lies at the roots of this controversy. In this study, I have tried to shed some light on the protocol’s stand towards such contentious issues as ”deforestation for reforestation”, ”leakage” and ”baseline inflation”. The general picture that emerges from this discussion is that the Kyoto Protocol is well equipped to tackle most of these problems. There is, for example, no danger that existing forests could be replaced with fast

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Summary

growing carbon plantations. The principles of accounting of domestic and international LUCF activities are reasonable and consistent, except for some clearly identifiable special problems such as changes of carbon fluxes in existing managed forests. CDM forestry is also sufficiently shielded against potential abuse. The CDM requirements are unique in this respect! The true question is, will the CDM be too costly with strict monitoring and verification? Experience with recent LUCF projects in Costa Rica, which apply sophisticated techniques such as adjustable national baselines, seems to indicate that this is not the case. By increasing the scale of projects and bundling domestic and international efforts Costa Rica was apparently able to reduce the specific transaction costs per unit of carbon mitigated, thereby allowing a higher overall level of control. Unfortunately, negotiators at COP6 did not subscribe to this view and in a surprising negotiation swoop excluded forest conservation from the list of eligible CDM activities. If this position would be upheld at the follow up meeting (COP6/II) this year, we would miss a window of opportunity. Indeed, these opportunities of tropical forest conservation through the CDM would be tremendous - biologically, economically and politically. Biologically, tropical deforestation is the second leading cause of human-caused GHGs. Additionally, protecting existing tropical forests will safeguard a variety of important ecosystem services. Economically, forestry is an important strategy of the optimal blend of mitigation options for climate change in the next 50 years. The Kyoto Protocol, on the other hand, could mobilize several billion dollars annually for tropical forest conservation for several decades. Consequently, if ratified by the requisite number of countries, the Kyoto Protocol may ultimately be as much a tropical forest conservation treaty as it is a climate change treaty. The acceptability of forest conservation projects in developing countries can be enhanced, if packaged into tandem with bioenergy projects. Combining these two efforts would diversify local employment opportunities, creating silvicultural and industrial jobs. It would also make CDM projects more likely to succeed and more attractive to investors. Thus, bundling these activities could release important social, financial and biological synergies. A specific problem of CDM forestry is the long-term requirement. CDM-forests must be durable and long-term to offset long-living greenhouse gases in the atmosphere. In this study, I – with the very notable help of John O. Niles – showed that this objective can be achieved by a system of withholding of contract benefits, which we call ”economic


135

liability”. A CDM forest-secured escrow account would be the most economical way to provide sufficient incentives for long-term protection. AIJ, the pilot phase of Joint Implementation, provides valuable lessons on the actual working of project-based Kyoto mechanisms such as JI and the CDM. Empirical evidence in this study shows that these mechanisms face an additional layer of regulation -- ”national preferences” of host and investor countries. While basic economic reasoning tells us that regulatory preferences will diminish the efficiency of the JI and the CDM, my empiricism clearly qualifies this result. AIJ are overwhelmingly ”no regrets”, i.e. measures with zero or negative costs. If this holds true for early CDM and JI, which can be reasonably expected, national preferences would only diminish the amount of cost savings that will be exploited. This may be the minimal price worth paying to achieve sustainable development and meaningful participation of developing countries in this early phase of international climate change policy. This report was offered in the spirit of ”lets make the best of what we have”. Internationally, the Kyoto Protocol embodies a vast amount of political momentum. This momentum, properly channeled, could establish a market-based environmental treaty that could begin to address not only one but two of planet's most pressing environmental challenges - climate change and tropical deforestation. Doing so may spur immediate financing of tropical forests as well as positioning the protocol in such a way that the U.S. senate could be convinced to support it. The U.S. has effectively a veto on the protocol since the protocol will only enter into force on the date on which ”not less than 55 Parties to the Convention, incorporating Parties included in Annex I which accounted in total for at least 55 per cent of the total carbon dioxide emissions for 1990 of the Parties included in Annex I, have deposited their instruments of ratification, acceptance, approval or accession” (Article 25 KP). While the U.S. share of Annex I carbon dioxide emissions in 1990 is only 22%, the majority of Annex I countries are not prepared to ratify a treaty that would exempt the U.S. as the world's single biggest carbon emitting country. The U.S. Senate Byrd-Hagel resolution notes that, although the UNFCCC is intended to limit emissions on a global level, the Berlin Mandate exempts all Non-Annex I nations from any commitments. The CDM, negotiated in the final hours at Kyoto, is the only way for NonAnnex I countries to make meaningful contributions to greenhouse gas reductions. Additionally, the Byrd-Hagel resolution indicates that the

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Summary

Protocol would not be ratified in the Senate if it imposed intolerable costs on the U.S. economy. Full-blown, unrestricted emissions trading among Annex I countries and among Annex I and Non-Annex I countries (along the CDM) appears the most effective way to minimize the ”cost of Kyoto”. As such, the proposed policies in this study may help make the Kyoto Protocol more attractive to the swing constituency, the U.S. Whether or not these proposals go far enough to appease the Senate and persuade the newly elected republican President will not be known until the Protocol comes up for a vote of ratification. In any case, they offer substantial political leverage to bring the U.S. on board.


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Chapter 9 Terms and Abbreviations Additional BSS: Human-induced activities related to greenhouse gas emissions from biological sources and sinks, that are currently not covered by the Kyoto Protocol. Example for additional BSS are selective logging and farming practices such as reduced tillage that lead to changes in soil carbon of agricultural land (for a comprehensive list of additional BSS see UNFCCC, 1998). Adjustable baseline: An adjustable baseline accounts for unforeseen outside developments such as a decreasing energy demand that affect the reference case of emissions for project-based Kyoto-Mechanisms (JI and CDM). Under an adjustable baseline such developments would lead to reaccounting of emission reductions. AIJ: The first Conference of the Parties (COP1) to the United Nations Framework Convention on Climate Change in Berlin established a pilot phase of so-called Activities Implemented Jointly (AIJ). This pilot phase started in 1995 and was to end in 1999. It was prolonged at the fifth Conference of the Parties in Bonn (1999) for an undetermined period after 2000. AIJ resembles the project-based mechanisms of the Kyoto Protocol, Joint Implementation and the Clean Development Mechanism. The key difference between AIJ and JI or CDM is that under the latter two investors will be able to obtain emission reduction credits, whereas crediting is specifically excluded for AIJ projects for the duration of the pilot phase. Annex I Parties: Industrialized countries that, as parties to the Framework Convention on Climate Change, agreed to reduce their greenhouse gas emissions by the year 2000 to 1990 levels. Annex I parties to the United Nations Framework Convention on Climate Change

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Terms and Abbreviations

(UNFCCC) consist of countries belonging to the OECD and countries designated as Economies-in-Transition. Annex II Parties: Annex II Parties that, as parties to the Framework Convention on Climate Change (FCCC), committed to fund the ”financial mechanism” (GEF) of the FCCC. Annex II is pretty much Annex I less economies in transition. Annex B Parties: Industrialized countries that, as parties to the Kyoto Protocol, agreed to reduce their greenhouse gas emissions an average about 5% below 1990 levels during 2008-2012. Annex B parties consist of countries belonging to the OECD and countries designated as Economiesin-Transition. Anthropogenic: Man-made or human-induced ARD: Afforestation, Reforestation and Deforestation (eligible practices for the accounting of biological sources and sinks under the Kyoto Protocol). Baseline: The baseline is a reference case of emissions, pretty much business as usual, to be compared to the projected or actual emissions of an activity. It is a crucial issue in emission reductions crediting under the project-based Kyoto-Mechanisms (JI and CDM). Berlin Mandate: A ruling negotiated at the first Conference of the Parties (COP 1), which took place in March, 1995, concluding that the present commitments under the Framework Convention on Climate Change are not adequate. The Berlin Mandate establishes a process that would enable the Parties to take appropriate action for the period beyond 2000, including a strengthening of developed country commitments, through the adoption of a protocol or other legal instruments (adopted from EPA Glossary on Climate Change). BSS: Biological Sources and Sinks (of greenhouse gases). The most important BSS are forest ecosystems. It should be noted however that some other ecosystems such as wetlands have a ver yhigh specific source potential (per ha.) due to their forceful trace gas emissions.


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Business as usual: Time path of emissions in the absence of policies designed to cut emission growth. Byrd-Hagel Resolution: In 1997, by a vote of 95-0, the U.S. Senate passed the Byrd-Hagel Resolution. This resolution stated that the senate would not ratify any climate change treaty if it 1) did not involve developing countries, nor 2) if it was unreasonably expensive. The CDM is the only aspect of the Kyoto Protocol that involves developing countries and lowers the cost of compliance, satisfying both objections raised by the Senate. C: carbon (C-emissions translate into carbon dioxide emissions using a factor 44/12 based on the relative molecular weights) Carbon risk: Carbon risk is a function of the appropriately discounted probability of passage of a treaty times the anticipated cost of compliance under ratification. CERs: Certified Emission Reductions (Article 12) Clean Development Mechanism: Under the Clean Development Mechanism (CDM) of the Kyoto Protocol, industrialized countries (Annex I-parties) may fund emission reduction projects in amenable developing countries (Non-Annex I-countries) and get credit for Certified Emission Reductions (CERs) from these projects. These CERs can then be used to meet the commitments of the Annex I-countries. Coase Theorem: A view put forth by Ronald Coase that externalities will be corrected by bargaining or some form of contractual agreement between the affected parties. COP: The Conference of the parties is the collection of nations which have ratified the Framework Convention on Climate Change (UNFCCC), currently over 150 strong, and about 50 Observer States. The primary role of the COP is to review the implementation of the Convention and to take the decisions necessary for the effective implementation of the Convention.

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CoPMoP: Conference of the parties (to the UNFCCC) serving as meeting of the parties (to the Kyoto Protocol) CP.1: The first COP took place in Berlin from March 28th to April 7th, 1995. CO2: Carbon Dioxide (CO2 emissions translate into carbon emissions using a factor 12/44 based on the relative molecular weights). CTOs: Certified Tradeable Offsets are CERs from CDM projects in Costa Rica. Each CTO guarantees one ton of carbon mitigated over a minimum period of 20 years. Double trigger: The Kyoto Protocol becomes effective if it is ratified by 55% of the signatory countries representing at least 55% of the global GHG emissions. Dynamic baseline: A dynamic baseline is a reference case of emissions considering changing trends of technology, economic policy, behavior etc. EITs: Economies in transition are Central and Eastern European countries and the states of the Former Soviet Union that are undergoing a transition towards an market economy. Fixed baseline: A fixed baseline is a "once and for all"-approach in setting a reference case of emissions. Once defined, the baseline will be valid over the entire project duration. It will not be adjusted according to new information arising in the course of project implementation. Fossil Fuel: A general term for combustible geologic deposits of carbon, including coal, oil, natural gas, oil shales, and tar sands. GEF: Global Environment Facility is the "financial mechanism" (bank) that deals with distributing funds put up by industrialized countries (Annex II parties) for technology transfer to developing countries.


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GHGs: Greenhouse gases absorb infra-red radiation in the atmosphere. The most important GHGs are water vapor, carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), halogenated fluorocarbons (HCFCs), ozone (O3), perfluorinated carbons (PFCs), and hydrofluorocarbons (HFCs). The Kyoto Protocol regulates emissions of six greenhouse gases. These gases are CO2 (carbon dioxide), CH4 (methane), N20 (nitrous oxide), and some industrial gases (SF6, PFCs and HFCs). The carbon equivalents of GHGs other than CO2 are calculated on the basis of global warming potentials Grandfathering: Initial allocation of emission rights based on current emissions GtC: Gigatons of carbon (=1 billion metric tons of carbon) GWP: The global warming potential (GWP) measures the CO2 equivalent contribution to global warming of other greenhouse gases, e.g. CH4 and N20. It is established by reference to the IPCC model on global warming and is conventionally based on a 100-year time horizon. The pertinent GWPs of CH4 and N20 are 24.5 and 310. Hot air: ”Hot air” is a term used to describe the fact that some economies in transition, particularly Russia and the Ukraine, were granted emission rights that exceed their projected emissions in the first commitment period of the Kyoto Protocol. IEA: International Energy Agency - a body of the OECD IPCC: The Intergovernmental Panel on Climate Change was established jointly by the United Nations Environment Programme and the World Meteorological Organization in 1988. The purpose of the IPCC is to assess information in the scientific and technical literature related to all significant components of the issue of climate change. The IPCC draws upon hundreds of the world's expert scientists as authors and thousands as expert reviewers. Kyoto forestry: The term Kyoto forestry describes the combined activities of afforestation, reforestation and deforestation which are

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accountable as biological sinks and sources of greenhouse gases under the Kyoto Protocol. Kyoto Protocol: The Kyoto Protocol to the United Nations Framework Convention on Climate Change (UNFCCC) was signed in Kyoto, Japan, in December of 1997.The Protocol includes legally binding limits on six selected greenhouse gas (GHG) emissions of Annex B parties (industrialized countries) and key provisions regarding accountability and flexibility. Letter of intent: The letter of intent is a mutual agreement between the host and the investor country to have an Activity Implemented Jointly. This form of government approval is a legal prerequisite for AIJ under the Berlin Mandate. LUCF: Land Use Change and Forestry MEA: Multinational Environmental Agreement MtC: Megatons of carbon (= 1 million metric tons of carbon) MtC/yr: Megatons of carbon per year National AIJ programs: National AIJ programs set out the objectives and criteria for the government approval of AIJ projects (see ”Letter of intent”). A detailed list of national AIJ programs can be found on www.unfccc.de. No regrets: Climate change mitigation activities with zero or negative cost. Climate change activities may generate revenues from fuel saving of from selling of forest products and services, eco-tourism etc.. ODA: Official Development Assistance OECD: Organization for Economic Cooperation and Development (industrialized nations)


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Project-specific baseline: A project-specific baseline is reference case of emissions that has been drawn up by examining a project on a case-bycase basis. QUELROs: Quantified emission limitation and reduction objectives for Annex B countries of the Kyoto Protocol. Sequestration: Uptake of carbon in plants and trees through the processes of photosynthesis and growth. Sinks: Carbon reservoirs such as forests and oceans that take in and store more carbon than they release. Carbon sinks can serve to partially offset greenhouse gas emissions. Sink enhancement: Sink enhancement refers to any activity that increases the biospheric carbon uptake such as sea fertilization, afforestation and reforestation. Snapback effect: Increased energy demand caused by the income effect of increased efficiency of usage. Static baseline: A static baseline is an extrapolation of the status quo over the entire lifetime of a project used as a reference case of emissions for project-based Kyoto-Mechanisms (JI and CDM). tC: tons of carbon Trace gas: Trace gases, unlike CO2 that is absorbed by vegetation, are abolute transfers from the biosphere to the atmosphere. They include methane, carbon monoxide, nitrous oxide, non-methylated hydrocarbons and others. Ultimate objective: The ultimate objective of the UNFCCC and the Kyoto Protocol is to stabilize GHG concentrations at a level that would prevent dangerous anthropogenic interference with the climate system. Umbrella projects: Umbrella projects are large-scale, nation-wide climate change mitigation projects with a very active government

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involvement in the planning and implementation stage of the project. This project type has been invented and applied in two large-scale forestry projects in Costa Rica. Funding of umbrella projects is done through a system of ”Certified Tradeable Offsets” (CTOs). UN: United Nations UNCED: United Nations Conference on Environment and Development in Rio de Janeiro, 1992 (”Earth Summit”) UNEP: United Nations Environmental Programme UNFCCC: United Nations Framework Convention on Climate Change WBGU: German Council of Scientific Advisers on Global Change