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Assessment of different types of units

This appendix sets out analysis and conclusions about different international units; it complements the discussion in Chapter 3.

Certified Emission Reductions (CERs)

CERs are issued under the CDM for emissions reductions that occur in developing countries.

Principle

Analysis

Conclusion

Economic efficiency

The wide coverage of the CDM, across a large number of countries, sectors and gases, allows for low-cost abatement to be sourced. The mechanism has been operating for some time and the market is now well established. There is a large number of CERs available in the market at historically low prices, currently below $0.50 (see Chapter 4). They represent a cost-effective option to help achieve Australia’s target.

Allow (subject to some exceptions discussed below)

Environmental effectiveness

The CDM has detailed rules and governance arrangements to ensure emissions reductions are genuine. Over time, the CDM has developed a sophisticated set of methodologies and rules for determining whether reductions are additional and these are constantly refined. Its operation has improved over time, and its Executive Board has made a conscious and consistent effort to identify and address environmental credibility concerns. It now operates with a high level of environmental integrity. Similar governance arrangements and verification processes are employed in Australia’s CFI and are proposed for the ERF.

Effective global response

Market mechanisms such as the CDM allow for lowest-cost emissions reductions to be sourced regardless of where in the world they occur. In this way, markets can promote and enable increased global action as individual countries can take on more ambitious targets at lower cost. Using CERs to contribute to Australia’s 2020 goals would help maintain market capacity and confidence, and demonstrate the mutual benefits trade can provide to both buying and selling countries.

Foreign policy and trade objectives

CERs are consistent with Australia’s foreign policy and trade objectives. They count towards Australia’s target under the Kyoto Protocol rules, and their use by Australia would generally be considered credible internationally.

First commitment period CERs

First commitment period CERs are issued for emissions reductions that occurred before the end of 2012.

Principle

Analysis

Conclusion

Economic efficiency

There is currently a large number of first commitment period CERs available in the market. Their availability and cost will depend on demand from other countries (see Chapter 4).

Allow

Environmental effectiveness

First commitment period CERs represent genuine verified emissions reductions. It could be argued that they do not represent ‘additional’ emissions reductions, as the reductions have already occurred and, if Australia doesn’t buy them, they will be cancelled at the end of the true-up.

Effective global response

Restricting the purchase of these first commitment period CERs would likely undermine investor confidence in the CDM, other market-based approaches and other clean investment schemes. This would not be consistent with supporting an effective global response to climate change.

Foreign policy and trade objectives

First commitment period CERs can be used towards Australia’s second commitment period target if they have been carried over. There is a limit on carryover equivalent to 74 million CERs for Australia.

If Australia wants to purchase more than 74 million first commitment period CERs, it could retire them in place of AAUs against its first commitment period target and increase the number of AAUs that can be carried over (see Appendix A).

Second commitment period CERs

Second commitment period CERs are issued for emissions reductions that occur from 1 January 2013.

Principle

Analysis

Conclusion

Economic efficiency

Currently, there is a limited number of second commitment period CERs available in the market at low prices. More are expected to become available over the period to 2020 at prices below $1.15 (see Chapter 4).

Allow from projects in:

  • countries that confirm the CERs they sell will not be counted towards meeting their own commitments and actions under the UNFCCC
  • sectors or for gases not covered by the host country’s commitment
  • countries that are not expected to take on commitment without assistance, such as least-developed countries

Environmental effectiveness

The CDM general rules provide primary assurance of the environmental integrity of CERs. However, in some cases the national goals to reduce emissions in host countries could affect additionality.

In the period 2013 to 2020, many developing countries have taken on commitments or actions to reduce their emissions under the UNFCCC. These commitments have many different forms—some are unilateral; others are contingent on financial support (such as the support delivered through mechanisms like the CDM).

The rules for how to account for these commitments and how they interact with the Kyoto Protocol mechanisms are subject to ongoing negotiation. To be additional and avoid double-counting, Australia can only use CERs where the same emissions reduction is not counted towards the developing country’s unilateral emissions reduction goals.

Until there is greater clarity on how second commitment period CERs are to be counted, additional filters on the CERs Australia can purchase may be required to ensure they represent an additional emissions reduction:

  • Where developing countries confirm that they will not count CERs towards meeting their own commitments, the CERs would be additional.
  • Where developing countries have taken on commitments that encompass only specific sectors or greenhouse gases, CERs from projects in uncovered sectors or gases would be additional.
  • Least-developed countries may not have commitments or be expected to take action without financial assistance. CERs from projects in these countries would be additional.

Effective global response

Some countries that are eligible to host CDM projects are not really ‘developing’ because they have high incomes but do not yet have a commitment under the UNFCCC. The CERs from projects in these countries would, strictly speaking, be additional. Purchasing these units would not, however, be consistent with Australia’s foreign policy objectives or an effective global response, as these countries can reasonably be expected to take on commitments.

Foreign policy and trade objectives

Second commitment period CERs can be used towards Australia’s target under the Kyoto Protocol and would be considered credible internationally.

Temporary CERs (first and second commitment period)

Forestry projects are credited with temporary CERs (called tCERs and lCERs) that have a limited life.

Principle

Analysis

Conclusion

Economic efficiency

There are very few forestry CERs available on the market.

The purchasing country (not the forestry host country) would need to replace the units when they expire or if there is a reversal of the carbon storage (for example, if the forest was destroyed). This buyer liability model creates extra risks for Australia. It also makes administering either a government purchase program or domestic policy more complicated, as the requirement to replace the CER would need to be tracked.

Do not allow

Environmental effectiveness

Temporary CERs are environmentally credible because, like other CERs, they are only issued for verified abatement from approved forest projects.

Effective global response

There is widespread acceptance of the role that land sector abatement will need to play in a carbon-constrained world. Under the CDM, this abatement is facilitated through the issue of temporary CERs.

Foreign policy and trade objectives

Temporary CERs can be used towards Australia’s target under the Kyoto Protocol and would be considered credible by some countries. First commitment period temporary CERs cannot be carried over. If Australia uses second commitment period temporary CERs, they would need to be replaced consistent with the Kyoto Protocol rules.

Large-scale hydro-electric generation projects (first and second commitment period)

Principle

Analysis

Conclusion

Economic efficiency

There is significant potential supply from large hydro-electric generation projects, which are likely to be low cost.

Do not allow unless the project meets criteria established by the World Commission on Dams

Environmental effectiveness

Large-scale hydro-electric generation projects can significantly reduce emissions compared to fossil-fuel generation. They can also displace local communities, and lead to loss of agricultural land and a decline in biodiversity. The World Commission on Dams has established a set of criteria for the development of these projects that is widely accepted as good practice. Most large hydro-electric CDM projects meet these criteria.

Effective global response

Hydro-electric generation has a role in an effective global response to climate change.

Foreign policy and trade objectives

The EU only accepts CERs from hydro-electric projects that meet the criteria. If Australia was to purchase CERs from hydro-electric CDM projects without similar restrictions, it could be criticised internationally.

Industrial gas destruction projects (first and second commitment period)

A large number of CERs issued to date have come from projects that destroy industrial gases—trifluoromethane (HFC-23) and nitrous oxide (N2O) from adipic acid production—that would have otherwise been released into the atmosphere.

Principle

Analysis

Conclusion

Economic efficiency

The cost of reducing HFC-23 and N2O emissions is very low. Some controversy around these projects relates to the large profit that projects received in the past, given the low cost of the emissions reductions compared to the CER price received at the time. European entities in particular transferred significant wealth to projects in developing countries.

Europe and other developed countries fund the phase-out of HCFC 22 under the Montreal Protocol. This, in turn, reduces the associated HFC-23. Some argue that an additional incentive from the CDM is therefore not required.

There is also some concern that the high rates of return for CDM projects has shifted production of adipic acid offshore to developing countries because the treatment under the CDM is much more favourable than in Europe.

Do not allow

Environmental effectiveness

These projects achieved real emissions reductions but there are widespread credibility concerns. The EU, for example, has restricted the use of CERs from these projects.

Initially concerns were raised with projects that destroy HFC-23 (which is a by-product of HCFC-22, controlled under the Montreal Protocol established to protect the ozone layer). Later, similar concerns were raised with projects that destroy N2O from adipic acid production.

Concerns centre on the perverse incentive to produce more HCFC-22 just to get the CERs from destroying the HFC23. The methodology has been amended to largely address these concerns.

Effective global response

These gases have high global warming potential and so an effective global response would provide incentives for these emissions to be reduced. Some consider that developing countries should act to reduce these emissions without the incentive from the CDM because the cost of the reduction is so low.

Foreign policy and trade objectives

While emissions reductions from these projects are real, they are widely perceived as not credible. If Australia was to purchase these, it could be criticised internationally and domestically, and may also increase scepticism about international units.

New coal-fired electricity projects (first and second commitment period)

The CDM credits new coal-fired electricity generators if it can be demonstrated that the generator is less emissions-intensive than the fossil-fuel plant that would have been built instead. This project type does not incorporate fossil-fuel electricity generators that deploy carbon capture and storage (CCS).

Principle

Analysis

Conclusion

Economic efficiency

These units make up only a very small proportion of the total potential supply. Currently, six projects of this type have been registered (approved)—five in India and one in China. To date, 606,306 CERs have been issued from these projects. There are an additional 55 projects in the pipeline but many are unlikely to be eligible under the most recent methodology. These CERs are unlikely to be available at a lower cost than other CERs.

Under a government purchase program, place a low priority on buying units

Environmental effectiveness

There have been concerns with the methodology for these projects—some argue the financial and common practice tests used to demonstrate additionality are not sufficient, and default factors used in setting the baseline might over-credit some projects (Lazarus and Chandler 2011). The methodology has been reviewed by the CDM Executive Board several times. The latest version has more stringent additionality tests and baselines than previous versions. Many other CDM projects use similar additionality tests and approaches to setting baselines.

Effective global response

By locking in new emissions-intensive infrastructure, these projects reduce the chance of keeping global average warming to below 2 degrees. Many countries, as well as international financial institutions such as the World Bank, have recently announced they will avoid funding new coal power plants in developing countries for similar reasons.

The premise of the CDM methodology is that a long-lived fossil-fuel power plant is going to be built in any event but, with support from the CDM, a less emissions-intensive plant can be built instead. The CDM does not assess any projects on the basis of whether the investment is consistent with a less-than-2-degrees-future; rather, it assesses if emissions will be lower than they otherwise would be.

Foreign policy and trade objectives

It is possible that those countries hosting projects would criticise the restriction, potentially reducing Australia’s influence.

Australia is also an exporter of coal and does not prohibit fossil-fuel generation domestically.

In practice, the low number of units from this source means that they could not make a large contribution to any purchasing strategy in Australia.

Investing in existing or only new projects

There is a large potential supply of CERs in the period to 2020 from projects that are already registered (approved). This potential supply is much larger than expected demand over the same period. Without additional demand, it is unlikely that many new projects would be developed.

Principle

Analysis

Conclusion

Economic efficiency

Excluding CERs from existing projects would significantly reduce the potential supply and likely increase the price. There are very few new projects currently requesting registration. This mostly reflects a lack of demand. If Australia demanded units from new projects, then project developers would likely respond. New projects are likely to require a price higher than some existing projects to come to market (see Chapter 4).

Allow from both existing and new projects

Environmental effectiveness

Some of the existing projects, but not all, will continue without an on-going incentive from the CDM. It could be argued that it would be more environmentally effective to purchase CERs from new projects only, or to only purchase CERs from projects that will continue without an on-going incentive.

Effective global response

Investors undertook existing projects with the reasonable expectation of market demand for their verified emissions reductions. Reassessing whether the project needs an on-going incentive after the investment has already been made would weaken market confidence, with investors less likely to invest again (or requiring a higher rate of return on new investments). This would not be consistent with an effective global response to climate change, which requires substantial investment.

Foreign policy and trade objectives

Kyoto Protocol rules allow for Australia to use CERs from both existing and new projects. It is unlikely that Australia would be criticised for using CERs from existing projects.

Prioritising projects to achieve broader foreign, trade or development objectives (first and second commitment period)

Units from projects that enhance Australia’s trade, foreign policy and development objectives could be prioritised.

Principle

Analysis

Conclusion

Economic efficiency

If Australia only allows units from projects that also enhance its broader foreign, trade or development objectives, it could reduce supply and increase costs. If the broader policy objectives can be achieved through the carbon market in a cost-effective way, targets purchasing rules could be a good way to meet Australia’s mitigation and other objectives at the same time. If, however, there are other, cheaper, options, it would be more economically efficient to have more open purchasing rules.

Under a government purchase program, prioritise units from projects that enhance Australia’s broader foreign, trade and development policy objectives where they can be sourced at a cost similar to other units

Environmental effectiveness

No specific concerns; could prioritise projects that deliver multiple environmental benefits.

Effective global response

An effective global response from climate change is more likely to be achieved if cooperation to address climate change can also enhance other objectives.

Foreign policy and trade objectives

Purchasing units from projects in specific countries could enhance Australia’s broader trade, foreign policy and development objectives. For example, Australia could allow units from projects located in neighbouring countries that are a particular focus of its development agenda; that use technology, inputs or skills exported from Australia; or that are owned by Australian developers.

Assigned Amount Units (AAUs)

AAUs are the primary compliance unit under the Kyoto Protocol. Trade in AAUs could also allow Australia to use units generated in domestic markets of other Kyoto Protocol countries, where those domestic units are backed by an AAU.

Principle

Analysis

Conclusion

Economic efficiency

There is a large volume of first commitment period AAUs that will not be used for compliance and can be carried over for use in the second commitment period. There may also be some second commitment period AAUs available in the period to 2020. It is unlikely that AAUs would be available at prices below other units.

Do not allow first commitment period AAUs

Allow second commitment period AAUs if satisfied with the stringency of the country’s target

Environmental effectiveness

There are environmental credibility concerns associated with the large volume of surplus AAUs, particularly from countries with economies in transition whose first commitment period targets were significantly above their business-as-usual emissions (referred to as ‘hot air’). Purchasing these units would not necessarily lead to an additional emissions reduction in the other country.

It is not yet clear if the same credibility concerns will arise with the second commitment period AAUs.

In the past, some countries have addressed the credibility concerns associated with AAU trades by funding green investment. Some of these schemes are similar to Australia’s Emissions Reduction Fund, but instead of investing in domestic projects the schemes invested in projects located in other countries (Tuerk et al. 2013). Similar investment schemes could emerge for the second commitment period and provide a credible way for Australia to source AAUs.

Where trade in AAUs is linked to a credible domestic market in another country, it would be environmentally credible. For example, EUAs are very credible, with the EU ETS having a binding cap and robust monitoring and verification procedures.

Effective global response

Trade in AAUs could help support an effective global response to climate change. Trade in emissions reductions between countries that have economy-wide emissions budgets will be an important element of the post-2020 framework, because it allows countries flexibility to cooperate and find the lowest-cost emissions reductions. Trade in AAUs is how this same flexibility can be achieved under the Kyoto Protocol.

Foreign policy and trade objectives

First commitment period AAUs count towards Australia’s target under the Kyoto Protocol rules; however, use by Australia would generally not be considered credible internationally. Australia has made a political declaration that it would not use other countries’ surplus AAUs from the first commitment period towards meeting its second commitment period target (see Appendix A).

Removal Units (RMUs)

RMUs are issued by countries with a Kyoto Protocol target for each tonne of CO2 that is removed from the atmosphere. RMUs can also be traded to other countries RMUs can also be traded to other countries.

Principle

Analysis

Conclusion

Economic efficiency

There are not many RMUs available on the market, but some could become available. They could be economically efficient if they are available for prices similar to other low-cost units.

Allow

Environmental effectiveness

RMUs are environmentally effective. Some concerns have been raised about the robustness of land sector accounting and the permanence of sequestration. The measurement and reporting of land sector emissions, however, is part of the Kyoto Protocol compliance process. The lack of permanence is dealt with in subsequent periods, with emissions counted in the selling country’s emissions inventory.

Effective global response

There is widespread acceptance of the role the land sector will play in a carbon-constrained world. Trade can facilitate this abatement, and trade in RMUs is how this is achieved under the Kyoto Protocol.

Foreign policy and trade objectives

RMUs count towards Australia’s target under the Kyoto Protocol rules and their use by Australia would generally be considered credible internationally despite them being excluded from the EU ETS. However, first commitment period RMUs cannot be carried over, so if Australia wanted to use them it would need to purchase them before the end of the true-up period and use them for compliance in the first commitment period (Appendix A). In the second commitment period, Australia would need to stay within the limit on the use of RMUs from forest management activities.

Emission Reduction Units (ERUs)

ERUs are issued under the Joint Implementation (JI) mechanism. JI allows a country with a Kyoto Protocol target (or an entity it approves) to implement an emissions reduction project in another country that also has a target, and to trade the resulting ERUs for use towards its target.

Principle

Analysis

Conclusion

Economic efficiency

From an economic perspective, there is a number of first commitment period ERUs available in the market. These units trade at similar prices to CERs. Rules for JI in the second commitment period are still under negotiation.

Allow first commitment period ERUs and second commitment period ERUs when they are available, with the following exceptions:

  • ERUs from large hydro-electric projects, unless they meet the criteria established by the World Commission on Dams
  • ERUs from projects that destroy HFC-23 and N20 from adipic acid production

Under a government purchase program, a low priority should be placed on ERUs from new fossil-fuel projects

Environmental effectiveness

In the first commitment period JI operated with two tracks. Track I allows the host country to verify emissions reductions itself using its own procedures. Under Track II, emissions reductions are verified under the supervision of an international body called the Joint Implementation Supervisory Committee (JISC). The ultimate decision about whether to issue the ERU is made by the host country.

As with AAUs, there could be some environmental credibility concerns with Track I ERUs because those countries with a large surplus of AAUs could declare a project has reduced emissions, without any real additional emissions reduction. JI projects approved under Track II have not faced the same credibility concerns because their verification is subject to international oversight.

Most countries who have participated in the JI have developed processes and programs that provide a degree of environmental integrity. Some use methodologies and procedures that are similar to those under Track II. Green investment schemes have also been used to develop and fund JI projects of high quality.

The Parties have agreed to review the operation of the JI for the second commitment period with the intention to streamline the mechanism to operate under a single track, align accreditation of auditors with arrangements under the CDM, and specify mandatory requirements for assessing additionality and approving baselines of projects. The final arrangements for the JI in the second commitment period as well as transitional arrangements are subject to ongoing negotiation.

As with the CDM, there are some particular types of JI projects that may not be credible sources of units. The same assessment would apply to large hydro-electricity, industrial gas destruction and new coal-fired power plants, and investment in existing projects. Forestry and other land-based JI projects would be acceptable as the resulting ERU is not temporary (unlike forestry CERs).

Effective global response

JI facilitates cooperative action between two countries that have mitigation commitments. Market mechanisms of this type will be an important element of an effective global response to climate change. Supporting the JI by using ERUs in the period to 2020 can help to maintain existing market capacity that will remain valuable post-2020.

Foreign policy and trade objectives

ERUs count towards Australia’s target under the Kyoto Protocol rules and use by Australia would generally be considered credible internationally. Australia can only carry over 74 million ERUs. If it purchases more first commitment period ERUs it could use them towards its first commitment period target.