After the shock of the Bushannouncement that the Kyoto Protocol was dead, joy was great to see it resurrected by the Bonn Agreement in July 2001. Bonn paved the way for entry into force but concessions had to be made that may overshadow the value of the agreement for developing countries. Through additional sinks, the targets of industrialised countries have been weakened. CDM competes with emissions trading and JI and is unlikely to create the multi-billion $ revenue streams dreamt of in earlier times. We thus have to carefully navigate between the Scylla of necessity to keep CER prices low and the Charybdis of undermined environmental integrity. The ten points discussed below should set the course:

The CDM is an important element in the overall strategy to protect the climate

Historical and current per capita emissions suggest very clearly that the developed countries have to take the lead in protecting the earth´s climate. Notwithstanding, rising emissions in developing countries are a problem which has to be addressed appropriately and quickly. The challenge is to find a development path which avoids the unsustainable emission levels of the industrialised world. If implemented sensibly, the CDM can provide financing for the technological (and sometimes institutional) changes needed. Learning and spill-over effects from successful CDM projects will contribute to the overall objectives of sustainable development and climate protection.

NGOs are going to watch very closely in what kind of CDM projects companies invest. Past experiences have shown that NGO campaigns can be very detrimental to a targeted company´s turnover. Hence, no big company from a country with a strong NGO community will want to invest in bad projects. This concerns baseline and additionality issues as well as environmental and social impacts of the projects. Thus, strict criteria for sustainability and additionality should be applied as well as conservative baselines. Here, the host country can play a decisive role. Monocultural forest plantations are especially unpopular, which leads to the recommendation to exclude this special type of forestry projects from national CDM programmes. Only if the CDM remains a credible mechanism as a whole will companies be prepared to use it. A tentative list of "good" project examples may help project developers and investors in designing and choosing good projects. NGOs are likely to support the choice of good projects by developing a quality label for the CDM.

The approval procedures (both in the investor´s country and in the host country) have to be simple, fast and predictable

In general, the share of the CERs in the total project revenues is too small to make companies accept high transaction costs associated with the approval process. Thus, a CDM programme with long and complicated approval procedures is never going to attract projects. Even more important than simplicity is the predictability of the outcome of the approval process, because project developers will not want to run the risk of bearing the sunk costs of designing a project without knowing if it will be approved. This means that a clear set of approval criteria has to exist and to be applied in an impartial way.

Information is crucial in minimising transaction costs and improving the image of the CDM

Low transaction costs and a good reputation of the mechanism are the centrepieces to a successful CDM. This can only be achieved if there is an effective flow of information to all relevant stakeholders as well as to the general public. There must be an institution which efficiently functions as a provider of all relevant information directly related to the CDM. This institution should provide capacity building and market the CDM programme actively. It needs to be easy to contact and it should build up a well-administered internet page, preferably available both in the domestic language and in English.

CERs need to get a value by linking them to the national climate policy instruments of industrialised countries

The CDM is no "stand-alone" instrument of climate policy but needs a backup by national instruments. Otherwise, CERs will not have a value for the investor. Already before the entry into force of the Kyoto Protocol, governments of industrialised countries should accept CERs as valid emission rights under their domestic trading schemes or grant emission tax credits for CERs. Even if only voluntary commitments of industry exist, CERs could be accepted towards the fulfilment of these commitments. Currently, few domestic programmes accept emission credits from CDM-like projects. Experience from the AIJ pilot phase shows that AIJ projects financed by investors from jurisdiction accepting emission credits were much more successful than the other projects. A crediting of CERs towards national climate policy instruments at a relatively high value could also alleviate problems from a very low world market price due to abundant supply of "hot air" (see point 7 below)

It is desirable to harmonise to a certain degree the criteria for approval and the means by which investors´ countries integrate CERs into their national climate policy

Diverging national regulations distort competition and thus reduce economic efficiency and possibly also market liquidity. To the extent that common principles can be agreed on and national policy schemes are compatible, harmonisation is very desirable. Harmonisation can be strived for on a regional scale (e.g. within the European Union), but also between investor countries and host countries as far as e.g. sustainability criteria are concerned. However, the harmonisation process should not lead to a further delay of CDM activities. The time until the Kyoto Protocol will (hopefully) enter into force should be used to start with the work towards harmonisation of climate policy schemes.

The "hot air" problem needs to be tackled, if the CDM is supposed to take off

Under the Bonn Agreement and in the absence of the U.S., supply of emission rights through "hot air" (i.e. reductions through the economic breakdown in the former Soviet Union) is likely to be higher than demand by the other industrialised countries. Under such a scenario, prices for emission rights will be very low, maybe just a bit higher than transaction costs for purchase of zero-cost "hot air". Unless Russia and Ukraine form a cartel and raise selling prices for emission rights, demand for CERs will be negligible. On the other hand, transaction costs for CDM will always be higher than for transfers of hot air. Thus the CDM can only get off the ground if either the U.S. re-enter the Protocol or the amount of available "hot air" is reduced. The latter could, for example, be achieved by swapping "hot air" against Russian foreign debt and retiring it. Nevertheless, the danger of "hot air" swamping the system could be averted by support from an unexpected side: if a country does not fulfil the eligibility requirements for the participation in the mechanisms (reporting, emissions monitoring), it cannot sell emission rights. And Russia is not likely to fulfil these requirements very soon...

The CDM may even be attractive to companies which usually do not invest in developing countries

The CDM has the potential to create export revenues and to attract new investors. These need not physically invest in countries they see to be risky. Under a unilateral CDM, i.e. a CDM without a project investor from abroad, a country with an unattractive investment climate still can create exportable services in the form of CERs. However, it now bears the risk that the CERs do not accrue if certifiers find that the projects are implemented in a faulty manner. Good know-how and reliable project implementation are thus a necessary condition to reap the benefits from unilateral CDM. However, a country does neither get the technology transfer nor the capacity building linked to bi- and multilateral CDM.

The CDM should not be development assistance but a private sector-based mechanism

A successful CDM will be an interesting market for industrial firms, project developers, consultants, certifiers, brokers, and financial institutions both from developing and developed countries. While currently most of the CDM-type projects are financed via public subsidies (Dutch CDM tender, parts of the World Bank´s Prototype Carbon Fund), in the future public involvement should be clearly restricted, especially regarding the investor´s country. Instead, the investor country should set incentives for investors via domestic policy instruments as described in point 5. Obeying to this rule, the CDM cannot be confused with official development assistance. NGOs should keep an eye on investor country governments to prevent that they reduce ODA in the same extent as new funds flow through the CDM. Unfortunately, the wording of the Bonn Agreement stating that the CDM should not lead to a "diversion" of ODA cannot guarantee that ODA stays above pre-CDM levels.

In the near future, small scale CDM projects provide the best opportunities for investors

The Bonn Agreement defined small projects that shall receive favoured and simplified treatment under the CDM. The CDM Executive Board will develop these special rules with priority, while it is likely that rules for large projects will still take some time. This means that renewable energy projects of less than 15 MW, energy efficiency projects with less than 15 GWh reduction and all other projects emitting less than 15,000 tonnes of CO2 p.a. get on a fast track. Especially India has a large supply of such projects and could build on its successful renewable energy programme. It is likely that the pioneers in small scale project development will have an advantage in attracting big ones later, because the transaction costs have already been lowered due to learning effects. q

The author is Head, Hamburg Institute of International Economics, Frank Vöhringer, University of Frankfurt.

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