FIVE years ago, International Rivers (IR) began monitoring the carbon emission reduction credits (CERs) being issued to hydropower projects under the Kyoto Protocol’s Clean Development Mechanism (CDM), concerned that funds earmarked for climate change mitigation were being channelled to large schemes. In December 2007, a IR published a report – ‘Failed Mechanism: How the CDM is subsidising hydro developers and harming the Kyoto Protocol’ – authored by Barbara Haya.

Key criticisms in the report focus on CDM in general but, in particular, how the concept of ‘additionality’ is interpreted. Haya claims that there is a problem with the interpretation, which she argues is a threat to the carbon credit mechanism’s environmental integrity. There are many aspects to how a project can be viewed under the guidelines, and those involved in the carbon qualification business note that the criteria for CDM qualification are not always clearly understood.

Hydropower had almost 700 projects either going through, or passed through, the CDM assessment process by late November 2007. The sector is responsible for about a quarter of the projects in the CDM system and 15% of annual generation carbon credits, according to data from the UN Environment Programme’s (UNEP) Risoe Centre, in Denmark.

The number of large hydro projects entering the CDM validation process approximately doubled every six months between January 2004 and June 2007. The sizes of proposed hydro projects are also increasing. According to the latest data from the UN Environment Programme’s (UNEP) CDM Pipeline, issued for November 2007, there were 156 (up from 118 in May 2007) hydro projects registered and eligible to generate CERs. There are also 518 (up from 285) projects under validation.

However, assessment processing in general, across all sectors, reportedly has been slowing in recent months, according to EcoSecurities, a company involved in originating, developing and trading carbon credits, and specialising in implementing renewables projects, particularly in hydro. There has also been a recent slowing in CDM project validation and issuance of CERs (one CER corresponds to one tonne of CO2 equivalent emissions reductions), partly due to a drop off in the percentage of registered schemes being submitted for assessment versus those with insufficient reviews, leading to multiple reviews and delays. The system is feeling the weight of more and more applications.

Testing for ‘additionality’

Carbon credits are granted if a project has been, or will be, judged to provide additionality benefits – reductions in greenhouse gas (GHG) emissions that must be beyond (ie, in addition to) what otherwise would happen in its absence.

To be classed as offering such cuts, a project must be proven to be realistic and credible, meet laws and regulations, but be held back by other barriers. Such barriers are: there are no similar ventures; or, if there are then the project can be seen as arguably different for various reasons, which can change relatively, with time (eg. technology or circumstances or practice or economics or geography or scale). Another check is that reductions from projects do not have the core motive of cross-subsidising between capped and non-capped systems, for it may be argued the net effect is negligible.

Xaver Kitzinger, a CDM project manager with EcoSecurities, says that only ventures not part of a dynamic baseline are eligible as CDM projects. He adds that project developers must either have investigated the benefits of CDM in the planning phase of the project or after serious unexpected difficulties occurred during the planning stage, such as cost overruns and subsequent funding problems.

The argument, therefore, is that an otherwise sound project can only overcome the barriers it faces, and so deliver GHG reduction, by securing the beneficial lift of CDM validation. But as passing the additionality test can bring extra revenues to projects beyond helping them to be built at all, it could be expected to be a point of debate, at the very least.

IR claims that the great majority of hydropower projects in the CDM system would very likely be built regardless of receiving carbon credits and, it argues, they are non-additional. As a consequence, the pressure group views the CDM mechanism and the additionality threshold as providing the hydropower sector with a massive windfall, estimating such extra revenues at up to US$1B annually.

Haya says: “Money that should be supporting decarbonisation in developing countries is flowing into the coffers of hydropower developers with the only effect on carbon emission levels being to increase them.”

She adds that hydro developers justify CDM applications “with surreal arguments”, such as projects already completed only being able to be completed if they receive carbon credit revenue. Haya further contends that there is a need to strengthen the rules of the CDM concerning additionality, social and environmental impacts, and stakeholder consultations.

The CDM assessment system is not static, Kitzinger notes. However, he cautions: “With all the scaremongering there is about non-additional projects being registered in the CDM the higher the perceived risks are, and the stricter the requirements become.”

He adds: “As risks increase, and costs to meet these stricter requirements increase, the cycle starts to chip away at itself and we end up with a CDM that enables only very few, very large projects with, perhaps, questionable sustainable development benefits to proceed. This is an outcome no-one wants.”

Revenue Bonus

Like it or not, the CDM is the main global carbon trading vehicle. Its credits are expected to be widely used to help Europe and Japan meet their emission reduction commitments under the Kyoto Protocol, while CDM offsets are also being proposed for use in emerging US carbon reduction schemes, including at the federal level and in California.

There remains a body of unwavering confidence in the CDM as a means of raising money to partly finance renewable energy schemes. Kitzinger says the popularity of renewables under the CDM, especially hydroelectric projects, is likely to rise further as opportunities for projects such as destroying hydroflourocarbons (HFC), which are often described as ‘low hanging fruits,’ start to run out.

Hydroelectric schemes have been one of the most successful project types in the carbon market to date, which is largely down to the CDM as it allows developing economies to receive credits for emissions reduction that can be sold to developed nations. The credit system offers future financial and project promotional benefits, which helps to leverage greater funding at the outset, and sometimes there can be shorter term benefits to cashflow via early hard currency funds being released against the collateral security of the credits.

Considering the current status of the new carbon market, an increased awareness among investors of the CDM and the very real effects on the return on revenue, it is not surprising that there is a growing perception of excellent funding opportunities for energy companies wishing to develop hydroelectricity projects. But the assessment of the economic attractiveness of a hydro CDM project depends, at its core, on the barriers faced by the project against the baseline circumstances of electricity production in a country or market, while environmental sustainability and social integrity are also key considerations.

There are costs associated with CDM project development – registration and validation fees as well as costs for the transactions of carbon credits – which are over and above the generic project risks, CDM or otherwise, but they pale into insignificance next to the benefits of long-term revenues. It is unsurprising, then, that the clamour for CDM recognition is accelerating apace.

The challenge, as seen by critics of the CDM currently, is to avoid giving credits to projects that would have happened anyway – so called free-riders. But the rules that have been specified to ensure additionality of projects, that is, to ensure the project reduces emissions more than would have occurred in the absence of the project, remain at the centre of the debate.

Rival Visions

There are currently two rival interpretations of additionality – environmentally-based and project-based. In the former interpretation, a project is additional if the GHG emissions afforded by the scheme are lower than the general baseline without the project. In the latter, which is sometimes termed ‘project additionality,’ the scheme would not have happened without numerous barrier-checks and CDM validation, which is the common approach.

Many investors argue that the ‘environmental additionality’ interpretation would make the CDM simpler. While dissatisfied at projects being validated by being analysed solely on their own, environmental NGOs have argued that following the ‘environmental additionality’ route would open the CDM to free-riders, permitting developing countries to emit more GHG while failing to produce emission reductions in the CDM host countries. It is arguably impossible to establish with certainty what would have happened without the CDM or in the absence of a particular project.

The business viewpoint on additionality is that the project developer’s intent should not be evaluated and that any project offering GHG emissions reductions below the general baseline should automatically qualify as additional. On the other hand, researchers and environmentalists consider additionality to be an imperative tool that is necessary to preserve the environmental integrity and successful implementation of the Kyoto Protocol.

As the debate continues and the majority of hydro schemes in the CDM assessment system have yet to be approved, IR is calling for them to be stopped. “Doing so would send a strong signal that it takes seriously the principle of additionality,” says Haya.

IR gives several recommendations for minimising conflicts of interest, such as preventing projects under construction or already completed from obtaining CDM funding, and that adherence to World Commission on Dams’ (WCD) social and environmental guidelines should be mandatory. In the longer term, it wants the CDM restructured or replaced, especially by eliminating the need to prove additionality on a project-by-project basis, “which is ultimately impossible with any degree of accuracy”, says Haya.

All groups agree that additionality is required to ensure the environmental integrity of project credits (ie credits must be in real, measurable and verifiable). “A more constructive approach,” Kitzinger adds, “would be taking steps on improving the quantification of additionality. If the project-by-project approach is viewed as inadequate, then let’s suggest other alternatives, for example, positive lists, or sectoral benchmarks.”


Issuance success of CERs by Sector following submission of Project Design Document (PDD)