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4.2. Cost Savings from Incentive Systems for Greenhouse Gas Emission Control

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Savings from Economic Incentives


Global warming is shaping up as one of the great challenges of the 21st Century. The UNEP provides a helpful guide to the basic issues, as does a CNN special report. The USEPA, the Department of Energy and other federal agencies are playing active roles in this issue.

The United Nations Framework Convention on Climate Change signed in Rio de Janeiro in 1992 committed signatory governments to address the issue of climate change, though it did not require specific actions. Most of the industrialized nations subsequently made commitments to reduce carbon dioxide emissions to levels estimated to have occurred in 1990 by some nearby but unspecified date. In December 1997, representatives from industrialized nations met in Kyoto, Japan and made specific commitments that were lacking in the 1992 Framework Convention.

Cooperative Implementation under the Kyoto Protocol

In the Kyoto Protocol, 38 industrialized nations plus the European Community committed to reduce their emissions of greenhouse gas (GHG) emissions in the period 2008-2012 relative to baseline emissions in 1990. The nations and their respective commitments are listed in Annex B to the Kyoto Protocol. These nations also are referred to as Annex I parties since all but three of them were identified in Annex I of the UN Framework Convention on Climate Change. The percent reductions vary from one nation to another but the aim is to achieve an average reduction of 5.2 percent, representing a reduction of more than 30% relative to a business as usual scenario with growth in incomes, population, and energy use over that 20 year interval. Australia’s commitment represents a small increase, reflecting its heavy dependence on coal and coal exports.

Among the Kyoto Protocol’s important features is the use of market-based mechanisms for achieving required emissions reductions at least cost. Termed “cooperative implementation,” the market-based instruments include: joint implementation (JI), the Clean Development Mechanism (CDM), and international emissions trading (IET). Joint fulfillment, another provision of the Kyoto Protocol, might also be viewed as a market-based approach.

The negotiators in Kyoto postponed for future deliberations many important and contentious decisions. International emissions trading is not well defined, in terms of how it would function, whether only parties could participate or also designated private sector entities, and other important features. Many important details regarding the CDM were left unresolved including the criteria to judge whether projects involve net reductions in emissions. Finally there is no mention of interim measures that can be undertaken prior to 2008 nor any opportunity to earn credits against future commitments for activities undertaken before 2008. How these and other issues are resolved will have a great bearing on whether the Kyoto Protocol is ratified by many nations and whether it is capable of meeting its stated objectives.

What is now termed the CDM was termed joint implementation (or international joint implementation) prior to the Kyoto Protocol. The experiences with joint implementation prior to Kyoto are of great relevance to future CDM activities. Consequently, this section reviews these activities in some detail for lessons to be learned.

Article 4: Joint Fulfillment. Joint Fulfillment lets countries with emission reduction commitments satisfy the commitments jointly by reallocating the total reductions among the parties. This provision was designed to allow the European Union (EU) as a regional economic integration organization to make a different distribution among its members from the requirements of the Kyoto Protocol. During the negotiations, the provision was defined to include any group of countries in Annex I that enter into such an agreement.

Article 6: Joint Implementation. Joint Implementation lets Annex I countries sell to or buy from other Annex I countries emission reductions associated with specific projects that reduce emissions or enhance greenhouse gas sinks. That is, countries, or designated legal entities within a country, may support of finance GHG reduction projects in another country and receive part or all of the GHG reductions that result from the project. Such JI projects must be approved by both nations, must produce GHG reductions beyond those that would otherwise occur, must be supplemental to GHG reduction activities by the acquiring country, and are banned if the acquiring country is not in compliance with its reporting and accounting obligations under the Protocol. Sales (transfers) reduce the assigned amounts of GHG that a country may release and purchases add to assigned amounts.

Article 12: Clean Development Mechanism. The Clean Development Mechanism (CDM) creates a means through which Annex I countries, or designated legal entities in Annex I countries, finance or sponsor GHG reductions in non-Annex I (developing) countries. The CDM would promote sustainable development in developing countries and help Annex I countries meet their GHG reduction requirements. Emission reductions resulting from CDM projects must be real and measurable and provide benefits in addition to those that would occur in the absence of the project. Emission reductions resulting from CDM projects will be subject to a certification procedure by 'independent auditors' that has yet to be elaborated.

Article 17: Emissions Trading. Under Article 17, international emissions trading is authorized between Annex I countries. Participants in ET potentially could include designated legal entities in addition to the countries themselves. Most of the details of ET remain to be elaborated. Among these details are: would liability rest with the buyer or the seller of emission reduction units? Who would certify the units? Would there be an international clearinghouse for the units? What reporting would be required? To prepare for ET, several countries, including Australia, Canada, and Norway have begun to establish national trading programs in GHG (so far, principally carbon dioxide).

November 1998 Meeting in Buenos Aires At the 4th Conference of the Parties to the UN Framework Convention on Climate Change (UNFCCC) in Buenos Aires, delegates met to discuss implementation issues related to the Kyoto Protocol. The Kyoto Protocol will enter into force only after being signed by governments and ratification by national congresses by 55 parties representing at least 55 percent of 1990 CO2 emissions from Annex I countries. To obtain that level of support, it will be important to have the US with a 36.1 percent share and Russia with a 17.4 percent share ratify the agreement. But the US Congress is on record insisting that developing countries participate and that there be no costs to the US economy (GNP loss or unemployment increase).

To obtain greater support from developing countries, Argentina proposed that developing countries accept GHG targets based on expected growth and that reductions be measured relative to that projection. The PRC and several other nations had very negative reactions so the proposal was dropped. During the conference, Argentina and Kazakstan announced their intention of joining Annex I. While the US representative signed the Kyoto Protocol on behalf of the government, ratification by the US Congress remains problematic.

By the end of the conference there was no agreement over the modalities for achieving the Kyoto Protocol targets. Operation of the Clean Development Mechanism and how emissions could be capped outside of Annex I nations remained contentious. The principal result of the conference was an agreement on a work plan to determine within two years specific modalities for implementing the Kyoto Protocol.

Pre-Kyoto Joint Implementation

At the first conference of the parties to the Framework Convention on Climate Change, held at the 1990 Rio Earth Summit, the parties agreed to a Joint Implementation pilot program. Under JI businesses, non-governmental organizations, and government entities in one country could jointly undertake mitigation and sequestration projects with similar entities in another country. Projects that diminish, sequester, or avoid global greenhouse gas emissions could be considered JI projects if the source of emissions being offset and the site of the emission abatement are located in two different countries.

The United States Initiative on Joint Implementation (USIJI) was the first national JI program to adopt a formal set of criteria and an evaluation process for JI proposals. An Evaluation Panel with representatives from US government agencies determined the acceptability of proposed projects. The first United States JI projects were accepted in January 1995 and others followed soon thereafter. Central America hosted most of the early US projects, but Russia and other nations also hosted JI projects. Projects involved energy end uses; energy production; biomass, geothermal, hydroelectric, and wind energy technologies; and forestry management. Through the end of July, 1998, the USIJI panel had approved 32 projects out of 110 that had been submitted (see Table). The other projects were withdrawn or rejected.

The USIJI conducts two rounds of review each year. For those projects that were accepted, most acceptances came during the round in which they were proposed or in the next round. Of the 32 projects accepted through July 1998, 6 involved end uses of energy, 12 provided improvements in the efficiency of energy production, and 14 promoted land use changes to enhanced greenhouse gas sinks.
Table 4.1 Accepted USIJI Projects
(July 31, 1998)
Project Name
Country
Project Type
RS
RA
PF
    Fuel Switching, District Heating System
Czech Rep.
    Energy end use
1
1
yes
    District heating (Zelenagrad)
Russia
    Energy end use
1
3
no
    Rusagas Fugitive Gas Capture
Russia
    Energy end use
2
2
yes
    District Heating Renovation (Lytkarino)
Russia
    Energy end use
5
5
yes
    District Heating Renovation (Metallurguichesky, Chellabinsk District)
Russia
    Energy end use
5
6
yes
    Energy efficient housing (Izindlu Ezigcinayo Ubushushu)
South Africa
    Energy end use
5
5
no
    Plantas Eolicas S.A. Wind Facility
Costa Rica
    Energy production
1
1
yes
    Enersol Rural Solar Electrification
Honduras
    Energy production
1
1
no
    El Hoyo-Monte Galan Geothermal Project
Nicaragua
    Energy production
2
2
no
    Bio-Gen Biomass Power Generation Project
Honduras
    Energy production
2
2
no
    Dona Julia Hydroelectric Project
Costa Rica
    Energy production
2
2
no
    Aeroenergia Wind Facility
Costa Rica
    Energy production
2
2
yes
    Tierras Morenas Windfarm Project
Costa Rica
    Energy production
2
2
yes
    Bel/Maya Biomass Power Generation Project
Belize
    Energy production
3
3
no
    Phase II, Sava Site
Honduras
    Energy production
3
3
no
    Rural Solar Electrification Project
Bolivia
    Energy production
3
3
yes
    Rural Photovoltaic Electrification
Sri Lanka
    Energy production
5
5
yes
    Renewable Energy Mini-Grid Project
Mexico
    Energy production
5
6
yes
    Forest Conservation (Bilsa Reserve)
Ecuador
    GHG sink
1
3
no
    Saratov Afforestation Project
Russia
    GHG sink
1
1
yes
    Rio Bravo Conservation and Forest Management
Belize
    GHG sink
1
1
yes
    Esquinas National Park
Costa Rica
    GHG sink
1
1
yes
    Klinki Forestry Project
Costa Rica
    GHG sink
2
2
no
    Silviculture in Siera Norte (Oaxaca)
Mexico
    GHG sink
2
6
no
    Scolel Té—Sustainable Land Management
Mexico
    GHG sink
2
3
yes
    Carbon Sequestration
Mexico
    GHG sink
2
3
yes
    Reforestation in Vologda
Russia
    GHG sink
3
3
no
    Project Salicornia: Carbon Sequestration and
    Halophyte-based Industries in Sonora
Mexico
    GHG sink
3
3
no
    Noel Kempff M. Climate Action Project
Bolivia
    GHG sink
3
3
yes
    Reforestation of Chiriqui Province
Panama
    GHG sink
3
3
yes
    Reduced Impact Logging
Indonesia
    GHG sink
3
3
no
    Consolidation of National Parks & Biological Reserves as Carbon Deposit
Costa Rica
    GHG sink
4
4
yes
Source: Lile, Powell, and Toman, 1998


Financing remains a major obstacle; just 13 of the 32 projects approved through July 1998 had obtained funding by sponsors. Participants in these projects assert that they faced large transactions costs in dealing with host governments and experienced significant delays in getting project approvals from the USIJI Evaluation Board and from host governments. Because project sponsors could not sell any carbon reduction credits from these projects (this was prohibited prior to the Kyoto Protocol), there must have been other motivations for participation. Sponsors identified development of new contacts in the host country, early entry into a potentially profitable business, the possibility of influencing future JI criteria, and favorable publicity as motivating factors.

The record of the early JI projects offers important lessons regarding the CDM and how it should be structured. After-the-fact assessments of a large number of US JI projects reveal difficulties in determining whether project activities truly are additional to activities that would have been undertaken without the JI program. Further, monitoring progress and measuring the success of JI activities in reducing GHG emissions have proven to be a challenge, particularly for projects designed to create or enhance carbon sinks. Since pre-Kyoto JI was largely an experimental activity, the consequences of a shortfall were not large. If credits had been sold or traded to other parties, the consequences would have been more serious.

Evaluating whether projects are “additional” to baseline activity and projections of baselines will be a major challenge in implementing the CDM of the Kyoto Protocol. Further, projects may reduce GHG emissions in one sector or region only to result in increases elsewhere, so-called “leakage.”

A number of methods potentially could be used to develop baselines. Historical emissions in a base year could be used, though this would restrict economic development severely in DMCs. For DMCs, the baseline could allow for economic growth by projecting emissions based on historical trends in emissions or based on projected GNP and emission/GNP factors. Finally, a baseline might be developed from the bottom up using project-by-project emissions, and adding these to obtain a baseline and reference projected level. The Kyoto Protocol uses 1990 emissions as the baseline for Annex I parties. Baselines for non-Annex I parties, which are necessary to determine whether CDM projects are additional, are not defined.

Determining whether a project is additional to what would have been done without the Kyoto Protocol is a particularly thorny issue. As the CDM is described in the Kyoto Protocol, it does not explicitly provide for the creation of GHG sinks. Eventually, activities such as planting forests to create carbon sinks might be accepted as part of the CDM; however, it could be difficult to demonstrate that tree planting is additional to what would have occurred in the baseline set of activities. Fuel switching from coal to natural gas reduces GHG emissions, yet the choice of fuels might be dictated by concerns regarding local air quality or cost considerations. Which activities yield GHG reduction credits and which ones are not additional to baseline activities will surely be debated into the future.

The Global Environment Facility (GEF), which is active in financing projects that offer climate change benefits, has developed an approach for dealing with a related, but distinct, concept of additionality. Normally GEF funded projects maintain domestic benefits at constant level while increasing global benefits. If a GEF-supported activity delivers additional domestic benefits, the GEF has devised an approach to treat the incremental costs of these additional domestic benefits.

Ensuring Compliance

The Kyoto Protocol does not describe the means that will be used to ensure compliance with targets and timetables. This section explores some of the issues that must be addressed. Much of the discussion applies to obligations, such as reporting, adoption of mitigation policies and measures, and financing. The discussion provides an overview of main compliance approaches that might be used in connection with the CDM.

Individual compliance mechanisms in international environmental agreements involves three interrelated elements:

Monitoring and reporting seeks to obtain data with which to determine compliance. Review and verification uses the information reported to ascertain compliance. Non-compliance responses and enforcement are triggered by the verification process and address violations of treaty obligations. Various parties bear responsibility for different stages of the compliance system.

Monitoring and reporting is generally the obligation of participants in the agreement, though these obligations could be delegated to others. Review and verification usually is performed by an independent appointed body, the secretariat to the agreement or some other neutral party. To have reasonable expectations that parties will comply, non-compliance responses and enforcement measures need to be authorized in the agreement.

Experience with other international agreements demonstrates that effectiveness and compliance are enhanced through clear and specific treaty language, transparent procedures and widespread dissemination of information, informal communication channels with stakeholders and non-governmental organizations, enforcement responses that can be tailored to address problems of varying severity, and provisions that encourage new parties to join.

Incorporating compliance procedures early in the development of an international agreement helps assure that the agreement will be effective and fair. Compliance procedures strengthen an international agreement by demonstrating that parties want to satisfy its requirements. Compliance procedures encourage parties to consider the binding nature of new commitments and their ability to comply before accepting new obligations. Consequently, thoughtful design of the compliance system should be a priority task in developing the provisions and obligations of an international agreement.

Monitoring and Reporting
Reporting by countries is required under both the UN Framework Convention on Climate Change and the Kyoto Protocol. Countries bear the primary reporting responsibility but they may delegate to legal entities the right to buy and sell certificates for GHG reductions. These legally-designated entities then incur a responsibility for reporting to their national government. National reporting facilitates efficient monitoring and transparency.

Concerns regarding data quality, which greenhouse gases to include and which sources and sinks to specify, were important issues in the negotiations. The Protocol covers the most significant direct greenhouse gases and incorporates known sources and sinks of greenhouse gases.

Uncertainty in inventories varies with different greenhouse gases and with various sources and sinks. Among GHG, the sources of methane are particularly uncertain but CFC sources are well known. Data quality also varies among countries. Unless addressed as monitoring procedures are developed, poor data quality could undermine the agreement.

Because the CDM and other cooperative implementation measures would give GHG emission reductions an explicit market value, trading should create incentives for national enforcement and international compliance. Because of this, countries or firms that want to buy or sell carbon equivalent units, would have a strong incentive to help ensure that other participants were dealing in verifiable emission reductions. These incentives should provide nations the impetus to deliver unbiased data and seek low-cost means of improving data quality.

In order to assess compliance with emission targets, complete accuracy of inventory data is not necessary, but removing systematic biases is important. Inventory data are estimates, at best, based on fieldwork, engineering calculations, and statistical sampling of diverse economic activities.

A number of approaches could be used to deal with uncertainty in emission inventory data:

Several observations follow. Rules to adjust for uncertainty could be difficult to design and to implement. Adjustment factors would have to be arbitrary in many cases due to limited understanding of several components of GHG inventories and sinks. Progressively including greenhouse gases as data improve could delay the inclusion of important gases. However, the Kyoto Protocol relies on this approach by including only a subset of possible land use change and forestry activities as sinks. Detailed standards could be attractive and would provide a basis for independent auditing and certification. Developing such standards could prove to be a formidable challenge. Who would pay for the necessary background work is an open issue.

Review and Verification

The purpose of verification is to assess compliance by parties with targets and other commitments. National reports provide the basic information for the verification process. In international agreements verification involves two steps: technical review of the data and an assessment of whether obligations have been satisfied by the party. The review process under the UNFCCC has not been tested with respect to the verification of national data. The Secretariat is tasked with detailed review responsibilities that could be augmented by assistance from NGOs and international organizations.

Non-compliance Responses and Enforcement

While there are a large number of possible responses to compliance problems, few examples exist of successful international enforcement procedures in international environmental agreements. Consultation and negotiation is a well-recognized (but potentially weak) enforcement process in international agreements. The UNFCCC recognizes the potential utility of consultation and negotiation in provisions of Article 13. Mediation and conciliation, the next logical step if consultation and negotiation fails, is featured in many international environmental agreements but is not explicit in the UNFCCC. Financial assistance and the prospect of withholding financial assistance in cases of noncompliance is featured in the Montreal Protocol and the UNFCCC. Suspending rights and privileges, such as the right to participate in the CDM, are a next logical step in progressively more stringent enforcement actions. Trade sanctions represent a further and more stringent step. While not explicitly authorized in the Kyoto Protocol, some international disputes have been taken to the International Court of Justice.

Financing

CDM projects are likely to follow much the same pattern of past joint implementation pilot projects. A project donor or sponsor provides some or all of the technology and funding for host country projects that reduce GHG emissions and provide other outputs. The donor receives some or all of the GHG credits while the host country receives the other valuable outputs. While donor countries are the nominal sponsor, it is really private sector enterprises within the donor countries that provided much of the financing for past JI projects. Commercial banks, host as well as donor central banks, and international financial organizations such as the World Bank and regional development banks could also play an active role in arranging financing for CDM projects.

Potential Savings from Market-Based Instruments

The potential savings from trading greenhouse gas emission reduction requirements among nations result from the marked differences in incremental control costs that different nations face. In testimony before the House Commerce Committee on March 4, 1998, Janet Yellen, chair of the Council of Economic Advisers, presented the administration's estimates (Council of Economic Advisors, 1998) of the cost of controlling carbon dioxide emissions under several scenarios.

It is important to recognize that the administration's estimates are based on the assumption that the US will not have to drastically reduce greenhouse gas emissions by anything approaching the 30 percent from the present trend amount that the Kyoto Protocol would seem to imply. Rather, the administration assumes that some form of international trading in greenhouse gas emission reductions will be authorized, requiring the US to reduce its annual emissions by about 3 percent from the trend amounts.

The so-called "Second Generation Model" developed by Battelle Laboratories predicts that if the US could not trade emissions permits with any other nation, the cost of reducing emissions would be equivalent to $108 per ton of carbon. If the US could trade with counterpart developed nations, the cost would fall to $72 per ton of carbon. If trading were to take place throughout the world, so that only the most cost-effective reductions worldwide took place, the cost per ton would be between $26 per ton. The administration's estimates are slightly more favorable, a range of $14 to $23 per ton of carbon.

How large are the potential savings from worldwide trading relative to go-it-alone program by the US? The reductions called for in the Kyoto Protocol, relative to trend amounts, would be 552 million metric tons of carbon. At a cost of $14 to $23 per ton of carbon, the administration estimates the cost to the US economy would be between $7 billion and $12 billion in the year 2010. With emission permit trading allowed only within nations and not between nations, the cost to the US would rise to $60 billion. Thus, trading carbon emission permits among nations to meet the Kyoto limits is predicted to save the US $48-$53 billion per year by the year 2010.

Carbon taxes are an alternative means of reducing carbon dioxide emissions. This approach would necessitate large increases in energy prices and generate substantial revenues for the government. The Second Generation Model predicts that a tax of $193 per ton of carbon would be required to reduce emissions by 550 million metric tons in 2010, assuming that no trading is allowed, even within the US. The difference between $193 and $108, or $85 per ton, is the estimated saving to the US economy from internal US trading. That amount is $47 billion. The total gains from worldwide trading are the internal gains of $47 billion plus the gains from trades with other nations of $48-$53 billion, for a total saving to the US economy of $100 billion.

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