California Construction Trucking Association (CCTA)

Nathanial Gronewold – ClimateWire – July 26, 2010

UNITED NATIONS -- Starting July 26, 2010, the members of the Executive Board of the Clean Development Mechanism (CDM) sat down to tackle arguably the most serious controversy since the beginning of the Kyoto Protocol system for offsetting greenhouse gas emissions in developing countries.

The Bonn, Germany-based U.N. affiliate will examine a dozen projects that constitute two-thirds of all offset credits issued to date. The projects involve the destruction of hydrofluorocarbon-23 (HFC-23), a potent greenhouse gas that results when chemical companies produce a refrigerant and propellant called hydrochlorofluorocarbon-22 (HCFC-22).

Paying firms through the issuance of lucrative credits to destroy the gas is necessary to combat global warming, board members and proponents say. A coalition of outside groups, on the other hand, has uncovered evidence that these companies are deliberately producing more of the waste just for the sake of destroying it to earn offset credits -- in essence, creating pollution to profit.

The CDM's harshest critics say outright fraud is at work and suggest that up to half of all the Certified Emission Reductions (CERs) ever issued are bogus. CERs are the offset credits earned from CDM projects, sold primarily into the European Union's cap-and-trade scheme.

Board members say it may be just a matter of tightening the rules to reduce the volume of CERs allowed per project.

"What the discussion is about now is: Are we seeing the adequate levels of safeguards?" said Pedro Martins Barata, current vice-chairman of the CDM Executive Board. Though he acknowledged that the evidence presented does indicate there's a problem, "it's not necessarily that they are gaming the system, but whether or not they are exploiting a flaw in the methodology."

Some worry that the review happening this week is a procedural delay, to kick the controversy down the road for further discussion.

"What we have now is that they've decided they're going to study the problem, which, as you well know, is oftentimes a surrogate for any real actions," said Samuel Labudde, a researcher with the nonprofit Environmental Investigation Agency.

CDM spokesman David Abbass insists the review is not meant to delay action.

A touchy political subject

But the HCFC projects are a touchy political subject, as they have given billions of dollars of extra proceeds to HCFC-22 factories, mainly in India and China. Two of the board members hail from those countries, and there are no rules in place which forces them to sit out the discussion.

At the center of the controversy are 19 chemical gas manufacturers, mainly located in China and India, with others in South Korea, Argentina and Mexico. Their production of HCFC-22 helps to avoid the production of ozone-eating substances now banned under the Montreal Protocol. But encouraging protection of the ozone layer has inadvertently led to emissions of HFC-23.

For years, these 19 plants have been earning the vast majority of CERs to destroy the byproduct gas. Today, these greenhouse gas offsetting projects utterly dominate the CDM. Research by Sandbag, a U.K.-based nonprofit monitoring emissions trading, says just 10 of them were the source of fully 66 percent of all CERs sold into the E.U. carbon market in 2009.

The disparity is justified, says CDM board Chairman Clifford Mahlung, because HFC-23 is some 11,000 times more potent a greenhouse gas than carbon dioxide.

"They have always attracted attention, however any doubts surrounding them that the board could act on have only recently emerged," Mahlung explained in an e-mail response to questions.

A 'perverse incentive' at work?

Last month, a coalition of carbon market monitoring groups sent a letter calling on CDM offices to look into suspicious behavior at some of the 19 plants. It charges that since 2005, a small number of firms have deliberately produced excess greenhouse gas pollution for the sole purpose of destroying it, earning far more CERs than they would have if they tailored production of HCFC-22 to market demand and not the CDM.

Firms under fire in China and India deny the claims, saying that they haven't manipulated any production data turned in.

But that's precisely the point, the groups say. They assert that the production data show that the companies are pumping volumes of HCFC-22 output far beyond market demand, and even through the worst global recession since the 1930s. Other abuses are alleged -- namely, that manufacturers are deliberately injecting fluorine gas into the process to create more HFC-23 waste.

"What the NGOs [nongovernmental organizations] would like is that they suspend the issuance of HFCs while the investigation is carried out," said Sandbag's Bryony Worthington.

Worthington said her organization isn't accusing firms of outright corruption. Nevertheless, she believes it is obvious that the rules as they exist create a "perverse incentive" to generate pollution for its own sake. HCFC-22, it turns out, is also a powerful greenhouse gas, and activists worry that any excess that manufacturers can't sell is simply being vented into the atmosphere.

What outcome the board will reach is not clear. Members themselves refuse to speculate.

Worthington said they could push the agenda item to the next meeting, to give more time for a thorough investigation. But she and others fear that the board will decide that the issue is far too political for it to take up, leaving it to the international climate negotiators to decide what to do.

Labudde says that's the worst possible outcome.

Outside groups want payments suspended

"The contracts that the Chinese and Indians have on these plants are so lucrative that they very much like to maintain them," he said.

Moves are afoot by the United States, Canada and Mexico to move all HFC gases under the Montreal Protocol's jurisdiction. The gases could be destroyed much more cheaply and easily under Montreal, experts say. But activists report pushback by India and China, which want them kept under the CDM.

"They're basically using the renewal for these [CDM] projects, at least China is, maybe as a condition ... for allowing the Montreal Protocol to regulate production and use" of HFC gases, Labudde said.

It's simply a matter of profit, says Worthington.

"The fact that you can all this money means there's now a disincentive to do anything else in that regulatory space to try and control these emissions," she said.

The battle over HFC-23 is heating up. Earlier this month, a coalition of nongovernmental organizations, including the Environmental Investigation Agency and CDM Watch, briefed E.U. parliamentarians in Brussels on the matter, attempting to drum up political support. And an aggressive letter-writing and media campaign is under way in the hope of pressuring the CDM board to suspend CER issuance this week -- putting millions of dollars on hold.

Critics and supporters of the CDM say improvements in the system have been made of late. But greater challenges lie ahead.

The board is in the midst of tweaking CDM work rules to speed up project registration and CER issues. A recent letter from the Carbon Markets & Investors Association praised the board for these moves and its efforts "to codify and explain procedures and decisions in a transparent and open manner."

Issues of conflicts of interest among the board members themselves have also been addressed, though not to the full satisfaction of CDM watchers. The board has adopted a code of conduct for members, and members' resumes are now available to the public for review. Still, only a handful of mostly Western members vocally indicate conflicts between themselves and projects under review before every meeting, while the rest remain silent.

Growing doubts about future carbon trades

Further out, however, the CDM's regulators and boosters will have to navigate a growing crisis of confidence in the system as a whole.

Critics contend that the concept of "additionality" -- a core tenet of international carbon offsetting -- is becoming diluted as the board seeks to please frustrated governments and private investors. Indeed, whereas earlier CDM officials earlier defined additionality to mean an offsetting scheme wouldn't be financially viable without the CDM, these days, the same office argues that developers merely have to have the hope of earning CERs in mind in order to be awarded credits.

But the biggest lingering threat to the Clean Development Mechanism is beyond the board's control.

More companies are becoming convinced that no new international climate change treaty will be achieved, threatening the very existence of the CDM.

Last week, the U.N. Framework Convention on Climate Change issued contingency plans that nations could consider should a "gap" exist between the Kyoto Protocol's expiration on Dec. 31, 2012, and the start of a new regime. The paper concludes that under a strict interpretation of the Kyoto Protocol, no new CDM projects could legally be registered after 2012 without a new agreement to pick up the slack on Jan. 1, 2013. New CER issuance would be out of the question, as well, the UNFCCC says.

The uncertainty is hitting the United Nations' international carbon trading scheme hard. Fewer and fewer projects are requesting registration, and new CER issuance is drying up.

And though many speculate that the European Union will continue to be a home for CDM credits out to 2020, that may not actually require the existence of much of the apparatus in its Bonn headquarters. Analysts at Bloomberg New Energy Finance say that existing CER volume is more than enough to meet future E.U. demand, and the company predicts weaker CER prices in the future, unless a halt on future HFC-23-linked credits crimps supply.