Kyoto flexibility mechanisms and renewable energy - opportunity or obstacle?

Despite the many concerns over its efficacy, the main strength of the Kyoto Protocol has been to focus the world's attention on implementing legally binding agreements by nations to reduce CO2 emissions, the main greenhouse gas. The key question I will address here is whether – and how – the renewable energy (RE) sector will benefit from the uptake of the Kyoto Flexibility Mechanisms.

The Kyoto Flexibility mechanisms - some definitions

Emissions Trading: enables two countries to trade 'Assigned Amount Units (AAUs') or 'permits' allocated under the Kyoto Protocol for the purpose of meeting their national targets. CERs, ERUs, and sink credits (see below) may also be traded.

Clean Development Mechanism (CDM): allows a developed country to invest in emissions reduction projects in developing countries to acquire Certified Emission Reductions (CERs) or 'credits' to assist in meeting their own national target.

Joint Implementation (JI): allows developed countries to invest in projects in other developed countries to acquire additional Emission Reduction Units (ERUs) towards meeting their own national target. This is effectively the transfer of Assigned Amount Units (AAUs) between two signatory parties to the Kyoto Protocol.

Carbon sequestration: Carbon sink 'credits' created via sequestration activities, e.g. tree planting, may also be traded to cover emissions.

Emissions Trading

With the envisaged emissions trading scheme under the Kyoto Protocol - essentially a market created by governments to facilitate the reduction of GHG at least cost - there are two types of allowances: allocated and created. Firstly, there is an allocated entitlement of AAUs based on parties’ agreed emissions limit. And, secondly, there are created credits. These are CERs from CDM projects, ERUs from JI projects and carbon credits from sequestration projects.

In fact, ERUs are not strictly created as they result in part from one country’s AAUs being transferred to another country, unlike CERs, which are new and additional to the AAUs allocated under the Kyoto Protocol. We can differentiate between JI projects and CDM projects in this respect.

Does RE create new credits?

In a CDM context, RE projects can create additional credits (just as any emission reduction activity would). These can then be counted towards the developed country's domestic emissions. On a domestic level within a Developed country, RE projects do not create new credits. In this context RE projects create emission 'offsets' against the permits that emitters already hold. In other words, RE projects simply help 'free up' existing permits, so that an emitter can sell their extra permits into the market.

Carbon sequestration

Scientists working for the UN's Intergovernmental Panel on Climate Change (IPCC) have confirmed that tree planting will simply buy the world a little time. The IPCC says carbon sinks will soon become saturated with carbon and start returning most of it to the atmosphere, temporarily accelerating global warming, not slowing it down. The problem of sink saturation was barely known even a couple of years ago, when the forests were first assigned an important role under the Kyoto Protocol.

The security of such long-term storage of carbon is uncertain for other reasons such as pests, diseases, land clearing, the threat of illegal logging, forest fires, and climate change itself. Sequestering carbon should not be treated as equivalent to curbing fossil energy emissions, which is guaranteed to result in climate change benefits. At this stage, there is no explicit provision for carbon sequestration projects under Article 12 (CDM).

Concerns with the flexibility mechanisms

If emissions trading can make cutting CO2 emissions reductions less costly, it will be easier to eventually wind-back all such emissions. However, even those who pioneered the adoption of the flexibility mechanisms have concerns that they may lead to the corruption and collapse of global efforts to contain climate change. For example, the flexibility mechanisms may:

1. Enable countries to avoid taking politically awkward domestic measures to combat pollution, e.g. such as removing subsidies from fossil fuel electricity.
2. Promote the establishment of sinks while diverting attention away from RE and energy efficiency (EE).
3. Fail to deter investment in extensive new carbon-based resources and technologies.
4. Create a 'blow out' in the AAUs of Annex 1 countries.
5. There have been many debates regarding the setting of baselines, matched by the concern that baselines can be manipulated to exaggerate the reductions being achieved.

That having been said, the flexibility mechanisms should be supported in principle on the basis that they are more politically acceptable then other options. In due course, this could enable targets to be tightened faster than otherwise and bigger reductions to be achieved.

Flexibility: a 2-edged sword for RE

The flexibility mechanisms are a two-edged sword as far as RE is concerned. RE could benefit in the short term as this sector:

1. will not have to purchase permits
2. may experience increased demand for their products and services by those large CO2 emitting organizations that do have to purchase permits
3. can create CDM credits and JI transfers
4. will help set the price of carbon in international trading
5. are part of the ultimate solution of creating a sustainable energy system.

In the short term, biomass projects may be the most attractive form of RE as it is currently one of the cheapest forms of RE and can be an adjunct to sequestration projects.

However, the early uptake of RE is not an assured outcome of the flexibility mechanisms as other options may be cheaper, easier or simply able to sell themselves better to prospective buyers. In Australia a critical compliment to the flexibility mechanisms is the provision of industry development policies and programs to ensure that a strong local RE sector is established. Otherwise, Australia may find in 2050 that it is just a small South Pacific customer in a global RE market that has been captured by the USA, Japan and Europe which are already cashing in on the 'boom' in RE growth.

Annual Growth Rate of various Energy sources (1990-97)

Design domestic emissions trading as if RE mattered

To this end, domestic emissions trading needs to be set up in a way that RE solutions are encouraged.

• Auction permits as the method of initial allocation

Auctioning makes RE (and other GHG reduction methods) relatively more cost-effective because beneficiaries of 'grandfathering' – allocating permits free to existing emitters – only need to purchase emissions permits that are additional to their allocation. Auctioning is also a de facto form of 'credit for early action' – those companies that reduce their emissions early are rewarded by having to purchase fewer permits once emissions trading is underway.

• Direct revenue from allocation of permits (assuming auctioning of permits in whole or part) to promotion of RE.

What happens to the revenue from sale of emissions permits is a critically important complement to any emissions-trading scheme. Within Australia, it has been proposed that some of the revenue from sale of emissions permits (estimated at $3billion / year at a permit price of $10/tonne of CO2) be applied to financial incentives for products and services that facilitate reduction of emissions by end-users.

In the absence of such measures, it is most unlikely that a scheme that concentrates on large emitters and relies on flow-on of price signals will be effective in encouraging an energy system towards low-CO2 outcomes.

• 'Hold back' permits during initial allocation so that they can be awarded to new entrants as well as RE companies.

One way to reduce barriers to new entrants would be for the government to reserve permits for new emitters. To further encourage the development of the RE industry, major RE projects could also be awarded some of the reserved permits, thus allowing them to trade in the primary market from its onset.

Government Action

Two key things that governments can do to promote the growth of sustainable energy solutions to climate change are to

1. Create long-term loan programs to finance long-lived RE projects.
At present RE projects can only get relatively short-term funding, e.g. less than 10 years, which make it difficult for companies to build new projects, generate low cost power and provide profits needed to attract other investors.
2. Stop government subsidisation of power generation projects that burn fossil fuels.
The fossil-fuel industry is mature and shouldn't need government assistance. Taxpayer-provided funding for carbon emitting power plants should end if governments are serious about reducing GHG emissions - and about promoting RE. In Australia the fossil fuel industry has received over $A3 billion in direct subsidies and over $A37billion in subsidies to consumers since the end of World War II .

RE industry action

The RE sector can also promote itself as a greenhouse solution via the flexibility mechanisms by: developing cost effective approaches to 'bundling' the CO2 benefits of small projects; streamlining certification , verification and monitoring; identifying multiple income streams from RE projects; developing partnerships with 'big emitters'.

CONCLUSIONS

Emissions trading requires a higher priority in the policy debate. Yet emissions trading alone will not be sufficient to create a sustainable energy system in Australia, to meet Australia’s international obligations under the Kyoto Protocol nor to prevent dangerous climate change. Other actions will be needed, such as RE industry development, removal of market barriers and streamlining the certification of CO2 savings from RE projects.

A strong focus must remain on reducing emissions at source.

A focus on sinks as a quick fix to climate change could divert investment away from RE and EE. Ultimately, we need to change the energy system and that means boosting investment in RE and EE.