Australia: The ABC Of Clean Development Mechanism (CDM)

This article provides a "back to basics" overview of the Clean Development Mechanism (CDM) under the Kyoto Protocol and looks at some of the issues and challenges which may face CDM projects. The author, Rebecca Mohr, is a partner at Deacons currently seconded to our Indonesian Associate Firm, Brigitta I Rahayoe & Partners. Rebecca has advised on a number of CDM projects and other climate change issues, including legal issues for proposed REDDs (reduced emissions from deforestation and degradation) pilot projects.

Context – the UNFCC & Kyoto Protocol

As we all know, under the United Nations Framework Convention of Climate Change (UNFCC) and Kyoto Protocol, Annex I parties - "developed" countries - are committed to reducing greenhouse gas emissions (GGEs) to specified levels. While "developing" countries do not currently have specified GGR limits imposed, most are parties to the Kyoto Protocol as "Non-Annex I" countries which can "host" CDM projects.

What is CDM and what are CERs?

CDM is one of the "flexibility mechanisms" under the Kyoto Protocol and implementing instruments to assist countries committed to reducing GGEs to meet emission reduction targets and help developing countries achieve sustainable development and reduce GGEs. In summary, Annex 1 parties, including Australia, can participate in eligible CDM projects in non-Annex I party countries - such as China, Indonesia and Malaysia - to obtain Certified Emissions Reductions (CERs).

CERs can be used by Annex 1 parties to contribute to meeting required GGE reductions imposed under the Kyoto Protocol. Allowances have also been made under emissions trading schemes in some jurisdictions for crediting CERs to meet, or meet part of, required targets. (At this stage, the status of CERs as part of any future Australian emissions trading scheme is somewhat uncertain).

The CDM is supervised by the (UN) CDM Executive Board and emissions reductions resulting from each CDM project are to be certified on the basis of: voluntary participation of each party involved; real, measurable, and long-term benefits related to the mitigation of climate change; and "additionally" - reductions in emissions additional to any that would occur in the absence of the certified project. CDM projects should also contribute to achieving sustainable development.

In terms of sustainable development the "host country", the Non-Annex-I developing country where the project is located, is able to determine whether or not the proposed CDM project assists in achieving sustainable development. In practice this means that one of the first "hurdles" of accreditation of a CDM project is meeting the particular requirements of the host country in relation to sustainability. (In Indonesia these requirements are generally consistent with recognised principles of sustainable development and include factors relating to impact on local ecology and local community welfare).

There are a number of limits of CDM projects including: the exclusion of nuclear facilities; that public funding for CDM projects from Annex I parties should not be diverted from official aid funding; and that CDM funding is separate from required financial obligations under the Kyoto Protocol. It is also a requirement that CDM projects should lead to the transfer of environmentally safe and sound technology.

The rules for accreditation of a CDM project are complex and complicated and there are additional limits on, for example, the eligibility of land use, land-use change and forestry projects (there are alternative proposals developing at the international level to deal with this under the "REDDs scheme") and rules in relation to methodologies for project activities.

There is an established legal process for CDM accreditation of a project and ongoing reporting obligations as well as detailed technical guidelines which apply.

In spite of the complex rules and requirements, at the time of writing there are around 1175 UN registered CDM projects world-wide.

Issues and challenges for CDM projects

Obviously the particular issues facing a proposed CDM project will vary depending on a wide range of factors including the type of activity, nature of emissions, scale of the project and location of the project. Naturally while this article is not exhaustive the following are some issues and challenges which may face CDM projects.

Complexity of rules and requirements

The first challenge for a CDM project is facing the complexity of the rules and requirements which apply under the UN scheme and understanding how these apply to the particular proposal. Obviously technical expertise is required in relation to issues like methodology and monitoring, and legal expertise in respect of the legal issues.

The "additionally hurdle"

A key issue at the outset and in planning any proposed CDM project is that of "additionally" – in summary showing that the project would not be able to proceed without CDM accreditation.

Documentation and contracts

It is essential that the project be properly documented in respect of legal as well as technical aspects. Specific project design documents should be prepared in accordance with the applicable UN guidelines. Essential legal documents will likely include contracts such as proposed Emission Reduction Purchase Agreements to "sell" CERs or other "credits" which may result from the project. It is important to ensure that fundamental legal issues are addressed for example that suitable arrangements are made for relevant parties to be "credited" with CERs (assuming the CDM project is accredited and CERs are issued).

Project circumstances and host-country laws?

Specific project circumstances and any matters particular to laws of the host-country should also be considered when documentation and contracts are prepared. While "pro-form" contracts can be of assistance, it is prudent to obtain project specific legal advice and in particular advice in relation to any applicable host-country laws.

Due diligence

As well as the usual commercial and technical due diligence, a comprehensive legal due diligence is strongly recommended including in respect of host-country legal requirements on sustainable development and practical issues such as land ownership of the proposed project site.

Big picture issues and closing comments

Perhaps the key "big-picture issues" for Australians involved in CDM projects are:

  • how will CDM projects and CERs for such projects "slot-into" the proposed Australian Emissions Trading Scheme; and
  • what will the picture be for CDM projects post-2012 (when the first commitment period under the Kyoto Protocol ends)?

The answers to these questions are still uncertain.

While the recent final report of the Garnaut Climate Change Review includes a comprehensive discussion of the opportunities for international trade in permits and discussion of opportunities for international linking (with the possibility for creation of a regional market) in the discussion of an Australian Emissions Trading Scheme, the detail of any ETS is yet to come.

As to the picture for international arrangements post 2012: discussions at the UN level continue, with expectations high that the principles for future action on climate change will be mapped-out at the conference of parties to the UNFCC in Copenhagen in 2009.

Despite this uncertainty CDM projects continue to attract investment – with the lure of CERs for projects which succeed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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