Analyst warns CDM reforms could spark carbon price spike

Reforms to the UN's Clean Development Mechanism (CDM) currently being considered by the offset scheme's Executive Board could lead to a spike in the price of carbon credits issued under the scheme.

That is the conclusion of a new analysis from research firm Point Carbon, which predicts that proposed reforms governing the liabilities faced by the Designated Operation Entities (DOEs) that check the validity of emission reduction projects would simultaneously constrict the supply of Certified Emission Reduction (CER) credits while leading to increased demand.

Under proposals due to be considered by the CDM Executive Board at its next meeting, the liability for the issuance of unwarranted excess CERs would be placed in the hands of the DOE that approved the project and deemed that it could legitimately issue carbon credits.

The move could also mean that the DOE responsible for the validation, verification or certification of excess CERs could be obliged to replenish these excess CERs with other CERs, or other carbon commodities, if they are found to have no connection to valid emission reductions.

"This draft procedure, proposing the correction of significant deficiencies and the excess issuance of CERs, would be a very tough provision indeed, if adopted, as it not only targets situations where the DOE has wilfully caused the issuance of excess CERs or has caused it through gross negligence, but also less serious examples of negligence," said Kjetil Røine, Manager at Point Carbon and author of the analysis. "It also appears that the procedures would be retroactive in the sense that a DOE could be forced to replenish CERs the Executive Board decides it has incorrectly issued in the past."

The proposed reforms are a response to repeated allegations from green groups that projects that have been approved to issue CERs under the CDM are either " gaming" the system or failing to deliver promised emission reductions.

The Executive Board evidently hopes that shifting the financial liability associated with breaches of the CDM on to DOEs will force these third party verification firms to carry out more thorough checks of emission reduction projects.

However, Point Carbon warns that the move would increase the financial risks faced by DOEs to such a level that emission reduction projects will face further delays gaining CDM approval while some DOEs may even choose to exit the market.

The analyst notes that if just 10 per cent of the CERs issued by the kind of HFC-23 projects that are at the centre of concerns over excess credits were found to have been "inappropriately issued" DOE's could be forced to pay up to €150m at current market prices to replace the suspect CERs.

"In sum, the draft procedures for how to deal with excess CERs signal a strong EB resolve on such problems, which could put several DOEs in very serious financial trouble if implemented and could lead to both increased demand for CERs and constrained supply," said Røine.