A Business perspective on credits for projects in other countries and emissions trading

John H. Shinn, International Petroleum Institute Environmental Conservation Association, ChevronTexaco, USA Abstract
The international climate change negotiations have identified options for countries to achieve their greenhouse gas emissions reduction targets by either contributing to emissions-reducing projects in other countries or through the international exchange of emissions-reduction credits (trading). Such approaches offer significant opportunities to achieve greenhouse gas emissions reductions at lower societal costs than other measures, while providing significant additional contributions to environmental protection and sustainable development. Businesses have the ability to play an important role in enabling these 'Mechanisms' to function to their maximum potential. The prospects for realizing these opportunities will depend on decisions concerning the international operation of the Mechanisms, and on the manner of implementation of the Mechanisms by national governments. These factors will in turn largely determine the role of businesses in the Mechanisms. This paper provides a business perspective on the opportunities, issues, and barriers surrounding the practical application of these Mechanisms through examination of some opportunities to apply them within the petroleum industry, and the identification of the issues that must be addressed to enable such commercial applications.

Introduction
Concern over potential climate changes associated with emissions of greenhouse gases has led to international negotiations seeking to limit the accumulation of these gases in the atmosphere. Because the gases become well-mixed in the atmosphere soon after release, efforts to reduce emissions in any location in the world are roughly equivalent in their impact on atmospheric buildup. The cost of reducing emissions can vary considerably from location to location, however, with many of the lowest cost opportunities existing in lesser developed areas (for instance due to use of older or less efficient equipment). Reducing the overall cost to society of addressing climate change concern calls for creating effective means to access such reduced-cost emission reduction opportunities. The Kyoto Protocol creates emission targets for only developed countries. In recognition of the importance of reducing the cost of emission reduction, the Protocol also creates mechanisms to access reduced cost opportunities in other areas. These mechanisms include emissions trading and credit for emission reduction projects conducted outside of ones national borders. Ongoing international negotiations and related national government policies will largely determine how effective these mechanisms can be in reducing the societal burden of greenhouse gas emissions reduction. Industry has an important role to play in the practical application of Kyoto Mechanisms. This is particularly true in the case of project-based activities that may largely be financed and operated by the private sector. Many governments have expressed a view that business participation in the Kyoto Mechanisms will be essential to meet reduction targets in a cost-effective manner. Commercial investment already represents a majority of international development monies, and substantial experience exists within industry in practical aspects of technology transfer and infrastructure development. Decisions on the international and national levels can either assist or hinder business in this role. In recognition of this important role of industry in the application of the Kyoto Mechanisms, the International Petroleum Industry Environmental Conservation Association (IPIECA) convened a meeting of experts from the UNFCCC process, governments, industry, educational institutions, and consultancies. Participants at the meeting examined the key opportunities, issues and barriers surrounding the practical application of the Kyoto Mechanisms. This paper provides a summary of the findings of this meeting; a detailed report of the workshop is also available from the IPIECA Secretariat.

The Kyoto Mechanisms

The Kyoto Protocol sets up three principle mechanisms: Emissions Trading. The ability to transfer Assigned Amount Units (AAUs the fundamental unit of emissions allowance under the Kyoto Protocol) between Annex B countries (countries having Kyoto emission reduction commitments). The economic potential of trading would be greater if it also allows companies to participate. Joint Implementation. Investment in GHG reduction projects in Annex B countries can earn the investor Emissions Reduction Units (ERUs). No new emission allowances are generated since projects result in an exchange of existing commitments. Clean Development Mechanism. Investment in approved GHG limitation and reduction projects in non-Annex B countries can earn the investor and host country Certified Emissions Reductions units (CERs). Provides the opportunity to generate additional allowances. CDM projects can commence from 1st January 2000, and the CERs generated can be banked for use in the first commitment period.

Compliance
In addition to the mechanisms, the protocol also creates a compliance requirement that has important impacts on users of the mechanisms. Countries having Kyoto commitments will be required to deliver allowances and credits to match (acquit) their actual emissions. In this manner, emissions allowances and credits under the Kyoto Protocol take on aspects of a currency. The value associated with the currency can affect the economies of nations and the viability of firms. The value and utility of the currency will depend on confidence in international and national compliance systems, including enforcement procedures and consequences for countries and firms that fail to meet obligations. Business especially needs to understand how its ability to participate in Kyoto Mechanisms could be affected by non-compliance by Parties (e.g. if a country does not meet its compliance needs, do credits it has issued become invalid?).

Opportunities Offered by the Mechanisms

While the primary driver for the Mechanisms is the potential to significantly lower the societal cost of greenhouse gas emissions reductions in the first commitment period, they can also contribute to other important development and environmental objectives. Numerous economic models have shown that the greatest benefits result when the least possible restrictions are applied to the Mechanisms. These studies have also shown that a very high degree of global participation will be needed to create needed reduced cost credits, further emphasizing the need for minimum barriers and for encouraging and rewarding participation. The added value of CERs and ERUs could be a significant incentive for companies to promote investment in projects in developing and transition economies. However, much more clarity is needed relating to the generation of credits from projects, their transferability, fungibility and ultimate ownership, to encourage business investment in potential JI or CDM projects. Investment in low emissions technologies not only contributes to both the objectives of the UNFCCC and the Kyoto Protocol, but, particularly in the case of developing nation investments (where the majority of emissions growth is expected over the next 100 years) can also address longer-term global emissions reduction objectives. Furthermore, in contrast to other measures (e.g. taxes, efficiency standards) such investments could offer significant additional benefits, many of which contribute to the sustainable development goals of the host country. These include: associated environmental and social benefits (such as job and infrastructure creation), enhanced utilization of advanced technology, and avoidance of diverting resources into older, higher-emissions infrastructure in developing regions, supporting the goals of sustainable economies through transfer of technology, incentives for early action (through CDM).

Design of Mechanisms that encourage and reward industry participation could significantly lower the societal cost of meeting targets in the first commitment period of the Kyoto Protocol.

Issues and Barriers to Private Sector Investment in the Kyoto Mechanisms

Four major categories of barriers may limit private sector investment and therefore the overall potential of the Mechanisms. These are: restrictions on the use of the Mechanisms; uncertainty and risk related barriers; institutional barriers; and timing issues.

Restrictions on Use of the Mechanisms

Because the greatest benefit of the Mechanisms derives from open access to the entire range of emissions reduction opportunities, constraints in the use of the Mechanisms reduce the potential for cost savings. Restrictions exist in many forms, each of which must be minimized to enable the Mechanisms to function for the greatest global benefit: Additionality Emissions reductions under CDM are required to be additional to those that would have otherwise occurred in the absence of the project. Definitions of additionality beyond those based upon emissions reductions (e.g. financial additionality, investment additionality) may be impractical to interpret and execute, and could substantially reduce project flow and discourage participation. Definition of Project Baselines The technical determination of additionality requires an estimate of emissions in the absence of the project (baselines). Methods for choosing such baselines can substantially impact the amount of credits granted for a given project activity. A balance is needed in choosing baselines that both protect the environmental integrity of project activities and yet provide incentives to invest in emissions reducing technology and infrastructure. Too stringent a baseline would dramatically cut incentives and project flow; too lax a baseline could generate false CERs and devalue the entire basis for emissions credits. Supplementarity Several measures have emerged seeking to limit the ability of nations with commitments to utilize CDM, JI and traded credits (under the intent of forcing domestic action regardless of cost). Nonmarket constraints on the use of trading and project activities artificially limit access to emissions reduction opportunities, raise the cost of compliance, and reduce private sector investment. Eligibility Requirements Proposals have also arisen that only allow certain sizes or types of projects to be credited (for instance, the exclusion of nuclear projects or inclusion of only projects below a specified size limit). Limitations on the type of projects permitted (e.g. the exclusion of particular technologies) artificially limits access to emissions reduction opportunities. Eligibility and additionality that focus on real, measurable, and long-term reductions (per the Protocol language) permit the greatest progress on emissions reductions at the least cost. Geographical Distribution Some countries have proposed quotas for the amount of projects or credits allowable with each region. Constraints on the geographical distribution of projects would restrict access to emissions reductions opportunities and penalise particular regions. Geographical distribution of capital investments would be stimulated by improving the general conditions for direct investment in developing countries.

Uncertainty and Risk-Related Barriers

Participation by Private Entities The Protocol remains unclear concerning the role of private entities in the Mechanisms. Enabling broad participation (including the investment and innovation capability of businesses) can encourage achievement of the emissions obligations of the Protocol and the objectives of the UNFCCC.

Ratification Uncertainty Uncertainty concerning the ratification of the Kyoto Protocol impedes broad industry participation in the Kyoto Mechanisms. In particular, the rules for the CDM and JI will be set by the COP/moP whose first meeting will only take place after the Protocol enters into force. Compliance by Parties Investment in the Mechanisms will be inhibited by poor governmental and international procedures and controls of measurement, certification and verification. Unclear rules concerning penalties for non-compliance by governments and their implications for the value and movement of credits would also reduce investment. Commercial market-based transactions that result in exchange of a property right must be based on confidence and contracts between buyers and sellers. Legislation whereby past or future transactions by firms might be restricted or unwound if their national government fails to comply with its obligations would undermine confidence in the system, and limit the ability of firms to participate. Role of National Governments and Linkages with International Systems Nations have a range of domestic policy instruments to utilize in addressing emissions, including, for example, taxes, regulations, efficiency standards, cap and trade permit systems, and voluntary agreements. If national systems link effectively with international systems so that internationally acquired credits are fully fungible and can be moved freely to satisfy domestic obligations, this will increase the potential of the Kyoto Mechanisms to reduce compliance costs and increase the incentive for business participation in them. Obligations under the Kyoto Protocol apply to governments not businesses. For multi-national corporations, the ability to participate in Kyoto Mechanisms will depend on both the international framework and how it links with domestic legislation in each of the many countries (both in and out of Annex B) where they are present. Firms need to understand domestic obligations and the role that internationally acquired credits and allowances might play in meeting these obligations. Until the domestic legislation in each country is defined, it will be difficult for businesses to assess what opportunities and challenges they face. Key issues that must be resolved are the types of policy instrument used, assignment of obligations, allocation of credits, ability to use credits acquired abroad, and the national compliance system.

Institutional Barriers
Development of intergovernmental systems such as the CDM Executive Body, Operational Entities, the CDM approval process, and national and intergovernmental regulatory bodies surrounding projects and trading will require significant time which will raise transaction costs and delay the use of the Mechanisms. Governmental and international organizations should make efforts to assist developing countries in building their institutional capacity to facilitate their use of the Mechanisms.

Timing Issues
The opportunity for early crediting from CDM projects could be a significant advantage of the Mechanisms. Delays in reaching key decisions to resolve the potential restrictions and uncertainties of the Mechanisms impedes investment decisions. Consideration of retroactive project certification and crediting might minimize the risk facing projects undertaken while the CDM process and institutions develop. Business also faces uncertainty concerning changes that may occur in the second commitment period. The petroleum industry is characterized by large physical infrastructure, significant investments with long lead-time on the return of capital, and complex commercial chains from production to end user. Investments in these sectors are based on planned long-time utilization of facilities and infrastructure. However, uncertainty in the evolution of obligations, covered gases, and relative weights for them affects long-term investments and markets for credits and allowances.

Summary
Many businesses are taking action to develop trading systems and projects in anticipation of the successful evolution of the Mechanisms. The work to date reveals a wide variety of promising prospects for business participation. Realization of these prospects will depend on the nature of the international framework and domestic implementation of the Kyoto Protocol, Mechanisms, and Compliance procedures. There is a need for significant progress in the negotiations if the Kyoto Mechanisms are to achieve their potential to lower costs, enhance technology transfer and promote sustainable development.

About IPIECA
The International Petroleum Industry Environmental Conservation Association (IPIECA) was founded in 1974 following the establishment of the United Nations Environment Program at the Stockholm Conference in 1972. IPIECA is the petroleum industrys principal channel of communication with the United Nations IPIECA is involved in global and international environmental and health issues related to the Petroleum Industry, including global climate change, oil spill preparedness and response, urban air quality management, and emerging issues, biodiversity and Agenda 21. IPIECAs programme takes full account of international developments in these global issues, including those developments within the United Nations and within intergovernmental institutions and industry groups.

Climate Change Working Group

Formed in 1988, the IPIECA Climate Change Working Group (CCWG) monitors analyses and informs the membership of key developments in the issue, especially those taking place at the UNFCCC and IPCC. The CCWG encourages the development of policy options that strike a balance between the projected consequences of potential climate change and the estimated costs of response options to mitigate or adapt to climate change. The CCWG sponsors dialogues and workshops addressing key aspects of the ongoing negotiations, and provides a technical publication series as a means of constructive input to the process.

Other Publications in the IPIECA Climate Change series

Climate Change: A Glossary of Terms A Guide to the Intergovernmental Panel on Climate Change Buenos Aires and Beyond - A guide to the climate change negotiations Technology Assessment in Climate Change Mitigation - an IPIECA Workshop Critical Issues in the Economics of Climate Change Socio-economic assessment of climate change Report of the Scenarios Workshop Science of Climate Change

Kyoto Mechanisms Workshop Taskforce

John Shinn ChevronTexaco (Chairman, CCWG) Frede Cappelen Statoil (Vice-Chairman, CCWG) Richard Sykes Shell (Vice-Chairman, CCWG) Georgia Callahan ChevronTexaco (Workshop Taskforce Chair) Jonathan Grant IPIECA (Project Manager) Suzie Baverstock BP Amoco Brian Flannery ExxonMobil Miriam Lev-On ARCO Tito Sale ENI

Contact Information
International Petroleum Industry Environmental Conservation Association 2nd Floor, Monmouth House, 87-93 Westbourne Grove, London, W2 4UL Tel: +44 (0) 20 7221 2026 Fax: +44 (0) 20 7229 4948 Email: [email protected] Internet: http://www.ipieca.org