Special Feature: Carbon Trading – A New Source of African Finance

Image: Flickr, Oxfam International
Image: Flickr, Oxfam International

Innovative countries are starting to finance new projects through the Kyoto treaty, which allows industrialised nations to cut emissions by paying for pollution reduction in the South.

By all accounts, the Bisasar Road Landfill in Durban is an unsavoury place. Plunked in the middle of an Indian suburb more than 20 years ago, the site spreads the odour of rotting garbage over the surrounding community and emits thousands of tonnes of harmful methane gas into the atmosphere each year.

Strange as it may seem, though, the stench may turn out to be the smell of money – if a controversial carbon financing deal signed last year between the city and the World Bank gets off the ground. At the inaugural Carbon Expo held in Cologne last June, Durban’s Landfill Gas to Energy project became the first in Africa to be financed through an emerging global market in carbon credits.

The 1997 Kyoto Protocol on Climate Change entered into force on 16 February this year and is giving rise to a new market for trading the kind of ‘hot air’ spewing from Bisasar landfill – specifically so-called greenhouse gases, such as carbon and methane, which trap solar heat in the atmosphere and slowly raise the earth’s temperature.

Free-market mechanisms

In its earliest phases, the treaty commits industrialised signatory countries to cut their greenhouse gas emissions in 2012 to an average of 5.2% below 1990 levels. Heavy penalties await those who fail to comply. While industrialised countries can do much within their own borders, the treaty’s Clean Development Mechanism (CDM) – one of three carbon-trading provisions outlined in Kyoto – allows industrialised countries to meet part of their obligations by financing projects in developing countries that achieve reductions in greenhouse gas emissions, and then claiming the certified emissions reduction credits (CERs) generated by these projects as their own.

The Durban project is made possible by an agreement to sell 3.8 million tonnes worth of certified emissions reduction credits (CERs) for $15 million to the Prototype Carbon Facility, a World Bank project funded by industrialised country industries and governments to promote the CDM.

The Durban Landfill Gas to Energy project would lead to emission reductions in two ways: first it would capture the methane gas that is produced by rotting garbage in three city landfills, including the Bisasar Road facility; and then by feeding the gas into a generator to produce electricity, the landfill project lessens demand on the city’s dirty coal-generated power, according to Lindsay Strachan, who is project manager for the Department of Cleansing and Solid Waste.

To Strachan, the deal promises not only to generate much-needed revenue for the city, but has also sparked new interest in alternative and renewable forms of energy around the country and on the continent. In a country like South Africa that is struggling to reduce poverty, fight AIDS and boost economic growth, he says, government has no money to spend on simple methane capture technologies that have become standard in Europe.

‘What’s happened is that suddenly this project could stand up on its own two legs, but without the CDM it never would have happened,’ he said. ‘CDM has really paved the way for sustainable development to happen in this country.’

Consequently, as industrialised countries scramble to find the easiest and most cost-effective ways of reaching their targets, experts say, industries and governments alike in the developing world are seizing the opportunity to transform their dirty emissions into bankable assets.

In South Africa, major industrial polluters and small-scale social development organisations alike are looking to attract carbon financing. Strachan has been advising cities such as Maputo and Kampala on the potential of landfill gas recovery projects. Mining and fuel companies are hoping to obtain financing by switching their operations from coal to cleaner-burning natural gas. Even the South African government’s Working for Water programme – which pays the unemployed to rehabilitate denuded land – is looking into obtaining carbon credits by planting eroded farmland with a native shrub species, the spekboom, that absorbs unusually large amounts of carbon.

The logic of the CDM is two-fold: Firstly, it allows developed countries to spend less on achieving their targets, by investing in developing countries where environmental standards are typically less advanced, and therefore cheaper to improve upon. Secondly, it provides an impetus for developed countries to transfer cleaner, but costlier, technologies to developing world industries that otherwise couldn’t afford them – thus enabling countries to pursue their development more sustainably.

‘The developed world essentially pays for the developing world to get sustainable technology at a much sooner stage,’ says Johan van den Berg, who is CEO of the carbon-trading consultancy CDM Africa Solutions, based in Cape Town. ‘Essentially, you get more emissions reductions for the same money.’

But if this emerging system of carbon finance offers the potential for development in poor countries, critics also insist that the CDM has equal scope for inflicting harm on the poor – and even to the treaty’s broader aims of curbing climate change – if it is not implemented properly. Kyoto is described by some critics as a complicated experiment in harnessing the free market system to curb global climate change – the product of lengthy and painstaking compromise between politicians, big business and environmentalists, all with widely diverging agendas.

The protocol hinges on the use of carbon-trading as a mechanism designed to allow countries to meet their targets with maximal efficiency, proponents say. This inherent free market structure ensures that while national governments bear ultimate responsibility for meeting their targets, virtually anyone – industries, governments, or multilateral institutions like the World Bank – can take part in emissions trading. Most countries are passing their requirements on to the private sector by issuing emissions quotas, called Assigned Amount Units (AAUs) to each specific industry – which in turn distributes them among individual companies.

Under this system, an energy company in Europe, for example, can in theory choose to earn its own CERs by cutting emissions at home, or it can buy them from another First World company that has a surplus of CERs to sell, or it can enter into an agreement to purchase them from, say, a South African power plant that is switching from dirty coal to cleaner natural gas. No matter which route it chooses, each tonne of greenhouse emissions to be saved earns one CER.

In theory, CERs are just another financial instrument. Not only can they be used to satisfy emissions reduction requirements under Kyoto, but they can be bought, sold or kept for the future. The beginning of this year saw the launch of the EU Emissions Trading Scheme, which allows European countries to trade allocations with one another, while carbon exchanges are being planned and opened around the world in countries such as Brazil, Japan, Singapore and Canada, which experts say could soon be linked in a global system of exchange.

As the reality of Kyoto hits home, fuelling demand for cheap sources of carbon credits around the globe, the carbon economy is growing more robustly than anyone expected, says Van den Berg.

The volume of greenhouse gas emissions credits traded globally rose from 78 million tonnes in 2003 to 107 million tonnes in 2004 – a 38% increase, according to the World Bank’s State and Trends of the Carbon Market 2005 report. And the price of carbon – which had fluctuated between $6 and $13 per tonne – has soared to new highs of $30 per tonne in recent months.

All told, the CDM can only be expected to claim a small share of all this market activity, experts say, as the treaty makes clear that all carbon-trading must be supplementary to cutbacks achieved at home. Nevertheless, it could have big impacts in countries like South Africa that face increasing pressure to achieve their economic growth needs in an environmentally-sustainable manner.

According to the Norwegian consultancy group PointCarbon, the CDM is expected to attract between $24 billion and $37 billion in environmentally sustainable investment to the developing world by 2012. Given the hot market so far, Van den Berg says, that figure will probably grow even higher.

But if the theory of CDM seems relatively simple, the practicalities are infinitely more complex. The system is governed by an international body called the Kyoto Executive Board, which sets the rules for participating in the scheme, maintains a registry of all approved CDM projects, and accredits firms that independently measure and monitor these projects at every stage.

Each CDM project must first be approved by a government-run Designated National Authority in its home country; then it must line up financing, be validated by independent auditors, register with the Executive Board, and then undergo a verification and certification process in order to receive CERs. Since most CDM projects by definition require up-front financing to begin, investors usually fix a price for CERs long before they are earned or issued.

Only one project so far is actually registered with the Executive Board – a landfill methane recovery project in Brazil – which is an indicator of the intricacy of CDM. The Protocol allows CERs generated from the year 2000 onwards. Even now, says Van den Berg, CDM deals tend to be highly speculative and involve a lot of risk for investors. There are no guarantees that a project will actually generate the CERs agreed to, or that these will ultimately be admitted to the investor country’s CER registry. And even the CERs themselves only exist in theory, as none have been issued yet.

In most cases, the project host and investor agree up front on a price for the carbon credits, with the purchasing institution paying up front for, perhaps, 10 years worth of carbon credits at a fixed price, often assuming the risk of the project in exchange for a reduced price for the credits.

Dirty industry

In spite of such uncertainties, South African officials have hinged their plans of achieving future sustainable development on attracting CDM investment. A National Climate Change Response Strategy released last year by government, for example, identifies the CDM as an important lever for shifting the economy away from dependence on cheap but dirty coal. As soon as 2012, the country will face mandatory targets under Kyoto, government officials have warned, which will render coal far too costly an alternative.

Ironically, the country’s wealth of dirty industry is precisely what makes it such a potentially attractive destination for CDM investors, Van den Berg says. While there may be limited potential for CDM investment in other African countries like Kenya and Namibia, which already have large clean energy sources like hydropower, South Africa desperately needs to find alternatives to coal, which supplies 90% of the country’s electricity.

‘South Africa has a very dirty electricity grid,’ says Van den Berg. ‘Our per capita emissions are much more like a developed country than a developing country. Working from this relatively poor position, it’s quite easy to improve on that.’

With foreign investors being drawn to the kinds of projects that achieve the largest emissions cutbacks for the lowest prices – the ‘low-hanging fruit,’ as the experts say – South Africa has much to offer.

Even so, it is a relative late-comer to the carbon-trading party, government officials acknowledge. While China, India and Brazil – all abundant potential sources of cheap carbon credits – have aggressively pursued CDM investment, and collectively account for 58% of all global transactions so far, the Durban project remains one of only about a dozen in South Africa that are in various stages of the approval process by the Department of Minerals and Energy (DME).

Richard Worthington, who is coordinator of the South African Climate Change Action Network, says this abundance of easily exploitable projects on the carbon market threatens to undermine the integrity of the treaty, by creating perverse incentives for countries and companies to keep polluting in order to attract investment, as well as by keeping carbon prices so low that only the cheapest and easiest projects that deliver large volumes of carbon credits remain viable.

Ironically, the CDM can also effectively transfer the impacts of dirty industry from developed to developing countries, he says.

US author Daphne Wysham writes, on the website for the organization CorpWatch, that all too often CDM projects serve to undermine, rather than help, sustainable development: ‘Critics charge that carbon trading is a smokescreen. At best, it is designed to attain “carbon neutrality” – representing no net growth in emissions for a country or industry, but doing so cheaply. At worst, it may make the warming climate even less stable, while robbing the poor of their rights.’

Other critics say the system will be open to abuse in developing countries which lack the monitoring and enforcement capacity to ensure that projects are carried out in a sound and sustainable manner.

According to Worthington, the bar was not set high enough in the 2002 Marrakesh Accords to the treaty, where the rules of CDM and the project categories to be allowed were set. As a result, the kinds of projects that are viable under current market conditions often offer dubious environmental benefits at best, he says.

According to the 2005 World Bank carbon-trading study, for example, the types of alternative energy and efficiency projects favoured by environmentalists account for less than 5% of all CDM projects. The most common categories, on the other hand – hydroflourocarbon emissions, methane capture and landfill gas recovery, biomass energy production and hydropower – often do little to further genuinely sustainable development, he argues.

The inclusion of carbon sinks – forested or agricultural areas that absorb carbon dioxide from the atmosphere – under CDM has been particularly contentious. Many scientists say that not enough is known about carbon sequestration to determine sound methods of accounting for and verifying how much carbon the sinks would actually absorb. Nor can they predict the extent to which carbon absorbed into the soil would actually remain there.

The Durban Landfill Gas to Energy project exemplifies the debate over whether CDM serves the needs of the global poor, or forces them to bear the brunt of reducing greenhouse emissions for the greater good – while the west carries on with business as usual.

To Sajida Khan, who lives across the street from the Bisasa Road Landfill, the dump once symbolised apartheid-era discrimination that lumped non-white communities with all the landfills and heavy industries that whites wouldn’t have in their own backyards. The community has fought for years to have the dump closed, also claiming that they have been exposed to toxic chemicals that have caused cancer clusters in the neighbourhood. Instead, Khan says, the city has ignored locals’ complaints and forged ahead with the project.

Now, the scheme faces an uncertain future. Khan has appealed against it, arguing that it will prolong the life of the dump and expose the community to increased pollution locally from the generators, while failing to make a difference globally. ‘This will cause harm to people at an international level too,’ she says. ‘Selling these credits to northern industries is going to give them license to increase their emissions there, and so people in the north who live around these industries will suffer too.’