The other side of Kyoto: are the pastures greener?

* The Kyoto Protocol has implications for emerging emissions trading markets

* Clean development mechanism (CDM) projects generate Certified Emission Reduction units (CERs) which can be traded on such markets

* Australia has joined the global trend towards decreasing greenhouse

With the Kyoto Protocol now in force, the focus has turned to its implementation and variations in emerging domestic and international emissions trading markets. This article examines the opportunities in one type of tradeable unit: Certified Emission Reduction Units (CERs) generated through Clean Development Mechanism (CDM) projects. We will also look at regional opportunities and changes for business under the protocol and beyond, as well as the broader issues about greenhouse gas emissions reduction.

The Kyoto Treaty

Countries that have ratified the Kyoto Protocol (the protocol) must meet targets for reducing greenhouse gas emissions during the first 'commitment period', 2008 to 2012. Parties that meet their targets will be allowed to trade emission units generated through any surplus reduction on the international emissions trading market.

Clean development mechanism (CDM) projects

A CDM project is a project undertaken in a 'developing' nation by an 'industrialised' nation or by private entities authorised to participate in the CDM. Article 12 of the protocol and the Marrakesh Accords set the framework and requirements for these projects.

In addition to providing for bilateral CDM projects (between an industrialised nation and a developing nation), the Marrakesh Accords also enable developing nations to undertake unilateral CDM projects (that is, without an industrialised nation's involvement).

CERs generated by a CDM project can be traded on the international emissions trading market or used by an investor (a state or private party) to offset emissions. The protocol and the Marrakesh Accords allow a private entity to participate in the CDM if it's authorised by a party to the protocol.

Registration requirements

CDM projects must meet certain requirements to be eligible for registration with the CDM Executive Board (the board) and therefore produce tradeable CERs. The board is a committee, established under the protocol, that supervises the international administration of the CDM. To be eligible for registration, CDM projects must, among other things:

* help the host country achieve sustainable development

* provide real, measurable and long-term benefits

* receive approval from a national authority designated by the host nation in accordance with the protocol

* satisfy 'additionality' criteria (see below)

* submit project documents to an independent organisation (accredited by the board and designated under the protocol, which can include a private company) for validation, and if successful, submit the project documents to the board for registration, and

* ensure that public funding for the project does not result in diverting official development assistance.

Project design documents required for registration must cover:

* a general description of the project

* a description of the baseline methodology

* monitoring methodology and plan

* an environmental impact statement, and

* stakeholder comments.

'Additionality'

As mentioned above, CDM projects must satisfy an 'additionality' criteria. Additionality is a concept used to evaluate the baseline emission against actual emissions. A project baseline compares the emissions of a proposed project with the emissions that would be generated if the project did not go ahead. Baselines are created on a project-specific basis, must be approved by the board, and take into account several factors (such as the then current source of emissions for a project of the type being considered). If actual emissions of a project are below the baseline, additionality is achieved and CERs can be generated.

The protocol also sets up a fast-track process to assist and promote smaller scale CDM projects and allow them to compete with larger projects. The fast-track process uses standardised baselines, less stringent eligibility rules, and a simpler project cycle process.

Opportunities for Australian business

Australia is located in a fertile region for CDM project development opportunities. Countries in the region that are parties to the protocol include: Cambodia, Vietnam, Thailand, Solomon Islands, Philippines, Indonesia, Malaysia, Republic of Korea, Papua New Guinea, Fiji and the Cook Islands.

The Australian Government cannot participate directly in CDM projects because it has not ratified the protocol. While the Marrakesh Accords allow private entities to participate in CDM projects, it is only with the authority, and under the responsibility of, a party to the protocol.

As a result, an Australian company may find it hard to convince say Malaysia to authorise the company's participation in a CDM project in preference to a Malaysian company. However, such national interest issues aside, opportunities still exist for Australian companies to be informally involved in a CDM project through contractual relationships with project participants.

The mix of eligible host nations, competitive technology and local expertise creates valuable opportunities for CDM projects and deals in Asia and the Pacific, particularly for industrialised parties seeking to partner energy and infrastructure projects.

Managing the risks

To maximise regional opportunities, CDM project participants and investors need to ensure protocol-related risks and international and domestic legal requirements are managed adequately. These risks include:

* host country political and sovereignty issues, and

* changes to environmental policies, regulation of foreign investment and taxation laws.

Involvement in projects must also be structured to ensure that the project is eligible under the protocol and that more common commercial risks are allocated appropriately.

Participants should assess projects to ensure emission reductions will be additional to levels that would have been reached if business continued as usual (additionality criteria). Therefore, adequate environmental assessments are integral to baseline methodology and in measuring reductions beyond what would have occurred if the project didn't happen.

Potential CDM projects Examples of potential CDM projects include:

* renovating and modernising aging industrial plants and equipment to improve efficiency

* constructing alternative power generators (eg biomass) in place of a coal-fired power station, and

* electrifying a rural area using wind or solar power.

Projects using nuclear technology are not eligible for the CDM process.

We expect interest in regional CDM projects to continue to grow, especially in light of the response to the start, earlier this year, of the European Union emission trading scheme and the approaching first 'commitment period' under the protocol in 2008.

Reducing greenhouse gas emissions

Outside the protocol, global focus on greenhouse gas emissions reduction is increasing and changing the business climate.

Despite not having ratified the protocol, the Australian Government and state and territory governments have implemented greenhouse gas emission reduction policies and schemes. While these regimes are in accordance with Australia's commitments under the United Nations Framework Convention on Climate Change, they also demonstrate the international trend towards decreasing greenhouse gas emissions irrespective of any protocol obligations.

For instance, the Premier of Victoria, Steve Bracks, formally endorsed in April this year, the London-based Climate Group's mission and greenhouse reduction principles. The principles commit Victoria to work with other stakeholders, national and provincial governments to reduce global greenhouse gas emissions.

In addition, Australian state and territory governments, in acknowledging the importance of addressing climate change, have established a working group to investigate and develop a multi-jurisdictional emissions trading scheme. This working group is due to provide a report on its investigations in the second half of this year.

In addition, growing consumer and public awareness of climate change has increased pressure on companies to disclose emissions reduction policies and strategies. Shareholder activism and threats of climate change litigation are emerging issues for companies when they assess commercial, reputational and legal risks. Companies are also being pressured by shareholders and potential investors to identify potential risk exposure to climate change/ greenhouse regulations, which includes the protocol.

Recent policies and trends have renewed a push toward a triple-bottom-line decision-making framework and sustainable development. While climate change-related reforms may frustrate business in the short term, the protocol and broader support for greenhouse gas reduction present valuable opportunities for reduced emissions, and 'clean' and renewable energy technologies, particularly at a regional level.

Chris Schultz may be contacted at Chris.Schulz@aar.com.au. Emily Gerrard may be contacted at Emily.Gerrard@aar.com.au. See also 'Kyoto Protocol', AAR Focus, February 2005. You can find this and other articles on the AAR website at www.aar.com.au.