Climate Finance: Regulatory and Funding Strategies for Climate Change and Global Development

Chapter 8 Sectoral Crediting: Getting the Incentives Right for Private Investors

Climate Finance 85 Chapter 8 Sectoral Crediting Getting the Incentives Right for Private Investors Rubén Kraiem Partner and Co-chair, Carbon Markets, Climate Change and Clean Technology Practice, Covington & Burling LLP Key Points • Sectoral crediting raises obvious concerns for investors in specific projects or activities within a sector, who will be concerned that they may not qualify for offset credits if the overall sectoral target is not met because of forces outside their control. • One potential solution to this problem is for the host government to indemnify investors for any shortfall in the offset credits awarded to a given project because of failure to achieve sectoral goals due to underperformance by other projects. • Another potential solution to this problem would be to require countries to submit comprehensive sectoral programs that will specify the contributions of individual projects or activities to the overall target. Once those programs are certified as adequate to meet the overall objective, individual firms could receive credits based on whether or not they fulfilled their portion of the sectoral target, not whether the overall sectoral target was met. One important and innovative proposal in current climate policy discussions is to abandon the project-based Clean Development Mechanism (CDM) in favor of sectoral targets and crediting, at least for certain carbon-intensive sectors in countries that meet a variety of other criteria. Under this approach, no carbon credits would be issued for individual 86 Rubén Kraiem mitigation projects or activities unless the entire sector managed to meet the sectoral target. This approach has the potential both to scale up mitigation investment in developing countries and to drastically streamline the monitoring and verification process for crediting emissions reductions. This approach, however, also raises an important concern for prospective investors: why invest in costly mitigation measures if there is a risk that the desired offset credits will not be issued, irrespective of how the individual activity or project performs, because the rest of the sector failed to meet its overall target? This chapter first explains the concept of sectoral crediting and the difficulties that it may present to investors, then outlines a possible solution to the problem that still preserves the central features of the sectoral approach. Sectoral Crediting: A New Flexibility Mechanism? Of the three flexibility mechanisms under the Kyoto Protocol, the CDM has had by far the greatest impact. Because of CDM, low-cost abatement technologies have been deployed in important sectors throughout the developing world. Local capacity has been created, and infrastructure put in place for measurement, monitoring, and verification of emission reductions . And CDM has provided an invaluable price signal for carbon abatement . But it has had some important limitations. Qualifying and registering individual projects have been unduly cumbersome, with higher-thanexpected transaction costs. The scale of deployment has been small by comparison with the actual abatement challenge. And, most importantly, the overall trajectory of emissions in key industrial sectors throughout the developing world has continued to point relentlessly upward. Sector-based crediting is increasingly seen as the next-generation complement or successor to CDM. Instead of crediting reductions in emissions achieved by project-level activities, the idea is to credit reductions based on the performance of an entire industrial sector in a given country . Reductions achieved in any one installation or project within a sector will be credited only if and to the extent that sectoral performance reflects an improvement against a baseline or achieves a target set for the sector as a whole. Sectors eligible for crediting might include power generation or cement and steel production, among others. The performance of the sector would be measured against a sectoral baseline (such as a set emissions Sectoral Crediting 87 level below business-as-usual (BAU)) or agreed target. A sectoral baseline or target could be set by reference to absolute emissions from the sector (i.e., absolute emissions relative to a baseline set below BAU for the sector ) or, more likely, on the basis of a carbon intensity target or a level of emissions performance based on a particular technology. The targets can be no-lose targets: credits are awarded if the target is met, but there is no obligation to achieve it or any sanction if there is a shortfall. What is critical is that there is an appreciable course correction on a broad sectoral basis—from a BAU scenario that is highly dependent on carbon-intensive industrial processes to...