Cleaner generation, free-riders, and environmental integrity: clean development mechanism and the power sector

This article provides a first-cut estimate of the potential impacts of the clean development mechanism (CDM) on electricity generation and carbon emissions in the power sector of non-Annex 1 countries. We construct four illustrative CDM regimes that represent a range of approaches under consideration within the climate community. We examine the impact of these CDM regimes on investments in new generation, under illustrative carbon trading prices of US$ 10 and 100/t C. In the cases that are most conducive to CDM activity, roughly 94% of new generation investments remains identical to the without-CDM situation, with only 6% shifting from higher to lower carbon intensity technologies.We estimate that the CDM would bolster renewable energy generation by as little as 15% at US$ 10/t C, or as much as 300% at US$ 100/t C. A striking finding comes from our examination of the potential magnitude of the "free-rider" problem, i.e. crediting of activities that will occur even in the absence of the CDM. The CDM is intended to be globally carbon-neutral-a project reduces emissions in the host country but generates credits that increase emissions in the investor country. However, to the extent that unwarranted credits are awarded to non-additional projects, the CDM would increase global carbon emissions above the without-CDM emissions level. Under two of the CDM regimes considered, cumulative free-riders credits total 250-600 MtC through the end of the first budget period in 2012. This represents 10-23% of the likely OECD emissions reduction requirement during the first budget period. Since such a magnitude of free-rider credits from non-additional CDM projects could threaten the environmental integrity of the Kyoto protocol, it is imperative that policy makers devise CDM rules that encourage legitimate projects, while effectively screening out non-additional activities.