Creation and Sharing of Credits through the Clean Development Mechanism under the Kyoto Protocol

The implementation of activities aimed to mitigate global greenhouse gas emissions is more cost-efficient in developing countries than in most of the industrialized world. Thus it has been a major, but contentious topic in the climate negotiations to allow crediting of emissions reduction in developing countries towards domestic emission targets of industrial countries. The Kyoto Protocol instituted a Clean Development Mechanism (CDM) that is to assure that the interests of all parties from industrialized and developing countries are equally represented. Many issues concerning the structure of the CDM remain to be decided. Crediting critically depends on these decisions. Credits should accrue only after verification. A crucial issue that influences all decisions on creation and distribution of credits is whether they are tradable. Concerning credit creation, it would be advisable not to set quotas on the share of CDM credited toward Annex-B targets as they give no dynamic incentive for innovation. To reach the latter goal, crediting should be gradually reduced in the long run. Crediting should also be related to externalities and thus be differentiated according to project categories. In a fund model, the reduction of credits could be evenly spread over all investors. In a clearinghouse model it would have to be related to each project. Uncertainties should not be covered through discounting but through a compulsory insurance. Credit sharing leads to higher costs for the investors and a lower demand for CDM projects. Free negotiation of the credit sharing ratio will lead to a competition between host countries. In case of tradability, host countries could set up projects with own funds to earn credits they can sell. Such a de facto extension of emissions trading could work against the goal of inducing developing countries to voluntarily adopt emission targets. This could be promoted by making credits non-tradable but allowing banking against future targets.