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CDM

The credit for destruction

15 February, 2007

A new controversy is brewing over HFC23 destruction projects in the Clean Development Mechanism. Robin Lancaster reports

The creation of carbon credits from the destruction of the potent greenhouse gas (GHG) trifluoromethane (HFC23) has been one of the most controversial issues during the early life of the Kyoto Protocol’s Clean Development Mechanism (CDM).

A by-product of the manufacture of the refrigerant HCFC22, many viewed HFC23 destruction projects as a cheap money-maker for a small number of industrial sites in a handful of developing countries that provided little discernible sustainable development benefit to those countries.

On the other hand, they have been lauded by some as a fine example of the potential of the CDM to generate huge reductions of a GHG that has a global warming potential 11,700 times greater than that of carbon dioxide (CO2).

Despite the reservations, which lead to a protracted approval process for the CDM methodology (AM0001) on which HFC23 projects are based, large volumes of certified emission reductions (CERs) from such projects have come to market.

The 10 CDM projects registered, so far, that are destroying HFC23 have the potential to create around 350 million CERs in Kyoto’s first commitment period (2008–12) out of a current expected total of about 1.8 billion from 500 registered projects. In the State and Trends of the Carbon Market 2006: Update report from the World Bank and the International Emissions Trading Association, released in October last year, CERs from HFC23 destruction projects accounted for 51% of contracted volume. However, this was down from 64% in 2005 and the report noted that there was now a “finite availability” of CERs available from these projects beyond 2006. This is because the strict criteria for project eligibility under AM0001 mean that virtually all the potential HCFC22 industrial facilities in developing countries have been, or are about to be, registered as CDM projects.

No more debate?

And so the debate over HFC23 destruction projects in the CDM was finished. Some may not like it, but under the strict CDM rules, a methodology had been approved and CERs created. That was, however, until the last UN climate change meeting (COP/MOP2) in Nairobi in November, when the Chinese delegation called for CERs to be allowed from the destruction of HFC23 from new production – something that is not allowed under AM0001.

“We thought the issue of HFC23 was over,” says Mark Meyrick, environmental products manager at EDF Trading in London. “It was only at the last COP that it was raised again.”

According to the secretariat of the UN Framework Convention on Climate Change (UNFCCC), HFC23 destruction from new HCFC22 production was already on the agenda of its Subsidiary Body for Scientific and Technological Advice (SBSTA) at the Nairobi conference. But no decision was made in Nairobi and the issue will be discussed again at the next SBSTA meeting in May, a UNFCCC spokesman told Carbon Finance.

SBSTA had been tasked by a previous COP to develop recommendations for the CDM Executive Board on this issue in relation to other international environmental agreements. Of particular relevance for HFC23 is the 1987 Montreal Protocol, which deals with substances that deplete the ozone layer and under which HCFC22 is to be phased out.

The critical issue for HFC23 is the risk of creating a “perverse incentive” in that the CDM could encourage industrial facilities to increase production of HCFC22 in order to generate more HFC23 to be destroyed and so create more CERs.

The UN’s Intergovernmental Panel on Climate Change (IPCC), in its 2005 Special Report on Safeguarding the Ozone Layer and Global Climate System: Issues Related to Hydrofluorocarbons and Perfluorocarbons*, noted that HFC23 emissions from HCFC22 production could be destroyed at a cost of less than $0.2 per tonne of CO2 equivalent. In comparison, a recent study** by the Center for Clean Air Policy, looking at GHG mitigation options in China, India and Brazil, estimated the cost of emission reductions from renewable energy is in excess of $10/t.

With CERs currently selling for €11 ($14)/t, the profit margins from HFC23 destruction projects are obvious. For example, Indian chemicals firm SRF, which operates one of the 10 registered HFC23 destruction projects, said in a recently released earnings report that it has, so far, sold 3.65 million CERs in the 2006–07 financial year for Rs4,050 million ($96 million). The sale of CERs has become a significant revenue stream for the company, second only to its technical textiles business and ahead of its chemicals and packaging units.

For some, the decision on whether to issue carbon credits for new HFC23 production is clear cut.

“It should not be allowed,” says EDF’s Meyrick. One reason is the Montreal Protocol, but he is also concerned that the carbon market could be flooded with CERs from HFC23 projects and that they will take carbon finance away from technologies with more sustainable development benefits, such as renewables.

“How do you get more countries involved and more variety of methodologies in the CDM?” he asks. Not with new HFC destruction projects, he suggests.

Liam Salter, Hong Kong-based head of WWF’s climate change programme, agrees. “HFC23 destruction projects are driving the price below the threshold for the technologies that are needed for a sustainable energy future,” he says.
“In China, for example, there are significant energy efficiency and renewable energy targets and carbon finance needs to be piled into those sectors to make it happen,” he adds.

But Neeraj Prasad, with the World Bank’s carbon finance unit, disagrees. “Having co-ordinated carbon finance business for the Bank in East Asia since 2003, and having personally managed a HFC23 project in China, I would assert that the HFC project has not, in volume terms, displaced a single project from any carbon fund pipeline,” he says.

“On the contrary, the firming of the market has probably encouraged many more project sponsors to take carbon emissions as a serious business,” he adds.

Laurent Segalen, Paris-based head of the European Carbon Fund, is also concerned that new HFC23 projects will drown the carbon market with CERs. But he would go further than banning new production and would cap the use of CERS from existing HFC destruction projects – at say 25% of the overall CER market. “So that there is room for renewable energy and energy efficiency projects,” he says.

“There’s the letter and the spirit. HFC23 [projects] abide by the letter, but not the spirit of the CDM,” he adds.

But, without the CDM, where is the motivation for a company to invest the millions of dollars needed to install the HFC23 destruction equipment?

Although the Montreal Protocol outlines a timetable for phasing out HCFC22 production in industrialised countries by 2030, developing countries are allowed to expand production until 2015 and only stop producing the gases in 2040 (see table). The IPCC report estimates that by-product emissions of HFC23 from increased HCFC22 production, mainly in developing countries, could be 60% higher in 2015 than they were in 2002 (the latest figures available when the report was compiled), increasing to around 272 million tonnes (Mt) of CO2e compared with 159Mt.

“If we are concerned about climate change, HFC23 has a high global warming potential and we should provide incentives to destroy it,” says Marco Monroy, Miami-based president of MGM International, an emission reduction project developer.

“I don’t think it will be a catastrophe if we let new HFC23 into the CDM,” he says. However, he adds several caveats, such as ensuring that there is genuine market demand for the HCFC22 and that the projects pass the CDM’s additionality criteria.

He notes that there are new HCFC22 plants already operating in China that are not eligible for the CDM under AM0001. “HFC23 is not being destroyed at these plants because it doesn’t qualify for the CDM under the approved methodology. There’s no incentive to destroy it.”

As Ben Feldman, a managing director at carbon asset manager Natsource – which has invested in HFC projects – in Washington, DC, says: “A non-decision [by SBSTA] is a decision, as new HCFC22 goes online and HFC23 goes into the atmosphere.”

Dave McGreal, purchasing development manager at UK-based chemicals producer Ineos Fluor, agrees. “There needs to be some sort of evolution, as HFC23 is being let loose into the atmosphere,” he says. His company is involved in two registered HFC23 projects in India and South Korea and has a third in the pipeline.

“There are GHGs hitting the atmosphere and just because they can be abated less expensively than others, doesn’t mean they shouldn’t be abated,” says Natsource’s Feldman.

Another CDM specialist adds: “It’s perverse to say that because someone is going to make a lot of money out of this by not putting it in the atmosphere, it should not be allowed to happen.”
The Chinese government, in a submission to SBSTA last year on this subject said it believed that new HCFC22 production facilities allowed under the Montreal Protocol should be eligible for HFC23 destruction under the CDM. China is already a significant participant in the market with six of the 10 registered HFC23 projects located in the country, and a further two have registration pending.

Government tax

It has instigated a 65% tax on the sale of CERs, which it says goes into a government fund for other sustainable development activities – none of the other countries hosting HFC23 projects (India, South Korea and Mexico) have a similar tax regime. In its SBSTA submission, China said that host governments should take such measures for new production “to avoid possible high economic benefits” from projects.

It also said that new production facilities should only qualify for the CDM after they have been in operation for three years and when owners of the plants can provide evidence of the demand for HCFC22. Another possibility would be for the HFC23 waste generation rate – the percentage of HFC23 produced per unit of HCFC22 – to be set at the lowest of the three most recent years of production, but no more than 3%, the same as AM0001.

Current state-of-the-art production facilities, such as DuPont’s Louisville Works in the US, have HFC23 generation rates as low as 1.37%, so there may be some scope for the volume of CERs from new production, if allowed, to be considerably less than from existing plants.
DuPont is not involved in HFC23 destruction in the CDM market. But it has destroyed HFC23 as part of a set of 1991 internal goals to reduce GHG emissions. “We were doing this way before the carbon market,” says Mack McFarland, an environmental fellow with DuPont Fluoroproducts in Wilmington, Delaware.

Others would prefer to see HFC23 destroyed in this way, outside of the CDM.

“We have to realise that carbon trading cannot solve everything,” says WWF’s Salter. “HFC23 destruction could be dealt with by grants, loans or regulation. There is enough money in the system for countries to subsidise this destruction or just regulate it. For example, use best-available-technology as [standard] practice.”

Australia, in its submission to SBSTA last year, suggested that the UN’s Global Environment Facility (GEF) could be used to fund the installation of destruction technology at cost. The GEF was set up in 1991 to help developing countries fund projects and programmes to protect the environment.

There needs to be some economic driver for companies to install the destruction equipment, says Ineos Fluor’s McGreal. “This might be the CDM or it might be from the freeing up of capital from some other organisation, such as the World Bank” he adds.

But the World Bank’s Prasad is concerned that, through a policy initiative or grant, there is no incentive for a developing country to agree to go along. “If they don’t have emission caps there is no reason to capture and remove HFC23 emissions,” he says.

The Bank does not have an official position on the subject, he adds. This is despite that fact that it was involved in one of the largest CER transactions through its Umbrella Carbon Facility, which involved two HFC23 projects in China. The deal was worth more than $1 billion and will see the facility buy over 100 million CERs.

And so, all eyes turn to the next SBSTA meeting in May, when many would like the situation to be put to rest for good – one way or another. “[Natsource] doesn’t have a position on the issue either way,” says Feldman. “But it would like a more coherent framework on what is allowed in order to give the investor a clear picture.”

* Special Report on Safeguarding the Ozone Layer and Global Climate System: Issues Related to Hydrofluorocarbons and Perfluorocarbons, Intergovernmental Panel on Climate Change, www.ipcc.ch

** Greenhouse Gas Mitigation in Brazil, China and India: Scenarios and Opportunities through 2025, Center for Clean Air Policy, www.ccap.org

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