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CDM
Going cool on HFCs
16 March, 2007
Carbon credit buyers are shunning the reductions generated by HFC23 projects. Christopher Cundy reports
Since the beginning of the Kyoto Protocol’s Clean Development Mechanism (CDM), controversy has plagued emissions reduction projects that destroy trifluoromethane (HFC23), an extremely potent greenhouse gas.
Criticisms focus on the fact that carbon credits from HFC23 destruction are very cheap to generate and the technology brings few sustainable development benefits to the developing world. The gas is a by-product of making HCFC22, a refrigerant gas that is controlled under another international agreement – the Montreal Protocol – and which is being phased out because of its potential to destroy the ozone layer (see Carbon Finance, February 2007, pages 14-15).
The negative publicity now appears to be influencing the price of certified emission reductions (CERs), the credits awarded to CDM projects that are equivalent to one tonne of carbon dioxide.
All kinds of buyers – whether they be funds, governments or companies trying to meet their compliance needs – are now willing to pay a premium for non-HFC23 credits, over fears their reputation will be tarred, say some brokers and carbon fund managers.
Views are split
Market participants appear split over whether this is an encouraging sign of a maturing carbon market, or a dangerous precedent that threatens the credibility of the CDM. Some say the discrimination will spread to other industrial gases; others argue this is a temporary phenomenon that will disappear as soon as CERs become scarce.
“Everybody has been expecting it. From the start, there was pressure from NGOs on the design of the [CDM] system and the exclusion of HFC23 projects,” says Reuben Maltby, chief operating officer at Carbon Capital Markets, a London-based emissions trading company.
However, he points out that it’s not just NGO-led bad publicity that is solely responsible for the HFC23 discount. “There’s more information in the market and buyers are becoming more sophisticated. And there’s a greater supply of CERs now,” Maltby says.
“I think people claim the moral high ground and say they’re not buying HFC23 credits for the sake of the environment. But you have to look at the other reasons for them doing it,” says a London-based broker, who asked not to be named. “It’s a long market, so people can be choosy. People also want to build up a diversified portfolio,” he says.
Others agree that the desire for a diverse portfolio could be an explanation for the price differentiation. According to last year’s World Bank report, State and Trend of the Carbon Market 2006:Update, CERs from HFC23 projects made up 51% of the world’s CER supply in 2006 (up to 30 September).
Some carbon funds have mandates to buy from a diverse range of projects and countries, and may simply have filled their quotas for HFC23 credits. With an imperative to buy from other types of projects, this could account for the price differentiation.
For instance, Carbon Capital Markets’ Carbon Assets Fund focuses on methane more than any other greenhouse gas. Maltby says this is primarily because this is where the company’s expertise lies. But a secondary concern was that market liquidity in HFC23-derived CERs could potentially be lower than that of methane-derived CERs.
“People set up their funds with rules not knowing how the market was going to develop,” says Mark Meyrick, environmental products manager at EDF Trading in London. However, without further analysis of the 50-plus carbon funds out there, he says it’s hard to judge how much of a factor this is.
Thorsten Ansorg, Frankfurt-based managing director of trading house Nobel Carbon Credits, is not won over by claims of diversification. “The average compliance buyer has to take care of the ‘short’ position of their portfolio and is not discriminating between different approved CERs,” he says.
Ansorg says, in his experience, major buyers are unconcerned with the source of their CERs and he describes the market for non-HFC23 credits as “niche”. “Large compliance buyers are buying, as the name says, large quantities. Therefore, the market offers little choice [other than to buy HFC23 credits]. If somebody has lots of time and money and a ‘greener than green’ agenda, combined with a small portfolio, the situation might be different,” he says.
The discount applied to HFC23 credits is running at 1.5% to 3% of the December 2008 CER price, or a range from €0.20 ($0.26) to €0.50, according to brokers and buyers.
“The discount has not yet extended to other types of credit, but potentially we will have a backlash against all industrial gases,” says Gilles Corre, a director at emissions broker Evolution Markets, based in London.
Carbon Capital Markets’s Maltby agrees that CERs from the destruction of industrial gases, such as nitrous oxide (N2O), could be discounted in future. “These are gases that could be easily got rid of through legislation. There’s a certain element of people expecting Montreal Protocol-style controls on them,” he says.
But Meyrick at EDF describes N2O as a “legitimate” gas. It is not covered by other environmental treaties, it is a by-product of fertiliser production, and, as potent greenhouse gas with 310 times the global warming potential of carbon dioxide, its destruction is desirable.
Market credibility
At a wider level, some see the HFC discount as seriously damaging the credibility of the CDM and the efforts of the UN Framework Convention on Climate Change (UNFCCC) to ensure that a CER represents a genuine emission reduction, wherever or however it was achieved.
“We completely disagree with any effort to discriminate on price, or other environmental value, of an issued CER. It is by definition up to the UNFCCC to decide what a valid project is,” says Ansorg at Nobel Carbon Credits.
Meyrick at EDF agrees. “I don’t think the market should be responsible for defining the environmental quality of a CER. That should be down to the CDM Executive Board. Once it’s got past that hurdle, it can’t be good for the market to decide otherwise,” he says.
But others see it as a sign of a maturing emissions market. In many other commodity markets where the product criteria are strictly defined, buyers are willing to pay more if it comes from a certain producer. Non-issued CERs are already subject to discounts depending on their risks, such as the type of project and the country it is located in.
“I think it’s a good thing. It’s a sign of the market doing what it’s supposed to,” says Maltby at Carbon Capital Markets.
“I don’t see it as a bad thing at the moment. I don’t think it will break up liquidity,” says Corre at Evolution Markets. He adds that verified emission reductions (VERs) which meet the ‘Gold Standard’ – a certification scheme for projects with the highest sustainability benefits – attract a premium over other VERs.
Soon, he says, Gold Standard CERs will be traded on the market. “It’s hard to see a Gold Standard CER not attracting a premium,” he notes.
