Decoding Durban: Deal or no Deal? Deal, for a Deal Later (Part 2)

Implications to the world’s transition to low-carbon economy

The economics of climate change or ‘climate economics’ is about how we price the world’s climate and the disasters induced by climate change in order to fit into the mainstream decision-making models. As climate change is attributable to anthropogenic carbon emissions, we have to look for ways to reduce and absorb excessive carbon dioxide on the planet. Before the technology of carbon capture and storage becomes mature, we need to attach a price to the emissions from economic activities through the creation of carbon permits for trading and to our carbon-sinking forests through financial incentives for stopping deforestation such as the UN’s REDD (Reduced Emissions from Deforestation and Degradation) programme. The implications of climate deals reached in annual summits to these two ‘commodities’ do matter because they currently form the twin pillars supporting the global transition to low-carbon economy. Let us take a look at forest protection financing and carbon market development.

 

Finance of forest protection

In the Durban conference, the media focused on whether delegates would reach a consensus regarding the second commitment period of the Kyoto Protocol only but overlooked some issues of climate change adaptation and associated financing whose importance is recognised by the Protocol. Climate change adaptation and financing have been crucial areas in the world’s efforts to combat climate change. Bringing the financing stream to optimal can facilitate our transition to low-carbon economy. To help vulnerable communities in poor countries adapt to the effects of climate change, the Green Climate Fund has to be operational by 2013 and explore new funding sources. It may also be necessary to review the functions of the REDD as part of devising a ‘game changer’.

REDD and REDD+

Forest protection is significant in decarbonising the planet. It is because deforestation is almost equal to the carbon emissions of the entire global transport industry. In Durban, delegates agreed to consider private funding and market-based mechanisms as options to finance the REDD+, which is regarded by many as a great step forward to halt deforestation.

REDD, launched by the United Nations in September 2008, will provide 20% of the world’s carbon-reduction potential by 2020. Via this programme affluent countries pay poor, forest countries not to cut down their forests. Such payments will be ‘offsetting’ the pollution created by carbon-producing industries in the developed world. The enhanced version of the pact, REDD+ (which goes beyond deforestation and forest degradation, and includes the role of conservation, sustainable management of forests and enhancement of forest carbon stocks), is opening the door for private sector finance to establish a pool of large, reliable buyers for forest carbon.   

Despite its objective that is to benefit the planet, the operational principle of the REDD programme entails a moral question. In 2010, Norway offered to pay US$1 billion each to Brazil and Indonesia if they had reduced deforestation. True, the money as a result incentivised a drastic drop of forest-cutting in Brazil and even a two-year logging moratorium in Indonesia. But the fundamental problem here is the ‘good citizens’ paying the worst ‘offenders’, who must essentially be big companies and big landowners, not to pollute. Or analogically put it this way, a bank robber is saying “how much will you pay me not to rob this bank?” The cost of paying to conserve forests globally is far more than the developed nations are likely to offer. In the midst of financial crisis, how much money can and will other countries really contribute? On the other hand, it is unclear whether the REDD will be sabotaged by loopholes, corruption and bureaucratic complexity. Campaigners were astounded whey they looked at the first batch of 16 forestry plans submitted by tropical nations seeking payment from wealthy nations under the REDD. Many of the plans presented schemes which would enable the forest countries to continue deforestation as usual, while still earning the cash. When the world has agreed to set up a green fund coordinating the global emissions-reducing efforts, is it a right time to study how best the REDD and the GCF can work together? Are these two funds overlapped with each other? Can they be merged strategically to yield the best results?

Sustainability of the green fund

Delegates’ having made headway on the Green Climate Fund is a matter of life and death for people in poor island states. To assist poor countries with climate change adaptation, the GCF has to be operational by 2013 and ensure funding sources to be sustainable.  After its official establishment in Cancun (COP 16), the transitional committee just submitted to the UNFCCC Executive Secretary a report on the objective, design and operations of the Fund in October 2011. It suggests funding come from governments, public or private sectors of developed countries, or bilateral or multilateral agreements. All developing countries are eligible for the funding which should be used to enhance their capacities of adaptation and emissions reduction, to begin relevant actions or to support technology development and transfer projects. In spite of the importance and urgency of setting up the green fund, many countries have thrown doubts on its amounts, sources and operations.

Unknown is whether the funding sources are sustainable in the long term since the current agreement cannot lead us to a viable forest investment market. The “Cancun Agreement” commits developed nations to raising US$30 billion as fast-start finance between 2010 and 2012; and to making pledges by May 2011. Nonetheless, data from the World Resources Institute shows that the EU and 23 other countries had promised a total of US$28.2 billion only as at the deadline. There is no way to ascertain how much money comes from the ‘Official Development Assistance’ with which developed nations have provided the less developed ones. A proportion of this amount is even appropriated in the form of loans. Neither in Cancun nor in Durban did they not seal a deal on climate financing. If there is no more progress in 2012, will the Fund becoming an ‘empty promise’ be the corollary?

Going beyond direct aid

No matter for GCF or REDD+ sustainable funding sources should not be ones that solely rely on public money from governments (i.e. aids and perverse subsidies). A versatile green/forest investment market is possible only if the system design can channel huge amount of private money into both mitigation (e.g. afforestation and renewable energy) and adaptation (e.g. disasters prevention) projects. Adaptation is badly needed by developing countries more vulnerable to climate change. Yet, only 10% of the funding is spent on adaptation projects today due to their profitability being lower in the eyes of businessmen. To bring forest investment into mainstream, the UN may consider allowing the GCF to take over REDD+, impose innovative taxes internationally and align it with the existing emissions trading schemes.

The merged fund can channel stable capitals sustainably through new financing streams: shipping levy and financial transaction tax (‘robin hood tax’).

·       The greenhouse gas emissions from international shipping are growing at rapid rate and account for 3% of global emissions (more than Germany’s total). Beyond the global emissions reduction regimes, the shipping sector, if charged US$25 per tonne of carbon emissions, will generate US$25 billion for the Fund annually. The revenue generated will be transferred to developing nations through effective regulatory framework in order to compensate the loss incurred to them as transport costs increase. The remaining amount of at least US$10 billion will aid developing nations adapt to climate change and reduce emissions. This proposal, according to a report by Oxfam and WWF for the UN in September 2011, is very realistic and has gained widespread support from the shipping sector (the International Chamber of Shipping), the World Bank, the IMF, trade organisations and even major international players including France, Germany and South Africa. While it was discussed in November’s G20 summit, no consensus was reached in the Durban conference.

·       The merged green fund can also benefit from the imposition of ‘robin hood tax’. It is small tax that could be imposed on financial transactions such as stocks, bonds, currencies and derivatives, etc. Assume each transaction be subject to a tax of 0.05%, new capitals amounting to US$400 billion can be raised for the green fund. France, Germany, Spain, South Africa, Argentina and Brazil have agreed to push forward the financial transaction tax plan and study the feasibility of using the money for climate change projects. But this tax to be included in the new EU treaty has been vetoed by the UK.

A carbon-trading system is a juggernaut which brings the economics of climate change into the boardrooms. If the green fund is aligned with existing emissions trading scheme it will nurture a mature green/forest investment market. Under the EU ETS, for instance, polluters are allowed to ‘offset’ their emissions through CDM (Clean Development Mechanism) projects in developing nations. CDM projects are currently limited to energy conservation and renewables only in emerging markets. Adding ‘forest carbon’ there will create sufficient incentives or demand for forest investment products. If a price is put on the CO₂ absorbed by forests and countries with ‘stored carbon’ in their uncut forests are allowed to sell those carbon ‘offsets’ to polluters in other countries, the standing forests will become more valuable than the logged ones, which yields money only when they are harvested.

Alternatively, the green fund may head towards a global green finance facility, as the Global Canopy Programme suggests. It could be a performance-oriented facility which has the authority to enter into long-term or advance market commitments to pay for verified reductions in deforestation. To unlock institutional investment in larger-scale projects, the facility may, for example, issue ‘forest bonds’ that guarantee to purchase forest carbon credits at an agreed floor price. Profits from credit sales in a future compliance market could be used to repay investors, to renew the fund or to reward forest communities. This arrangement would also revitalise the carbon market by providing incentive to purchase insurance against political or policy risks.

Development of the carbon market

When it comes to carbon market, it is another pillar underpinning the global transition to low-carbon economy. The Durban deal, which includes an agreement to work towards a new treaty, provides what the head of carbon markets at Bank of America Merrill Lynch described as a ‘Viagra shot’ for the floundering carbon markets. Right before the climate summit, carbon prices plunged to record lows (€6 per CER in six months) as EU ETS had been hard hit by Eurozone instabilities and qualm of an excess supply of carbon credits. But are the bankers too optimistic?

Going into doldrums the global carbon markets are likely to be. Pessimistic towards the Durban conference, big investment banks have laid off many brokers and analysts of their climate-related businesses since autumn. Some major players including Russia, Japan, Australia and New Zealand had expressed their reluctance to future negotiations on the second commitment period. Canada even withdrew from the protocol this month while the United States are being held back by their general elections 2012. True, delegates finally agreed to extend the Kyoto Protocol with the second commitment period running from 2013 to 2017 in the last-minute deal. However, will the extension period happen to be a ‘runaway’ period that ends up with less number of countries committed to emissions reduction?

Besides, the poor track record of climate negotiations should worry us about the possibility that a new binding climate treaty coming in late 2015 is not what the world expects. After all, a Kyoto II is supposed to have been done by the end of 2009. Not unreasonable that there will be a perverse incentive for low-carbon technology investors (carbon credit buyers). This is one of the ‘known unknowns’ for carbon markets after 2013 and 2017/2020. (No one knows if the five-year second commitment period of the Protocol will really end in 2017 and if there will be a three-year vacuum period between 2017 and 2020).

Another ‘known unknown’ is the performance of carbon markets in the shadow of global economic downturn. Carbon markets are no different from mainstream financial markets determined by demand and supply. The Eurozone crisis and financial turmoil are resulting in sluggish economies in Europe and America. It will be a long way to full economic recovery. Expectedly the carbon emissions will fall and so do the demand for and the price of carbon credits. Owing to the uncertainties in post-2013 market, a number of buyers are now catching the last train to get their projects registered by the end of 2012 for guaranteed profitability. 

Despite Kyoto II not yet born in Durban, as the last conference before 2012, this summit is anyway more prominent than the previous two. The Durban agreement extending the Kyoto Protocol allows CDM to continue. It is only that the uncertainties looming over the future’s climate treaty would bring concerns on it impacting the existing project models. For example, to limit supply of carbon credits and support carbon prices, perhaps the EU ETS will restrict transactions to internal market only or permit transactions with external markets with provisos. There would be scattered, internal carbon markets emerging in China and individual states in America after their legislation for carbon trading recently. Except these, what we can know at present is far too little for a mid-to long-term forecast of global carbon market development. 

Part 3 is coming soon!

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