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Lifting AAU restrictions would hurt ERU credits - NGO

04 Mar 2013 20:16:00 | edcm

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Possible changes to emission reduction unit (ERU) rules may hurt demand for and exacerbate an oversupply of offset credits by 2015, Brussels-based non-governmental organisation (NGO) Carbon Market Watch warned in a report published Monday. The NGO monitors the environmental credentials and efficiency of offsets and lamented that such changes would reverse recent gains made at international climate negotiations to improve the integrity of Kyoto credits.

ERUs are offset credits that can be used to comply with the EU Emissions Trading System (ETS). They are issued either for project-based emission reductions or by converting an equivalent number of tradeable Kyoto credits, so-called assigned amount units (AAUs). Under the rules, ERUs could only be issued in countries deemed to have economies in transition by the Protocol, many of which are in eastern Europe - most notably Russia and Ukraine.

AAUs were issued to signatory countries of the Kyoto Protocol in line with the emission levels signed up for under the first (2008-2012) commitment period. Because industrial output has fallen since the start of the global recession in 2008, countries have accumulated an oversupply of AAUs. However, the report also highlighted an initial over-allocation as contributing to the AAU glut.

"Many of the former economies in transition had weak reduction targets under [the first Kyoto commitment period] CP1. At the time, when their targets were defined, their emissions were already well below the level that they committed to CP1. That meant that they received millions of excess AAUs," policy brief "Doha Decision on the Kyoto surplus explained" by Carbon Market Watch said.

The AAU surplus has prompted many signatories to convert these credits into ERUs that can then be sold on the secondary ETS market. "A country with a weak reduction target and therefore a significant AAU surplus has an incentive to maximise the issuance of JI credits," the report said. High ERU issuance has depressed these offset credits' prices in the ETS. The benchmark contract lost 92% of its value over the course of 2012 (see EDCM 28 December 2012). This means financial incentives for carbon reduction projects in transitional countries have dwindled.

AAU cuts

As a result, environmental groups have warned that the size of the AAU surplus threatened progress pledged under the Protocol. But an amendment agreed at the most recent climate negotiations round in Doha in November 2012 may have had a positive impact on the role that ERUs can play in delivering emission reductions, Carbon Watch said in its report.

Amendment "3.7ter" applies a formula to countries' actual average annual emissions for 2008-2010 to calculate how many AAUs need to be cancelled by 2015 to limit the oversupply in future. "Since all [second commitment period] countries have to have a somewhat stringent target under 3.7ter, this may lead to an improved environmental quality of JI," according to Carbon Market Watch.

Under the amendment, 3.6bn AAUs will be cancelled by 2015. This could transform the current oversupply into a shortage of 2.2bn AAUs over the period and help raise demand, and thus prices, for ERUs.

Effect in doubt

Possible changes to the rules governing ERUs could erase the additional demand for JI credits that the amendment creates in coming years. Under the current system, AAUs from the first commitment period cannot be exchanged for ERUs generated by projects after 2013. Only AAUs handed out to countries that have signed up to a second commitment period are eligible for such an exchange. The second commitment period's AAU allocation is only expected to happen in 2015, meaning that demand for projects cutting emissions is expected to pick up in the interim. But the Subsidiary Body for Implementation (SBI) will reconsider this rule in Bonn in 2013, probably in May or June, the NGO has warned. The SBI may decide to allow the use of AAUs issued during the first commitment period to generate ERUs after 2013, it said. "If the rules are changed and host countries are allowed to use their CP1 surplus AAUs to convert into ERUs, they will have no incentive to limit issuance of ERUs to only those projects that are truly additional." Additionality refers to the number of emissions cut against business-as-usual because of a project.

The SBI is one of two permanent subsidiary bodies established by the Conference of Parties/Meeting of the Parties (COP/CMP). The COP/CMP is the governing body of the UN Framework Convention on Climate Change (UNFCCC), which oversees the Kyoto Protocol and its mechanisms, such as the JI. ERUs are issued under the auspices of the UNFCCC.

Global carbon market

Offsets are used in budding carbon markets across the world, which could help provide non-EU demand for ERUs.

New Zealand has launched a consultation for its domestic carbon market on the carrying over of offsets and AAUs from the first to the second commitment period. The government favours barring individual account holders from carrying over offsets, the consultation noted. In contrast, the country favours to carry over AAUs automatically and without quantity restrictions. The consultation also lists the need to specifically apply to carry over AAUs as another option. Silvia Molteni

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