China’s CDM trade threatened by uncertain carbon legislation

Investment in CDM carbon credits in China may slow because of the prolonged uncertainty over global climate change legislation, analysts say

China's dominant position as the top supplier of carbon credits generated from Clean Development Mechanism (CDM) projects is threatened by the current uncertainty surrounding future carbon legislation, according to some analysts.

CDM is a carbon market mechanism devised under the Kyoto Protocol. It allows participants in developed countries to invest in carbon reduction projects in developing countries and earn carbon credits, known as Certified Emission Reductions (CERs), in return. The generated CERs can then be counted towards participants' compliance targets.

However, the future of the Kyoto Protocol is itself uncertain. Its first phase ends in 2012 and international negotiations on climate change failed to agree on any pratical plans for the future.

"China is being pushed to move away from being just a CDM host and towards shouldering a higher proportion of its own emission reduction budget," says Trevor Sikorski, carbon analyst at Barclays Capital.

China is still validating roughly 100 CDM projects per month, but investment in new projects is slowing, says Sikorski. "Big project developers are still managing existing portfolios, but the uncertainty surrounding the future of the CDM as a global carbon market mechanism is deterring investors from starting new projects. People are concerned about who would buy the credits once you have them," adds Sikorski.

Jørund Buen, carbon analyst at carbon consultancy firm Point Carbon, disputes that investment in carbon projects is slowing. "I have heard some of the large, established players saying CDM investment in China is drying up, but this is in reference to carbon credit purchases, rather than investments in the projects producing the credits. It is not clear that the inflow of CDM projects - neither in general nor from China - is slowing," he says.

Buen says that instead of a slow down in CDM activity, there has been more of a shift in the kind of participants that are originating new projects: "The more established players are licking their wounds over CDM delays, and are now concentrating on securing as high a yield as possible from their existing portfolio rather than originating new projects. The purchases and investments we do see are partly made by other players," he adds.

China is the largest supplier of CERs in the world, and has registered 925 projects, about 40% of all CERs since the scheme was born, according to the United Nations Framework Convention on Climate Change (UNFCCC). China is expected to produce more than 60% of the 4,200 projects in the pipeline worldwide that are expected to generate 2.9 billion CERs. China currently has a target to reduce its energy intensity by 20% between 2006 and 2010.

The Chinese media recently reported that plans for a pilot national carbon trading scheme were underway. Current proposals include a choice between setting an absolute cap on carbon dioxide emissions in a certain area or industry, or a second option of converting the country's carbon intensity target into carbon-related allowances for trading schemes.

China's potential domestic trading scheme could also be seen as a distraction from CDM for investors. "It's difficult to do CDM when other regulatory instruments apply," says Sikorski.

But Point Carbon's Buen says it's too early to say whether China's domestic scheme will have an impact on CDM investment. "I think it is much too early to say. China has so far signalled that it intends to initiate pilots in selected provinces and cities, which may or may not include carbon trading," he says.