In the recent ‘Study on the Integrity of the Clean Development Mechanism (CDM) Final report’ (December 2011, Ref: CLIMA.B.3/ETU/2010/0020r, referred to as ‘Study’) a sectoral crediting mechanism (SCM) has been described as a baseline-and-credit scheme rewarding GHG emission reductions from a covered sector against a pre-determined threshold possibly below business as usual (BAU) levels. Under a SCM a crediting baseline (also called a crediting threshold), is set well below BAU emissions. This guarantees that credits are only granted if a covered sector has undertaken mitigation below business-as-usual.
Under the SCM credits are only awarded if emissions are equal or less than the crediting ‘baseline’ or ‘threshold’.
The important feature of the SCM is that the nature of the baseline or threshold can vary; it can be expressed as an absolute emissions limit, as an emissions or energy efficiency intensity target, or by non-GHG parameters such as a (clean) technology penetration rate.
This threshold in most instances would be a so-called “no-lose” target. Overachievement would be credited while non-achievement would not be penalized. For example, emission reductions achieved beyond the baseline are credited but failure to meet it would not lead to a penalty.
Credits emanating from a SCM could be issued either to the government hosting a SCM or to companies that participate in a SCM programme. If the government is credited, it might ‘redistribute’ credits to companies, raising all kind of technical, equity or subsidy issues. A SCM programme will also need to find answer to the question on whether only the host government can sell credits into other carbon markets or the private sector can do so as well.
As the Study estimates, the possibly biggest merit of the SCM is the greater scope for scaling up emission reductions.
Furthermore, by expanding the scope of emission reductions beyond the project level, the SCM circumvents the additionality testing inherent to the current CDM and affects the generation of carbon finance and the transfer of mitigation technologies.
A key question regarding SCM may be whether the sectoral mechanism should be subject to verification by auditors accredited internationally, nationally, or locally. A related question would be whether such requirement should be set by UN decisions or national legislations. There may also be a case where domestic project-based or other types of crediting mechanisms are set up in addition.
On the one hand, the SCM reduces red tape compared to the CDM through the non-requirement of additionality tests and thus provides for greater simplicity in design. Another advantage of SCM is its flexibility in setting baselines. As was set above these can be set in terms of absolute emission levels, such as sectoral caps, in terms of indexed (relative) baselines, such as performance standards and benchmarks, or in terms of technology penetration rates.
Relative, i.e. intensity-based crediting baselines tend to be more acceptable to industry as well as fast growing (emerging) economies as they are seen less as a constraint to capacity growth as absolute targets. Intensity-based targets are considered to suit developing economies particularly well, where economic growth projections are particularly difficult. The downside is the uncertainty in the environmental outcome.
As an example of a relative target consider a sector crediting mechanism based on a power plant emission intensity standard (gCO2/kWh), which can result in significant emission reductions and ensures environmental integrity as long as it is set below the BAU.
Alternatively, a baseline can be defined as a level or rate of technology penetration. For example, a technology penetration baseline for wind power generation can be defined as the actual power generation from wind power plants (i.e. GWh), the installed wind power capacity (GWe) or the share of wind power in total power generation (as percentage). Credits can be generated from the difference between the ex-ante established penetration level (e.g. targeted MWh of wind power generation) and the monitored technology penetration (e.g. actual MWh of wind power generation) multiplied by a GHG emission factor (EF).
Technology penetration baselines in particular could be used in a sub-sector where the host developing country envisages measures to promote specific technologies. The strong link between technology penetration baselines and domestic policies and measures to promote a particular technology in the SCM could be a potential answer to the hydro and wind additionality controversy under the CDM.
However, there have also been noted two disadvantages of technology penetration baselines: the difficulty to assess the BAU rate of technology penetration and the emission factor in sectors where several technologies are applied.
Under the SCM the entire sector’s performance can be credited but individual performance of a participating company cannot. The Study underlines that from an investor perspective there is need for incentives and rewards for proactive entities that are delivering beyond the baseline and equally for assistance to entities that are not meeting the baseline and failing to deliver. Consequently it is important to set in place the right mix of policies that incentivise entities for mitigation actions and address the lack of other entities’ actions.
Sectoral crediting mechanism found recently the legislative reflection in the California climate regulations. Under the California cap-and-trade, subject to other regulatory requirements, sector-based offsets, in addition to counting towards the usage limit for total offsets, are limited to 2% of a firm’s total compliance obligation in the first compliance period and 4% of a firm’s total compliance obligation in the second and third compliance periods.
An important analysis regarding so-called ‘New Market Mechanism’ (NMM) - ‘Design options for sectoral carbon market mechanisms’ Final Report of 31 August 2012 (CLIMA.B.3/SER/2011/0029 - http://ec.europa.eu/clima/news/articles/news_2012111402_en.htm) can be found below.