Global emissions effects of CDM projects with relative baselines

CDM is an offset mechanism designed to reduce the overall cost of implementing a given global target for greenhouse gas (GHG) emissions in Annex B countries of the Kyoto Protocol. A problem with CDM is that it provides incentives to increase, if possible, the baseline emissions for CDM projects, to optimize the value of CDM credits. Under a “relative baselines” crediting rule, the CDM may also unduly increase energy consumption even during the CDM implementation phase. Less than full offset of emissions is then likely, and the CDM will lead to increased global GHG emissions. We show that this is a potentially serious problem, due to asymmetric information between project hosts and the regulator, the CDM Executive Board, and to the basic rules for crediting CDM quotas. In certain cases, the use of “relative baselines” to credit CDM quotas could fully eliminate any emissions reductions achieved by CDM projects. Remedies to overcome the problems are discussed. They may involve setting the baseline independently of initial energy intensity and final output for the project; or involve information revelation mechanisms that minimize policy losses and net rent capture by project sponsors.

► The baseline for CDM projects, against which emissions offsets are computed, can be manipulated by project hosts. ► Moreover, under “relative baselines”, CDM credits are given in proportion to output, thus serving as an output subsidy. ► In consequence, the CDM will often leads to global increases in GHG emissions, and this is more likely when baselines can be manipulated. ► Remedies exist, among them to set baselines independently of CDM projects, or to design optimal regulation mechanisms taking asymmetric information directly into consideration.