Recently enacting post-2012 use restrictions on CERs from industrial gas projects and projects registered post-2012 from non-LDCs as well as legal possibility for enacting further similar measures influencing demand-side for CERs were among the most salient drivers that have given an effect of dropping CERs prices and significant uncertainty among investors and developers. As regards CDM carbon credit market many different signals appeared lately and interactions thereof are not easy to analyse. At the one end of the spectrum we have a Durban decision to extend the Kyoto Protocol for a second period, at the other end there appear new initiatives and designs as Sectoral Crediting Mechanism (SCM) features thereof have some advantages over CDM. CDM market as from 2013 will undoubtedly be at the crossroad and the current prices for CERs seem already reflect this setback.

Such effect could have been predicted earlier given among others the provision of the Article 11a(9) of the Directive 2003/87/EC (in the wording amended by the Directive 2009/29/EC) – see for instance article ‘EUA/CER spread tendency and legal framework for CER’s after 2012’ or ‘Article 11a(9) of the Directive 2003/87/EC – a headache for compliance buyers’.

The salient qualitative difference as regards CERs and ERUs use in the third trading period, as compared to the years 2008-2012, is that as from 2013 CERs and ERUs will not be compliance units within the EUETS but will be exchangeable with EUAs. The modalities for this exchangeability pursuant to the Article 11a of the EU ETS Directive are quite differentiated.

The first thing is that to swap CERs and ERUs with third phase EUAs the request from the operator will be necessary and the deadline March 31, 2015 will need to be observed. This exchange will generally concern CERs and ERUs issued in respect of emission reductions up until 2012 from project types which were eligible for use in the EU ETS during the period from 2008 to 2012 that have not been already used up (the Commission made clear that given the exchange route is only for operators, an exchange will be declined if an operator has exhausted the limit of its entitlements for exchanging credits, as reflected in Articles 11a(2-4) and (8) of the ETS Directive).

In this point ends the understandable portion of EU ETS Directive in its part relating to the CERs and ERUs market as from 2013.

Why there is danger that anyone will not be much more willing to buy CERs

The IETA organisation in its paper ‘The Consequences of the Durban COP for the Carbon Market and Climate Finance’ (released in December 2011 at www.ieta.org) highlighted the hypothesis that it does not seem likely that anyone will be much more willing to buy CERs. As it further elaborates, at first sight it might appear, with larger developing countries in effect signing up to an international agreement, that their post-2013 CERs might again be eligible in the EUETS. But the formidably complex provisions in the EUETS Revised Directive do appear to rule that out.

The said stance of IETA is reasoned in the following way:

Firstly - CERs would have to fit within the existing quantitative limits, which are quite tight;

Secondly - the law specifies only Least Developed Countries (LDCs) as sources of post-2012 new project credits – this is not dependent on any international agreement, though it seems they would have to ratify one if it existed;

Thirdly - agreements between the EU and third countries allowing new CERs to be accepted were only to be triggered in the absence of an international agreement, and Commission officials had recently been making clear that negotiations would not start until failure at an international level was clear. Any ratification condition, of course, could put off the golive date of such an agreement until the eve of 2020.

IETA concluded that ‘The market will eagerly await clarification from the Commission of how, if at all, Durban has changed anything here. Pending that, it would seem unwise for developers to assume the EU is back in the demand game, outside LDCs’.

Current regulatory position

The recent document of the European Commission, although made some important  clarifications with respect to CERs and ERUs use as from 2013 (see: ‘Questions and answers on use of international credits in the hird trading phase of the EU ETS’ source: http://ec.europa.eu/clima/news/news_archives_en.htm#REGULATORY), was not able to ease the uncertainty.

In additional portion of Q&A the Commission appears to literally refer to ambiguities raised by IETA by reasoning:

‘The adoption of a second commitment period of the Kyoto Protocol without a legally binding agreement for the period beyond 2012 under which other developed countries commit themselves to comparable emission reductions and economically more advanced developing countries commit themselves to contributing adequately according to their responsibilities and capabilities is therefore not an international agreement as referred to in Article 11a(7) of the EU ETS Directive and Article 5(3)of the Effort Sharing Decision.’

The Commission also expressly underlined that articles 11a(7) of the EU ETS Directive and Article 5(3) of the Effort Sharing Decision (ESD) limit the acceptance of CDM credits to those from countries that have ratified the new "international agreement on climate change". They do not "broaden" access in any way.

Particularly important is the following Commission’s interpretation:

‘Thus, once an international agreement pursuant to Article 11a(7) of the EU ETS Directive and Article 5(3) of the ESD is reached, the limitation to CDM credits from new projects from the LDCs for the period starting in 2013 continues to apply. Any broadening of the eligibility criteria to allow new credits from other countries, with the exception of credits used under Article 11a(5), would require an amendment of the ETS Directive. Credits from projects in LDCs and other countries started before 2013 will only be accepted if they originate from countries that have ratified the agreement.’

So, the effect appears to be that the IETA suppositions cited at the beginning gained regulatory confirmation to the full extent.

Qualitative restrictions

I signalled the problem with the provision of Article 11a(9) of the Directive 2003/87/EC in the post ‘Article 11a(9) of the Directive 2003/87/EC – a headache for compliance buyers’ a long time ago. After the recent communication from the Commission the uncertainty with eligibility of the said Kyoto units due to potential qualitative restrictions unfortunately persists.

The European Commission reminded in the communication concerned that qualitative restrictions adopted so far to CERs from the start of the EU ETS in 2005 are full use restrictions:
a) from projects at nuclear facilities,
b) projects in agriculture and forestry (so-called LULUCF).

Furthermore, as of 1 January 2013 CERs and ERUs from projects involving the destruction of trifluoromethane (HFC-23) and nitrous oxide (N2O) emissions from adipic acid production will be prohibited in the EU ETS (an exception is made until 30 April 2013 for destruction from existing projects that is credited before 1 January 2013, for compliance with 2012 commitments).

As regards any other potential moves in that area the Commission declared that while the legislation allows putting in place further use restrictions adding to those already adopted, the European Commission is currently not considering any additional ones.

The word that should be stressed in the previous phrase is: ‘currently’. The investors should be mindful of the fact the Directive does not limit the types of restrictions that can be introduced. These will depend on project-type, economic, environmental, strategic and administrative circumstances.

Given the exact wording of the controversial Article 11a(9) of the Directive (from 1 January 2013, measures may be applied to restrict ‘the use of specific credits from project types’) the  Commission failed to precisely specify the legal definition of ‘specific credits’.

Under 'type' the Commission understands credits that were generated using one or several methodologies approved by the UNFCCC CDM Executive Board and JI Supervisory Committee. 'Specific credits' could refer to all credits under a project type or credits from a project type generated in a set of countries.

The creation of a positive list of unrestricted credits isn’t, however, possible because EU legislation does not foresee such a list.

CERs/ERUs banking

The modalities for banking CERs or ERUs from the second into the third trading period are quite complicated matter.

The first fundamental issue is that for phase 3, credits can only be used for compliance in the EU ETS if exchanged for phase 3 allowances. This exchange of international credits with a first commitment period identifier into allowances will only be allowed until March 2015.

The very subtle distinction is, however, not all EU ETS account holders being able to carry over credits within limits. Under the EU ETS, only compliance buyers (i.e. not all account holders) can exchange unused credits within the limits provided in Article 11a of the Directive. So, only “operators” as defined in the ETS Directive can exchange CERs/ERUs for allowances.

Perpetual status of the project as regards the LDCs list

The said Communication provides a substantial note on Least Developed Countries (LDCs) list. As there had been no international agreement at the end of 2010, nor had there been any EU agreements with third countries, Article 11a(4-5) provides a default situation of prohibition on using new-project CERs beyond 2013, unless they are from LDCs or can be swapped for CERs from LDCs.
According to the Commission "A project in an LDC that is included in the UN list when the project is registered by the CDM Executive Board may continue to generate credits up to 2020, whatever happens to the list” (the issue relates to the situation where a country loses its LDC status: when the project is at validation stage, when the project is registered or when  CERs have already been issued).

Crediting period renewal

Another important clarification relates to the crediting period renewal. The Commission’s answer to the question ‘Does the registration date pertaining to ‘projects that were registered before 2013’ referred to in Article 11a(2-4) correspond to the start date of the first crediting period of the project, or to the start date of any subsequent crediting period?’ is ‘The start date refers to the start date of the first crediting period. Hence credits from projects that were registered prior to 2013 and that have their crediting period renewed after 2012 will continue to be usable (in the absence of use restrictions)’. Such broad interpretation is, undoubtedly, particularly advantageous for developers of the said projects.

PoAs

The potential significance of the clarification on Programme of Activities (PoAs) is so far-reaching that it seems that it would be most appropriate to quote literally the whole passage.

According to Article 11a(2) credits from projects registered pre-2013 are eligible for compliance in the EU ETS .

Question: ‘Does this imply that CDM Project Activities (CPAs) included after 2012 to PoAs registered pre-2013 are also eligible?’

Answer: ‘Article 11a(3) of the EU ETS Directive states that "…competent authorities shall allow operators to exchange CERs and ERUs from projects that were registered before 2013 issued in respect of emission reductions from 2013 onwards for allowances valid from 2013 onwards". This wording would indicate that the moment of registration of a project is to be taken as a cut-off date for determining whether future CERs would be eligible for use in the EU ETS. A PoA is only registered once and CPAs are added to a PoA without a separate registration. It is therefore the Commission's interpretation that CERs from CPAs added after 2012 to a PoA registered prior to 2013 can be used for compliance in the EU ETS.

The Commission is, however, also aware that this interpretation of Article 11a(3) may increase the supply of CERs from non-LDCs. This contradicts the spirit of the Directive to allow only CERs from projects registered after 2012, if they come from LDCs. The Commission will therefore continue to monitor the evolution of PoAs, including their impact on the development of new sectoral mechanisms. The Commission notes that the Directive allows the Commission to propose appropriate regulatory measures under article 11.a(9) of the EU ETS, if the situation would require this.’

It was impossible to refer to all of these matters in this short post. It is, therefore, highly advisable that the readers make use of the above-quoted link to the original release from the Commission.