An Open Letter to Fred Krupp

"The Clean Development Mechanism [the offset part of the Kyoto Protocol], which provides about 95% of the offsets used in the European market, is clearly broken and should be quickly phased out."

Fred Krupp, President EDF, Wall Street Journal Environmental Capital blog, 20 March, 2009

My first reaction to reading that parting statement in what was otherwise a very rational and cogent interview was unprintable in a family blog like this.

First of all, let’s get a few things straight. When it comes to protecting the environment and harnessing market forces to that end, Fred Krupp is a god. Maybe I should even capitalize that description. There is nobody who has done remotely as much for that particular cause—including our Nobel Prize winning inventor of the Internet—as Fred Krupp. I have been a regular and long-standing contributor to the Environmental Defense Fund (EDF), even during the unfortunate period when their abbreviated acronym likely confused a fair number of Viagra seekers on Google. The staff there is analytical, innovative and ferociously dedicated to their cause. They’ve gotten their viewpoint into the inner workings of many of the US’s mega corporations, generally at the CEO or Board level. They basically investment-banked the biggest private equity deal of all time—the KKR takeover of TXU - mainly to stop a massive planned expansion of coal-fired power. Calling EDF and Fred the father of environmental markets is not remotely an exaggeration.

While to my regret I don’t know Fred personally, we did actually once spend the better part of an afternoon together, though I doubt he would remember it. It was in the lovely city of Kyoto, Japan, on a Sunday in the middle of the 1997 namesake climate conference, and our Japanese hosts had arranged a series of different tours around that historic city. Coincidentally, I ended up on the same tour as Fred, and for at least one portion of the tour, we ended up chatting as we walked down a small winding street together with a multi-star admiral from the Defense Department who was part of the US delegation. At the time, EcoSecurities was less than a year old, still had a grand total of two employees and to say we (and therefore me) were nobodies would be a gross exaggeration; we had several steps to climb before we would even register at the "nobodies" level. Fred, on the other hand, was already a superstar.

At Kyoto, the CDM was hardly born of unanimous acclaim, and EDF had no small role in getting the negotiating buy-in on market based approaches that helped convince a number of skeptical countries. In 2001 when the US largely disappeared from the international climate world, it’s not an exaggeration to say that EDF also took a hiatus from the dialogue about the operational aspects of the CDM. Fair enough—EDF’s main constituency is the United States and US policy (though they also run an extensive China program). But to be frank, it was very unfortunate to lose their rationality and capability in the process, and I would argue that some of the maddening aspects of the current CDM—from a business perspective—are a direct consequence of losing the US (and by association, EDF) influence on its development in those crucial startup years.

So, when phrases like "should be quickly phased out" get bandied about, my first question (after my blood pressure settles) is: exactly how has the CDM has failed so much that the father of environmental markets believes it to be beyond saving? Let’s take a look at the results. The first CDM project was registered at the end of 2004, just a little more than 4 years ago. Today there are 1,500 projects registered (representing some 1.5 billion tons of emission reductions through 2012) and at least another 2,500 in the pipeline. Billions of dollars have been raised in the capital markets and there are methodologies covering at least 100 different project types. A sector dedicated to financing global environmental improvements has emerged. Projects are distributed across some 68 countries around the world. When you’ve tramped across a landfill in Brazil, a piggery in Mexico, a steelworks in China and a refinery in Ghana, all of which are linked by the single commonality that their management wants to become more climate friendly (and get paid for it), you know that a sea change in global business attitudes has occurred. Maybe Fred and the guys from EDF need to get a bit more mud on their boots and see what what’s actually happening out in the field at the micro-level.

There are many indisputable shortcomings of the CDM. First, far too many first-generation CERs came from HFC-23 reductions, rather than from changeovers to renewable energy and energy efficiency. Second, the process of assessing the "additionality" of certain clean energy assets that were at various stages of development has been deemed questionable by some outside observers. Third, an overwhelming preponderance of CDM capital flows have gone to China. And fourth, the regulatory process that oversees the CDM often seems to have been designed by Kafka, with a helping hand from Dante.

There are answers to all of these critiques, not the least of which is that we’ve barely passed the fourth year of what should be a many decade process of "learning by doing." The main issue is that you cannot set up a legitimate market system that only lasts a few short years, sunsetting almost as soon as it starts. Of course in these conditions projects that paid the highest immediate returns were identified and executed first. Of course in these conditions clean energy projects that were at some stage along the development pipeline were the most likely to try to engage the CDM financing instrument. And of course China grabbed the lion’s share of projects—half the developing world’s emissions are there, they can be found in large concentrations, and the Chinese government has made a regulatory system that was rational and workable through which to tackle them.

We Americans who basically went offshore about eight years ago to actually buikd the CDM "business" that was vaguely envisioned by the US and EDF are now coming home. We think our experience to date has some relevance and should be heard in the US policy debates. Though it’s been a never ending challenge, I can’t think we didn’t succeed at some important levels. Just for one, that two person company I was half of at Kyoto now has some 300 employees, offices throughout the world and has registered more than 150 projects within the CDM system representing 100 million odd tons of potential reductions by 2012. Anybody who thinks this is so easy is welcome to join our staff on one of several exciting field trips—climbing a 200 foot smokestack to check the calibration on flow meters, negotiating coalmine gas royalty agreements with provincial officials over endless baijiu, or trying to dry clean the stench of pig feces from biogas plants out of your clothes are all popular options. It’s not easy, it’s not always fun, but if you want a market instrument that’s going to work in the developing world, this is where you have to go. Blithe statements about failure are frankly a bit insulting to those of us who actually followed up on the promise and trajectory that was laid out a dozen years ago.

The latest concept that EDF is promoting around global carbon market solutions has been dubbed "ClearPath." Though sparse in detail, the basic idea involves developing countries taking on voluntary caps that are somewhat greater than their current emissions, so they can sell excess emission rights today and use the proceeds to finance transitional energy technologies to move their emissions downward. EDF estimates that this will raise some $250B to $1.5T over the first decade of operation—a fairly substantial range, to say the least. In principal, it’s an admirable concept, and it is undeniable that covering the broadest possible sweep of countries with hard caps is something to which we should aspire.

However, the idea that it’s going to be easy to come up with the "right" amount of extra emissions allocation for any sizable number of countries is ludicrous. A simple observation of developing country emissions profiles should immediately raise the question of how to construct something even remotely equitable. On a GHG per capita basis, South Africa is at 50% compared to the US, China is at 25%, Mexico is at 20% and India is at about 10%. It is already hard enough to get industrial countries to seriously talk about hard caps – now we need to layer this variable into the equation and create a reasonable supply and demand balance that will be both politically palatable and still incentivize serious reductions ? And this is assuming we can get the necessary monitoring, reporting and verification of GHG emissions data for developing countries in place to ensure that ClearPath could distribute credits accurately and appropriately.

I’m not against the ClearPath – far from it – and if EDF and its negotiator allies can convince a sweep of key developing countries to take this up (while not just flooding the market with a next generation of "Hot Air"), my hat is doffed with genuine admiration. But in my heart, I don’t think that’s realistic. And to be honest, I’d like to know what Plan B is, in case ClearPath is greeted with the skepticism I expect.

As far as I’m concerned, Plan B must involve fixing the CDM so that it can continue mobilizing capital, incentivize emissions entrepreneurs and technologies, and slowly push the global supertanker of emissions slightly away from its current trajectory. There are many ways to fix the CDM to keep it moving, and to make it more environmentally credible, transparent and predictable for capital allocation and project development. Perhaps we can indeed get a small handful of countries to experiment with ClearPath. But as a colleague is fond of saying, climate change will have no silver bullet; rather, will require multiple rounds of silver buckshot.

I guess my problem with a throwaway quote like Fred’s regarding the CDM is that it feeds a (very ironic) attitude encapsulated in the US policy debate about international offsets—the "not made in America" issue. Ironic, because the CDM, emissions trading—and the whole idea of environmental markets in general—sprouted from American soil. In coming back to the global negotiating table, the US can make a real difference by addressing the various shortcomings of the CDM, and by coming up with constructive solutions that actually learn from past experiences. The essentials would be to make the regulatory process simpler and more conservative (by endorsing real technology benchmarks across sectors, avoiding the project by project system of the CDM) and creating a longer time horizon for achieving emissions value, (so that the benefits of emissions savings can correlate with project finance timelines). To be frank, what we have accomplished—given those shortcomings of the Kyoto/Marrakech architecture—is to my mind remarkable.

In 2008, Fred wrote a book called "Earth: The Sequel." Disappointingly, it was not a sci-fi thriller about moving to another, hipper, planet, but rather about how we fix our relationship with this one through emerging markets for new energy technology. I’d like to think the CDM deserves the same kind of consideration for a sequel, and I don’t think it’s unfair to ask exactly which particular shortcomings of the CDM have convinced Fred that we exclusively need to tread a radically different path. CDM is far from perfect—few have ever claimed otherwise – but it has indeed lit a wildfire of enthusiasm for emissions reductions that we will not rekindle easily if it is summarily doused with a bucket of "been there, done that" cold water. ClearPath is an admirable idea, but fraught with complexities that make the CDM look like a crayon maze on a kid’s meal menu at Denny’s. If we can get five or ten countries with different profiles to sign up and work out the kinks for the next decade, that’s a triumph right there. In the meantime for the other 150+ countries in the world, let’s discuss the strengths and weakness of CDM and international credit systems rationally, with some nuance and with aims of improvement—and not just pander to popular misconceptions.

Marc Stuart is the Co-Founder and Director of New Business Development for EcoSecurities, a global carbon trading firm. The views expressed are his own and do not necessarily represent the view of EcoSecurities.