The CDM was a late addition to The Kyoto Protocol and is one of the market mechanisms within the system. The CDM is concerned with achieving “carbon reducing” trade between Annex 1 (Developed Countries) and Non Annex 1 (Developing Countries).
Effectively, the CDM allows the securitisation of carbon reductions relative to a hypothetical or actual base line of emissions that would occur in a business as usual scenario. Thus reducing CO2e in the atmosphere and stopping further increases in CO2e is rewarded through these incentives. (CO2e is carbon dioxide and equivalent harmful gases).
Hence, the decision to build a hydroelectric power station as opposed to a coal-fired power station allows the securitisation of the net reductions of CO2e’s experienced. These can then be sold on as carbon credits.
Thus previously, the coal-fired power station was more economically viable. Now with the inclusion of revenue generated from the sale of the credits, the hydroelectric power station becomes the economic choice and carbon has been reduced in the atmosphere*.
The CDM is designed for use in the developing world where currently there are no caps on emissions. However, it is not only popular with developing nations keen to accelerate their development and adopt clean technology used by the developed world, but also with businesses in the developed world keen to secure credits under the price of EUA’s (the central unit within the EU ETS (European Union Emissions Trading Scheme) and effectively a permit to pollute 1 ton of CO2e.
This was the objective of the CDM, whose dual mandate is to reduce emissions for industrialized countries and accelerate the sustainable development of developing nations.
(There are a number of caveats inherent in the continuation of this situation such as the future price of electricity, the price of coal, the efficiency of the power station, the efficiency of the hydroelectric power station, the assumption that water volumes will be maintained and of course the price that is achieved for the credits).
Emission Reduction Units (ERUs) are very similar to CERs. However, as opposed to being generated through the CDM in the case of CERs, ERUs are generated though the Joint Implementation (JI). While the CDM is concerned with achieving “carbon reducing” trade between Annex 1 (Developed Countries) and Non Annex 1 (Developing Countries), the Joint Implementation is concerned with achieving “carbon reducing” trade between Annex 1 countries. Similar principles to that of the CDM apply to Joint Implementation projects and again any JI project must reduce emissions against a “business as usual baseline”, i.e. the reductions must be additional.
As with the CDM, import of ERUs cross border is capped at between 10 and 20% of the importing countries gross allowances. However, a further benefit of JI projects is that they reduce emissions in the host country and as such free up EUAs that would normally have had to be utilized for compliance purposes. As such, JI projects not only produce ERUs for the sponsoring country, they also liberate EUAs from the host country, which can then be sold back to the market. Joint Implementation projects may start from 2000 onwards, however, ERUs can only be used for compliance purposes from 2008.