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Contributions from
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Tribune
Congo’s overburdened peacekeepers
The Philippines: controversy over NGO meddling
Kyoto Protocol: new incentives for investors
03/2006
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[ Climate protection ]
New investment options
The Kyoto Protocol’s Clean Development Mechanism (CDM) enables investors to get credit for climate-protection measures they fund in developing countries. The example of Morocco shows that a small country can benefit from the new system. On the other hand, even emerging giants should carefully design their policies. China, for instance, may not yet be living up to its potential.
[ By Anne Arquit Niederberger ]
The Kyoto Protocol entered into force in February 2005. This agreement defines obligations for industrialised countries to limit greenhouse gas emissions. Although domestic reductions are required, the targets can be met, in part, by emission reductions achieved through climate protection projects implemented in developing countries. The resulting certified emission reductions (CERs) can be traded internationally. The size of the global carbon market has been estimated at € 5.5 billion in 2005 (Point Carbon, 2005) and tens of billions of Euros annually by 2010.
As countries adopt domestic legislation to fulfil their Kyoto commitments, private companies have an incentive to become involved in the CDM. Under the EU Emission Trading Scheme, for example, the greenhouse emissions of approximately 11,500 industrial installations in the 25 member countries have been capped. Companies can use CDM credits to comply, thus avoiding hefty penalties (currently €; 40 per excess ton of carbon dioxide emissions, increasing to €; 100/ton in 2008).
It has been suggested that the CDM may expand the traditional economic determinants of foreign direct investment flows (Arquit Niederberger & Saner, 2005). It provides multinationals with new opportunities to enhance competitiveness, expand markets and lower their cost of compliance with legislation in their home countries through carbon market transactions (Table p.121). Multinational companies might, for instance, invest in improving energy efficiency in their foreign affiliates, thereby gaining competitive advantages and generating tradable CERs.
The financial contribution of industrialised country entities (such as governments, private companies, market intermediaries) to CDM projects can take a number of forms. The basic CDM transaction models are (Arquit Niederberger & Saner, 2005: 5-6):
– equity investment in CDM projects,
– contracts to purchase CERs generated by CDM projects and
– CER trade on secondary markets.
At present, the most common form of transaction is contracts to purchase CERs, generally on delivery (Lecocq & Capoor, 2005: 25). This approach limits the risk to the buyer and can improve the profitability of a greenhouse gas reduction project. However, it cannot always mobilise the up-front financing that is needed for equipment purchases and construction. For some developing countries, the FDI model may have advantages, especially for capital-intensive projects.
Morocco’s strategy
Morocco is a country of 32.5 million people. It is not a major player in the world economy. Nonetheless, this country has proven successful in attracting CDM investors. Morocco ratified the Kyoto Protocol in 2002 and contributed to further developing CDM rules. It quickly adopted a strategy for the period 2003-2005 to promote CDM investment. The strategy included developing and implementing the institutional prerequisites and procedures for CDM. The capacity of economic actors to develop CDM projects was strengthened, for instance, through support for pilot projects. Government agencies and NGOs were briefed on their respective roles. The government also promoted the country’s CDM investment opportunities internationally.
By mid-January 2006, two Moroccan wind projects had been registered by the Kyoto Protocol’s CDM Executive Board. Four projects were under validation by a Designated Operational Entity, and another 15 projects had been approved by the Moroccan Designated National Authority. The pipeline is growing continuously.
The Moroccan government considers the CDM an important strategic tool to promote clean technology transfer and environmental protection. It has drafted a sustainable development strategy covering several areas, including the development of solar and wind energy resources, enhancement of energy efficiency, a comprehensive transport policy, waste managent as well as afforestation and reforestation programmes.
One result of this convincing strategy is Morocco’s ability to attract foreign investment into the development of its wind energy resource. The 10.2 MW Tétouan wind farm project is an example in case. It has been operational since 20 May 2005. It consists of 12 wind turbines and will generate around 50% of the electricity needed at a new cement plant of Lafarge, a French building materials company. Compared with fossil-fuel power generation, the wind farm will reduce green-house gas emissions by 30,000 tons annually. Lafarge will get the emission reduction credits. The company is estimated to have spent about €; 10 million on the facility. Obviously, the wind farm is contributing to the development of Morocco’s energy sector. It also helps to reduce the country’s dependence (as well as expenditure) on fuel imports.
The challenge for investment promotion agencies is to attract investors, based on new CDM-related determinants of FDI. These include the availability of low-cost emission reduction opportunities, efficient domestic institutions for CDM approval, market accesss for advanced climate protection technologies and access to complementary CDM assets possessed by domestic firms (knowledge of the local language and CDM opportunities, for instance). To do so will require sophisticated knowledge of emerging carbon markets and better integration of ministries of commerce or trade in CDM policymaking. In the case of Morocco, the Ministry of Industry, Commerce and Economic Promotion is a member of the National CDM Council.
China’s untapped potential
CDM financial flows do not necessarily correlate closely with FDI flows (Arquit Niederberger & Saner, 2005). That is evident in the case of China. This country is an FDI front-runner, currently garnering more inward FDI than any other developing country. Its potential to reduce emissions is immense, because its booming economy is one of the most energy- and emission-intensive on earth. Although the potential synergies are huge, a concerted effort will have to be made to enhance CDM investment to encourage the transfer of advanced technologies in support of sustainable development. The official goal of the 11th 5-Year Plan is to reduce the energy intensity of the Chinese economy by 20% between 2006 and 2010.
In 2004, the World Bank estimated the potential for carbon dioxide emission reductions in China at up to 117 million tons of carbon dioxide by 2008-12 (the end of the Kyoto Protocol’s first commitment period). This figure has been revised up to 200 million tons annually. Recent developments suggest that the potential will prove even more substantial.
Chinese officials anticipate that 200 to 300 CDM projects will be submitted for approval in 2006. As of 10 January 2006, the Chinese Designated National Authority had approved 18 projects, with an emphasis on renewable energy (mainly wind) and non-CO2 greenhouse gas reduction projects. In spite of these figures and in spite of the international business community’s enthusiasm for China, the interaction of foreign direct investment and the Clean Development Mechanism is not straightforward. There are a number of potential barriers that could prevent China from taking full advantage of CDM. Three will be discussed here.
First of all, some of the major greenhouse gas emitting enterprises in China are in the natural resource (oil, metals) and natural monopoly sectors (electricity) that only offer restricted access to foreign investors. These tend to be large, state-controlled enterprises that are often joint stock companies. Investment restrictions thus might limit CDM in the form of FDI, although state-controlled enterprises could still engage in CER sales to foreign buyers.
Second, majority foreign-owned joint ventures or wholly foreign-owned enterprises are ineligible for the CDM according to Chinese regulations. This rule is intended to ensure local development benefits. It is likely, however, to limit the extent to which state-of-the-art technology is transferred to China. Moreover, it penalises enterprises that significantly contribute to China’s economic development through a combination of industrial value added, tax payments, domestic supply and export activity.
Over half of export products are manufactured by foreign-invested enterprises, and export activity generates one-third of Chinese GDP. Over 70 percent of FDI in China goes to wholly foreign-owned enterprises. Rather than penalising such companies, China would be well advised to use the opportunities provided by carbon markets as perks for foreign investors to contribute to a sustainable development of the Chinese economy. This is all the more so as the government wants to continue attracting foreign investment, despite pressure to roll back preferential tax treatment and other incentives.
Although there is insufficient empirical evidence to draw any general conclusions about the overall impacts of FDI on China’s environment, the OECD (2001) and Chinese experts have indicated that:
– a substantial fraction of FDI flows to pollution-intensive industries;
– multinationals’ home-country standards affect the standards they employ in their affiliate’s operations in China, and there is a tendency for investors from Asian countries, who account for the majority of FDI to China, to have lower home-country standards than OECD investors;
– ambitious domestic environmental regulations and/or enforcement by Chinese authorities are lacking.
This paves the way for some negative environmental consequences from FDI. By opening CDM eligibility to majority foreign-owned enterprises, China would have an effective tool to ameliorate such unintended negative consequences, as the added value of CERs would offer a new economic incentive for foreign investors to voluntarily go “beyond compliance.” In this way, investment policy could be brought into better alignment with the emphasis of the 11th 5-Year Plan on a “scientific approach to development.”
Finally, with China’s substantial and growing market- and resource-seeking outward FDI, mainly driven by growing domestic competition and a need to access energy and metal resources, Chinese trans-national corporations could also profit from additional CER sales to industrialised country entities associated with its own outward FDI projects around the globe (Arquit Niederberger & Saner, 2005: 21). However, this emerging business opportunity appears to have been largely overlooked by Chinese enterprises thus far, and the Chinese government has yet to signal whether it would authorise its enterprises (whether domestic- or foreign-controlled) to engage on the invest/buy side of CDM transactions.
Actively promoting CDM markets, resources and strategic assets can improve a country’s overall FDI attractiveness, while encouraging foreign-invested companies to voluntarily go beyond compliance with domestic energy and environmental legislation, with the promise of advanced technology transfer and other sustainable development benefits.
Dr. Anne Arquit Niederberger
runs the consultancy Policy Solutions with offices in Switzerland and New Jersey. This essay draws on a publication she co-authored with Raymond Saner of the Centre for Socio-Eco-Nomic Development in Geneva.
saner@csend.org; policy@optonline.net
References:
Arquit Niederberger, A., and R. Saner, 2005:
Exploring the relationships between FDI flows and CDM potential, Transnational Corporations, 14(1), 1-40.
Lecocq, F., and K. Capoor, 2005:
State and Trends of the Carbon Market 2005 (Washington DC: IETA/The World Bank).
OECD, 2001:
Environmental Priorities for China’s Sustainable Development, OECD Document CCNM/CHINA(2001)25 (Paris: Organisation for Economic Cooperation and Development).
Point Carbon, 2005:
Global Market Outlook 2005, Carbon Market Analyst, 4 February.
World Bank, 2004:
Clean Development Mechanism in China: Taking a Proactive and Sustainable Approach, 2nd Edition (Washington DC: The World Bank).
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