By Jeff Coelho
LONDON (Reuters) - The U.N.'s carbon offset scheme will play only a small role in the developed world's pledge to raise $100 billion in annual climate aid for developing nations by 2020, and analysts say that is driving the need for new sources of funding.
The Clean Development Mechanism (CDM), created as part of the 1997 Kyoto Protocol, allows rich nations to invest in emissions-cutting projects in the developing world in return for carbon credits.
Yet new investment in it has fallen by 80 percent since 2008 to $1.5 billion in 2010, with even less expected this year.
"I fear that will be smaller again (in 2011)," said Ben Caldecott, head of European policy at Climate Change Capital, a London-based investment management and advisory group.
That is less than 1 percent of a funding target announced at global climate talks in Mexico in 2010, prompting calls for new schemes to raise cash and help limit the planet's warming.
Investment has plunged because of the CDM's uncertain future and waning demand for carbon credits. CDM prices hit record lows last week.
"The one success it (Kyoto) had, CDM, is now dying because of policy uncertainty," Caldecott said. "Clearly other mechanisms are required to deliver that financial flow."
"If carbon markets are to play a significant role in curbing global warming, carbon prices will need to be much higher ... and backed by regulation to ensure a steady flow of private and public funding in low-carbon technologies."
The CDM has managed to raise more than $160 million for an international fund to help poor nations adapt to climate change through a 2 percent levy on all issued CDM credits, called certified emission reductions (CERs).
But there will be less money going into the pot if carbon prices stay near record lows.
NEW FINANCING SCHEMES
Analysts say alternative ways to help achieve the financing goal include carbon taxes, subsidies for renewable energy, guaranteed grants and climate bonds.
Companies that are heavily invested in the CDM market, such as Climate Change Capital, Camco International and others have been diversifying away from the offset market.
"Most people aren't going to make a multi-hundred million dollar investment decision on the back of a few CERs where the mechanisms are uncertain," Geoff Sinclair, head of carbon finance and trading at Standard Bank, told Reuters.
Government officials currently meeting in Durban, South Africa, to address the future of the Kyoto Protocol are likely to weigh other possible financing schemes, as well.
These include performance-based mechanisms to avoid deforestation and awarding developing nations for cutting emissions across sectors such as energy or transport.
With developing nations now emitting more than 50 percent of man-made emissions, there is also growing pressure on China, Brazil and others to curb their carbon footprints under a new pact.
Analysts say the absence of a new binding global deal puts the focus on bilateral agreements.
"One should expect that other forms of low-carbon finance will continue to grow relative to CDM as governments act bilaterally through innovative mechanisms," said Abyd Karmali, global head of carbon markets at Bank of America Merrill Lynch.
"The larger emerging markets will also begin to put in place their own mix of policies and measures to help bend the trajectory of emissions downwards," he said.
Karmali cited as examples India's energy efficiency trading system, South Africa's subsidy scheme for renewable energy and China's seven pilot emissions trading programmes.
China and India account for nearly 70 percent of the more than 3,600 registered CDM projects to date. By 2020, however, the CDM will likely be limited only to emission-reduction projects in the least developed countries, Karmali said.
Under the Kyoto pact, targets were set for nearly 40 industrialized nations and the European community to lower greenhouse gas emissions by an average of around five percent against 1990 levels over the period 2008-2012.
Scientists say global emissions will need to be cut by 25 to 40 percent from 1990 levels by 2020 in order to avoid runaway climate change.
(Reporting by Jeff Coelho; editing by Jason Neely)