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Saturday, January 10, 2009

CDM Project Validation Issues

Carbon Credits, Like People, Can Have Validation Issues

Jon M Queen, Las Vegas NV (17 December, 2008)

As 2008 comes to a close, investors and project developers in the carbon market are asking a common question. How can the validation process for projects under the Kyoto Protocol’s Clean Development Mechanism (“CDM”) be improved?

That question, raised but left unanswered at December’s 14th Conference of the Parties to Climate Convention, is essential to address. Project developers now can wait six months or longer before receiving validation services. Extended project validation queues reduce a CDM project’s carbon credits for compliance purposes under Kyoto, because CDM projects first must be: (i) validated by a specially designated auditing company called a Designated Operational Entity (but commonly referred to either as a “DOE” or a “validator”); and (ii) registered at the CDM Executive Board under the United Nations Framework Convention on Climate Change.

Given that CDM is an important tool and catalyst for beneficial new technology transfers and energy improvements for less developed countries, the long (and often inconsistent) CDM project validation processes undercut and even obviate many of these positive externalities. CDM project validation wait times can range from several months to over a year! These delays create market uncertainty and inefficiency, reducing CDM’s effectiveness as a weapon against climate change and as a high profile vehicle for large countries, companies and financial institutions to become engaged in the clean and renewable energy space.

Despite the serious validation delays in today’s CDM market, one simply cannot speed things up and blindly accelerate the validation process. Doing so would erode the important environmental due diligence and auditing function that validation is designed to provide in the first place.

The last thing that anyone wants is a systemic carbon credit credibility dilemma. The environment does not benefit from emissions reductions achieved solely on paper. Likewise, interest in new green energy projects will drop if a glut of hastily (or sloppily) validated carbon projects drives down the value of carbon credits to zero.

The small group of environmental auditing companies approved to perform CDM validation services under the Kyoto Protocol say it is impossible for them to keep pace with the large number of new projects submitted to them for validation each month. There are simply too many projects and not enough trained personnel to provide validation services.

Looking at the large number of new carbon projects originating in countries like China, India and Russia each month, it is easy to see the truth in this statement. But by the same token, these companies are not small shops; many are the crème de la crème of the commercial environmental auditing industry. These companies are, by and large, highly experienced and reputable multi-national firms with long histories of auditing services for large deals all over the world.

So why are the same firms so short-staffed and unable to meet demand for their services, in what clearly is a boom market for them?

While it is true that CDM projects are cropping up at high rates, employee attrition is a key part of why validators cannot keep pace with the demand for their services. Carbon funds and financial institutions often pay premiums for experienced project validation professionals to defect from their companies and join new investment or risk management teams. By the time a validator trains someone to perform their job effectively and assume a degree of personal responsibility and self-management, the employee is most likely entertaining several job offers for higher salaries.

This is, I suspect, a new type of problem for validators. Before CDM and the Kyoto Protocol, top environmental auditing companies faced relatively low risk of their employees being poached by a major banks or similar clients. The specialized expertise held by these professional auditors generally had little direct relation to the qualifications needed to be a commercial success in a banking, trading or investment firm.

This traditional divergence ceases to exist with CDM, where nowadays a 25 year old person with decent people skills, a good work ethic and 3 years of strong project validation experience can compete against MBA candidates for spots working under an investment bank’s managing director.

The attrition challenges presently confronting CDM validators are not new or unique over time. They are the exact same challenges that large corporate law firms experience everyday due to interaction between their best young associates and the wealthy business clients and institutions they represent. If CDM validators start making the types of salary adjustment decisions that big corporate law firms make for their associates and partners, it would directly address their attrition problem.

Big law firms typically do not pay associates and partners at the same levels as investment banks, yet they are not understaffed and can grow to match client demand. They commonly experience widespread attrition among young to mid-level associates, but this attrition is manageable from a business point of view because more experienced senior associates and partners generally stick around. Law firms maintain and slowly grow out their partner and senior associate base, while calculating junior associate hiring numbers to reflect a degree of expected attrition.

Validators should simply admit that CDM is a multi-billion dollar industry heavily focused on the skills and expertise their employees possess. Their personnel are therefore highly valuable, and they should re-assess the financial packages presently being offered to mid-level and senior employees. Adjustments should be made that create more of a “brass ring” structure that incentivizes employees to have a long-term career with the company.

When this happens validators will see their attrition rates decrease to manageable levels, and the CDM market will witness a decline in the delays and lag times for project validation work. Salary adjustments for validators’ employees will result in higher prices for validation services, but what of it? What is wrong with a little price bump, given the present alternative? Most validation costs are directly paid today by off-take purchasers, not the original project owners or developers. Is it not better to deter projects with low projected emission reductions from seeking validation, via increased prices for validation services, than for thousands of projects to be brought to a worldwide standstill because too few qualified validation professionals exist to service the market?

Validators should transition into a more commercially oriented employee compensation mindset to set the CDM validation and registration process back on track. That is the best and most direct solution to the present bottleneck.

Until the day when validators’ technical experts can reasonably decline banking job offers with roughly similar skill requirements, there will always be frustrating delays and lost market value arising from the CDM “validation issue.”


  1. I am not sure what the answer is for the validation bottleneck now. Maybe money will help, maybe not. Perhaps there won't be enough time to find out until the next go round, if there is a big aau dump and things go into pseudo hibernation for a while. I hope not though.

  2. If only does were the problem now... davai davai oil, make a come back baby!

  3. i think carbon's got a lot of issues: oil and gas price issues, recession issues, CDM Executive Board issues, potential hot air aau oversupply issues, and so on. but validation too :-)

  4. Vaildation companies will soon have more time on their hands if the markets don't recover soon! People probably won't be doing as much CDM or JI until prices find their footing.