Transaction costs and the clean development mechanism

The emissions trading provisions of the Kyoto Protocol and its clean development mechanism (CDM) are designed to permit greenhouse gas (GHG) emission reductions at the lowest cost globally. However, to ensure climate integrity, these reductions must pass through vigilant approval, monitoring and evaluation procedures that create additional transaction costs unrelated to the physical process of eliminating GHGs. Moreover, the CDM's additionality criterion creates constraints that magnify the influence of these transaction costs on project viability. If these costs are extreme, they could undermine the success of the CDM, and possibly of the Kyoto Protocol itself. This article describes the trading provisions of the treaty, creates a working definition of transaction costs, and discusses their effects. It then analyzes the process of creating a CDM project to identify the sources of transaction costs, illustrated by an example of a fuel substitution project in Ghana. The conditions for project profitability are analyzed and compared with recent GHG emission credit prices in Europe. The specific Ghanaian results are not generalizable to all CDM projects, but the model does suggest a template that can be used to analyze the effects of project and transaction costs in other contexts.