The Clean Development Mechanism (CDM), established under the Kyoto Protocol, is the primary international offset program in existence today, and while not perfect, it has helped to establish a global market for greenhouse gas (GHG) emission reductions. It generates offsets through investments in GHG reduction, avoidance, and sequestration projects in developing countries. The United States is not party to the Kyoto Protocol, but was instrumental in negotiating the treaty and championing market mechanisms as a way to achieve the targeted reductions at lower cost. The CDM has managed to establish—in its relatively short eight years of existence—a credible, internationally-recognized, $2.7 billion carbon offset market with participation from a large number of developing countries and private investors. It has also created processes and methodologies that other programs are already emulating.

A vast amount of work and investment—by participating countries, the private sector, and the United Nations Framework Convention on Climate Change (UNFCCC) secretariat—have gone into developing the CDM’s rules, procedures, and institutional structures. The creation and rapid growth of a large and unprecedented international program, however, has not been without its challenges or controversies. Issues have been raised regarding the governance of CDM, the quality of approved projects, and the contribution of CDM to sustainable development. Concerns about these issues have fueled a strong debate among U.S. policy analysts about the ability of the CDM to deliver emission reductions of sufficient quality and quantity, and the role for international offsets in any future U.S. policy framework.

Economic modeling by the U.S. Environmental Protection Agency (EPA) and the U.S. Energy Information Administration (EIA) demonstrates the importance of international offsets in lowering the cost of U.S. emission reductions. Emission reduction projects in the developing world, such as those undertaken through the CDM, have the potential to be some of the lowest cost reduction options globally. Yet, these lower costs can only be realized if the transaction costs associated with administering an international offset program like the CDM are kept to a minimum while simultaneously ensuring high quality emission reductions.

This paper outlines a set of principles for ensuring high-quality offsets, examines the CDM against these criteria, and reviews lessons learned, institutional changes that have been made, and the ongoing challenges.