Technology choice and CDM projects in China: case study of a small steel company in Shandong Province

Abstract

Corporate motives and strategies of both investing and hosting country affect the outcomes of a clean development mechanism (CDM) project—who introduces what technology to whom—and result in large differences in economic viability and the CO₂ emission reductions. This is particularly true for steel industry in which steel making consists of many detailed and complex processes, a given strategy could produce cumulative effects of the individual technologies used, leading to large energy savings overall. The objective of this study is to demonstrate some analytical methods that can be used to quantitatively evaluate the impacts of technology selection on the profit performance of CDM projects. Specifically, in this study we analyze a CDM project to introduce energy saving technology from Japan to a small steel manufacturer in China's Shandong Province, and conduct a simulation of the quantitative relationships between various technology options and profitability. Based on these results, we examine the environmental and economic significance of technology selection for CDM projects. To take this further, we then reconsider the profitability of a project as typical FDI activity (i.e., without the CDM), and by comparing this outcome with the CDM case, we clarify the significance and potential of the CDM.

Introduction

The use of flexibility mechanisms known as the so-called Kyoto Mechanisms, including the clean development mechanism (CDM), was approved internationally to help Annex I countries meet their greenhouse gas (GHG) emission reduction targets, at the third session of the Conference of the Parties (COP-3) to the UN framework convention on climate change (UNFCCC) in 1997. The CDM entered its implementation phase after 4 years of negotiations that culminated in comprehensive agreement in 2001 (the Marrakesh Accords) relating to its operational rules. At COP-8 in November 2002, the CDM executive board approved trial accreditation and verification of operational entities (OE) that are responsible for the administrative functions of registration and certification of CDM projects, moving the preparations for institutional arrangements into the final stage. Because many of the implementation rules had been undecided up to that point, much CDM-related research focused on discussions about the CDM system itself and methods to estimate baselines. But with implementation rules decided, the focus of research will now shift to issues such as estimating the CO₂ reduction potential of CDM projects, the selection of priority sectors, and building the implementation capacities. In the Asian region, developing countries are beginning such work, in cooperation with international organizations such as the World Bank (National Strategic Studies for Indonesia, Thailand, China, etc. at http://www.worldbank.org/nss), and the United Nations Environment Programme (UNEP, CDP Capacity Building Program for Vietnam, Cambodia, and Philippines at http://cd4cdm.org/).

Energy costs account for a large portion of production costs in energy intensive industries such as steel making, creating a strong incentive to save energy. Energy saving strategies for the steel industry can be broadly classified into simplification of processes and improvements in work operations, continuous casting, recovery and utilization of waste energy, and thermal recycle of sludge and wastes—and each of these involves a range of technologies. Generally speaking, because steel making consists of many detailed and complex processes, a given strategy could produce cumulative effects of the individual technologies used, leading to large energy savings overall. This phenomenon has been witnessed in Japan's steel industry, in which improvements in operational efficiency implemented carefully in all processes have helped to realize a large improvement in productivity (Japan Iron and Steel Federation, 1991; Kotani and Kondoh, 2002). Three major factors that affect the potential of CO₂ emission reductions in a CDM project are: (1) differences in the technology levels between the technology provider and technology recipient, (2) costs, and (3) incentives for the participating entities. Each of these is closely related to the technology selection, i.e., what kinds of technologies are introduced to which country. In other words, for the steel industry the selection of technology is one of very important factors for a CDM project.

A common method used to ascertain the CO₂ reduction potential of a CDM project is to calculate the relationship between the average unit emissions reduction (i.e., average cost per unit of CO₂ reduction) in a particular industry and the predicted price of certified emission reductions (CERs) (e.g., Kainuma et al., 1999, Kainuma et al., 2000; Jiang et al., 1998; Baron and Lanza, 2000; Woerdman and van der Gaast, 2001; Jotzo and Michaelowa, 2002; Chen, 2003). This is the mainstream approach because the focus is on considering differences between industries, from a macro perspective, by estimating the CO₂ emission reductions that could be achieved from CDM projects for industry overall, or for one particular industry. But the case of the steel industry makes it clear that estimates resulting from this approach can only have limited meaning, if one considers the importance of technology selection or differences in the significance of a given technology in a given industry. In addition, if one considers that CDM projects are ultimately conducted on a project-by-project basis, and that the investors are likely to be mainly from private sectors, the situations for specific projects can differ widely. Such individual project-specific variations including technology selection can largely affect average unit emissions reduction, and accordingly obscure the overall picture of sectoral CO₂ reduction of the steel industry.

Meanwhile, in the context of economic globalization, corporations from developed countries are constantly scouring the world for investment opportunities, and technology is transferred from developed to developing countries as a part of global strategies of corporations. This dynamic foreign direct investment (FDI) activity presents developing countries with many options for the introduction of energy saving technologies. It is important to understand whether or not the new mechanism offered by the CDM changes the business decisions of corporations. Such motives and strategies affect the outcomes of a CDM project—who introduces what technology to whom—and result in large differences in economic viability and the CO₂ emission reductions. This is why we are emphasizing the need to specify concretely who are the technology providers and recipients, when evaluating a CDM project, and to conduct analysis only after being as specific as possible about the technology. This is also why individual case studies are so important.

The objective of this study is to demonstrate some analytical methods that can be used to quantitatively evaluate the impacts of technology selection on the profit performance of CDM projects. Specifically, in this study we analyze a CDM project to introduce energy saving technology from Japan to a small steel manufacturer in China's Shandong Province, and conduct a simulation of the quantitative relationships between various technology options and profitability. Based on these results, we examine the environmental and economic significance of technology selection for CDM projects. To take this further, we then reconsider the profitability of a project as typical FDI activity (i.e., without the CDM), and by comparing this outcome with the CDM case, we clarify the significance and potential of the CDM.