PESD senior fellow and Nobel laureate in Physics, Burton Richter, explains why an inclusive internationalization policy of both ends of the nuclear fuel-cycle can provide much needed carbon-free energy while limiting the potential for the proliferation of nuclear weapons. He insists that the nuclear proliferation problem can be remedied by a tightly monitored program through international policy and diplomacy where incentives to tame proliferation are increased, inspections are more rigorous, and a sanctions program is agreed upon and adhered to.

The Clean Development Mechanism (CDM) of the Kyoto Protocol is the first global attempt to address a global environmental public goods problem with a market-based mechanism. The CDM is a carbon credit market where sellers, located exclusively in developing countries, can generate and certify emissions reductions that can be sold to buyers located in developed countries. Since 2004 it has grown rapidly and is now a critical component of developed-country government and private-firm compliance strategies for the Kyoto Protocol. This Article presents an overview of the development and current shape of the market, then examines two important classes of emission reduction projects within the CDM and argues that they both point to the need for reform of the international climate regime in the post-Kyoto era, albeit in different ways. Potential options for reforming the CDM and an alternative mechanism for financing emissions reductions in developing countries are then presented and discussed.

As the United States designs its strategy for regulating emissions of greenhouse gases, two central issues have emerged. One is how to limit the cost of compliance while still maintaining environmental integrity. The other is how to "engage" developing countries in serious efforts to limit emissions. Industry and economists are rightly concerned about cost control yet have found it difficult to mobilize adequate political support for control mechanisms such as a "safety valve;" they also rightly caution that currently popular ideas such as a Fed-like Carbon Board are not sufficiently fleshed out to reliably play a role akin to a safety valve. Many environmental groups have understandably feared that a safety valve would undercut the environmental effectiveness of any program to limit emissions of greenhouse gases. These politics are, logically, drawing attention to the possibility of international offsets as a possible cost control mechanism. Indeed, the design of the emission trading system in the northeastern U.S. states (RGGI) and in California (the recommendations of California's AB32 Market Advisory Committee) point in this direction, and the debate in Congress is exploring designs for a cap and trade system that would allow a prominent role for international offsets.

This article reviews the actual experience in the world's largest offset market-the Kyoto Protocol Clean Development Mechanism (CDM)-and finds an urgent need for reform. Well-designed offsets markets can play a role in engaging developing countries and encouraging sound investment in low-cost strategies for controlling emissions. However, in practice, much of the current CDM market does not reflect actual reductions in emissions, and that trend is poised to get worse. Nor are CDM-like offsets likely to be effective cost control mechanisms. The demand for these credits in emission trading systems is likely to be out of phase with the CDM supply. Also, the rate at which CDM credits are being issued today-at a time when demand for such offsets from the European ETS is extremely high-is only one-twentieth to one-fortieth the rate needed just for the current CDM system to keep pace with the projects it has already registered. If the CDM system is reformed so that it does a much better job of ensuring that emission credits represent genuine reductions then its ability to dampen reliably the price of emission permits will be even further diminished.

We argue that the U.S., which is in the midst of designing a national regulatory system, should not to rely on offsets to provide a reliable ceiling on compliance costs. More explicit cost control mechanisms, such as "safety valves," would be much more effective. We also counsel against many of the popular "solutions" to problems with offsets such as imposing caps on their use. Offset caps as envisioned in the Lieberman-Warner draft legislation, for example, do little to fix the underlying problem of poor quality emission offsets because the cap will simply fill first with the lowest quality offsets and with offsets laundered through other trading systems such as the European scheme. Finally, we suggest that the actual experience under the CDM has had perverse effects in developing countries-rather than draw them into substantial limits on emissions it has, by contrast, rewarded them for avoiding exactly those commitments.

Offsets can play a role in engaging developing countries, but only as one small element in a portfolio of strategies. We lay out two additional elements that should be included in an overall strategy for engaging developing countries on the problem of climate change. First, the U.S., in collaboration with other developed countries, should invest in a Climate Fund intended to finance critical changes in developing country policies that will lead to near-term reductions. Second, the U.S. should actively pursue a series of infrastructure deals with key developing countries with the aim of shifting their longer-term development trajectories in directions that are both consistent with their own interests but also produce large greenhouse gas emissions reductions.

The developing LNG trade does not have symmetric participants. LNG buyers in continental European and Japan tend to be monopoly gas and electricity companies with incentive and financial ability to sign long-term contracts. In contrast, prospective LNG buyers in the US and the UK participate in competitive wholesale markets and regulatory oversight with disincentives for volume commitments. As a result, integrated LNG sellers use US and UK as "markets of last resort" with implications for variability in actual LNG deliveries and for the division of rents in the growing LNG trade.

This text is a working paper version of Chapter 5 in Mark Hayes' doctoral dissertation to be published in 2007 by Stanford University Press.