"The domestic market will probably remain small, because you just need to ask the simple question - who will buy emissions in China?" Under the UN's Kyoto Protocol, China has been under no obligation to cut its own carbon emissions, and Lu said the only potential domestic buyers were big enterprises or high-income celebrities trying to improve their reputations. [2]

In the absence of a carbon cap, the UN saw a win-win in providing an incentivizing market mechanism for non-Annex 1 countries to reduce carbon emissions. If Annex 1 countries invested in suitable projects in non-Annex 1 countries, the UN would issue certificates for Certified Emission Reductions (CERs) equivalent to the amount of greenhouse gases reduced, for the Annex 1 countries to apply to their carbon caps.

And so the Clean Development Mechanism was born.

The CDM spawned phalanxes of consultants and administrators eager to put the policy into practice and profit from the cost of perhaps US$200,000 needed to prepare a good application. Investment bankers also proved eager participants, since the CERs yield wonderful derivatives for future delivery that could be traded on the European Climate Exchange (ECX). At present, an inventory of approximately 400 million tonnes worth of CERs and other carbon offset instruments worth over $10 each - and the expectation of many more in the pipeline - drives yearly trading volume of about $100 billion on the ECX.

The system turned out to be wildly complicated in execution because, in the best tradition of bureaucratic capitalism, it was necessary that only unprofitable projects could be funded.

There was no political constituency for supporting construction of profitable hydropower, windfarm, or biomass facilities that China or other developing countries would have theoretically built themselves. In CDM parlance, these were "business as usual" plants.

The only projects eligible for inclusion in the CDM program demonstrated "additionality", meaning that they represented additional capacity that could be brought on-line only because of the enabling income from the CER transaction. Evaluating and approving a CDM project is, therefore, a complex exercise in baselining and project monitoring to assure that the narrow project parameters were honored.

China proved itself an apt pupil at the CDM game.

Professor Lu Xuedu was a fixture on the executive board of the CDM in its early years, rising to the position of vice chairman in 2005. The Chinese government set up a Department of Climate Change under the National Reconstruction and Development Commission to vet and endorse applications for forwarding to the CDM. China also promulgated a regulation mandating that a Chinese corporation act as a project partner to any EU developer looking to do a project in China, so that China would share in the CERs and revenue.

After Kyoto came into force, China, by virtue of its knowledge of the CDM process and a steady stream of well-documented and suitable projects, quickly gained the lion's share of CDM "registrations" - and profits, as it laid off its CERs to investors at about 8 euros (US$11) to 9 euros per tonne, about half of the going secondary market rate.

With estimates of China's credited CO2 reductions as high as 120 million tonnes per year, this is a revenue stream of perhaps $1 billion per annum. [3]

But with all this money flowing toward China, controversies quickly arose.

A hydro-fluorocarbon, HFC-23, produced as a by-product in the manufacture of air conditioning refrigerant, is a particularly potent greenhouse gas, trapping 12,000 times as much heat as CO2 and potentially generating 12,000 times as many CERs per tonne of effluent. Therefore, China and India, in the midst of a booming demand for air conditioner refrigerant, generated applications for HFC-23 destruction facilities that generated over half of the total volume of CERs issued by the CDM in its early years of operation. Most of the capacity was in China.

The Chinese were accused of HFC profiteering by environmental groups apparently haunted, to paraphrase H L Mencken on the Puritans, "by the fear that someone, somewhere may be making money".

Or as Samuel LaBudde of the Environmental Investigation Agency put it, "Self-enrichment at the expense of climate mitigation is indefensible". [4]

Although there is a cap on total CERs generated by the projects, and the Chinese government captures 65% of the HFC-23 CER revenue as tax to fund sustainable development, the high multiple for HFC-23 CERs might very well provide incentive for some hanky-panky. The EIA alleged that as much as 66% of the HFC-23 reductions in the 19 projects (in China and elsewhere) approved or in the CDM were "fake offsets". [5]

However, as a matter of business understanding rather than environmentalist rough justice, the developing world has a license to produce CHFC refrigerants until 2030. Absent a mandate to compel countries like China and India to install the HFC-23 destruction equipment, the Annex 1 countries will have to pay for the privilege of ensuring the destruction of HFC-23, and the CDM is perhaps an effective mechanism for getting it done.

Nevertheless, the EU, which is funding the HFC-23 gravy train, has thrown its weight behind an investigation and broadly hinted that it finds HFC-23 CERs distasteful. The CDM Executive Board has yielded, holding up approval of five HFC-23 projects from China.

HFC-23 CERs are a big deal for the two biggest players in the CDM, China and India. They are also a big deal for the ECX, which sees HFC CERs as an important element in the liquidity and volume of the exchange.

In an indication of the interests at play, the EU Climate Action Commissioner, Connie Hedegaard, "conceded that it is time to 'strike the right balance between leverage and clarity'". [6]

"Leverage" refers to the EU's ability to guide the CDM's project orientation by disallowing certain kinds of transactions. It has been widely bruited about that the EU will pull the plug on HFC-23 CERs after Kyoto expires in 2012.

"Clarity" means protecting the operation of the CER exchange by calling into question the viability both of CERs that have already been issued, and those still in the pipeline. With the disruption in HFC-23 based CERs, Barclay's predicted that CER prices will spike over 40% in 2012. [7]

Another constituency is the World Bank. Of the five HFC-23 projects that the CDM has put on hold, two projects in China - with a possible CER revenue stream of over $2 billion - were funded by the World Bank (which has defended the projects and the operating status of the plants vociferously). [8]

On the other hand, the US has entered the fray on behalf of the EU, backing a plan to turn HFC-23 into a treaty obligation funded by the Montreal Protocol (originally purposed to end the production of ozone-depleting fluorocarbons; ironically the HFC-23 problem is a by-product of the new, ozone-safe refrigerants).

The mess will be on the agenda at Cancun.

In an indication of the dire straits of the climate change process and the apparent impossibility of achieving consensus on significant, game-changing reductions, HFCS-23 reform - reducing the developed world's cost of removing a greenhouse gas that is already being removed from the atmosphere - is being billed as "the biggest climate deal on the table this year". [9]

It is predicted that, with the active opposition of the BASIC countries and the lack of enthusiasm from green-sector investors, the HFCS-23 reform may very well go nowhere.

As the US ozone czar put it, ''There are vast amounts of money to be made under the CDM,'' Reifsnyder said. ''Why would people be more interested in destroying them more cheaply under the Montreal Protocol?'' [10]

China's CDM headaches are not limited to the big-budget issue of HFC-23. The country's aggressive hydropower policy, with its attendant problems of environmental degradation and compulsory population relocation, has attracted the hostile scrutiny of advocacy groups such as International Rivers and Probe International.

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