Overview of CDM financial mechanisms
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  • Notes : Only currently active markets are shown on this graph. Carbon markets currently being developed (e.g. Massachusetts), but where no transaction has been recorded, to our knowledge, as of July 1 2002, are excluded from this graph. The sizes of the bubbles do not represent exact volumes transacted on each particular sub-market, but aim at conveying general order of magnitudes.
  • Notes : 68 MtCo2e projection made by PointCarbon .
  • Notes : Renewables sum up wind, hydro, solar, geothermal and biomass
  • Notes : Asia’s large share in volume comes from one single transaction from Transalta in India involving a total of 54 MtCo2e over 40 years. JI large volume comes all from one transaction, which needs to be further analyzed.

Overview of CDM financial mechanisms Presentation Transcript

  • 1. CDM: OVERVIEW OF FINANCIAL MECHANISMS Climate Change Information Center Manila Observatory Ateneo de Manila University
  • 2. Contents
    • Mechanics of CDM
    • Basics of CDM Financing
    • Risks in CDM Financing
    • State of the Carbon Market
  • 3. 1. Mechanics of CDM
  • 4. Clean Development Mechanism
    • Enables developed countries (known as Annex I countries) to meet their emission reduction commitments in a flexible and cost-effective manner
    • Assists developing countries (non-Annex I countries) in meeting their sustainable development objectives
    • Investors benefit by obtaining Certificates of Emissions Reductions ( CERs )
    • Host countries benefit in the form of investment, access to better technology, and local sustainable development
  • 5. What are the Criteria for CDM Projects?
    • Sustainable development
      • Host country criteria
      • Environmental Impact Assessment
      • Stakeholder consultations
    • Greenhouse Gas (GHG) emission reductions
      • Environmental additionality
    • Project additionality
    • Project viability
      • Technologically proven
      • Financially sound
    • Host country approval
    • Project validation and registration
  • 6. CDM Project
    • Achieves Sustainable Development objectives for the host developing country
    • Reduces GHG Emissions
  • 7. Simplistic numerical example
    • Provide electricity for a barangay
    • “ Business-as-usual” (baseline): Diesel generator sets
      • Cost of project $10
      • Emissions 1 tC
    • Cleaner project (CDM-eligible): Micro-hydro
      • Cost of project $13
      • Zero Emissions
  • 8. Simplistic numerical example
    • CDM Investor (e.g. Japan)
      • Invests $3 ($13-$10, difference between cleaner and business-as-usual project)
      • Gains Certificate of Emissions Reduction of 1 tC, which it can meet some of its Kyoto Protocol commitments to reduce emissions
  • 9. Simplistic numerical example
    • WIN – WIN – WIN
    • WIN for the host country
      • Sustainable development benefit: Cleaner energy production technology
    • WIN for the Annex I country
      • Credits for emissions reduction
    • WIN for the Global Environment
      • Emissions reduction
  • 10. Kyoto Protocol: Flexibility Mechanisms Present day 2012 (BaU) Assigned Amounts Domestic Actions Joint Implementation Emission Trading Annex I Emission Trading Clean Development Mechanism Domestic Actions 2012 with KP - 5% 1990 level
  • 11. Price of a Unit of Emissions Reductions: A Competitive Market Cost of Reducing in the Host Country (Developing) < Price of a Unit of Emissions Reductions by CDM Cost of Reducing in the Investor Country (Annex I) <
  • 12. Preparation and review of the Project Baseline Study and Monitoring Plan (MP) Validation process Negotiation of Project Agreements Periodic verification & certification Construction and start up Project completion 3 months 2 months 2 months 3 months 1-3 years Up to 21 years
    • Upstream Due Diligence, carbon risk assessment and documentation: $ 50K
    • Baseline: $30 K
    • Monitoring Plan: $25K
    • External consultant: $25K
    • Processing and documentation: $30k
    • Consultation and Appraisal: $75K
    • Negotiations and Legal documentation: $30K
    Carbon Asset Creation and Maintenance Costs The PCF Experience: Transactions Costs Total through Negotiations
    • All expenses: $265 K
    • Initial verification at start-up: $25K
    • Verification: $10-25 K
    • Supervision: $10-20K
  • 13. 2. Basics of CDM Financing
  • 14. Starting Point: Viable Project
    • A potential CDM Project is a feasible project
      • Technologically feasible
      • Financially sound
    • A potential CDM Project is a project which has an Environmental Compliance Certificate ( ECC )
  • 15. Total Project Costs and Sources of Finance
    • Total Project Cost Estimates
    • Investment costs, including development costs, up to commissioning of project
    • Sources of Finance to be Sought or Already Identified
    • Critical to identify other debt and/or equity finance
    • Typical sources of funding: international development banks, government funding, private financing, supplier credit
    • CDM contribution = typically 5-15% of total project costs
  • 16. Important Distinction
    • Project Financing
      • Equity
      • Debt
    • CDM Finance / CER Revenue
  • 17. Financing Options in a CDM Project
    • Equity
    • Annex I Investor co-finances part of a CDM project in return for shared financial returns and CERs
    • Local investors co-financing CDM projects in a host country may wish to share in CERs so that they have the opportunity to sell the credits at a later time
  • 18. Banks Investor Debt Equity Power Purchase Agreement $$ Electricity CDM Equity Financing CDM Investor Equity $$ CERs
  • 19. Financing Options in a CDM Project
    • Loan
    • Annex I Investor provides loan or lease financing at concessional rates in return for CERs
  • 20. Banks Investor Debt Equity CDM Debt Financing CDM Investor CERs Electricity $$ Debt $$
  • 21. Financing Options in a CDM Project
    • Emission Reductions Purchase Agreement
    • Annex I investor agrees to buy CERs as they are produced by the project
  • 22. Banks Investor Debt Equity Power Purchase Agreement $$ Electricity Emission Reductions Purchase Agreement CDM Investor $$ CERs Emission Reduction Purchase Agreement
  • 23. Financing Options in a CDM Project
    • Carbon Funds
    • Annex I investors contribute to a mutual fund
    • Mutual fund agrees to buy CERs as they are produced by the project
    • Examples
      • WB Prototype Carbon Fund
      • Netherland’s CERUPT
  • 24. How Carbon Funds Work.. Industrialized Governments and Companies Developing Countries and Communities Carbon Fund $ Technology Finance $ Technology Finance CO Equivalent 2 Emission Reductions CO Equivalent 2 Emission Reductions
  • 25. Banks Investor Debt Equity Power Purchase Agreement $$ Electricity $$ Carbon Credits Nature of Carbon Financing Contract Carbon Fund $ $ 2 2 Emission Reduction Purchase Agreement
  • 26. Emission Reduction Purchase Agreement
    • Will improve IRRs
    • Forward contract
      • Payment upon delivery of verified ERs
      • Upfront payments are rare
    • Will provide a hard currency revenue ($, €, £, ¥)
    • Helps secure financing and reduce project risk
      • Future ER payments as collateral for project loans
      • Can be paid into an escrow account, protecting lenders from currency convertibility and transfer risks
  • 27. How CDM can matter FIRR CER income 0 Without CERs implemented With CERs not implemented No CDM Without CERs not implemented; with CERs implemented CDM
  • 28. Impact of Carbon Finance on Project Financial Rate of Return
    • Revolution in Solid Waste Management
    • Important impact on small-holder crop-processors and animal production
    Methane Kick 5-10+ Municipal Solid Waste 3-7 Crop/Forest Residues 0.8-2.6 Hydro, Wind, Geothermal  IRR Technology
  • 29. Banks Investor Debt Equity Power Purchase Agreement $$ Electricity CDM Equity Financing CDM Investor Equity $$ CERs ODA Non-ODA
  • 30. Banks Investor Debt Equity CDM Debt Financing CDM Investor CERs Electricity $$ Debt $$ ODA Non-ODA
  • 31. Banks Investor Debt Equity Power Purchase Agreement $$ Electricity $$ Carbon Credits Emission Reduction Purchase Agreement ODA Non-ODA Carbon Fund $ $ 2 2 Emission Reduction Purchase Agreement
  • 32. 3. Risks in CDM Financing
  • 33. Risks in CDM Financing
    • Renewable energy projects are considered risky by financing institutions
    • Multitude of risks could reduce the value of the project to zero
    • Measures are needed to mitigate risks at different stages of the project
  • 34. “ Normal” Project Risks
    • Political/Country Risks
    • Sponsor Risks
    • Construction Risks
    • Technical Risks
    • Fuel Risks
    • Environmental Risks
    • Financial Risks
    • Legal Risks
    • Operation Risks
  • 35. CDM-Specific Risks
    • Market/Price Risk
      • Will there be a market for project-based ERs?
      • Will contract price exceed market price?
    • Policy/Compliance Risk
      • What if no Kyoto Protocol?
      • What if host country does not ratify or comply?
      • What if host country does not approve project?
    • Market and Policy Risk are closely linked
  • 36.
    • Baseline Risks
      • Eligibility--will ERs be Kyoto-compliant?
        • Will project be validated and registered?
        • Will ERs be verified and certified?
      • Baseline design--is the baseline robust? Will its assumptions remain valid over time?
      • Performance-- actual performance will determine level of ERs generated
    CDM-Specific Risks
  • 37. 4. Emerging Trends in the Carbon Market
  • 38. Summary of carbon markets currently in operation Project-based Emission Reduction purchases Allowance Trading Within National trading systems Intra-Firm trading Retail UK DK Shell BP “ Pre-Compliance” From voluntary To Kyoto Pre-Compliance
  • 39. Market Intelligence: “Few Countries Benefiting, Little Private Sector Buying”
    • Market: cumulative 200 million tonnes CO 2 traded ($500 million) since 1996
    • Five-fold increase between 2001 and 2002
    • Only 43% of all carbon transactions made in CDM/JI (2001-2002), dominated by Dutch and PCF
    • Only 13% of the private sector’s purchases were in CDM (2001-2002)
    • African countries, smaller countries and small-scale projects are largely bypassed
  • 40. Carbon Market Volume has increased Source : Authors’ own calculation, as above, volume projection by PointCarbon
  • 41. Who is buying ER Credits? Source : Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon 1996-2000 2001-2002
  • 42. Balance in Asset Classes Emerging Source : Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon
  • 43. Carbon Finance flows 2001-2002 Source : Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon USA Canada Australia Latin America Asia Africa
  • 44. Who’s buying where? (2001-2002) Source : Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon In 2001-2002, private companies acting alone have purchased only 13% of their reductions in developing countries.
  • 45. World Bank Carbon Finance Vehicles Bio Carbon Fund Netherlands CDM Facility Italian Carbon Fund                                                 
  • 46. World Bank’s Carbon Finance Business - at a Glance
    •  
    • Carbon Purchases agreed and under negotiation: ~40, ~US$250 million
    • Number/Value of PCF and Netherlands Projects approved for carbon purchase : 64, US$ 440 million
    • Carbon Asset portfolio: ~50 million tCO 2 e
    • Underlying CDM/JI project finance: ~$3.0 bn
  • 47.  
  • 48.  
  • 49. Sample Projects
    • Latvia: $2.5 million PCF Purchase
      • anaerobic decomposition of about 20,000 tons of garbage a year
      • ERs from the existing landfill site gas recovery began June 2002
    • Uganda: $3.9 million PCF purchase
      • a 5.1 MW and 1.5 MW small hydro generating facilities in the West Nile region
      • Displaces >200 small and few large public diesel gensets
    • Chile: $6 m PCF Purchase
      • 26MW run-of-river hydro generating 175 GWh to replace coal/gas
    • Brazil: $5 mm of PCF Purchase
      • Substituting coal/coke by sustainably produced charcoal in pig iron production, plus afforestation and ecosystem restoration, biodiversity and health benefits
  • 50. Lessons from PCF: Carbon Prices $3.60 [+option] Romania Afforestation $4.00 Czech small-scale energy efficiency $3.75 + 0.2 South Africa Durban waste management $3.50 + 0.5 Colombia wind farm $3.50 C. America small wind/hydro $3.50 Poland District Heating Fuel Switch – Coal to Geothermal and Biomass $3.50 Brazil sustainable charcoal replacing coal/coke $3.50 [ +option] Chile: 25 MW hydro run-of-river $3.00 Uganda small hydro (5&1.5 MW) remote area
  • 51.  
  • 52. Carbon Funds in Asia
    • Asian Development Bank CDM Facility
    • Development Bank of Japan
      • Carbon Fund of Japan
    • JBIC Carbon Fund
  • 53. Carbon Prices Source : PCF estimates, based on database assembled with Natsource,Co2e.com and PointCarbon
  • 54. Pricing of Emission Reductions
    • Price range offered depends on the
      • Legal jurisdiction of the ER
        • Kyoto Protocol, EU trading system, domestic trading systems such as those in UK or Denmark or the voluntary market
      • Price signal in the market for the jurisdiction
      • Willingness to pay of the buyers
    • Price outcome in a project depends on risk sharing in the contracts including
      • Regulatory risk (e.g. Kyoto Protocol entry into force, eligibility of project, verification and certification)
      • Project performance and delivery risk
  • 55. Price Differentials b/w CER & AAU
    • Different Carbon Markets
    • Legal Status of Asset
      • AAU has more secure status than CER
      • CER has Kyoto Risks
    • Different Trading Regimes
      • AAU: Cap-and-trade
      • CER: Baseline-and-credit
        • Each reduction has to be certified – higher transaction costs
        • Baseline risks
    • Compartmentalized Carbon Markets
      • At present, not allowed to trade CER in EU Trading Schemes
  • 56. Estimated and Contracted ERs 5 10 Year Estimated emission reductions Minimum contracted emission reduction Additional emission reductions Contract default value
  • 57. Actual performance and contract volume 5 10 Year Expected ERs
  • 58. Actual performance and contract volume 5 10 Year Expected ERs “ Swept” amount ERs freed due to sweeping Minimum contracted amount
  • 59.  
  • 60.  
  • 61. Buyers of Carbon Credits [MtCe/yr] ( Source: Grubb, March 2003)   Historical Emissions Low Surplus ( High Demand , Low Supply) High Surplus ( Low Demand , High Supply)   1990 2000 % change 2000-2010 Carbon Balance % change 2000-2010 Carbon Balance GROSS DEMAND       220   53 EU Carbon 911.4 895.5 7% 120 -3% 30 Japan Carbon 305.3 313.7 10% 58 -3% 17 Canada Carbon 128.6 158.0 15% 61 0% 37 + Net other GHGs (+5, -5%)       12   -2 - Managed forest allowance       -30   -30
  • 62. Sellers of Carbon Credits [MtCeq/yr] (Grubb, March 2003)   Historical Emissions Low Surplus (High Demand, Low Supply ) High Surplus (Low Demand, High Supply )   1990 2000 % change 2000-2010 Carbon Balance % change 2000-2010 Carbon Balance SUPPLY       331   587 Russia Carbon 647 450.7 20% 106 0% 196 Ukraine Carbon 191.9 104.5 20% 67 0% 87 Accession 10 Carbon 245.2 146.6 25% 45 5% 75 Other EITs 87.8 45.4 25% 24 0% 36 Other GHGs (10, 20%)       24   79 + Managed forest allowance       40   40   CDM         15     50
  • 63. Probable prices for CERs ( £/tCO 2 e) (Grubb, March 2003)
    • Renewable energy and energy efficiency projects under CDM fast-track procedures for small scale projects
      • £10 – 25 per tCO 2 e
    • Land use and other CDM projects
      • £ 5 – 15 per tCO 2 e
  • 64. Key Factors in CDM Market Development
    • Need 5 years+ for carbon finance to make a difference in a project at current prices;
    • Buyers only want ERs delivered by 2012. They heavily discount ERs after 2012
    • If value of post 2012 ERs is not assured by 2006, CDM market activity will decline sharply
  • 65. Lead Time and Uncertainty Constraints on Project-Based Mechanism (esp. CDM) 2006 2008 2003 2012 Operating Wind, Efficiency, Waste to Energy Large Hydro, Geothermal, Coal to Gas Power CDM Investment Window: 3years IF NO Decision; No Incentive beyond 2012, No Investment, Market Development Stalled Operating = Start Construction
  • 66. CDM: Challenges ahead
  • 67. Roberto C. Yap, S.J., Ph.D. Environmental Economist Climate Change Information Center Manila Observatory Ateneo de Manila University Tel +63 2 426-6144 Fax +63 2 426-6070 rcyapsj @observatory.ph