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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.
  • 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