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Understanding Carbon Credits Business
 

Understanding Carbon Credits Business

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Give an idea why The UNFCCC structured Carbon Credits business is a market failure.

Give an idea why The UNFCCC structured Carbon Credits business is a market failure.

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    Understanding Carbon Credits Business Understanding Carbon Credits Business Presentation Transcript

    • Understanding the Carbon Credits Business Amit Gopal Chauhan 28 th March 2008 SIBER, KOLHAPUR
    • I will Talk About
      • Governance
      • Global Warming
      • IPCC, UNFCCC, Kyoto Protocol
      • Carbon Trading
      • Requirements for a CDM project
      • Examples
      • Discussion on price factors
      • Market strategy one should adopt
      • CDM market failure
      • Conclusion
    • Governance
      • Three pillars
        • Governments
        • Institutions
        • Markets
      • When one fails other compensates
      • When one fails it either self corrects and evolves with new attributes. Or depends on the other pillars for a change.
      • The cycle should repeat it self.
    • Global Warming
      • Its responsible for life on Earth
      • Water Vapor, CO2, Methane, N2O caused natural GW Historically
      • Industrialization has magnified the emissions of GHGs exponentially
      • Increase in temperature, increase in sea water level, extreme movements of draught/ hurricanes/ floods expected
    • IPCC, UNFCCC, Kyoto Protocol
      • Intergovernmental Panel on Climate Change
      • United Nations Framework Convention on Climate Change
      • North & South agree to mitigate climate change before “ it is too late”
      • Agree that they have “ Common but Differentiated responsibilities ”.
      • Kyoto Protocol which in details describe how the GHGs can be reduced entered into force on 16th February 2005.
    • The Kyoto protocol Annex I Non-Annex I Not ratified
    • Kyoto Protocol
      • It relies on market based flexible mechanisms to reduce GHGs emissions to mitigate GW.
        • Emission trading (trading of allowances between Annex I governments)
        • Clean Development Mechanism (CDM) (projects in Non-Annex I countries with participation of Annex I countries)
        • Joint Implementation (JI) (projects between Annex I countries)
    • GHGs With GWPs under Kyoto Carbon dioxide GWP: 1 Hydrofluorocarbons GWP: 11,700 Methane GWP: 21 Sulphur hexafluoride GWP: 23,900 Nitrous oxide GWP: 310 Perfluorocarbons GWP: 9,200
    • GWP & Carbon Credits If one tonne of GHG emission is reduced then number of carbon credits issued will be equivalent to the GWP. 23900 Sulphur hexafluoride SF 6 11700 Hydrofluorocarbons HFCs 9200 Perfluorocarbons PFCs 310 Nitrous oxide N 2 O 21 Methane CH 4 1 Carbon dioxide CO 2 Global warming Potential Name Formula
    • Carbon Credits are also Known as…
      • Emission reduction unit (ERUs),
      • Certified emission reduction (CERs),
      • Assigned amount unit (AAUs)
      • Removal unit (RMUs)
      • Voluntary emission reduction (VERs)
    • Generating Carbon Credits GHG emissions Time Project commissioned “ With project” emission level “ Without project” emission level Carbon credits Project based emission reductions need to be calculated and verified 1 reduced Ton of Carbon Dioxide equivalent = 1 Carbon Credit hereafter they can be sold on the open market.
    • Supposed benefits of the market mechanisms
      • Help identify lowest-cost opportunities for reducing emissions and attract private sector participation in emission reduction efforts.
      • Cost of limiting emissions varies considerably from region to region, the benefit for the atmosphere is the same, wherever the action is taken.
      • Developing nations benefit in terms of technology transfer and investment brought about through collaboration with industrialized nations under the CDM.
    • The Carbon market (1)
      • International agreements to reduce greenhouse gases:
      • EU Emissions Trading System (EU-ETS) requires EU countries to reduce emissions of greenhouse gases by 6% during 2005-2007
      • Kyoto Protocol requires Annex I countries (West and Eastern Europe, North America, Japan, New Zealand, Australia) to reduce emissions of greenhouse gases by 5.2% during 2008 – 2012
    • The Carbon market (2)
      • Voluntary participation of Non-Annex 1 countries (Brazil, China, India, South Africa, etc.)
      • The Linking Directive allows credits from Clean Development Mechanisms (CDM) and Joint Implementation (JI) projects to help companies comply with their obligations
    • Registry systems under Kyoto (1)
      • National Registries : containing accounts within which units are held in the name of the government or in the name of legal entities authorized by the government to hold and trade units
      • CDM registry : for issuing CDM credits and distributing them to national registries. Accounts in the CDM registry are held only by CDM project participants, as the registry does not accept emissions trading between accounts.
    • Registry systems under Kyoto (2)
      • In addition to recording the holdings of Kyoto units, these registries “settle” emissions trades by delivering units from the accounts of sellers to those of buyers, thus forming the backbone infrastructure for the carbon market
    • Registry systems under Kyoto (3)
      • Each registry will operate through a link established with the International transaction log put in place and administered by the UNFCCC secretariat. The ITL verifies registry transactions, in real time, to ensure they are consistent with rules agreed under the Kyoto Protocol. The ITL requires registries to terminate transactions they propose that are found to infringe upon the Kyoto rules
    • Registry systems under Kyoto (4)
      • In verifying registry transactions, the ITL provides an independent check that unit holdings are being recorded accurately in registries. After the Kyoto commitment period is finished, the end status of the unit holdings for each Annex B Party will be compared with the Party’s emissions over the commitment period in order to assess whether it has complied with its emission target under the Kyoto Protocol
    • Registry systems under Kyoto
    • Requirements for South for participating in CDM
      • The host country where the project is executed is a Kyoto signatory.
      • The project meets the sustainable development criteria framed by the country.
      • The projects results in real, measurable, long-term GHG reduction.
      • The projects must be Additional (i.e. must face some financial, technical, common practice barriers. It should be proved that the project must not have been commissioned without the CDM)
    • Basic data needed for CDM!
        • Evidence of CDM consideration
        • Start & commissioning dates
        • Financial analysis (IRR calculation)
        • Electricity saving data
        • Barrier analysis information
        • EIA report, if required by law
        • Contractual agreement between each individual sub-project and the bundling agency
    • CDM Sectors Agriculture Afforestration and reforestation Waste Handling and disposal Solvent use Fugitive emissions from production and consumption of halocarbons and Sulphur hexafluoride Fugitive emissions from fuels Mining & Mineral Production Transport Construction Energy Distribution loss prevention Energy Efficiency in Industry (demand & supply) All types of Renewable energy
    • Outline of the CDM project process (1)
      • An industrialized country that wishes to get credits from a CDM project must obtain the consent of the developing country hosting the project that it will contribute to sustainable development.
      • Then, using methodologies approved by the CDM Executive Board (EB), the applicant (the industrialized country) must make the case that the carbon project would not have happened anyway (establishing additionality),
    • Outline of the CDM project process (2)
      • Must establish a baseline estimating the future emissions in absence of the registered project.
      • The case is then validated by a third party agency, called a Designated Operational Entity (DOE), to ensure the project results in real, measurable, and long-term emission reductions.
    • Outline of the CDM project process (3)
      • The EB then decides whether or not to register (approve) the project.
      • If a project is registered and implemented, the EB issues credits, called Certified Emission Reductions to project participants based on the monitored difference between the baseline and the actual emissions, verified by the DOE.
    • Steps is CDM PIN / PCN & PDD Development Host Country Approval Validation Verification Monitoring Implementation Registration Certification Project Developers / Consultant GOI / MOEF i.e. DNA DOE CDM EB Project Developers Project Developer + DOE DOE CDM EB Issuance of CERs CDM EB
    • CDM Project Activity Cycle (1)
      • Project Activity Design: The Project design document (CDM-PDD) and the Guidelines for completing CDM-PDD including a glossary of terms (Approval, authorization, project participants etc.) have been developed by the Executive Board on the basis of Appendix B of the CDM modalities and procedures. Project participants shall submit information on their proposed CDM project activity using the Project design document (CDM-PDD).
    • CDM Project Activity Cycle (2)
      • Proposal of a New Baseline and/ or Monitoring Methodology: The new baseline methodology shall be submitted by the designated operational entity to the Executive Board for review, prior to a validation and submission for registration of this project activity, with the draft project design document (CDM-PDD), including a description of the project and identification of the project participants.
    • CDM Project Activity Cycle (3)
      • Use of an Approved Methodology: The approved methodology is a methodology previously approved by the Executive Board and made publicly available along with any relevant guidance. In case of approved methodologies the designated operational entities may proceed with the validation of the CDM project activity and submit project design document (CDM-PDD) for registration.
    • CDM Project Activity Cycle (4)
      • Validation of the CDM project activity: Validation is the process of independent evaluation of a project activity by a designated operational entity against the requirements of the CDM as set out in decision 17/CP.7, the present annex and relevant decisions of the COP/MOP, on the basis of the project design document, as outlined in Appendix B.
    • CDM Project Activity Cycle (5)
      • Registration of the CDM project activity: Registration is the formal acceptance by the Executive Board of a validated project as a CDM project activity. Registration is the prerequisite for the verification, certification and issuance of CERs related to that project activity
    • CDM Project Activity Cycle (6)
      • Certification/ Verification of the CDM project activity: Verification is the periodic independent review and ex post determination by the designated operational entity of the monitored reductions in anthropogenic emissions by sources of greenhouse gases that have occurred as a result of a registered CDM project activity during the verification period. Certification is the written assurance by the designated operational entity that, during a specified time period, a project activity achieved the reductions in anthropogenic emissions by sources of greenhouse gases as verified.
    • Possible CDM projects in Energy Sector for example
      • Renewable Energy (wind, solar, biomass, hydro, geothermal etc.)
      • Energy Efficiency
      • Combined Cycle Gas Turbines (CCGT)
      • Super Critical Technology for Power Generation
      • Renovations & modernization of Power plants
      • Reduction in T&D loss
      • Fossil fuel switch - Coal to Gas, Oil to Gas
      • Waste gas: heat, pressure, electricity
      • SF6 abatement
      • Biomethanation
      • Coal Mine Methane (CMM)
    • Possible CDM projects in Oil & Gas Sector for example
      • Gas flaring reduction,
      • Re-injection,
      • Associated gas recovery,
      • prevent pipeline leakage,
      • Geological storage of GHGs
    • Possible CDM projects in Iron & Steel Sector for example
      • Cleaner and more efficient coke production
      • Furnace efficiencies and upgrades
      • Heat Recovery from Direct Reduction Kiln
      • Energy Capture from Waste Gas
      • Fuel switch to natural gas / biomass, for various ovens and kilns
      • Green Belt Development & Afforestration to act as a sink for CO2
    • Possible CDM projects in Chemical Industry
      • Energy Efficiency
      • Wastewater/ Methane Avoidance
      • Biodiesel and Biofuels
      • Biomass Energy
      • Fossil fuel switch - Coal to Gas, Oil to Gas
      • Gas pipeline leakage
      • HFCs abatement
      • Renewable Energy: Biomass, Geothermal, Hydro, Solar, and Wind
      • Waste gas: heat, pressure, electricity
      • Process modification
      • Forestry - Afforestation and Reforestation etc.
    • How is CDM relevant for Businesses? By selling the emission reductions from a project to a Annex I party additional cash flows can be realised. Emission cap Actual emissions Buyer Carbon Credits Carbon value ( € ) Annex I party Emission reduction project The CDM project reduces the carbon emissions in the CDM country
    • Impact on the IRR of The Project IRR Benchmark Project return excluding CDM revenue Project return including CDM revenue CDM cash flow The gap between the project return and the required return on investment threshold The CDM cash flow increases the IRR of the project making it more interesting for investors. (2%-100%, diversification, offshore revenue stream) 12 % 15 % 16 %
    • Project Example
      • Waste heat Power Generation
      • 50 MW combined cycle gas-steam turbine (CCGT)
      • 12 MW condensing steam generator (CSG )
      • 85% load factor
      • Displaces 500 GWh / a of fossil grid electricity
      • CERs: 400,000/p. a = Rs. 660 million up to 2012
      • Biomass Power Plant
      • 10 MW Rice Husk plant supply and grid export
      • 70% load factor
      • Displaces 70 GWh / a of fossil grid electricity
      • CER: 55,000 p a = Rs. 90 million up to 2012
    • Energy Efficiency Projects for Example
      • Doing the same with less
      • Potential & Opportunities
        • Cogeneration
        • waste Heat/ gas Recovery
        • Energy Management System
        • Combustion Control
        • Fuel Switching
        • High efficient Refractory
        • Industrial Process Modifications/Fuel Savings
    • Types of project
      • Measures/technologies
        • Diffuse/small scale energy efficiency:
          • Energy efficient devices (bulbs, motor controller, appliances)
            • Distribution
            • Labelling/government programme
          • Buildings’ energy efficiency (insulation, SSC renewable, etc)
        • Large scale (industrial) energy efficiency (demand/supply side)
          • ‘ Pure’ energy efficiency
          • Waste heat/gas recovery
          • Fuel switch
    • Methodologies
        • Pure EE:
          • AM0018 – Steam optimization
          • AM0020 – Water pumping efficiency improvement
          • AM0038 – Improved electrical efficiency in SiMnmetal production
          • ACM0007 – Single cycle to combined cycle power generation
        • Fuel switch:
          • AM0017 – Natural gas cogeneration (BSL=gas-heat + grid-elec)
          • AM0029 – Construction of new natural gas power plants
          • AM0036 – Fuel switch Fossil fuel to biomass for heat generation
          • ACM0003 – Fuel switch in cement plants
          • ACM0009 – Fuel switch coal or petroleum to Natural gas
        • Waste heat/gas recovery:
          • AM0024 – Waste heat recovery in cement plants
          • AM0032 – Cogen from waste gas/heat
          • AM0037 – Flare reduction and gas utilisation at oil & gas facilities
          • ACM0004 – Waste gas/heat for power generation
      Applicability conditions!
    • Traditional project risks Threats to project Source: Miller and Lessard, 2000 Regulatory and political risks Operational risk Technical risk Social acceptability Market risk Financial risk Completion risk Not enough financing to complete project Project does not pass completion tests Project does not operate reliably Project does not meet regulatory commitments Community protests lead to permit denial or revocation Project boycotts Bankers reluctant to lend
    • Additional CDM project risks
      • Institutional and regulatory risk
      • Methodology risk
      • Host country risk
      • Validation risk
      • Registration risk
      • Monitoring and verification risks
    • Time frame and uncertainty ~33% formal review Up to 70% request for review Not known Variable Not known ~50% Rejection Level Up to 3 months Up to 6 mo, if reviewed 1-3 weeks 1 month – 3 years 2-6 months Up to 2 years Time frame Up to 2.5 months Up to 8 weeks LS Not requested Variable 30 days 3 weeks Consult. Request for review Registration Annex 1 approval LOA Validation Propose methodology Step
    • Time frame and uncertainty None Yet Up to 66% formal review Up to 75% request for review Not Known 26% rejected Rejection Level Up to 4 Months Up to 2 Months Up to 5 Weeks 2-4 Months Up to 4 Months Time Frame N/A Up to 1.5 Month 15 days N/A N/A Consult Formal review Request for review Issuance Verification Formal review Step
    • Project Risks Apparent costs - Equipment - O&M - Management Hidden costs - Opportunity costs (late start) - Overrun budgets
      • Operational risks:
      • Reduced CER generation
      • Equipment failure
      - Administrative expenses and other transaction costs (lawyers, consultants) Total real costs
    • The CER Price Structure EURO 5 15 CER Price Counterparty & Default Risk Commissioning Risk Late Delivery Risk Underperformance Risk Asset Transfer Risk Baseline & CER Calculation risk Registration Risks Volatility risk International Transaction Log & Cap risk Hot Air & Supply Risk UNFCCC Policy Risk, Political Risks EU ETS market price
    • The Myth of the Carbon Credit High risk Medium risk No risk Delivery risk Low Medium high Price High risk Medium risk No risk Country- and project risk Small, medium & large sized companies Medium and large scale companies AAA rated companies Ownership Created by CDM projects Created by JI projects Allocated by Annex I countries: Real Commodity Existence CER Certified Emission Reduction ERU Emission Reduction Unit EUA European Union Allowance
    • Key Price determinants for CDM projects
      • Risk allocation
      • Creditworthiness & experience of project sponsor
      • Viability of underlying project
      • Contract structure (e.g. upfront payments incur discount, penalties for non-delivery, ability to pay penalties)
      • ER vintage & seniority
      • Cost of validation & potential certification
      • Host country support & willingness to cooperate
      • Additional environment and social benefits
    • Contract Types
      • 1) Seller does its utmost to deliver a flexible/non-firm volume , buyer guarantees to buy
      • - Few preconditions
      • 2) Seller does its utmost to deliver a flexible/non-firm volume , buyer guarantees to buy
      • - The contract is only valid on a set of preconditions
      • 3) Seller guarantees to deliver a firm volume , buyer guarantees to buy
      • - The contract is only valid on a set of preconditions
      • 4) Seller guarantees to deliver a firm volume , buyer guarantees to buy
      • - Non-delivery: seller pays mark-to-market/liquidated damages CERs or cash
    • Cost of developing a CDM Project
      • Apart from the project development, implementation cost. The developer has to pay for
        • The consultant fees
        • Registration with the Designated National Authority (MOEF)
          • Public hearing
        • Validation fees (to Designated Operational entity)
        • Registration fees at the UNFCCC
        • Monitoring & Verification fees (to third party DOE)
        • CERs Issuance fees
        • Contribute to the UNFCCC adaptation fund
      • Then bargain for the price of the CERs with the Buyers
      • A picture of Market Failure!!
    • CDM Market in India is
      • Consultant driven
      • Buyers are there but few and offer low price
      • Brokers promise good price but reliability record is poor
      • Size of the projects is very small though the quantity is large… hampers bargaining capacity of the project developer
      • Most project developers hoard( do not sell) CERs in expectation of higher price
      • Most projects face problems in implementation.
    • Why CDM is a market failure? (1)
      • Too sophisticated/complex a market
      • Too expensive to enter
      • The future beyond 2012 is yet uncertain
      • Does not survive the Cost Benefit analysis
      • Huge Markets like agriculture untouched
      • Forestry projects are too complex
      • The project developer doesn’t get a fair price
      • The ultimate buyer doesn’t get a fair price
    • Why CDM is a market failure? (2)
      • Profits go in the pocket of middlemen
      • CDM popular only in developing countries not in Lower developed countries
      • Technology transfer which CDM promises already exist with South in some cases
      • Little initiative by government entities to take up CDM projects
      • Proving additionality is very difficult in most of the cases
      • Carbon exchanges have played limited role till yet
    • Critiques & Concerns (1)
      • Some emission reductions under the CDM are false or exaggerated
      • In 2007 the CDM was accused of paying €4.6 billion for projects that would have cost only €100 million if funded by development agencies
      • Where as the project developers feel they did not get a fair price
    • Critiques & Concerns (2)
      • The first commitment period of the Kyoto Protocol excluded forest conservation/avoided deforestation - carbon emissions from deforestation represent 18-25% of all emissions, and will account for more carbon emissions in the next five years than all emissions from all aircraft since the Wright Brothers until at least 2025.
    • Market strategy one should adopt (1)
      • Enter as early as possible….project conceptual stage
      • Educate oneself and staff thorough…before going to consultant
      • Invite a buyer as a project participant at an early stage
      • Appoint a consultant for CDM PDD writing and handling UNFCCC matters…note your job is to execute the project
      • Option of in-house PDD development can also work for you…delegate the job
    • Market strategy one should adopt (2)
      • Sell some CERs in advance and hold some portion for expectation of higher price…don’t hold all the CERs
      • Carbon market will stay in some way or the other….the market will correct itself or be get corrected
      • Expect local carbon markets in the future….say in next 7-12 years
    • Conclusion
      • The market need a major makeup
      • Simplify
      • Active role from institutions to take up programme of activities CDM
      • Efficient, transparent, carbon exchanges
      • More information and education
      • Considering other than market approach to mitigate climate change