Climate Change

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  • The CARBON economics of CDM projects varies…The size of the carbon layer varies between project types…
  • Climate Change

    1. 1. Economics of Climate Change Paradigm Shift from Projects to Programs Amit Bando November 13, 2009
    2. 2. Agenda How do we evaluate climate change projects? The current project cycle Gaps in the evaluation process From projects to programs 2
    3. 3. The Kyoto Protocol provides the basis for evaluating climate change projects Kyoto Protocol (1997) The Protocol creates legally binding obligations for 38 industrialized countries to return their emissions of greenhouse gases to an average of 5% below their 1990 levels by 2012 Marrakech Accords (2001) Define the principles of the Kyoto Protocol’s flexible mechanisms: the Clean Development Mechanism (CDM), Joint Implementation (JI) and Emissions Trading (ET) 3
    4. 4. The role of the Clean Development Mechanism (CDM) Advantages for developed countries: Developed countries can reduce emissions anywhere in the world They can count these reductions towards their own targets CDM allows developed countries to generate ‘carbon credits’ (Certified Emission Reductions, CERs) in developing countries relatively low-cost & politically acceptable Advantages for developing countries: inward investment, environmental & technology benefits 4
    5. 5. In 3 years, the CDM has sparked a $5 billion/year market Number of Projects in the CDM Pipeline, January 2005 – February 2008 3,035 2,838 2,593 Compound Monthly Compound Monthly Growth Rate = 13% Growth Rate = 13% 2,285 1,759 Approximately 3 billion Approximately 3 billion CERs by 2012 CERs by 2012 1,141 67 Jan 05 83 118 171 Mar May Jul 05 05 05 275 440 554 Sep Nov Jan 05 05 06 647 749 1,311 1,885 1,495 883 Mar May Jul 06 06 06 Sep Nov Jan Mar 06 06 07 07 May July Sep Nov Jan 07 07 07 07 08 5
    6. 6. How a CDM project generates carbon credits Greenhouse gas emissions Carbon credits (CERs) Carbon credits (CERs) represent the difference represent the difference between the baseline and between the baseline and actual emissions actual emissions Project start Project start Historical Trend Time 6
    7. 7. ‘Kyoto gases’ that can earn credits There are over 30 atmospheric greenhouse gases…But only 6 attract carbon credits: • Carbon dioxide (CO2) • Methane (CH4) • Nitrous oxide (N2O) • Perfluorocarbons (CxFx) • Hydrofluorocarbons (HFCs) • Relevant to biocarbon & industrial projects Sulfur hexaflouride (SF6) Relevant to industrial projects 7
    8. 8. Each of these gases has a different warming potential Each of these gases has a different ‘radiative forcing’ capability and a different atmospheric residence time Need for a ‘common currency’, so that all carbon credits are denominated in the same way Solution: develop a relative scale, using CO2 as a reference gas 8
    9. 9. Global warming potential Greenhouse Gas Greenhouse Gas (GHG) (GHG) Global Warming Global Warming Potential (GWP) Potential (GWP) Carbon dioxide Carbon dioxide 11 Methane Methane 21 21 Nitrous oxide Nitrous oxide 310 310 Perfluorocarbons Perfluorocarbons 6,500 ––9,200 6,500 9,200 Hydrofluorocarbons Hydrofluorocarbons 140 ––11,700 140 11,700 Sulfur hexafluoride Sulfur hexafluoride 23,900 23,900 Relative scale – everything is measured relative to CO2 e.g. methane is 21 times more potent as a greenhouse gas than CO2 e.g. sulfur hexafluoride is 24,000 more potent! 9
    10. 10. Global warming potential Greenhouse Gas Greenhouse Gas (GHG) (GHG) Global Warming Global Warming Potential (GWP) Potential (GWP) Carbon dioxide Carbon dioxide 11 Methane Methane 21 21 Nitrous oxide Nitrous oxide 310 310 Perfluorocarbons Perfluorocarbons 6,500 ––9,200 6,500 9,200 Hydrofluorocarbons Hydrofluorocarbons 140 ––11,700 140 11,700 Sulphur hexafluoride Sulphur hexafluoride 23,900 23,900 Carbon credits are always expressed in terms of ‘carbon dioxide equivalence’ (CO2e) e.g. 1 tonne of CO2 = 1 tCO2e (= 1 carbon credit = 1 CER) e.g. 2 tonnes of CH4 = 42 tCO2e (= 42 carbon credits = 42 CERs) e.g. 2 tonnes of SF6 = 47,800 tCO2e (= 47,800 carbon credits = 47.8 kCERs) 10
    11. 11. Additionality Environmental additionality – the project produces fewer greenhouse gas emissions than the baseline scenario It is essential that the project achieve environmental additionality – otherwise, it will not generate any carbon credits! However, the project developer must also usually demonstrate that, without carbon revenues, the project would not be viable and/or commercially attractive – this is known as financial additionality 11
    12. 12. Additionality – benchmark analysis Revenue / NPV / IRR Choose an appropriate financial indicator and compare it with a relevant benchmark value: e.g. required return on capital or internal company benchmark Investment threshold Project without carbon element Project with carbon element Carbon revenue Carbon revenue makes the makes the project attractive project attractive relative to relative to investment investment alternatives alternatives Project without Project without carbon revenue carbon revenue is profitable – is profitable – but not but not sufficiently sufficiently profitable profitable compared with compared with alternatives alternatives 12
    13. 13. Some examples of additionality  ?  Capturing methane from an urban landfill and flaring it — Carbon credits represent the only source of income for undertaking this activity Capturing methane from an urban landfill and utilizing it to generate electricity — Project developer would have to demonstrate that the electricity revenue alone would not make this project attractive Building a large hydro project for the grid in Ethiopia — Questionable additionality: there is already plenty of hydro activity in Ethiopia 13
    14. 14. Crediting period CDM mitigation projects • Project developers have two crediting period options: – A maximum of 7 years, which can be renewed up to 2 times (i.e. a potential total crediting period of 21 years) – A maximum of 10 years, with no option for renewal CDM sequestration projects (forestry) • Project developers have two crediting period options: – A maximum of 20 years, which can be renewed up to 2 times (i.e. a potential total crediting period of 60 years) – A maximum of 30 years, with no option for renewal 14
    15. 15. A maximum of 10 years with no option of renewal Greenhouse gas emissions Crediting period Starting date of Starting date of the crediting the crediting period period e scen baselin der the ons un i Emiss ari o Emissions under the project scenario 10 years No renewal No renewal 15
    16. 16. Agenda How do we evaluate climate change projects? The current project cycle Gaps in the evaluation process From projects to programs 16
    17. 17. 6 to 12 months CDM project CDM project development development // PDD PDD Host country Host country approval approval Project Project validation validation CDM Executive Board DNA Project Project feasibility feasibility assessment assessment // PIN PIN 1.5 months Crediting period of the project DOE Project Developer The CDM project cycle Project Project verification verification Project Project registration registration CER CER issuance issuance 17
    18. 18. 6 to 12 months CDM project CDM project development development // PDD PDD Host country Host country approval approval Project Project validation validation CDM Executive Board DNA Project Project feasibility feasibility assessment assessment // PIN PIN 1.5 months Crediting period of the project DOE Project Developer The CDM project cycle Project Project verification verification Project Project registration registration CER CER issuance issuance 18
    19. 19. 6 to 12 months CDM project CDM project development development // PDD PDD Host country Host country approval approval Project Project validation validation CDM Executive Board DNA Project Project feasibility feasibility assessment assessment // PIN PIN 1.5 months Crediting period of the project DOE Project Developer The CDM project cycle Project Project verification verification Project Project registration registration CER CER issuance issuance 19
    20. 20. 6 to 12 months CDM project CDM project development development // PDD PDD Host country Host country approval approval Project Project validation validation CDM Executive Board DNA Project Project feasibility feasibility assessment assessment // PIN PIN 1.5 months Crediting period of the project DOE Project Developer The CDM project cycle Project Project verification verification Project Project registration registration CER CER issuance issuance 20
    21. 21. 6 to 12 months CDM project CDM project development development // PDD PDD Host country Host country approval approval Project Project validation validation CDM Executive Board DNA Project Project feasibility feasibility assessment assessment // PIN PIN 1.5 months Crediting period of the project DOE Project Developer The CDM project cycle Project Project verification verification Project Project registration registration CER CER issuance issuance 21
    22. 22. 6 to 12 months CDM project CDM project development development // PDD PDD Host country Host country approval approval Project Project validation validation CDM Executive Board DNA Project Project feasibility feasibility assessment assessment // PIN PIN 1.5 months Crediting period of the project DOE Project Developer The CDM project cycle Project Project verification verification Project Project registration registration CER CER issuance issuance 22
    23. 23. 6 to 12 months CDM project CDM project development development // PDD PDD Host country Host country approval approval Project Project validation validation CDM Executive Board DNA Project Project feasibility feasibility assessment assessment // PIN PIN 1.5 months Crediting period of the project DOE Project Developer The CDM project cycle Project Project verification verification Project Project registration registration CER CER issuance issuance 23
    24. 24. 6 to 12 months CDM project CDM project development development // PDD PDD Host country Host country approval approval Project Project validation validation CDM Executive Board DNA Project Project feasibility feasibility assessment assessment // PIN PIN 1.5 months Crediting period of the project DOE Project Developer The CDM project cycle Project Project verification verification Project Project registration registration CER CER issuance issuance 24
    25. 25. Costs of a typical CDM project Pre-Registration CDM Costs Post-Registration CDM Costs 53,000 US$ 164,500 Assumes a 10-year Assumes a 10-year project. project. 34,000 111,500 10,000 77,500 67,500 16,500 38,000 51,000 13,000 Initial Monitoring Validation Indicative CDM Cost Profile For A ‘Typical’ CDM Project Ongoing Verification By DOE Ongoing Annual Monitoring Recurrent costs Recurrent costs discounted at 3% discounted at 3% annual rate to express annual rate to express in present-value in present-value terms. terms. Registration costs, Registration costs, Administration Fee Administration Fee and Adaptation Fund and Adaptation Fund Levy not included. Levy not included. PDD PIN 25
    26. 26. CER volumes from CDM projects 4.5m 970,000 Average Annual CER Production by CDM Project-Type 520,000 318,000 206,000 170,000 En So e la (h rgy r ou e se ffi ho cie ld nc s) y B io ga s W in Tr d an sp or t H yd ro em 2 O is si on R ef s or es ta tio La n En nd f er gy ill g a (p ef ow fic s er i en ) cy N Fu gi tiv e H FC s 83,000 79,000 74,000 54,000 26,000 18,000 26
    27. 27. Carbon revenues also vary on a project-by-project basis 7,934 7,934 Standard deviation Standard deviation (kCERs by 2012) (kCERs by 2012) Markers indicate maximum, mean and minimum project size within each technology 1,811 1,811 4,128 4,128 3,039 3,039 1,711 1,711 928 928 543 543 661 661 1,228 1,228 379 379 1,101 1,101 330 330 0 0 827 827 1,179 1,179 0 0 91 91 13 13 0 0 B io m as s en er g W y in H d yd ro G So eo th lar er m a Ti l d B al Ag io g R ric as ef ul o r tu C oa L est re l m an ati in dfi on e ll m ga et s Fo ha ss Fu ne il fu giti el v sw e C itch e Tr me an nt sp EE or ho P t us FC EE E eh s o E se in lds rv du i EE ce str y En su sec er gy pp tor di ly s st i rib de ut io n 234 234 762 762 27
    28. 28. Agenda How do we evaluate climate change projects? The current project cycle Gaps in the evaluation process From projects to programs 28
    29. 29. Limitations of current evaluation process  Each project is evaluated in isolation  Benefits outside project boundary are discounted  “Additionality” is difficult to define  NPV/IRR is the single metric  Impacts of leveraging and collateral on asset value are not fully considered
    30. 30. Limitations of CDM market  Projects are financed sequentially starting with those generating the most CERs at lowest cost  Bias towards funding larger stand-alone projects  Bias towards mitigation and away from adaptation  Monitoring is costly and often impractical -- flaw in project design leading to implementation problems  Lack of uniform registry of CERs
    31. 31. Lack of an “enabling environment”  Regulatory and institutional support is often lacking  Evaluation methods and guidelines are complicated  Markets for CERs often very “thin” internationally  Small countries and marginal populations unable to participate in CDM
    32. 32. Greenhouse gas emissions The crediting period is fixed Baseline must Baseline must be reassessed be reassessed by DOE at each by DOE at each renewal renewal Emissions under the baseline scenario The baseline The baseline scenario may scenario may become less become less favorable favorable Emissions under the project scenario 7 years 7 years 7 years 32
    33. 33. Agenda How do we evaluate climate change projects? The current project cycle Gaps in the evaluation process From projects to programs 33
    34. 34. Programmatic CDM offers new opportunities Regular CDM Regular CDM Size-Distribution of Potential CDM Project Sites •• Single site, stand-alone Single site, stand-alone projects projects •• ‘Carbon upgrades’ ‘Carbon upgrades’ Bundled CDM Bundled CDM Number of installations / units •• Bundling several Bundling several projects under a single projects under a single PDD PDD •• All projects must be All projects must be identified ex ante, and identified ex ante, and must start at the same must start at the same time time Programmatic CDM Programmatic CDM large medium Installation / unit size small •• Addresses the ‘long Addresses the ‘long tail’ of small units tail’ of small units •• Permits sector-wide Permits sector-wide transition to low-carbon transition to low-carbon economy economy •• Particular relevance to Particular relevance to non industrial sector non industrial sector 34
    35. 35. Greenhouse gas emissions Why not “optimize” the crediting period? Baseline must Baseline must be reassessed be reassessed by DOE at each by DOE at each renewal renewal Emissions under the baseline scenario The baseline The baseline scenario may scenario may become less become less favorable favorable Emissions under the project scenario 7 years 35
    36. 36. Leverage affects value of CERs      Incorporate collateral into evaluation models so that equilibrium determines leverage, not just rate of interest Variations in leverage causes fluctuations in CER values In absence of interventions, leverage becomes too high in boom times and too low in bad times “Natural buyer” hypothesis has been used in Macroeconomics to study financial cycles -- used to model market for CERs Provides guidance to regulators on when to restrict leverage
    37. 37. Figure 1: Overall Methodology for Energy Sector Analysis Step 1 Step 2 Step 3 Demand Forecast R eg ressi o n M et h od Least-cost Generation & Transmission Expansion (Using Horizon-year Plan) Planning Study S im u lat ion M od els Costs and Benefits Quantification W illingness to-Pay Energy Supply Incremental Step 4 Environmental Impacts Economic Analysis Sensitivity and Risk Analysis Bene fits Trans fer Method Spreadsheet Calculat ion

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