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Introduction to carbon finance

Overview

• Project-based emission reduction mechanisms have successfully attracted investment flows into low carbon projects, BUT:

they have mostly benefited large stand-alone projects in advanced developing countries

they are deemed insufficient to curb carbon emissions trends in emerging economies

• Small-scale and dispersed emissions reduction activities have suffered from limited access to the international carbon market due to high transaction costs

• Uncertainty on the future of Kyoto-based project mechanisms in the post-Kyoto era: scaling up or disappearing?

• In the medium-term:

increased focus on sustainability issues and geographical distribution

increased interest in voluntary markets, where demand is driven by consumer and CSR trends rather than policy

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Joint Implementation and Clean Development Mechanism

JI and CDM projects involve developing and implementing projects that reduce GHG emissions abroad, thereby generating carbon credits that can be sold on the International ET carbon market and other regulated markets such as the EU Emissions Trading Scheme.

These carbon credits generate an additional income stream for the project and provide a cost effective means of assisting Annex I countries and companies within those countries to meet their emission commitments.

• JI is a project mechanism where an Annex I country can benefit from emission reductions achieved through a project implemented in another Annex I country

Joint Implementation

(JI)

• CDM is a mechanism where an Annex I country can benefit from emission reductions achieved through a project implemented in a non-Annex I country (developing economies – China, India, South Africa…).

Clean Development Mechanism

(CDM)

• Parties with commitments under the Kyoto Protocol have accepted targets for reducing their emissions. These targets are expressed as “assigned amounts” over the 2008-2012 commitment period.

• Emissions trading allows countries that have excess emission allowances to sell them to countries that are struggling to meet their targets

Emission Trading Scheme (ETS)

CDM: how it works

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• The achievement of emission reduction projects by Annex I Countries (industrialized and economies in transition) in non-Annex I Countries.

• The achievement of projects allows to obtain “Certified Emission Reductions” (CERs)• CERs are credited to the investor Country and can be used for compliance• Legal entities authorized by Parties can participate in projects

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CDM approval cycle

Origination and preparation of the Project Idea Note (PIN) and Host Country Approval

Preparation of project documentation (PDD, Baseline Study and Monitoring Plan)

Validation process and other Parties approval

Periodic verification & certification (Verification report Supervision report)

Project completion

Registration by EB

Complex registration procedure to ensure transparency

Issuance

Time till registration

~ 18 months

Example CDM: Grid-connected generation from RES

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Registered projects>1000 large-scale> 900 small-scale

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

c

Example:

1 MW PHOTOVOLTAIC PLANT IN SOUTH AFRICA

-The plant displaces 1 MW on the grid, which would be otherwise produced by coal power plants (baseline for SA)

- The project will receive yearly an amount of credits proportional to the CO2 that the coal plant would otherwise emit in the atmosphere (~ 2000 credits/year)

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The role of the Clean Development Mechanism (CDM)

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

Advantages for developed countries:

relatively low-cost & politically acceptable

Advantages for developing countries:

inward investment, environmental &

technology benefits

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The Carbon Market, a “baby” already worth 150 bln $

Volumes and prices for Kyoto offset transactions (CERs and ERUs)

Source: World Bank

Size of the global carbon market

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CDM in numbers

• Total projects registered from 2006: over 5000

• Amount of CERs expected: approx 3.000.000 kCERs

• Uneven regional distribution - Africa is an unexploited market for CDM

Total cumulated CERs by project-typeRegistered CDM projects (2003-2010)

Number (%) of CDM projects in each category

HFCs, PFCs & N2O reduction

2%

Renewables60%CH4 reduction &

Cement & Coal mine/bed

20%

Supply-side EE11%

Fuel switch2%

Demand-side EE4%

Afforestation & Reforestation

1,0% Transport0,4%

Africa:2%

Middle East & North Africa (MENA):

1%

Asia & Pacific:80%

Latin America17%

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POST-2012 perspectives

• Although there is still uncertainty about a new global climate deal, Cancun provided encouraging signals

• CDM is a self-financed mechanism, so it can survive as long as there is demand for credits (no Kyoto-2 is needed)

• Increased focus on African countries

“…the Kyoto framework allows the CDM to continue beyond 2012, even in absence of a 2nd commitment period.. Environmental integrity of CDM must be improved and its use as an offsetting mechanism should be increasingly focused on Least Developed Countries”Comm. Hedegaard, DG CLIMA, EU Commission, Sept. 2010

• In the EU-ETS (the main source of demand for credits today) the post-2012 scenario in case of no global deal is already set:• Use of credits from projects registered before 2012 will be allowed through 2020• Projects registered after 2012 will be allowed if:

• located in Least Developed Countries• within the framework of bilateral agreements between EU and third countries

Post-2012 perspectives: LDCs

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• Currently <1% of developing country emissions, BUT• Robust economic growth provides emission mitigation opportunities

• Generation Capacity additions >150 GW

• Potential CO2 emission savings >700 Mt/year against BAU

Scaling up CDM: Programmes of Activities (PoAs)

• Registered PoAs are applying project types that are considered as rather complex within the CDM.

• This trend is confirmed by projects applying for registration. PoAs allows for an overall reduction of CDM transaction costs for project types with a high number of appliances in dispersed areas

• Typical projects are:• efficient lightning (CFL) • improved cooking (stoves) • Off-grid renewables• Methane avoidance

Source: KfW

POA regional trends

POAs can enhance geographical distribution of carbon finance

Source: KfW