carbon risk management – post 2012 and beyond

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Results, Discussion and Conclusion of the Dissertation

What are the Risks to Carbon Credit Projects Post 2012Kyoto Protocol?

by Dean Skivington

The focus of the research is to explore the current project risks and use the known

data and risk management tools, as well as use deterministic and stochastic ap-

proaches, in scenario-based concepts.

The research questions are:

1. What are the current risks for carbon credit projects under the Kyoto Protocol?

2. How are these known risks being managed?

3. What risks are to be expected for the post 2012 regime?

4. How can these predicted risks be managed?

After a brief introduction to the topic, a comprehensive literature review on availablebooks and articles on the topic was written (not included in this paper), which looked

firstly at the Kyoto Protocol, the carbon credit, market, the risks of the carbon market

and explores risk management procedures. It also discusses the Kyoto Protocol post

2012 and gives an outlook of the situation in the future. After the literature review the

methodology states the research method, design and process (not included in this

paper). The third part of the dissertation and first part to be included in this paper is a

summary and comparison of the results of the primary research. The analysis of the

results includes the suggestion of three scenarios for three different periods of time.

A worst-case scenario, an ideal situation and a realistic situation are explained for

three periods: up to the end of 2012, 2013-2015 and 2016-2020. The second part of

this paper looks back at the literature review and at the fieldwork and discusses simi-

larities and differences. The last part of this paper is the overall conclusion of the re-

search project, which incorporates recommendations for the industry as well as fur-

ther research.

Comment [IE1]: Between what and what?


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Dean Skivington 2

Results

Review of the Questionnaires

A research was conducted to understand the Kyoto Protocol, the carbon markets and

the role and risks faced by the carbon projects in current markets and post 2012 sce-

nario, when the first phase of the Kyoto Protocol comes to a closure. Seven profes-

sionals involved in the carbon markets were requested to share their views via a

questionnaire. The respondents were:

Juned Khan, Royal Climate Care, Royal International Federation and other

boards

Chris Charge, Biogas Technology Ltd

Fergal Mee, Carbon Action

Phil Smith, Hoshin

Richard Selby, Global Carbon Ukraine

Anonymous

Walter Gama Barboza, B & G Empreendimentos/B & B Ambiental

The questionnaires are annexed at the end of the document for reference. The fol-

lowing sections briefly review their comments:

How has the Kyoto Protocol changed the situation of climate change?

Kyoto Protocol has changed the situation of climate change by creating environmen-

tal awareness, establishing a carbon credit market, supporting infrastructure devel-

opment in implementing projects and in bringing more finance to developing econo-

mies. Out of seven respondents, three mentioned the creation of awareness about

the environment as Kyotos largest impact on climate change. Three respondents

also mentioned that Kyoto Protocol has impacted the climate change by creating

carbon markets/carbon credits. A few respondents mentioned more than one way in

which Kyoto Protocol has changed the climate change situation.

Comment [IE2]: The completed questionnair


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Dean Skivington 3

What impact did the Kyoto Protocol have on the carbon market?

All the respondents believe that the Kyoto Protocol has had a direct impact on the

development of the carbon markets, with two pointing out that Kyoto Protocol hasbeen instrumental in developing carbon as a marketable commodity.

Some quotations from the respondents are:

The carbon market could not exist without Kyoto.

To a large extent Kyoto is the carbon market.

Without Kyoto Protocol there would be no carbon market.

Kyoto Protocol is the originating point of carbon markets.

Has Kyoto Protocol been successful?

On being asked if the Kyoto Protocol had been successful, only two respondents out

of seven gave a definitive yes, while the rest could not give a definitive answer and

mentioned sectors where the Kyoto Protocol has been successful and other areas

where it has not performed. Three respondents mentioned that the Kyoto Protocol

has been successful in creating awareness, while the reasons for its failure were giv-

en as ripe with corruption and projects have limited impact.

Figure 6: Result Success of the Kyoto Protocol

Has Kyoto Protocol been

successful?

5

2 No definitive

answer

Yes


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Dean Skivington 4

How do you see the future of Kyoto Protocol post 2012?

The views on the future of the Kyoto Protocol post 2012 seem divided, with onlythree respondents giving a definitive yes. One respondent answered with a defini-

tive nothing, meaning no future, while anothersaw only a limited future for the

Kyoto Protocol post 2012. The remaining two respondents believed that the future of

the Kyoto Protocol will largely depend on the future developments and the new

mechanism that is developed post 2015.

The current financial crisis in Europe is seen as the reason behind the death of

Kyoto Protocol, as nobody is going to take the lead. Post 2012 the Kyoto Protocol

may exist in the form of a carbon market, which is seen to be from Kyoto. Even if

Kyoto Protocol is not renewed as an international treaty, the market will see a rise in

bilateral and multilateral trades in carbon credits.

Figure 7: Result Future of the Kyoto Protocol

What alternatives are there to the Kyoto Protocol?

As an alternative to Kyoto Protocol, three respondents clearly suggested that bilateral

arrangements like carbon trading agreements and Clean Development Mechanism

(CDM) loan schemes may be developed. The bilateral arrangements, which may be

United Nations (UN)-brokered, would replace the global platform. It is suggested that

in absence of an international binding protocol:

A voluntary market may emerge which gives incentives to buyers

Future of Kyoto Protocol Post

2012

3

1

2

1Yes

No

To be seen

Limited Future

Comment [IE3]: To what question?


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Dean Skivington 5

The private sector infrastructure will be replaced by non-governmental organi-

sations (NGOs)

Bilateral agreements may be developed

New derivative schemes from Kyoto Protocol, like Nationally Appropriate Miti-

gation Actions, CDM loan schemes that focus on sustainable development of

poor countries, could be created

Emission taxes could be introduced

What are the known risks for carbon credit projects?

The respondents pointed out the following as the known risks for the carbon credit

projects:

Activities not supported by the policies

National levels of governance

Regulatory hurdles

Lack of robustness of any Measurement, Reporting and Verification (MRV)

system

Fraudulent projects

Seen as free money

Favouring wrong projects

Credibility of carbon accounting practices

Market failure due to over supply

Price of carbon credits

Risks associated with verifications and the approval process

These can largely be grouped as follows:

Fraud risks: This can occur in fraudulent projects, fraud accounting practices and

the fact that the free money has attracted many non-deserving projects and politi-

cians.

Regulatory risks: These risks are process-related and include the risks in verifica-

tion and approval process, and the dependence of a project on the national regula-

tions and governance system of country where the project is being implemented

Comment [IE4]: Your wording implies that th

is an explanation ofNationally Appropriate Mitig

tion Actions: is this correct? The abbreviation has

been removed because it is not subsequently use

Comment [IE5]: What is?


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Dean Skivington 6

Market risks: These include risks associated with market failure due to oversupply,

too much price fluctuation, and very low carbon prices.

What mechanisms are in place to control existing risks?

The lack of effective risk control mechanisms is visible in the fact that three respond-

ents clearly mentioned that they were not aware of any mechanisms that are in place

to monitor and control the existing risks. Three respondents believe that the systems

set up by the UN, such as their programs, standard methodologies, approval mecha-

nisms, monitoring systems and permissions for accredited entities, actually function

as risks, monitors and controllers. The remaining one respondent mentioned the use

of due diligence tools for monitoring and controlling the existing risks while finalising

the Emission Reduction Purchase Agreement.

Figure 8: Result Mechanisms to Monitor and Control Risk

What are the predicted risks for carbon credit projects post 2012?

The risk of market collapse in the near future was seen as the biggest risk factor pre-

dicted for the carbon projects, with four respondents discussing its collapse, partly

ascribed to low Carbon Emission Reduction (CER) prices, in their answers. The other

predicted risks for the carbon credit projects, as mentioned by the respondents, are

as follows:

Financial companies that fail to meet their environmental goals

Still existing market for fossil fuels

Mechanisms to Monitor and Control the

existing Risks

3

3

1Not Aware

UN programs

and initiat ives

Other Tools


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Dean Skivington 7

Risk of fraud

Low carbon prices

Delay, performance and compliance risk

Figure 9: Results Predicted Risks for Projects Post 2012

What mechanisms are in place to protect carbon projects post 2012?

Respondents were divided on the mechanisms in place to protect carbon projects

and their stakeholders post 2012, with three respondents being optimistic that the

new improved mechanisms developed for the second commitment period will have

mechanisms in place to protect carbon projects and their stakeholders post 2012,

while two respondents say that they do not see any safety mechanisms in place (es-

pecially for new projects, as the existing ones still have some time left to run), and

one respondent saying that the mechanisms are not effective anyway.

Other mechanisms that are in pace to safeguard carbon projects post 2012 are the

credibility of projects, the existence of voluntary markets, and own mechanisms.

What are the incentives to take on the carbon credit projects?

The incentives to take on the carbon credit projects that have been listed by the re-

search respondents are as follows:

Economic (including tax incentives, project financing, a revenue source)

Corporate Social Responsibility (CSR) benefits for companies

Predicted risks for carbon credit projects post

2012

1

14%

4

58%

1

14%

1

14%

Failure to meet

goals

Low CER prices/

Market collapse

Fraud

Delay, performance

and compliance

risks

Comment [IE6]: This figure is very small: can

you make it larger so it can be read more easily?

Comment [IE7]: What do you mean?


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Dean Skivington 8

Energy savings/environmental

Minimal benefits

Regulated market

Technological

Out of these, economic benefits (including tax incentives, project financing, and a

revenue source) and CSR benefits for a company are seen as the largest set of ben-

efits: each of these were mentioned by five respondents out of seven. The second

biggest benefit is that of energy savings and the related environmental benefits, men-

tioned by three respondents out of seven.

Figure 10: Results Incentives to Take On Projects

Is it worth taking up carbon credit projects?

The respondents were divided in their opinion on whether it is worth taking on the

risks of a carbon credit incentive project, with two agreeing, two disagreeing and the

remaining three saying that the answer depends on the project conditions (national

and international political considerations, quantities of carbon generating potentialand broader economic development).

Incentives to take on carbon credit

projects

32%

31%

19%

6%6%6%

Economic (including

tax incentives,

project financing, a

revenue source)CSR

Energy

Savings/Environmen

tal

Regulated market

Technological

Minimal Benefits

Comment [IE8]: Environmental what?

Comment [IE9]: Technological what?

Comment [IE10]: Again, can you make the

figure larger?


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Dean Skivington 9

Figure 11: Results Risk versus Rewards

How do you see the future of carbon credit projects?

Only three respondents out of seven said they were optimistic about the future of

carbon credit projects in general. While three did not answer the question directly and

said that the future of these projects is dependent on many variables such as the

economic crisis in European Union (EU) and future policies, one respondent said

they say that there was no future for carbon credit projects under the current system.

As a way forward for the carbon industry, the following are possible:

Creating an improved industry that is flexible enough to undergo transfor-

mations every six months

Increasing the participation of institutional investors rather than small scale

carbon outfits

Developing a private international voluntary market

Diversifying the plan

Internationalising the disparate Measurement, Reporting and Verifications

Developing carbon market by identifying sellers and buyers

Utilising available and upcoming market based mechanisms

Is it worth taking on risks of a carbon

credit incentive project?

2

2

3Yes

No

Depends


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Dean Skivington 10

Figure 12: Results Future of Carbon Credit Projects

What is the way forward?

There was no overwhelming common ground in the way forward suggested by the

respondents; however, the tone seems to suggest that the best way forward will be to

utilise the already established mechanisms and modify them to make them more flex-

ible in adapting to global changes, including institutional investors and developing

systems to prevent fraud and corruption (maybe through privatisation).

What other agreements exist?

The role of other agreements such as Durban 2015 and Europe 2020 is still largely

seen as ambiguous. Only two respondents out of seven expressed optimism about

these agreements, and with a word of caution that these agreements are largely

aspirational and somewhat diluted in their focus. The remaining respondents were

vary of their role as they believed that the importance of these agreements will lar-

gely depend on whether emerging economies like India and China agree to curb their

emissions.

The Way Forward: Three Scenarios

Based on the desk research conducted and the primary research through question-

naires, three scenarios can be developed: the worst case, best case and the most

realistic case. Since the current condition with the global climate change regime is so

unstable, these three scenarios can be applied to three different time periods in an

Future of carbon credit projects ingeneral

3

43%

3

43%

1

14%Optimistic

Depands

No future

Comment [IE11]: This is not clear.


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Dean Skivington 11

attempt to better understand the three possible scenarios. These different time peri-

ods are until the end of 2012, 2013-15 and 2016-20.

Table 3: Three Scenario Timeline

Period up to the End of 2012

The current carbon market is very unstable and it is possible that three different sce-

narios emerge by end of 2012, depending on the circumstances. The major influenc-

ing factors being the EU collapse, the current economic crisis and the unwillingness

to major emerging economies like India and China to sign the treaty.

In the worst case scenario, it is possible that the whole carbon market will collapse.

As the future of the carbon projects is currently so unstable, investors are reluctant to

invest in the market. As pointed out by one of the questionnaire respondents, even

with the existence of their own companys risk assessment mechanisms, the inves-

tors are reluctant to invest in any new carbon projects. Under this scenario, in ac-

cordance with the current trends, the price of the CERs and Voluntary Emissions Re-

ductions (VER) continues to drop, ultimately making it economically worthless for

investors to invest in a carbon project. The numbers of fraudulent projects may in-

crease (or stay as high as it is now, especially in Russia), further reducing the credi-

bility of the carbon investments and the related portfolios.

The volatile political and economic scene will divert the attention of nations from that

of climate change to maintaining their Gross Domestic Product (GDP). The voluntary

sector will also see a drop, along with the compliance sector, resulting in the com-

plete breakdown of the carbon sector. In the absence of compliance and VER, coun-

Comment [IE12]: Is this a reference to the

euro?


12/30

Dean Skivington 12

tries continue to pollute (or at least do not decrease their pollution levels substantial-

ly), resulting in further environmental degradation.

In the best case scenario, the political and economic instability will not impact the

climate change efforts. Countries continue to invest in infrastructure development to

reduce consumption of fossil fuels (like closing down coal power plants etc.) along

with other more holistic efforts. As a result, the carbon projects will see a natural pro-

gression from 2012 to the next period of a renewed Kyoto Protocol. The new projects

attract investors, just as the existing projects will continue to receive funding.

In the most realistic scenario, the investors will wait and watch. The existing car-

bon projects will not be affected; however, the new projects might not attract inves-

tors. The current trend of decrease in carbon prices will continue, with an increase in

the volumes of carbon credits generated. The 803 registered CDM projects (2007),

generating 168 MCERs per annum, are expected to add up to 1,070 MCERs up to

end of 2012.

Figure 13: CDM Pipeline (November 2010)

Source: CGES (2010)

2013-2015

This phasewill be the most unstable phase, as a new international agreement with

legal force to reduce Green House Gas (GHG) emissions will be finalised by 2015, to

come into force


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Dean Skivington 13

after 2020.

In the worst case scenario, the governments of different countries will fail to agreeon any formal agreement in setting targets to reduce GHG emissions. The top pollut-

ers, including India and China, will not agree to bind themselves to the target re-

ductions. As no nation will agree to lead, there will be complete breakdown of the

existing climate change discussions. The existing European economic crisis and the

near failure of the first phase of Kyoto Protocol in achieving actual emission reduc-

tions are seen as the major factors here.

The carbon prices will continue to drop in this phase, due to an oversupply of credits

generated from projects started before 2012.

The risks to the existing projects, for example the existing market for fossil fuels, the

risk of fraud, low carbon prices, and delay, performance and compliance risk, would

not have been mitigated. This increase in risks in absence of substantial risk as-

sessment and management mechanisms will defer investments in new carbon pro-

jects. Various insurance products, like Energy Savings Insurance (ESI), Credit Deliv-

ery Insurance (CDI) etc., and the establishment of various funds to support GHG mit-

igation projects in dealing with their associated risks, such as the post-2012 Carbon

Credit Fund, the Internation Finance Corporation (IFC) post-2012 Carbon Facility and

the World Bank Carbon Finance Unit (CFU), will not prove to be very effective as

they may be too little to save the market, resulting in the loss of credibility of the car-

bon market.

In an ideal scenario, 2013-2015 will see the global national governments come to-

gether and sign a binding treaty by 2015. This treaty will be formally applicable from

2020 and will bind all countries, including industrialised countries and the emerging

economies like India and China, in agreeing to reduce their emission levels or pay afine for not doing so. Even though the agreement will formally come into force from

2020, it will stabilise the carbon market, encouraging investors to invest in carbon

projects. The carbon markets will continue to develop with carbon value on an in-

crease.


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Dean Skivington 14

The projects will see proper risk assessment and management systems/mechanisms

in place, like well designed insurance products, funds aimed to cover various projects

risks, and the standards/policies developed to protect projects from already knownrisks like fraud, corruption in system, standardisation of systems to reduce delay and

performance related risks and importantly deciding the role of national governments

in these projects. In an ideal situation, the investment finance to establish and im-

plement carbon projects will not be seen as free money, and the investments will

actually support sustainable development in the region.

A voluntary carbon market will also develop parallel to the compliance market. With a

healthy competition between compliance and voluntary carbon market, the carbon

prices will increase, attracting more and varied investors.

Figure 14: Growth of Compliance and Voluntary Carbon Markets

Source: SKM (2012)

In the most realistic scenario, it is understood that the nation members may not

come to an agreement and an international global treaty may not be signed. Howev-

er, this global platform will be replaced by bilateral and multilateral trades (which

could be UN-brokered or not), as pointed out by respondents optimistic about the

Comment [IE13]: Will it be possible to read t

print here, once the dissertation is printed?


15/30

Dean Skivington 15

future of Kyoto Protocol, and the carbon markets will still exist. In the absence of an

international binding force, voluntary carbon markets will arise and CERs will be re-

placed by VERs.

The voluntary market will see further development, with investments coming in from

corporations, and other entities looking to make themselves carbon-neutral. Now that

corporations globally have realised the importance and benefits of a robust CSR poli-

cy, corporations will push the carbon market through VERs. The current recession

and EU breakdown will not be impact this as this scenario will be pushed by private

sector and NGOs.

The 803 registered CDM projects (2007) are generating 168 MCERs per annum, and

are expected to add up to 1,070 MCERs to 2012. Most of these projects will continue

to generate CERs even after 2012, the exact quantity depending on the crediting pe-

riod of the projects.

2016-2020

In the worst case scenario, this phase will see a further breaking down of carbon

projects and the carbon market will cease to exist. The existing projects will not be

renewed and new projects will not f ind investors, cutting down investment in develop-

ing countries.

In an ideal situation, this time period will see the member countries reaching a con-

sensus that all the major carbon emitters, along with the developed countries, bind

themselves to reduce and regulate carbon emissions. This will see the carbon mar-

kets stabilise, as the CDM projects are implemented globally. The risks faced by the

carbon credit projects will be reduced considerably, such that, under an integrated

international market, trading will become more transparent.

The new international agreement which will be designed to overcome the shortcom-

ings of the existing Kyoto Protocol will be more inclusive (in terms of sectors), and be

flexible such that it can be modified according to the fast-changing political and eco-

nomic circumstances globally, as pointed out by respondents optimistic about the

furture of Kyoto Protocol. Based on Rio 2020, the new agreement will be holistic in its

approach and will tackle poverty reduction and economic growth, climate and clean


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Dean Skivington 16

energy, food security and sustainable agriculture, water, healthy seas and oceans,

biodiversity, healthy forests and ecosystem services. The existing Kyoto Protocol is

often criticised for the fact that it is based on a flawed concept, such that it instead ofactually reducing emissions, it allows industrialised countries to evade the responsi-

bility by buying the credits from the developing countries. It is expected that in its

new form, the climate change treaty that will come in force after 2020 will learn from

this and will devise measures to counter these issues.

In another possibility, if the countries do come together to sign a treaty, and the new

version of Kyoto Protocol is similar to the existing system, then the CDM will remain

the most influential tool, with a support role from other flexible mechanisms like the

Joint Implementation (JI) and International Emissions Trading (IET).

In the most realistic situation, the 2016-2020 period will still face political instability;

however, the bilateral and multilateral carbon agreements will come into play. Even

as the countries keep the discussions on climate change and the need to curb GHG

emissions alive, it is expected that a formally binding treaty will not be signed and

agreed by all parties (including China and India).

The EU will continue its emission trading until at least 2020, as it has already intro-

duced policy and has regulatory measures in place; the developing countries will be

impacted as they will receive limited investments for their carbon projects from de-

veloped countries. In the absence of a single market, the regional carbon trading

markets will become stronger and each will have its own set of eligibility criteria and

carbon prices. Under these conditions, it will be a buyers market as the sellers will

need to look for the best price offers. The carbon credit projects will face greater risks

under this scenario.

Comment [IE14]: Can you be more precise?

Comment [IE15]: Can you expand this point


17/30

Dean Skivington 17

Figure 15: Potential Growth in Carbon Market in $ Trillion

Source: Forbes (2010)

Discussion

The Kyoto Protocol has beyond a doubt impacted the situation regarding climate

change. The actions of the Kyoto Protocol has, arguably, reduced GHG emissions,

encouraged its members to develop policies supporting energy efficiency, and pro-

moted the development of renewable sources of energy, along with sustainable

forms of agriculture. The literature also supports the contention that the Kyoto Proto-

col has encouraged technological advancements through the exchange and transfer

of low-carbon technologies to developing countries. Its largest contribution to manag-

ing climate change has been its mechanisms, like CDM and JI, and setting up and

mobilising environmental monitoring and verification systems.

The Kyoto Protocol has attempted to tackle global warming by reducing GHG emis-

sions. To achieve this, a mechanism of carbon trading has been established whereby

the member nations can exchange carbon credits. A nation that is emitting GHG in

excess of its allowable limit can buy carbon credits. Each unit of tradable credit

(CER) is equivalent to one ton of Carbon Dioxide Equivalent (CO2-eq) reduced in Comment [IE16]: See note above on the deftion of this abbreviation.


18/30

Dean Skivington 18

comparison to the established baseline. The Kyoto Protocol has developed the car-

bon market through its mechanisms of CDM and JI, amongst others. It has had a

direct impact on the carbon markets. In fact, according to this survey, the carbonmarket would not have existed without the Kyoto Protocol.

When the questionnaire respondents were asked about their opinion on the impact of

the Kyoto Protocol on climate change, the two strongest impacts mentioned were the

generation of environmental awareness and the establishment of the carbon credit

market. The other impacts of the Kyoto Protocol, according to the survey, were its

support for the development of infrastructure in developing countries for project im-

plementation, and in attracting more finance into the developing economies. In fact,

Kyotos role in actually reducing the GHG emissions was questioned by one of the

questionnaire respondents.

The success of Kyoto Protocol is very debatable. The results from the survey were

largely negative, with only two out of seven respondents answering a clearyes. The

only area where the Kyoto Protocol is believed to have been successful is in creating

awareness regarding climate change issues. Existing literature on this largely agrees

with this finding of the survey, as the Kyoto Protocol is seen to be successful in being

the first step and providing the platform for future climate change regimes. The

emission targets set up by the Kyoto are anyway not adequate to meet todays cli-

mate change challenges. To deal with the current levels of emissions, reductions of

up to 85 percent by industrialised countries by 2050 are required: the Kyoto Protocol

currently demands a reduction of just 5 percent. So, the Kyoto Protocol was, from the

beginning, not designed effectively to have any actual impact. It has received criti-

cism from the beginning for setting its GHG reduction targets significantly too low. It

is suggested that as the first commitment period of the Kyoto Protocol comes to an

end, a new treaty should be devised (for implementation post 2020) that includes the

following three conditions:

The participation from all polluting members, globally

A substantive enough emissions cut to have an impact on the current climate

condition

Enforcement effective enough to deter any non-compliance

Comment [IE17]: Can you expand on this po

Comment [IE18]: To what question?


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Dean Skivington 19

The carbon credit projects have many associated risks, which can be largely grouped

into fraud risks, regulatory risks and the market risks (derived from our survey). How-

ever, the Kyoto Protocol has set up various mechanisms to control and assess risksto make the whole process of carbon trading effective.

Risk management mechanisms: the way forward

According to the finance theory, the carbon markets contain both systematic risks

(risks affecting the entire market) and unsystematic risks (risks specific to a particular

project or entity). Systematic risks such as the impact of the recent financial crisis

and the macro regulatory framework are extremely important and must be addressed

at an appropriate level. Development of more sophisticated risk management pro-

cesses, tools and products is important because these will, over time, attract a

broader range of investors and greater capital flows to help fight climate change.

It is possible to take the risk management forward by adopting various measures,

which are listed below:

Figure 16: Risk Management Mechanisms

Insuranceproducts

Carbon

funds

Regulatory

uncertainty

Uncer-

tainty

about

Green fund

Project

implemen-

tation risks

Additionally

aspects

Risk Man-

agement

Mechanisms

Comment [IE19]: Why are you including this

long quotation here? How is it worked into the

argument?

Comment [IE20]: Uncertainty about the pos

2012 seems incomplete.


20/30

Dean Skivington 20

Insurance products

Based on the findings from the questionnaire, the risk management mechanisms cur-

rently in place include systems set up by the UN, such as their programmes, stand-ard methodologies, approval mechanisms, monitoring systems, and permissions for

accredited entities, and due diligence tools.

None of the respondents mention insurance products and specialised funds intro-

duced in the market to counter the risks for carbon projects, both current and post

2012. These are considered in the literature review. Leading insurance companies

have responded to the risks in the market by offering specific products:

RNK Capital LLC and Swiss Re have jointly implemented a carbon offset insurance

product for managing Kyoto Protocol-related risk in carbon credit transactions. The

policy provides coverage from failure to deliver the agreed number of emission rights,

risks related to delays in registration and certificate issuance of CDM projects.

The Kyoto multi-risk policy offered by Munich Re is designed to cover losses that oc-

cur if the investor has to deliver the credits in to a secondary market or is forced to

comply with reduction requirements due to the non-deliverance of the carbon credits.

Carbon Credit Delivery Insurance by AIG Inc covers technological, political or credit

risks. AIG is also developing carbon credit insurance endorsements, renewable en-

ergy certificate insurance, and forest carbon sequestration insurance.

Carbon funds

Carbon funds are a significant feature of the carbon market, especially CERs and

ERUs, and can serve as a tool for risk management. A carbon fund is a vehicle to

pool investments in the carbon market and their structure and role vary. Some focus

exclusively on purchasing CERs and/or Emission Reduction Units (ERUs) for com-pliance use by their investors. Others purchase allowances and credits and hope to

resell them at a higher price. More recent funds take equity stakes in emission reduc-

tion projects and provide both financial returns and credits to their investors.

Comment [IE21]: Used by whom?


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Dean Skivington 21

To lower the uncertainty associated with period after 2012, when Kyoto Protocol

creases to be in effect, various carbon funds have been developed to support carbon

credit projects.

The funds are as follows:

The Post-2012 Carbon Credit Fund, established in 2008, has EUR 125 million avail-

able to invest in carbon credits projects that were expected to be produced from 2013

to 2020, from GHG-reducing projects, either directly financed by the IFC or by local

banks financed by IFC.

The IFC Post-2012 Carbon Facility offers financial products to help mitigate risks in

the carbon market by absorbing the risks associated with long-term projects and

credit risks in the emerging markets. The facility provides advisory services and up-

front loans to projects earning income from sales of carbon credits.

World Bank Carbon Finance Unit facilitates the financial reward through carbon cred-

its for the reduction of GHG emissions by emitters in developing countries.

Figure 17: Growth Graph of Carbon Funds and Facilities at the World Bank

Source: World Bank (2012/1)


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Dean Skivington 22

Figure 18: World Bank Carbon Finance Projects Worldwide

Source: World Bank (2012/2)

These carbon funds propel much needed finance into the carbon credit projects and

in a way helps in the risk management.

Uncertainty about the post-2012 regime

There is a lot of uncertainty in the market; this which is leading to a decline in the

carbon market. The value of emission reductions after 2012 is uncertain, so projects

with longer payback periods become progressively less attractive, reducing the flow

of new projects.

The world community can take the risk management forward by bringing in strong

environmental legislation which will restore the confidence of the public and lead na-

tions to invest in carbon projects.

Regulatory uncertainty

Another potential mechanism for managing risks is managing regulatory uncertainty.

With over 68 developing countries participating in the CDM, managing the implemen-

tation capacity of each of them becomes very difficult, especially for the buyer. Each

Comment [IE22]: Can you be more specific

here?

Comment [IE23]: carbon trading?


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Dean Skivington 23

host country has a different risk profile, infrastructure to support CDM projects, rules

and regulations on CDM project developments covering taxation, CER ownership

rights, floor pricing, grid feed-in tariffs, government funding and interpretation ofsus-tainable development. Mechanisms are required to stabilise this regulatory risk by

establishing a clear and efficient process for host country approval.

China is an excellent example, as the supplier of over 53% of global CERs. In the

last three years it has invested in provincial and county level CDM centres, focused

on capacity-building and given strong guidance on tax and floor pricing regulations.

CDM project monitoring, methodology and implementation risks

A CDM faces different risks at different stages of its development. Implementing a

CDM project requires technical skills and an experienced team. The project team

should have a financially robust project, along with the knowledge of the generation

and delivery of CERs, and the cycle that ultimately leads to the issuance of carbon

credits, etc. This can be very demanding, as the project owner is usually kept busy

with the core business.

A project undergoes a very rigorous process of validation, registration, verification

and investigation before the CERs are made available to the buyers in the carbon

markets. The following illustration shows the steps involved. Each of these steps has

underlying risks associated with them.

Comment [IE24]: Can you give a page numb


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Dean Skivington 24

Figure 19: The CDM Project Cycle

Source: CO2 Focus (2012)

The monitoring risks faced by the CDM projects were brought forward in the re-

sponse received for the questionnaires. Even a registered project is required to un-

dergo verification and be subject to on-going and regular performance checks

against the monitoring plan. A project that issues CERs one year will not necessari-

ly, left to its own devices, issue CERs the next year; and post registration there are

very real technical risks that need to be tackled in project operations to ensure con-

sistent CER issuance. The monitoring systems must work in accordance with the

monitoring plan and if they do not, then a project can encounter further delays due to

a need to submit for a revision or to change the monitoring system itself.

Risks related to aspects of additionality

The concept of additionality was not discussed by any of the respondents, either as a

drawback/risk to the projects or even as the risk management mechanism. However,

the literature review brings forward the need to reconsider this aspect in the new pro-

tocol. The concept of additionalitycreates confusion within industries about the

seemingly arbitrary judgments of how similar projects in different countries or even

geographic locations are judged under different rules. As such, the goal of the CDM

with respect to additionality may warrant reconsideration. Future iterations of CDM

Comment [IE25]: Will the words in the figur

be legible once the dissertation is printed?

Comment [IE26]: Page number?


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Dean Skivington 25

and developments of Executive Board regulations would do well to reconsider their

goals for additionality and their mechanisms for achieving it.

The demonstration of additionality is an important feature for maintaining the integrity

of a CDM project. The concept of additionality, initially introduced in Article 12.5(c) of

the Kyoto Protocol and paragraph 43 of the modalities and procedures for the CDM,

refers to the question whether the proposed project activity would lead to a reduction

of anthropogenic emissions of GHGs by sources below those that would have oc-

curred in the absence of the registered CDM project activity.

To be able to maintain a consistent approach for demonstrating the additionality as-

pect, the board approved the tool for the demonstration and assessment of addition-

ality (the additionality tool) and the combined tool to identify the baseline scenario

and demonstrate additionality (the combined tool). Both these tools follow a gener-

ic approach of including an assessment of consistency with laws and regulations, an

investment analysis, a barrier test, and a common practice test. The additionality

aspect should be seriously considered in the decision to proceed with the project

(prior consideration). Although not mandatory, additionality has been a very im-

portant consideration in selecting CDM projects.

The carbon credit project may face an additionality risk, post 2012, depending on the

decision of the new protocol on the eligibility criteria for a project, especially the crite-

ria ofadditionality for the avoided deforestation projects.

As a way forward, the additionality factor needs strengthening. In fact this has al-

ready been addressed. The CDM Executive Board (the Board) has been requested

(the request was made during the Conference of Parties (COP) serving as the meet-

ing of the parties to the Kyoto Protocol, at its seventh session in Durban, South Afri-

ca) to continue ensuring environmental integrity when developing and revising base-

line and monitoring methodologies and methodological tools, in particular by consid-ering possible ways of improving the current approach to the assessment of addi-

tionality, in order to provide clarity to encourage project activities in the private sector

and the public sector. In response to this request, the board included the project

Improvements in the demonstration of additionality (project 164) in its 2012 CDM

management plan (CDM-MAP). The CDM-MAP further specifies that the secretariat

Comment [IE27]: Who are you quoting?

Comment [IE28]: What is this a reference to

this the CDM Executive Board mentioned below?

Comment [IE29]: Why is this?

Comment [IE30]: Who are you quoting?


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Dean Skivington 26

should prepare a concept note on possible improvements in the demonstration of

additionality.

United Nations Framework Convention on Climate Change (UNFCC) suggests that

innovative approaches to demonstrate additionality could be developed and adopted,

highlighting the need for objective and simplified approaches to demonstrate addi-

tionality, while acknowledging the difficulties in identifying appropriate innovative ap-

proaches. UNFCCC makes the following suggestions and recommends to prioritise

work on both the improvement of the existing approaches and the development of

new approaches in parallel:

Introduce performance benchmarks in methodologies

Positive and negative lists of certain renewable energy technologies may be

implemented in ACM0002, the Application of Combination of Large Scale

Methodology

Positive lists of certain project types for Least Developed Countries (LDCs)

Green Climate Fund

The Green Climate Fund created at the UNFCCC meeting in Durban will go a long

way toward reducing ever-increasing emissions in developing countries by broadly

distributing investment risks and encouraging an increased flow of private capital into

the fight against climate change.

The Green Climate Fund will help spread the investment risks more broadly. The

fund, as committed to in Durban, will have enough money to invest in different parts

of the world, in different technologies, and in different business models, and it will be

able to build different tools to meet the specific needs of each investment. With a

very diverse portfolio, the fund will be more effective in managing risks than individual

countries.

Comment [IE31]: What does this refer to?


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Dean Skivington 27

Conclusion and Recommendations

ConclusionThe world is now facing ever-increasing pressures on limited resources for energy

and food requirements. It is undeniable that our past and current actions have led to

climate change, and the need is for policies and actions that promote holistic and

sustainable development. The UN Conference on Human Environment (UNFCHE) in

Stockholm, in 1972, was the first global platform that discussed the issues relating to

the environment and the need for the global community to come together for asser-

tive action towards saving the Earth. After many conferences and accords, the Kyoto

Protocol was established in 1997 and enforced in 2005. The Kyoto Protocol set out to

reduce the GHG emissions by 5% across the developed world in comparison to 1990

baseline; it completes its first commitment period in 2012. Its achievements and suc-

cess has been debated on many platforms, mostly suggesting that although the Kyo-

to Protocol has not been able to reduce the actual amount of GHG emissions, it has

brought discussion of climate change to an international platform. The Kyoto Protocol

has generated awareness of the changing climate and the potentially damaging im-

pact it can have on human existence. During a short survey, which was conducted as

part of this paper, it was suggested that the biggest success of the Kyoto Protocol

has been in awareness-generation and in establishing the carbon markets.

As the first commitment period of the Kyoto Protocol comes to an end, there is uncer-

tainty in the carbon markets. The carbon projects are exposed to many risks, in both

the pre-2012 period and post it. Fraud, regulatory and the market related risks were

brought forward during the survey. With all these risks that the current and the future

carbon projects face, the risk assessment and management become very important.

Most of the survey respondents were pessimistic about the existing risk management

systems, as most of them were not aware of that such mechanisms existed. Howev-

er, in response to the needs for this kind of risk assessment, the UNFCCC has in-deed established regulations and standardisations. Other existing risk management

mechanisms are carbon funds, for example the Post-2012 Carbon Credit Fund, the

IFC Post-2012 Carbon Facility, the World Bank Carbon Finance Unit and various

insurance products such as the Kyoto multi-risk policy, and the Carbon Credit Deliv-

ery Insurance amongst many others.


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Dean Skivington 28

As the first commitment period of Kyoto Protocol comes to an end, two scenarios are

possible from post 2012. In the first most likely scenario, the nations will likely not beable to come together and agree on a single internationally accepted binding treaty.

This will lead to the collapse of the compliance carbon market; however, it is ex-

pected that the bilateral and multilateral exchanges will replace the international trea-

ty, keeping the voluntary carbon market alive. In the absence of an international bind-

ing force, voluntary carbon markets will rise and CERs will be replaced by VERs. The

voluntary market will see further development, with investments coming in from cor-

porations, and other entities looking to make themselves carbon-neutral. The current

political instability in the EU and the economic downturn will not impact the carbon

markets as much. The EU will continue its emission trading until at least 2020, as it

already has introduced policy and regulatory measures in place. In the absence of a

single market, the regional carbon trading markets will become stronger and each will

have its own set of eligibility criteria and carbon prices. Under these conditions, it will

be a buyers market as the sellers will need to look for the best price offers. The car-

bon credit projects will face greater risks under this scenario.

In the other scenario, member countries will reach a consensus that all the major

carbon emitters along with the developed countries bind themselves to reduce and

regulate carbon emissions. The carbon markets will stabilise, as the CDM projects

are implemented globally. The risks faced by the carbon credit projects will be re-

duced considerably, such that under an integrated international market, trading will

be more transparent. The treaty for the second commitment period will learn from the

mistakes of the first treaty. It will be more flexible to the changing environment, more

inclusive, as it will include more sectors under its banner, and most importantly the

new treaty will be holistic in its approach. Based on Rio 2020, the new agreement will

tackle poverty reduction and economic growth, climate and clean energy, food secu-

rity and sustainable agriculture, water, healthy seas and oceans, biodiversity, healthyforests and ecosystem services. The treaty will be finalised by 2015 with another five

years for the member countries to ratify it.

The carbon credit projects may face an additionality risk, post 2012, depending on

the decision of the new protocol on the eligibility criteria for a project. The CDM Ex-

Comment [IE32]: Here you are giving two

scenarios, but you have discussed three above.


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Dean Skivington 29

ecutive Board has realised that the additionality factor needs strengthening and, in

response to the request made by Conference of the Parties, it has prepared a con-

cept note dealing with the concept of additionality more transparently. As a way for-ward, no overwhelming commonalities have been observed; however, the tone

seems to suggest that the best way forward will be to use the already established

mechanism. The current systems need to be made more transparent to avoid fraud

and corruption. Based on the response received in the survey, it is estimated that the

member countries will most likely not be able to come to a consensus, and post 2012

will see growth of voluntary carbon market and bilateral carbon exchanges. As these

will be more independent than a global treaty, these arrangements will respond to the

need of risk management more by modifying Project Monitoring, Methodology and

Implementation Risks, and will also be able to deal with the risks due to regulatory

uncertainty better. Through bilateral arrangements, the buyers will be better able to

assess the country risk profile along with the implementation capacity. This was prov-

ing to be very diff icult when there were over 68 members participating in the Kyoto

Protocols CDM mechanism.

Recommendations

Based on the results of this dissertation, various recommendations should be made.

As this research has revealed, no best practice risk management procedures and

risk management guidelines are in place. It is suggested that fundamental guidelines

on how to tackle the risk that stakeholders of carbon projects are facing are devel-

oped. Especially for the period of Durban 2020, there needs to be strict and compre-

hensive risk management guidelines, for example set by the UNFCCC, national gov-

ernments and the financial institutes that fund the projects. The UN or a similar insti-

tution could control these guidelines. This will guarantee that all projects are as-

sessed in the same way and individual project risks are reduced.

Following on from there, a global carbon market should be established. There needs

to be a flat price for carbon credits which never falls below a certain point. A sug-

gested minimum figure could be $50 per ton. This would prevent the risk of project

failure and secure a truly sustainable carbon market. The prices would be based on


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Dean Skivington 30

the current pricing model apart from a mechanism that each market introduces a min-

imum carbon value as suggested in Durban. Carbon capital would be traded like

bonds, currency etc.

To ensure the future of a self sufficient global carbon market there needs to be a de-

cision made on either government green grants or the carbon market. To ensure the

future of the carbon market, any future grants for green projects should be replaced

with loans, which could then be paid back with funds generated from the carbon

credits. The government could replace its green grant systems by being involved as

a guarantor in the projects, giving the banks confidence in the projects.

This year the UK government launched that it is mandatory for the FTSE (Financial

Times Stock Exchange) 350 to report their carbon emissions for each year. This is a

prime opportunity for the UK to take hold and develop a model that can be rolled out

across the entire UK market, and possibly scaled down and could be adopted world-

wide. This could be achieved within ten years. Each company reports a baseline of

their carbon emissions depending on size, operation and type of company and are

then given a yearly carbon allowance for the future based on this baseline. For ex-

ample, company A might have a baseline of 1000 tons per year. In year two, its

emission rate increases to 1100 tons per year; the company has to buy 100 tons by

law. Company B might have an allowance of 1500 tons per year but only uses 1200

tons. In that case company B can sell 300 tons to the government or to an interna-

tional platform which acts an intermediary and sells the credits to companies who

have exceeded their baseline. The same concept is applied to whole countries. The

trading profits could be used to help tackle poverty, recovery after natural disasters

etc.

This research will help clarify the carbon industry and especially the current and post

2012 risks of carbon credit projects. In terms of further research it is recommended tolook into Durban Platform and Rio +20, how to move forward and how to plan for it.

Further it would be interesting to involve a wider panel of experts in a larger scale

projects, interviewing experts from around the world to establish a better understand-

ing of the situation and to back the study up with quantitative data.

Comment [IE33]: By whom?

Comment [ds34]:

carbon risk management – post 2012 and beyond

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