CD4CDM National Workshop, Accra, Ghana February 2006

Glenn S. HodesUNEP Risø Center

CARBON FINANCE

ww

w. o

e ko

.de

Benefits of Carbon Finance

• As a new source of private investment for development + public goods, carbon finance offers an unique opportunity to increase private and public investment in clean technologies in developing countries.

• Between 10-50% of revenue for waste management + renewable energy projects can come from CF.

• Powerful leverage effect on other FDI.• Payment on regular schedule and in hard currency

smoothes cash flow and can securitize critical up-front capital for project construction (e.g. bridge loans).

• Help increase sustainability and extend the social and community impacts/benefits of typical energy projects

ww

w. o

e ko

.de

Why a Carbon Market?

• Regulations, present or anticipated, create constraints on greenhouse gas (GHG) emissions of governments, firms (e.g. Kyoto Protocol obligates industrial Parties to reduce emissions by avg 5 % below their 1990 emissions over 2008-12.

• Since GHGs mix in the atmosphere, it does not matter where emissions are reduced

• Compliance with regulation can be achieved through in-house (“make”) or flexibly through purchase (“buy”) “GHG commodities”. The market has responded to the entry into force of Kyoto and the EU ETS – and is now a real compliance market.

ww

w. o

e ko

.de

Structure of the Carbon Market

Allowance Markets

UK ETS

EU Emission Trading Scheme

Chicago Climate Exchange

New South Wales Certificates

Project-Based Transactions

JI and CDM

Voluntary

RetailOther

Compliance

ww

w. o

e ko

.de

Annex BNon-Annex B The Kyoto Protocol

• Assigns GHG emission targets to Annex B countries between 2008 and 2012

• 3 Flexibility Mechanisms

- Joint Imple-

mentation

- Emission

s Allowance Market

- Clean Development

Mechanism

ww

w. o

e ko

.de

EU Emissions Trading Scheme

• Caps over 40% of EU CO2 emissions• 2 phases : 05-07 and 08-12

• JI and CDM authorized…• But NOT LULUCF (review in 2006)

ww

w. o

e ko

.de

Canada

• Sectoral covenants under negotiation• Domestic carbon market

• Strategy calls for some use of CDM; could be largest bilateral buyer program

ww

w. o

e ko

.de

Japan

• National Policies still in the making

• Firms and government active on CDM market

ww

w. o

e ko

.de

USA

• Policies constraining GHG emissions in various States (e.g., Oregon, Mass., etc.)

• Chicago Climate Exchange (CCX), private allowance market

ww

w. o

e ko

.de

Kyoto Compliance Gap

• CERs from CDM projects are in high demand – OECD almost 6.0 Billion tCO2 below KP target.– Assuming 50% met from domestic measures,

projected gap of 3 Billion tons. Less than 20% booked for delivery by 2012.

• But supply market is highly competitive • And CDM competes with domestic/internal

measures!! – Gains from trade fundamental to carbon market:

country mitigation cost curves matter.

ww

w. o

e ko

.de

Growing Voluntary Market• A large and growing number of companies have engaged in

programs to reduce their GHG ‘footprint’ absent regulations– Various motivations: corporate responsibility, public

relations, strategic positioning, competitive advantage, learning-by-doing, etc.

– These firms have large-scale emissions (2002 survey: 18 firms with more CO2 emissions than France had voluntary targets for 2010)

• Individuals and Firms have engaged in purchases of carbon credits to be “carbon neutral” (event, corporation, or product)– Example: World Cup, G8 Summit, BA travel

ww

w. o

e ko

.de

2005 State and Trends of the Carbon Market Report

• Funded by World Bank CF-Assist Program. • Based on material provided by

Evolution Markets LLC, Natsource LLC, and on interviews with many market players. Limited public information on transactions.

• Database of 487 project-based transactions (signed or advanced stage of negotiation) + aggregated data on allowance markets

Report downloadable from: www.carbonfinance.org

ww

w. o

e ko

.de

0

100

200

300

400

500

600

1998 1999 2000 2001 2002 2003 2004 2005

Known Estimated

Total Value of Contracts over 1 b$ (data

in million U.S.$, nominal)

(Jan-Apr)

ww

w. o

e ko

.de

Buyers: European Governments and Firms In percent of volume purchased From Jan.04 to Apr.05

Other EU32%

UK12%

Gov. Netherlands16%

Japan21%

New Zealand7%

Canada5%

Australia3%

USA4%

ww

w. o

e ko

.de

Supply Concentrated In percent of volume sold from January 2004 to April 2005

OECD14%

TransitionEconomies

6%

Africa0%

India31%

Rest of Asia14%

Brazil13%

Rest of Latin America22%

ww

w. o

e ko

.de

Number (%) of CDM projects in each sectorBiomass energy

Hydro

EE Industry

Wind

Agriculture

Landfill gas

Fossil fuel sw itch

Biogas

Cement

HFCs

Fugitive

Solar

Geothermal

EE Households

N2O

EE Service

Tidal

Transport

ww

w. o

e ko

.de

Prices Depend on Risks(weighted average prices from Jan. 2004 to April 2005 in U.S.$ per metric tonne of

CO2e)

$0.00

$2.00

$4.00

$6.00

$8.00

ER VER CER ERU

ww

w. o

e ko

.de

Key Price Determinants

• Guarantee of delivery of registered ERs• Creditworthiness of project sponsor• Viability of underlying project, and liabilities of seller

in case it under-performs• ER vintage: pre- or post-2012• Cost of validation and potential certification• Host country support or barriers• Additional environment and social benefits

ww

w. o

e ko

.de

Allowance Markets Exploding (in million tCO2e)

(Jan.-March)

0

5

10

15

20

25

30

35

40

2002 2003 2004 2005

ww

w. o

e ko

.de

Insights on Price Differential• Large price differential:

– EU Allowances: 7 up to 25 euros / tCO2e (spot and forward contracts)

– Project-based: 3 to 7+ dollars / tCO2e (forward contracts on expected CERs)

• Allowances and project-based contracts have very different risk profiles:– Project and country risks: high in CDM, none in

allowances– Compliance/regulatory risks: high in CDM, none

in allowance– Delivery risks: higher in CDM

ww

w. o

e ko

.de

Intermediation - a key to success

• Identify project opportunities at lower cost• Get equity and debt financing when the

intermediary is a financial institution• More effectively design and/or evaluate projects• Reduce transaction costs

– Example of Infrastructure Development Finance Corporation (IDFC), India, one of the most successful intermediaries agreement with over a dozen opportunities identified/ evaluated

– Development Bank of Southern Africa

ww

w. o

e ko

.de

Conclusions and Caveats• Volumes should increase rapidly for CERs … • Almost 600 CDM projects already registered or in

process of validation.• Uncertainties still need to be addressed.

– How many allowances will Russia and Ukraine bring to market?

– How much volume will CDM deliver? Issue of projects lead-time

– Will UN and EU emission registries be fully operational and compatible by 2008 (i.e. extent of arbitrage)?