A handy document for understanding Clean Development Mechanism under Article 12 of the Kyoto Protocol.

1. CDM:
A Quick Overview

2. Background
2

3. Increasing climate change have pushed the discussion process about a framework reducing
greenhouse gases
3

4. Global warming
4

5. International response to Climate Change
Milestones
1979: First World Climate Conference
1988: Intergovernmental Panel on Climate Change
1990: IPCC and Second WCC call for global treaty for climate change
1992: UN Framework Convention on Climate Change adopted
1994: UNFCCC entered into force
1997: Kyoto Protocol adopted
2001: Marrakesh Accords
2005: Kyoto Protocol entered into force
5

6. Kyoto Protocol
» 11 December 1997 – Kyoto Protocol adopted in Kyoto, Japan
» The overall emission reduction target for Annex I Parties as a group is at least 5 percent
below 1990 levels, to be achieved by the commitment period 2008 to 2012 (an average over
the five years).
» 16 February 2005 – Kyoto Protocol enforced
» 191 signatories
6

7. Kyoto Protocol
Australia Estonia Latvia Liechtenstein Russia
Austria Finland Lithuania Slovakia Slovenia
Belarus France Luxembourg Spain
Belgium Germany Netherlands Sweden
Bulgaria Greece New Zealand Switzerland
Canada Hungary Norway Turkey
Croatia Iceland Poland Ukraine
Czech Rep Ireland Portugal Romania UK
Denmark Italy USA
EC Japan
* Countries with economies in transition to a market economy.
* Countries which did not ratify Kyoto protocol.
7

8. Flexibility Mechanisms
» Joint Implementation (Article 6) - fulfilment of emissions limitation and reduction
commitments jointly among Annex I Parties.
» Emissions Trading (Article 17) - between Annex I countries to fulfill their reduction
commitments. Any such trading shall be supplemental to domestic actions.
» Clean Development Mechanism (Article 12) - to assist Parties not included in Annex I in
achieving sustainable development and to assist Annex I countries in achieving compliance
with their emission reduction commitments.
8

9. Emission trends in Annex 1 countries
Decreased emissions
(1990 baseline)
Increased emissions
(1990 baseline)
9

10. What Annex I countries can do
Limitations of CO2 emissions in
developed countries (Annex I)
4 options for companies
1/ Pay expensive 2/ Carry out carbon 3/ Buy emissions 4/ Carry out carbon
fines. reduction through credits on the reduction through
processes CO2 market (ETS). technology transfers
improvement. in CDM or JI project.
10

11. Opportunities for industries
11

12. Opportunities for industries
» Technology transfer to improve process and energy efficiency
» Co-finance investments by selling emission credits
» Prepare for future commitments (after 2012)
» Achieve sustainable development
12

13. Clean Development
Mechanism
13

14. Clean Development Mechanism
» The basic principle of the CDM is simple - GHG
emissions contribute equally to climate
change irrespective of where they occur
» CDM encourages investment in clean
technologies in Developing Countries
» Many emissions reduction opportunities are
less expensive in developing countries
» The CDM ‘rewards’ emissions reduction of the
6 key Green House Gas. The ‘Credits’ are
computed in equivalent Metric Tonnes of CO2
(Carbon dioxide), with multiples being
GHG Sources
assigned for converting each gas to its CO2
CO2 Fossil fuel combustion, deforestation; equivalent eg. 1 MT of Methane = 21 MT of
agriculture Carbon dioxide, 1 Mt of SF6 = 23,900 Mt CO2e.
CH4 Agriculture, land use change, biomass burning,
land fills
N2O Fossil fuel combustion, agriculture; industrial
HFCs Industrial / manufacturing
PFCs Industrial / manufacturing
SF6 Electricity transmission, manufacturing
14

15. Types of CDM projects
Carbon project
Atmospheric
Emission reduction removal
Gas Avoiding new
recovery emissions
& End-of-pipe
utilization
Reduce emission Reduce energy losses Land-use
Destruction Storage
factor Reduce energy mitigation
during transmission/
consumption
distribution
Fuel Substitution Energy
efficiency at
generation
Renewable Fuel Waste
energy switch heat/gas GHG efficiency at
utilisation 15
production

16. Types of CDM projects
Clean energy
» Use of renewables (e.g. hydro power) to supply electricity to the grid, to local
communities and to commercial facilities
» Use of biomass residues for energy generation / cogeneration – e.g. bagasse
from the sugar industry, coffee husks from the coffee industry, etc.
Wind power Run-of-river Bagasse Timber
hydro residues 16

17. Types of CDM projects
Waste management
» Capturing the methane from animal waste, human waste (sewage), agricultural
waste (biomass) and urban landfills
» Can be combined with electricity generation to produce a second stream of
carbon credits
Animal waste Sewage / wastewater Landfill
17

18. Types of CDM projects
Bio-carbon
» Forestry plantations – e.g. restoration of mangrove forests
» Agro-forestry – e.g. shade crops, nitrogen capture in soils
» Bio-fuels – e.g. bio-ethanol from molasses, bio-diesel from palm oil
Forestry Agro-forestry Bio-fuels Transport
18

19. How a CDM project generates carbon credits
NOTE: greenhouse gas
emissions must also
include project emissions
Carbon creditsoccurring
– emissions (CERs)
represent the difference
within the project
between the baseline and
boundary:
Greenhouse gas emissions
actual emissions
e.g. fossil fuel emissions
from construction
e.g. soil disturbance from
tree-planting
AND: leakage – emissions
Project start occurring outside the
project boundary
Historical Trend Time
19

20. Estimating emission reductions
What would the level of emissions be in the absence of the project?
= X Emissions factor
‘Guesstimate’ of
Baseline emissions associated with
baseline activity
activity
The baseline scenario:
• E.g. the default IPCC
Existing or historical emissions factor for
emissions kerosene is 71 tCO2/TJ
Emissions from
economically attractive
alternative
technologies
Average emissions of
similar project activities
20

21. Estimating emission reductions
= X Emissions factor
‘Guesstimate’ of
Baseline emissions associated with
baseline activity
activity
What is the level of emissions in the presence of the project?
= X Emissions factor
Project
Project activity associated with
emissions
activity
21

22. Estimating emission reductions
= X Emissions factor
‘Guesstimate’ of
Baseline emissions associated with
baseline activity
activity
What is the level of emissions in the presence of the project?
= X Emissions factor
Project
Project activity associated with
emissions
activity
e.g. fuel consumed e.g. IPCC default emission factor
22

23. Estimating emission reductions
= X Emissions factor
‘Guesstimate’ of
Baseline emissions associated with
baseline activity
activity
–
= X Emissions factor
Project
Project activity associated with
emissions
activity
=
Emissions reductions Denominated in tonnes of CO2-
1 tCO2e = 1 CER
equivalent
23

24. CDM Pipeline - Worldwide
6000
5832 5935
Number of Projects in the CDM Pipeline globally, 5583
January 2007 – February 2011 5396
5151
5000 4904
4682
4502
4319
4130
4000 3939
3744
3553
3386
3183
3000 2931
2697
2000
1000
0
July 08
Aug 08
Sep 08
Nov 08
Jan 09
Nov 10
Jan 11
Oct 08
Mar 09
Apr 09
May 09
Jun 09
July 09
Aug 09
Sep 09
Nov 09
Jan 10
Feb 11
Dec 08
Oct 09
Feb 10
Mar 10
Apr 10
May 10
Jun 10
July 10
Aug 10
Sep 10
Dec 09
Oct 10
Dec 10
Feb 09
24

25. CDM Pipeline - India
Number of Projects in the CDM Pipeline in INDIA,
442
450 January 2007 – February 2011 433 436 440
428
419
398 405
400 390
352 360
350 347
331 337
320
302
300 287
250
200
150
100
50
0
July Sep Nov Jan Mar May July Sep Nov Jan Mar May July Sep Nov Jan
08 08 08 09 09 09 09 09 09 10 10 10 10 10 10 11 25

26. CDM Revenue from some projects
Sector Wind Hydro Biomass Solar
PLF
23% 65% 80% 15%
CERs/MW
1800 5100 5800 1200
CER Revenue in INR 12 Lacs 32 Lacs 34 Lacs 8 Lacs
(@65/Euro ,10 Euro/CER)
Per Unit Revenue (Paise / kwh) 55 48 48 55
900 CERs for a million units saved or generated through
Thumb Rule for calculations renewable sources
26

27. Project Developer
The CDM project cycle
6 to 12 months 1.5 months Crediting period of the project
Project
CDM project
feasibility
development
assessment
/ PDD
/ PIN
DNA
Host country
approval
Project Project
DOE
validation verification
Executive
Board
CDM
Project
CER issuance
registration
27

28. Project Developer
The CDM project cycle
6 to 12 months 1.5 months Crediting period of the project
Project
CDM project
feasibility
development
assessment
/ PDD
/ PIN
DNA
Host country
approval
Project Project
DOE
validation verification
Executive
Board
CDM
Project
CER issuance
registration
28

29. Project Developer
The CDM project cycle
6 to 12 months 1.5 months Crediting period of the project
Project
CDM project
feasibility
development
assessment
/ PDD
/ PIN
DNA
Host country
approval
Project Project
DOE
validation verification
Executive
Board
CDM
Project
CER issuance
registration
29

30. Project Developer
The CDM project cycle
6 to 12 months 1.5 months Crediting period of the project
Project
CDM project
feasibility
development
assessment
/ PDD
/ PIN
DNA
Host country
approval
Project Project
DOE
validation verification
Executive
Board
CDM
Project
CER issuance
registration
30

31. Project Developer
The CDM project cycle
6 to 12 months 1.5 months Crediting period of the project
Project
CDM project
feasibility
development
assessment
/ PDD
/ PIN
DNA
Host country
approval
Project Project
DOE
validation verification
Executive
Board
CDM
Project
CER issuance
registration
31

32. Project Developer
The CDM project cycle
6 to 12 months 1.5 months Crediting period of the project
Project
CDM project
feasibility
development
assessment
/ PDD
/ PIN
DNA
Host country
approval
Project Project
DOE
validation verification
Executive
Board
CDM
Project
CER issuance
registration
32

33. Project Developer
The CDM project cycle
6 to 12 months 1.5 months Crediting period of the project
Project
CDM project
feasibility
development
assessment
/ PDD
/ PIN
DNA
Host country
approval
Project Project
DOE
validation verification
Executive
Board
CDM
Project
CER issuance
registration
33

34. Project Developer
The CDM project cycle
6 to 12 months 1.5 months Crediting period of the project
Project
CDM project
feasibility
development
assessment
/ PDD
/ PIN
DNA
Host country
approval
Project Project
DOE
validation verification
Executive
Board
CDM
Project
CER issuance
registration
34

35. Project PDD
Project
Idea Note
idea
(PIN)
Designated
Host Country Approval
National
Authority
Validation Operational
Entity
Registration
Financing and implementation
Project Monitoring
owner
Verification and certification
Executive Issuance of CERs
Board 35

36. Critical aspects
36

37. Baseline study
» Every carbon project requires a baseline study
» The purpose of the baseline study is to determine the baseline scenario for each GHG
component of the project
» The baseline must be explicitly defined
» Selection of the baseline must be justified in a transparent manner
» In order not to exaggerate the emission reductions achieved by the project, the
baseline study must adopt a conservative approach whenever assumptions about
future developments need to be made
» The principle of conservativeness
37

38. Additionality
Has been defined as:
» Environmental additionality – reductions in GHG emissions
» Financial additionality – the project only happens because of the financial incentive
offered by carbon credits
» Legal additionality – the project does more than what is required by local law
» The Kyoto Protocol is somewhat vague, stating simply:
“Reductions in emissions must be additional to any that would occur in the absence of the
project activity”
38

39. Additionality
Ideally, a project should demonstrate a combination of these forms of
additionality
It is essential that the project achieve environmental additionality –
otherwise, it will not generate any carbon credits!
Typically, a project developer also demonstrates that, without carbon
revenues, the project would not be viable and/or commercially attractive
The CDM Executive Board has developed an ‘additionality tool’ for CDM
projects
39

40. Financial additionality – benchmark analysis
» Benchmark analysis
Choose an appropriate financial indicator and compare it with a relevant benchmark
value: e.g. PLR
Carbon revenue
makes the project
Revenue / NPV / IRR
attractive relative
to investment
Investment alternatives
threshold
A project can be
money-making
Project without
carbon revenueas
and qualify is
profitable – but not
‘additional’!
sufficiently
profitable
compared with
alternatives
Project without Project with
carbon element carbon element
40

41. 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 utilising 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
41

42. 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
42

43. Crediting period
A maximum of 10 years
with no option of
renewal
Greenhouse gas emissions
Emissions under the project scenario
Starting date of
the crediting 10 years No renewal
period 43

44. Why not maximize the crediting period?
Baseline must be The baseline
reassessed by scenario may
DOE at each become less
Emissions under the
renewal favourable
baseline scenario
Greenhouse gas emissions
Emissions under the
project scenario
7 years 44

45. Why not maximise the crediting period?
Baseline must be The baseline
reassessed by scenario may
DOE at each become less
Emissions under the
renewal favourable
baseline scenario
Greenhouse gas emissions
Emissions under the
project scenario
7 years 7 years 7 years 45

46. Transaction of
CERs
46

47. Options to seller
Sellers can choose from the following options for sale of their issued CERs:
1. Individual Buyer Identification
2. Full Market Access
3. Auction
47

48. Individual Buyer Identification
» Step-1: Seller enters into an exclusive brokerage agreement with the broker for the sale of
CERs.
» Step-2: Broker, goes to the market and brings in buyer offers
» Step-3: The offers are discussed with the seller and buyer and an appropriate offer chosen.
» Step-4: Broker helps the seller negotiate an acceptable emission reduction purchase
agreement (ERPA) between the seller and buyer.
» Step-5: Delivery of the CERs comprises the seller inviting the escrow agent (broker) to
become a project participant. Henceforth, the CERs are transferred to the escrow account to
be transferred to the buyer on the receipt of payment from their buyer.
48

49. Highlights
» Offer prices from individual buyers drive the core of the process. Price negotiation is
important.
» ERPA negotiation is a time consuming process. Technically price is firmed up and becomes a
binding commitment only after ERPA is executed. Until then price and quantity agreed are
selling/buying intentions.
» There is a possible long time gap between when the sale is in principle agreed to when it is
executed.
» The buyer offers a discounted price for the CERs to account for the perceived delivery risk
associated with the CERs.
» The mechanism is not suited for a seller to take advantage of the favourable changes in a
dynamic market.
» Seller can exercise very limited control once the process is set in motion.
49

50. Full access market
» A non-exclusive agreement signed by seller with broker.
» The CERs are delivered to broker and is held by it until the transaction is completed or until
the seller instructs it to transfer the CERs.
» Broker uses its open market access and reports to the seller the open market price on a day-
to-day basis.
» Seller instructs the broker to sell at a price point with which it is happy.
» Execution of sales initiated after written instruction from seller.
» Broker gives the requisite delivery assurances to the buyers on the seller’s behalf.
» Transaction is executed only on the seller's instruction and at its comfort.
» Once the transaction is successfully executed, the transfer of the sale proceeds is made
within days of the transaction
50

51. Highlights
» Seller gets an access to open market price on a day to day basis.
» The seller has the benefit of locking a price which he is comfortable with, thus protecting
himself from the downside risk in the volatile market.
» Delivery risk associated with issued CERs significantly mitigated through pre-delivery.
» Buyers are ready to pay the open market price (which is generally higher than the
individually negotiated price).
» Seller exercises control and is able to drive the process.
» Faster settlement.
51

52. Auction
» Electronic process for sale and purchase of CERs arranged and hosted by some brokers
online.
» Seller wishing to participate has to complete the registration process and commit at least 10
business days prior to the auction date and pre-deliver to the escrow agent, the units to be
sold at the auction.
» Subsequently, seller also sets the floor price which is his discretion of the price below which
he would not wish to sell.
» Immediately before the auction the broker sets the reserve price which is a reasonable price
threshold decided taking into account various factors as recent price trends, market
sentiments.
» Sellers with floor price lower than or equal to reserve price can participate.
» Once the auction is successfully completed, the purchase prices is paid to the seller by the
escrow agent within 10 business days of the process.
52

53. Floor and Reserve Price
Each seller sets a floor price below which they will not sell
Seller A
Floor € 17.00
Seller B
Floor € 16.00
Seller C
Floor € 15.00
Seller D
Floor € 14.00
53

54. Floor and Reserve Price
» Each seller sets a floor price below which they will not sell
Seller A
Floor € 17.00
Seller B
Floor € 16.00
Seller C
Floor € 15.00
Seller D
Floor € 14.00
» The floor price is set not less than 2 weeks prior to each auction.
54

55. Floor and Reserve Price
Broker subjectively sets the Reserve Price (same for all seller) taking into account market
conditions on the day of the auction
Seller A
Floor € 17.00
Seller B
Floor € 16.00
Reserve price set at €15.55 ………………………………………………
Seller C
Floor € 15.00
Seller D
Floor € 14.00
55

56. Floor and Reserve Price
Broker subjectively sets the Reserve Price (same for all seller) taking into account market
conditions on the day of the auction
Seller A
Floor € 17.00
Seller B
Floor € 16.00
Reserve price set at €15.55 ………………………………………………
Seller C
Floor € 15.00
Seller D
Floor € 14.00
Reserve Price must be set at reasonable level to uphold the integrity of the market
56

57. Floor and Reserve Price
Broker subjectively sets the Reserve Price (same for all seller) taking into account market
conditions on the day of the auction
Seller A
Floor € 17.00
Seller B
Floor € 16.00
Reserve price set at €15.55 ………………………………………………
Seller C
Floor € 15.00
Seller D
Floor € 14.00
Reserve Price must be set at reasonable level to uphold the integrity of the market
If too high nothing will sell despite fair market bids being placed and buyers will never use
auction again
57

58. Floor and Reserve Price
Broker subjectively sets the Reserve Price (same for all seller) taking into account market
conditions on the day of the auction
Seller A
Floor € 17.00
Seller B
Floor € 16.00
Reserve price set at €15.55 ………………………………………………
Seller C
Floor € 15.00
Seller D
Floor € 14.00
Reserve Price must be set at reasonable level to uphold the integrity of the market
If too high nothing will sell despite fair market bids being placed and buyers will never use
auction again
If too low then no seller will participate 58

59. Floor and Reserve Price
If seller has his floor price above the reserve price then he will not participate in this auction. In
this way he is assured that he does not sell below his floor.
Seller A
Floor € 17.00
Seller B
Floor € 16.00
Reserve price set at €15.55 ………………………………………………
Seller C
Floor € 15.00
Seller D
Floor € 14.00
59

60. Floor and Reserve Price
If seller has his floor price above the reserve price then he will not participate in this auction. In
this way he is assured that he does not sell below his floor.
Seller A
Floor € 17.00
Seller B
Floor € 16.00
Reserve price set at €15.55 ………………………………………………
Seller C
Floor € 15.00
Seller D
Floor € 14.00
60

61. Floor and Reserve Price
If seller has his floor price above the reserve price then he will not participate in this auction.
In this way he is assured that he does not sell below his floor.
Reserve price set at €15.55 ………………………………………………
Seller C
Floor € 15.00
Seller D
Floor € 14.00
Only sellers with floor price equal to or lower than the reserve price shall participate in the
auction. These sellers will sell to the best buyers bidding above the reserve price.
61

62. Highlights
» Secure and transparent electronic based platform
» Access to multiple buyers through one single platform.
» The auction event runs for a couple of hours only so that the parties are the least affected by
the volatility of the CER market.
» Low-Risk CERs: issued and pre-delivered will command the best price
» Fast payment and delivery cycle: 10 day settlement
» Smaller volumes can be aggregated to present a more attractive volume to the market.
Likewise, Larger volumes can be sold by signing a single contract even when there are
multiple buyers
» Lower transaction costs as one agreement is needed for multiple sales.
» Seller has the option of choosing his floor price, which will protect him from the adverse
movements in the price in the time between making the trade undertaking and setting the
reserve price.
» Seller can elect to be paid in the currency of his choice.
62

63. Transaction services
» Spot Sale » CERs are issued
» Delivered into CDM account of seller
» Forward Sale » Ready to be sold
» The CERs can be sold even before they are
issued to you.
» Allows the seller to lock in a price for CERs thus
protecting him from the downside risk
associated with the volatile market.
» Ensures a guaranteed and a steady cash flow for
your CERs transacted.
63

64. Way Forward
64

65. First commitment period to end in 2012.
What next ?
Copenhagen Cancun
65

66. Copenhagen
» 6-18th December 2009
» COP 15/MOP 5
» Representatives of 192 countries
» No outcome
» Hopes to “seal the deal”
» But was a “weak agreement”
» Sticking points
» The main issue is that of "burden-sharing".
» But which countries must make the cuts and by how large should they be?
66

67. Cancun
» Not a failure like Copenhagen
» 193 nations on track to deal with climate change
» So called “Cancun Agreements”
» Highlighted the obstacles that await
» Both industrialized and developing nations have to cut their carbon emissions over the next
decade
67

68. Highlights
» Creation of "Green Climate Fund" that will transfer money from rich countries to poor ones
» Formation of research centres that will ease the transfer of clean-energy technology
between nations
» A system in which developing nations can be compensated for keeping rain forests intact
» In addition, India, the United States and China worked on the plan for international
monitoring of emissions pledges from developing nations — the International Consultation
and Analysis (ICA) approach to Monitoring Reporting and Verification (MRV)
» Although Cancun conference was more about rescuing the complex international climate
negotiation framework from irrelevancy or even collapsing
» The future of the “Kyoto Protocol” deferred to CoP 17 at Durban, South Africa.
» At the last moment India stated that it is willing to accept legally binding commitments in
place of its oft-repeated policy of only voluntary action to cut greenhouse-gas emissions.
» Environment minister Jairam Ramesh generalized the idea saying that all countries must
accept binding commitments under an appropriate legal form
» Countries in India's vicinity - Bangladesh, Maldives, Bhutan and Nepal - also supported
legally binding agreement
» Brazil and South Africa - are also in favor of a legally binding agreement
68

69. » Five pairs of rich and poor nations had tackled questions leading to a positive result at the
Cancun. They are:
Britzil: Britain and Brazil; greatest responsibility, assigned to break the deadlock
over the future of the Kyoto Protocol.
Bangralia: Australia and Bangladesh developing draft text for international
financing and technology transfer.
Spalgeria: Spain and Algeria working together on adaptation assistance for
developing countries.
Grenaden: Sweden and Grenada; work on long-term global goals for slowing
climate change,” the “shared vision” text for the long-term cooperative action
track (the non-Kyoto-based agreement).
New Zindonesia: New Zealand and Indonesia; working on “other issues about
curbing greenhouse gases,” most likely the flexible mechanisms like the REDD+
deforestation plan and land use, land-use change and forestry (LULUCF) language
69

70. What next?
» IETA annual carbon market survey shows traders’ patience wearing thin with market and
regulatory uncertainty
» Confidence in future market price has fallen, undermining low-carbon investment
» No major agreement
» Efforts at country level
PAT
REC
JNSSM
70

71. For Further queries contact
Priyanka Abbi
Senior Consultant
Climate Change Division
E-mail: priyanka.abbi@itpsenergy.com/
priyankaabbi09@gmail.com
Contact: 0124 430 5541
71