Given at Birla College 2009

1. Understanding the Carbon
Credits Business
Amit Gopal Chauhan
31st December 2009
Refresher course of Academic Staff College ,
University of Mumbai, Birla College, Kalyan
1

2. I will Talk About
• Governance
• Global Warming
• IPCC, UNFCCC, Kyoto Protocol
• Carbon Trading
• Requirements for a CDM project
• Examples
• Discussion on price factors
• Market strategy one should adopt
• CDM market failure
• Conclusion
2

3. Governance
• Three pillars
– Governments
– Institutions
– Markets
• When one fails other compensates
• When one fails it either self corrects and
evolves with new attributes. Or depends on
the other pillars for a change.
• The cycle should repeat it self.
3

4. Global Warming
• Its responsible for life on Earth
• Water Vapor, CO2, Methane, N2O caused
natural GW Historically
• Industrialization has magnified the emissions
of GHGs exponentially
• Increase in temperature, increase in sea water
level, extreme movements of draught/
hurricanes/ floods expected
4

5. IPCC, UNFCCC, Kyoto Protocol
• Intergovernmental Panel on Climate Change
• United Nations Framework Convention on Climate
Change
• North & South agree to mitigate climate change
before “it is too late”
• Agree that they have “Common but Differentiated
responsibilities”.
• Kyoto Protocol which in details describe how the
GHGs can be reduced entered into force on 16th
February 2005.
5

6. The Kyoto protocol
Annex I
Non-Annex I
Not ratified 6

7. Kyoto Protocol
• It relies on market based flexible mechanisms
to reduce GHGs emissions to mitigate GW.
– Emission trading (trading of allowances between
Annex I governments)
– Clean Development Mechanism (CDM) (projects
in Non-Annex I countries with participation of
Annex I countries)
– Joint Implementation (JI) (projects between
Annex I countries)
7

8. GHGs With GWPs under Kyoto
Methane
Methane
Carbon GWP: 21
GWP: 21 Nitrous
Carbon Nitrous
dioxide
dioxide oxide
oxide
GWP: 11
GWP: GWP: 310
GWP: 310
Sulphur
Sulphur
hexafluoride
hexafluoride
GWP: 23,900
GWP: 23,900
Perfluorocarbons
Perfluorocarbons
Hydrofluorocarbons GWP: 9,200
GWP: 9,200
Hydrofluorocarbons
GWP: 11,700
GWP: 11,700
8

9. GWP & Carbon Credits
Formula Name Global warming Potential
CO2 Carbon dioxide 1
CH4 Methane 21
N2O Nitrous oxide 310
PFCs Perfluorocarbons 9200
HFCs Hydrofluorocarbons 11700
SF6 Sulphur hexafluoride 23900
If one tonne of GHG emission is
reduced then number of carbon credits
issued will be equivalent to the GWP.
9

10. Carbon Credits are also Known as…
• Emission reduction unit (ERUs),
• Certified emission reduction (CERs),
• Assigned amount unit (AAUs)
• Removal unit (RMUs)
• Voluntary emission reduction (VERs)
10

11. Generating Carbon Credits
“Without project”
emission level Carbon
credits
GHG emissions
“With project”
emission level
Project commissioned Time
Project based emission reductions need to be calculated and verified
1 reduced Ton of Carbon Dioxide equivalent = 1 Carbon Credit
hereafter they can be sold on the open market. 11

12. Supposed benefits of the market
mechanisms
• Help identify lowest-cost opportunities
for reducing emissions and attract private sector
participation in emission reduction efforts.
• Cost of limiting emissions varies considerably from
region to region, the benefit for the atmosphere is the
same, wherever the action is taken.
• Developing nations benefit in terms of
technology transfer and investment brought
about through collaboration with industrialized
nations under the CDM.
12

13. The Carbon market (1)
International agreements to reduce greenhouse gases:
• EU Emissions Trading System (EU-ETS) requires
EU countries to reduce emissions of greenhouse
gases by 6% during 2005-2007
• Kyoto Protocol requires Annex I countries (West and
Eastern Europe, North America, Japan, New
Zealand, Australia) to reduce emissions of
greenhouse gases by 5.2% during 2008 – 2012
13

14. The Carbon market (2)
• Voluntary participation of Non-Annex 1
countries (Brazil, China, India, South Africa,
etc.)
• The Linking Directive allows credits from
Clean Development Mechanisms (CDM) and
Joint Implementation (JI) projects to help
companies comply with their obligations
14

15. Registry systems under Kyoto (1)
• National Registries: containing accounts within
which units are held in the name of the government
or in the name of legal entities authorized by the
government to hold and trade units
• CDM registry: for issuing CDM credits and
distributing them to national registries. Accounts in
the CDM registry are held only by CDM project
participants, as the registry does not accept
emissions trading between accounts.
15

16. Registry systems under Kyoto (2)
• In addition to recording the holdings of Kyoto
units, these registries “settle” emissions trades
by delivering units from the accounts of sellers
to those of buyers, thus forming the backbone
infrastructure for the carbon market
16

17. Registry systems under Kyoto (3)
• Each registry will operate through a link
established with the International transaction
log put in place and administered by the
UNFCCC secretariat. The ITL verifies registry
transactions, in real time, to ensure they are
consistent with rules agreed under the Kyoto
Protocol. The ITL requires registries to
terminate transactions they propose that are
found to infringe upon the Kyoto rules
17

18. Registry systems under Kyoto (4)
• In verifying registry transactions, the ITL
provides an independent check that unit
holdings are being recorded accurately in
registries. After the Kyoto commitment period
is finished, the end status of the unit holdings
for each Annex B Party will be compared with
the Party’s emissions over the commitment
period in order to assess whether it has
complied with its emission target under the
Kyoto Protocol 18

19. Registry systems under Kyoto
19

20. Requirements for South for
participating in CDM
• The host country where the project is executed is a
Kyoto signatory.
• The project meets the sustainable development
criteria framed by the country.
• The projects results in real, measurable, long-term
GHG reduction.
• The projects must be Additional (i.e. must face some
financial, technical, common practice barriers. It
should be proved that the project must not have
been commissioned without the CDM)
20

21. Basic data needed for CDM!
• Evidence of CDM consideration
• Start & commissioning dates
• Financial analysis (IRR calculation)
• Electricity saving data
• Barrier analysis information
• EIA report, if required by law
• Contractual agreement between each individual sub-project and the
bundling agency
21

22. CDM Sectors
All types of Energy Efficiency Energy Distribution Construction
Renewable in Industry loss prevention
energy (demand &
supply)
Transport Mining & Mineral Fugitive emissions Fugitive
Production from fuels emissions from
production and
consumption of
halocarbons and
Sulphur
hexafluoride
Solvent use Waste Handling Afforestration and Agriculture
and disposal reforestation
22

23. Outline of the CDM project process (1)
• An industrialized country that wishes to get credits
from a CDM project must obtain the consent of the
developing country hosting the project that it will
contribute to sustainable development.
• Then, using methodologies approved by the CDM
Executive Board (EB), the applicant (the
industrialized country) must make the case that the
carbon project would not have happened anyway
(establishing additionality),
23

24. Outline of the CDM project process (2)
• Must establish a baseline estimating the future
emissions in absence of the registered
project.
• The case is then validated by a third party
agency, called a Designated Operational
Entity (DOE), to ensure the project results in
real, measurable, and long-term emission
reductions.
24

25. Outline of the CDM project process (3)
• The EB then decides whether or not to
register (approve) the project.
• If a project is registered and implemented, the
EB issues credits, called
Certified Emission Reductions to project
participants based on the monitored difference
between the baseline and the actual
emissions, verified by the DOE.
25

26. Steps is CDM
PIN / PCN & PDD Development Project Developers / Consultant
Host Country Approval GOI / MOEF i.e. DNA
DOE
Validation
Registration CDM EB
Implementation Project Developers
Monitoring Project Developer + DOE
Verification DOE
Certification CDM EB
Issuance of CERs CDM EB
26

27. CDM Project Activity Cycle (1)
• Project Activity Design:
The Project design document (CDM-PDD)
and the Guidelines for completing CDM-PDD
including a glossary of terms (Approval,
authorization, project participants etc.) have
been developed by the Executive Board on
the basis of Appendix B of the CDM
modalities and procedures. Project
participants shall submit information on their
proposed CDM project activity using the
Project design document (CDM-PDD). 27

28. CDM Project Activity Cycle (2)
• Proposal of a New Baseline and/ or
Monitoring Methodology: The new baseline
methodology shall be submitted by the
designated operational entity to the Executive
Board for review, prior to a validation and
submission for registration of this project
activity, with the draft project design document
(CDM-PDD), including a description of the
project and identification of the project
participants.
28

29. CDM Project Activity Cycle (3)
• Use of an Approved Methodology: The
approved methodology is a methodology
previously approved by the Executive Board
and made publicly available along with any
relevant guidance. In case of approved
methodologies the designated operational
entities may proceed with the validation of the
CDM project activity and submit project design
document (CDM-PDD) for registration.
29

30. CDM Project Activity Cycle (4)
• Validation of the CDM project activity:
Validation is the process of independent
evaluation of a project activity by a designated
operational entity against the requirements of
the CDM as set out in decision 17/CP.7, the
present annex and relevant decisions of the
COP/MOP, on the basis of the project design
document, as outlined in Appendix B.
30

31. CDM Project Activity Cycle (5)
• Registration of the CDM project activity:
Registration is the formal acceptance by the
Executive Board of a validated project as a
CDM project activity. Registration is the
prerequisite for the verification, certification
and issuance of CERs related to that project
activity
31

32. CDM Project Activity Cycle (6)
• Certification/ Verification of the CDM project
activity: Verification is the periodic independent
review and ex post determination by the designated
operational entity of the monitored reductions in
anthropogenic emissions by sources of greenhouse
gases that have occurred as a result of a registered
CDM project activity during the verification period.
Certification is the written assurance by the
designated operational entity that, during a specified
time period, a project activity achieved the reductions
in anthropogenic emissions by sources of
greenhouse gases as verified.
32

33. Possible CDM projects in Energy
Sector for example
• Renewable Energy (wind, solar, biomass, hydro, geothermal
etc.)
• Energy Efficiency
• Combined Cycle Gas Turbines (CCGT)
• Super Critical Technology for Power Generation
• Renovations & modernization of Power plants
• Reduction in T&D loss
• Fossil fuel switch - Coal to Gas, Oil to Gas
• Waste gas: heat, pressure, electricity
• SF6 abatement
• Biomethanation
• Coal Mine Methane (CMM)
33

34. Possible CDM projects in Oil & Gas
Sector for example
• Gas flaring reduction,
• Re-injection,
• Associated gas recovery,
• prevent pipeline leakage,
• Geological storage of GHGs
34

35. Possible CDM projects in Iron &
Steel Sector for example
• Cleaner and more efficient coke production
• Furnace efficiencies and upgrades
• Heat Recovery from Direct Reduction Kiln
• Energy Capture from Waste Gas
• Fuel switch to natural gas / biomass, for
various ovens and kilns
• Green Belt Development & Afforestration to
act as a sink for CO2
35

36. Possible CDM projects in Chemical
Industry
• Energy Efficiency
• Wastewater/ Methane Avoidance
• Biodiesel and Biofuels
• Biomass Energy
• Fossil fuel switch - Coal to Gas, Oil to Gas
• Gas pipeline leakage
• HFCs abatement
• Renewable Energy: Biomass, Geothermal, Hydro, Solar, and
Wind
• Waste gas: heat, pressure, electricity
• Process modification
• Forestry - Afforestation and Reforestation etc.
36

37. How is CDM relevant for Businesses?
Annex I party Emission
reduction project
Carbon Credits
The CDM project reduces
the carbon emissions
in the CDM country
Emission
Actual
cap
emissions
Carbon value (€)
Buyer
By selling the emission reductions from a project to a Annex I party
additional cash flows can be realised.
37

38. Impact on the IRR of The Project
16 %
CDM cash flow
The gap between 15 %
the project return
and the required
return on
investment 12 %
threshold
IRR Benchmark
Project Project
return return
excluding including
CDM revenue CDM revenue
The CDM cash flow increases the IRR of the project making it more interesting
for investors. (2%-100%, diversification, offshore revenue stream)
38

39. Project Example
Waste heat Power Generation Biomass Power Plant
 50 MW combined cycle gas-steam  10 MW Rice Husk plant supply
turbine (CCGT) and grid export
 12 MW condensing steam  70% load factor
generator (CSG)  Displaces 70 GWh / a of fossil
 85% load factor grid electricity
 Displaces 500 GWh / a of fossil  CER: 55,000 p a = Rs. 90
grid electricity million up to 2012
 CERs: 400,000/p. a = Rs. 660
million up to 2012
39

40. Energy Efficiency Projects for
Example
• Doing the same with less
• Potential & Opportunities
– Cogeneration
– waste Heat/ gas Recovery
– Energy Management System
– Combustion Control
– Fuel Switching
– High efficient Refractory
– Industrial Process Modifications/Fuel Savings
40

41. Types of project
• Measures/technologies
– Diffuse/small scale energy efficiency:
• Energy efficient devices (bulbs, motor controller, appliances)
– Distribution
– Labelling/government programme
• Buildings’ energy efficiency (insulation, SSC renewable, etc)
– Large scale (industrial) energy efficiency (demand/supply
side)
• ‘Pure’ energy efficiency
• Waste heat/gas recovery
• Fuel switch
41

42. Methodologies
– Pure EE:
• AM0018 – Steam optimization
• AM0020 – Water pumping efficiency improvement
• AM0038 – Improved electrical efficiency in SiMnmetal production
• ACM0007 – Single cycle to combined cycle power generation
– Fuel switch:
• AM0017 – Natural gas cogeneration (BSL=gas-heat + grid-elec)
• AM0029 – Construction of new natural gas power plants
• AM0036 – Fuel switch Fossil fuel to biomass for heat generation
• ACM0003 – Fuel switch in cement plants
• ACM0009 – Fuel switch coal or petroleum to Natural gas
– Waste heat/gas recovery:
• AM0024 – Waste heat recovery in cement plants
• AM0032 – Cogen from waste gas/heat
• AM0037 – Flare reduction and gas utilisation at oil & gas facilities
• ACM0004 – Waste gas/heat for power generation
Applicability conditions! 42

43. Traditional project risks
Project does
not Project does not
meet regulatory operate reliably
commitments
Operational
risk
Community Regulatory Project does not pass
Technical
protests and risk completion tests
lead to permit political risks
denial or
revocation
Threats to
project
Social Completion
acceptability
risk
Market Financial Not enough
risk risk financing to
Project
complete project
boycotts
Bankers reluctant
to lend
Source: Miller and Lessard, 2000 43

44. Additional CDM project risks
• Institutional and regulatory risk
• Methodology risk
• Host country risk
• Validation risk
• Registration risk
• Monitoring and verification risks
44

45. Time frame and uncertainty
Step Propose Validatio LOA Annex 1 Registration Request for
methodology n appr review
oval
Consult. 3 weeks 30 days Variabl Not Up to 8 weeks LS Up to 2.5
e requ months
este
d
Time Up to 2 years 2-6 1 1-3 Up to 6 mo, if reviewed Up to 3 months
fram mont mo wee
e hs nth ks
–3
yea
rs
Rejectio ~50% Not Variabl Not Up to 70% request for ~33% formal
n know e kno review review
Leve n wn
l 45

46. Time frame and uncertainty
Formal Verificati Request for Formal
Step review on Issuance review review
Up to 1.5
Consult N/A N/A 15 days Month N/A
2-4
Up to 4 Mont Up to 5 Up to 4
Time Frame Months hs Weeks Up to 2 Months Months
Not Up to 75% Up to 66%
Rejection Know request for formal
Level 26% rejected n review review None Yet
46

47. Project Risks
- Equipment
- O&M Apparent costs
- Management
- Opportunity costs (late start)
- Overrun budgets
Total real costs
Operational risks: Hidden costs
- Reduced CER generation
- Equipment failure
- Administrative expenses and
other transaction costs (lawyers,
consultants)
47

48. The CER Price Structure
48
CER Price
15
Counterparty & Default Risk
Commissioning Risk
Late Delivery Risk
5
Underperformance Risk
Asset Transfer Risk
Baseline & CER Calculation risk
Registration Risks
Volatility risk
International Transaction Log & Cap risk
EURO
Hot Air & Supply Risk
UNFCCC Policy Risk, Political Risks
EU ETS market price

49. The Myth of the Carbon Credit
EUA ERU CER
European Union Emission Certified
Allowance Reduction Unit Emission
Reduction
Existence Allocated by Created by JI Created by CDM
Annex I projects projects
countries: Real
Commodity
Ownership AAA rated Medium and large Small, medium &
companies scale companies large sized
companies
Country- and No risk Medium risk High risk
project risk
Delivery risk No risk Medium risk High risk
49
Price high Medium Low

50. Key Price determinants for CDM
projects
• Risk allocation
• Creditworthiness & experience of project sponsor
• Viability of underlying project
• Contract structure (e.g. upfront payments incur
discount, penalties for non-delivery, ability to pay
penalties)
• ER vintage & seniority
• Cost of validation & potential certification
• Host country support & willingness to cooperate
• Additional environment and social benefits
50

51. Contract Types
1) Seller does its utmost to deliver a flexible/non-firm volume, buyer
guarantees to buy
- Few preconditions
2) Seller does its utmost to deliver a flexible/non-firm volume, buyer
guarantees to buy
- The contract is only valid on a set of preconditions
3) Seller guarantees to deliver a firm volume, buyer guarantees to buy
- The contract is only valid on a set of preconditions
4) Seller guarantees to deliver a firm volume, buyer guarantees to buy
- Non-delivery: seller pays mark-to-market/liquidated damages CERs
or cash
51

52. Cost of developing a CDM Project
• Apart from the project development, implementation cost. The
developer has to pay for
– The consultant fees
– Registration with the Designated National Authority (MOEF)
• Public hearing
– Validation fees (to Designated Operational entity)
– Registration fees at the UNFCCC
– Monitoring & Verification fees (to third party DOE)
– CERs Issuance fees
– Contribute to the UNFCCC adaptation fund
• Then bargain for the price of the CERs with the Buyers
• A picture of Market Failure!!
52

53. CDM Market in India is
• Consultant driven
• Buyers are there but few and offer low price
• Brokers promise good price but reliability record is
poor
• Size of the projects is very small though the quantity
is large… hampers bargaining capacity of the project
developer
• Most project developers hoard( do not sell) CERs in
expectation of higher price
• Most projects face problems in implementation.
53

54. Why CDM is a market failure? (1)
• Too sophisticated/complex a market
• Too expensive to enter
• The future beyond 2012 is yet uncertain
• Does not survive the Cost Benefit analysis
• Huge Markets like agriculture untouched
• Forestry projects are too complex
• The project developer doesn’t get a fair price
• The ultimate buyer doesn’t get a fair price
54

55. Why CDM is a market failure? (2)
• Profits go in the pocket of middlemen
• CDM popular only in developing countries not in
Lower developed countries
• Technology transfer which CDM promises already
exist with South in some cases
• Little initiative by government entities to take up
CDM projects
• Proving additionality is very difficult in most of the
cases
• Carbon exchanges have played limited role till yet
55

56. Critiques & Concerns (1)
• Some emission reductions under the CDM are
false or exaggerated
• In 2007 the CDM was accused of paying €4.6
billion for projects that would have cost only
€100 million if funded by development
agencies
• Where as the project developers feel they did
not get a fair price
56

57. Critiques & Concerns (2)
• The first commitment period of the Kyoto
Protocol excluded forest conservation/avoided
deforestation - carbon emissions from
deforestation represent 18-25% of all
emissions, and will account for more carbon
emissions in the next five years than all
emissions from all aircraft since the Wright
Brothers until at least 2025.
57

58. Market strategy one should adopt (1)
• Enter as early as possible….project conceptual
stage
• Educate oneself and staff thorough…before going to
consultant
• Invite a buyer as a project participant at an early
stage
• Appoint a consultant for CDM PDD writing and
handling UNFCCC matters…note your job is to
execute the project
• Option of in-house PDD development can also work
for you…delegate the job
58

59. Market strategy one should adopt (2)
• Sell some CERs in advance and hold some
portion for expectation of higher price…don’t
hold all the CERs
• Carbon market will stay in some way or the
other….the market will correct itself or be get
corrected
• Expect local carbon markets in the
future….say in next 7-12 years
59

60. Conclusion
• The market need a major makeup
• Simplify
• Active role from institutions to take up
programme of activities CDM
• Efficient, transparent, carbon exchanges
• More information and education
• Considering other than market approach to
mitigate climate change
60