Kyoto and the Clean Development Mechanism (CDM)

Swedish International Development Agency

SESSION 5

United Nations Environment ProgramDivision of Technology Industry and Economy

CDMClean Development Mechanism

(and trading of CERs)

ACME Applying CLEANER PRODUCTION to MULTILATERAL ENVIRONMENTAL AGREEMENTS

ACME – Session 5 – Clean Development Mechanism - 2 / 39

OUTLINEObjectives of this session

1/ Overview of the Clean Development Mechanism (CDM)> What are the objectives and purpose of CDM ?

2/ Basics> What are the key concepts ?

3/ Organisation of a CDM project> What are the different steps of a CDM project ?

4/ Statistics> Where are we now with the CDM and how are emission reduction credits traded on the markets?

5/ Opportunities for industrials> What are the challenges and opportunities for industrials in developing countries ?

OVERVIEWAbout Kyoto Protocol

Signed in 1997; in force since 16 February 2005.

Ratified by more than 130 countries> Major non participants: USA and Australia.

Commits Annex 1 countries to reducing greenhouse gas emissions.> GHG emissions may be reduced by ~ 5% below 1990 levels in 2008-2012;> Individual, quantified emission targets for each industrialized country;> 6 greenhouse gas covered: CO2, CH4, N2O, HFC, PFC, SF6.

3 flexibility mechanisms for financing emission reduction abroad.> Clean Development Mechanism (CDM)> Joint Implementation (JI)> International Emissions Trading (ET)


OVERVIEWCDM: the basic idea


What is the Clean Development Mechanism (CDM) ?

> A mechanism that allows Annex B Countries to undertake GHG emission reduction projects in non-annex B countries, and to use the achieved emission reductions to meet their own emission goal.

> In CDM projects, the Annex B country fund the project and provides any necessary know-how and technology transfer to the non-annex B country where the project is implemented.

> CDM works because emission reductions are many times more expensive to achieve in Annex B countries than in non-Annex B countries (the opportunities for emission reduction are bigger there).

Make difference between Annex I and Annex B countries!

Examples of CDM projects


OVERVIEW

OVERVIEWIntroduction to the carbon market

Two main commodities traded in the carbon market> Emission allowance (AAU and EUA)> Project-based emissions reductions (CER and ERU)

Four different major markets> Kyoto Protocol> EU Emissions Trading Scheme> Canada Greenhouse Gas Offset System> Japan (voluntary trading system)

JICDM

Annex 1 countriesEU – 25CanadaJapan

Other OECDEmission Reduction Units

(ERUs)Certified Emission Reduction

(CERs)

Central and Eastern Europe

Developing Countries


OVERVIEWCDM organisation and objectives

Rules, modalities and procedures of CDM are defined in:> Kyoto Protocol;> Follow-up decisions of COP;> Decisions of CDM Executive Board.

CDM EB (Executive Board):> Responsible for further development of CDM rules, and supervising implementation;> Composed of 10 members + 10 alternates;> Reports to the COP (Conference of the Parties).

Twin objectives of CDM:> Help Annex 1 countries meet their objectives in a cost-effective way;> Contribute to sustainable development of the host country.


BASICSAdditionality and baselines

“A project is eligible for CDM if greenhouse gas emissions are reduced below those that would have occurred in the absence of the CDM project.”


Years

GHG emissions(tCO2eq)

Project implementation

Emissions baseline

Emissions after the project

1. Validation of project design, baseline and monitoring plan

2. Verification / Certification of emission reductions

ADDITIONALEMISSION

REDUCTIONS

BASICSConditions for additionality

Investment barrier

A financially more viable alternative to the project would have led to higher emissions.

Technological barrier

A less technologically advanced alternative to the project (lower risk) would have led to higher emissions.

Barrier due to prevailing

practice

Prevailing practice or existing regulatory or policy requirements would have led to implementation of technology with higher emissions.

Other barriers Competitive disadvantage, managerial barriers…


BASICSCDM requirements

Emissions Lower emissions, no leakage, no double counting.

Financial No ODA, no GEF funds, should lead to additional money inflow.

Regulatory The project should exceed regulatory standards.

Technological CDM should promote appropriate new technologies.

Investment CDM should make the IRR of the project an acceptable one. The project should not have happened without the CDM revenue.


BASICSWhere is CDM applicable ?

Renewable energy> Wind power> Solar> Biomass power> Hydro power

Waste management> Capturing of landfill methane emissions to generate power> Utilisation of waste and waste water emissions for generation of energy

Energy efficiency measures> Boiler and steam efficiency> Pumps and pumping systems> Efficient cooling systems> Back pressure turbines> etc…

Cogeneration in industries having both steam and power requirements

Power sector> Induction of new technologies which are efficient (thermal)> Reduction in technical T&D losses

Fuel switching> From fossil fuel to green fuel like biomass…

Electrical energy saving1 kWh = 0.8 ~ 0.9 kg CO2

Power generation (waste heat / renewable)1 MW = 4.000 ~ 5.000 t CO2

Coal saving1 kg = 1.3 ~ 1.6 kg CO2

Fuel oil saving1 litre oil = 3 ~ 3.5 kg CO2

NG based power generation1 kWh generation = 0.35 ~ 0.45 kg CO2

1 kg NG burning/saving = 2.4 ~ 2.5 kg CO2

ACME – Session 5 – Clean Development Mechanism – 11 / 39

ORGANISATIONCDM project cycle


ORGANISATIONContent of the PIN (Project Idea Note)

Standardized format for the PIN> the type, size and location of the project;> the anticipated total amount of GHG reduction compared to the “business-as-usual” scenario (which will be elaborated later in the PDD, while describing the baseline);> the suggested crediting life time;> the financial structuring (indicating which parties are expected to provide the project’s financing);> the project’s socio-economic or environmental impacts/benefits;> history of the project regarding other donors and funding tenders;> capacity of project developer to invest in the project.


ORGANISATIONContent of the PDD

Standardized format for PDD – Project Design Document (main document in the CDM cycle)

A. General description of the projectB. Setting of the baselineC. Duration of the project / Crediting periodD. Setting of the monitoring planE. Estimation of GHG emission reductionsF. Environmental impactsG. Stakeholders’ comments-Annex 1: Contact information on participants in the projectAnnex 2: Information regarding Public FundingAnnex 2: Baseline informationAnnex 3: Monitoring plan


ORGANISATIONPDD: CDM baseline methodologies

Approved methodology

> Statement of which approved methodology has been selected;

> Description of how the approved methodology will be applied in the context of the project.

New methodology

(to be submitted to UNFCCC secretariat)

> Description of the baseline methodology and justification of choice, including an assessment of strengths and weaknesses of the methodology;

> Description of key parameters, data sources and assumptions used in the baseline estimate, and assessment of uncertainties;

> Projections of baseline emissions;

> Description of how the baseline methodology addresses potential leakage.


ORGANISATIONPDD: Approved methodologies


Statistics on October 2005 from http://cdm.unfccc.int/ (UNFCCC)

ORGANISATIONPDD: Methodologies submitted


Statistics on October 2005 from http://cdm.unfccc.int/ (UNFCCC)

ORGANISATIONPDD: Crediting period

Carbon credit (CER) can be generated as from now:> Banking by buyer for use towards compliance in 2008-20012.> Banking by project proponent for sale in later years.

Crediting period:> Usually starting the later of CDM registration, and start of project operation.> Fixed crediting period of up to 10 years. OR> Renewable crediting periods of up to 7 years (maximum 3 x 7 years).


ORGANISATIONHost country approval

Formal confirmation by the Designated National Authority (DNA) of the hosting country that the project meets sustainable development objectives.

Sustainable development criteria set by the DNA:> Social well being: employment, alleviation of poverty, etc.> Economic well being: investment consistent with needs of the people.> Environmental well being: impacts on the local and global environment, pollution, etc.> Technological well being: transfer of environment safe and sound technologies.


ORGANISATIONValidation

Independent assessment by a Designated Operational Entity (DOE) that project meets criteria of the Kyoto Protocol.

DOE shall:> Review the PDD and supporting documentation;> Conduct site visit;> Interact with stakeholders;> Source other relevant additional information from various sources;> Publish the PDD in the web for international stakeholder comments.

A successfully validated project can be submitted to CDM Executive Board for registration.


ORGANISATIONRegistration

Automatic registration of submitted projects unless 3 members of the CDM Executive Board or one of the parties involved file a request for review within a delay of:

> 4 weeks for small scale project;> 8 weeks for large scale project.

Registration fees are payable to the Executive Board by the project participants depending on the quantity of emission reductions:

> Between 5.000 to 30.000 US$.


ORGANISATIONLast steps

Last steps of the process:

> Project financing.> Monitoring emissions.> Validation and certification.> Insurance of CERs.


ORGANISATIONTransaction cost of the CDM

Estimation of transaction costs during the CDM cycle

> PDD ~ 15.000 to 30.000 €> DNA approval ~ 5.000 €> Validation ~ 10.000 €> Registration ~ 5.000 to 30.000 US$> Administration ~ 0,2 US$ / CER> Verification 5.000 € per turn

At CER prices of 10 €/t CO2 equivalent, the viability threshold of projects is at ~ 10.000 CERs/years.


ORGANISATIONCDM additionality tool

“An optional flow chart, adopted by the executive board in October 2004, applicable to any type of project for the demonstrate of additionality.”


STEP 0 – Preliminary screening based on the starting date of the project activityStart date of claiming credits for project should precede date of registration

CDM consideration proved = PASS

STEP 1 - Identification of alternatives consistent with current laws and regulationsIf proposed CDM project is the only alternative left, the project is non-additional

More than one alternative = Pass

STEP 2 - Investment Analysis CDM financially attractiveSTEP 3 - Barrier Analysis

No barriers , the project is non-additional

CDM financially not attractive

STEP 4 - Common Practice Analysis (credibility check)If similar activity can be observed with no essential difference, the project is non-additional

CDM faces Barriers = PASS

No similar activity or similar activities present but difference in circumstances = PASS

STEP 5 - Impact of CDM registration If CDM benefits have no impact, the project is non-additional

PROJECT ACTIVITYIS ADDITIONAL

ORGANISATIONFast track for small-scale CDM project

Why do we need a fast track?> Process not worth it for small projects (high transaction costs); > Many small projects deliver significant local sustainable development benefits;> Small-scale technologies are some of the most promising for solving the long term problem of climate change (e.g. solar; wind; fuel cells); > CDM might lose public support if rules are biased toward large capital-intensive projects.

Size limits for small-scale projects > Electricity generation from renewable sources, up to 15 MW.> Energy efficiency projects saving, up to 15 GWh p.a.> Project reducing emissions up to 15.000 t CO2eq p.a.

Small-scale projects benefits from simplified rules and procedures> Simplified PDD;> 14 pre-approved baseline methodologies (feb. 2005);> Same operational entity may undertake validation and verification / certification;> For small-scale projects, sufficient to demonstrate that barriers would have led to higher emissions in absence of CDM.


STATISTICSUpswing of CDM (1/3)

Carbon market in 2005:> In 2005, global carbon market transactions worth €9,4 billion.

> In 2005, CDM projects transactions worth €1,9 billion.

Statistics of CDM (as per June 2006):> 225 projects registered, for an average of 70 millions CERs/Year.> 36 projects submitted for registration, for an average of 4,6 millions CERs/Year.> 860 projects known to be prepared for registration.

> 165 proposed baselines methodologies were sent to the CDM EB for approval, 60 approved, 66 rejected and 39 are pending.

Statistics on July 1st 2006 from http://www.cd4cdm.org/ (UNEP)



Number of projects registered or known to be prepared for registration:

End of 2004 End of 2005



Annual volumes (million tCO2e) of project-based emission reductions transactions and annual average price in US$ per tCO2.


STATISTICSRegistered projects (1/3)

* List of host countries: Argentina, Armenia, Bangladesh, Bhutan, Bolivia, Brazil, Chile, China, Colombia, Costa Rica, Ecuador, El Salvador, Fiji, Guatemala, Honduras, India, Indonesia, Israel, Jamaica, Malaysia, Mexico, Morocco, Nepal, Nicaragua, Panama, Papua New Guinea, Peru, Republic of Korea, Republic of Moldova, South Africa, Sri Lanka and Viet Nam.

Expected average annual CERs from registered projects by host countries*Registered project by host countries*

Statistics on July 1st 2006 from http://cdm.unfccc.int/Statistics/



Statistics on July 1st 2006 from http://cdm.unfccc.int/Statistics/

Registered project by scope

Registered project by Annex 1 countries involved



CDM projects in each sector CERs until 2012 in each sector

Statistics on July 1st 2006 from http://www.cd4cdm.org/ (UNEP)


OPPORTUNITIESWho is buying CER?

January 2004 to December 2004Overall volume: 110,0 million tCO2e

January 2005 to March 2006Overall volume: 453,5 million tCO2e

* as a share of volume contracted.

Buyers based in Europe (41% in 2004, 56% in 2005) and Japan (36% versus 38%) dominate the market for project-based transactions.


January 2004 to December 2004 January 2005 to March 2006

OPPORTUNITIESLocation of projects


Asia accounted for the largest share (73%) of contracted volume of project-based transactions signed.


OPPORTUNITIESWhat is being sold ?

January 2004 to December 2004 January 2005 to March 2006


Technology share of emission reduction projects:


OPPORTUNITIESHow are CERs sold ? (1/2)

Contractual arrangements vary depending on how risks are located between Buyer and Seller:

> Project risk - whether or not the project will adequately perform and produce the expected amount of emissions reductions.> Country risk - whether the political and investment climate of host country is stable.> Regulatory risk – whether or not the project will ultimately be deemed additional and registered by the CDM Executive Board.

Various contract features are used to allocate these risk between the buyers and the seller:

> Guarantees;> Upfront payments;> Penalties and damage clauses;> Default clauses;> Disbursement schedules.


OPPORTUNITIESHow are CERs sold ? (2/2)

Carbon funds available through

> International tenders for CDM projects> Voluntary corporate initiatives> Multilateral Funds> EU commitments for carbon purchase> Bilateral negotiations with the consortium of buyers

Prices of CERs > Average price of 7,5 US$ / tCO2eq in 2005 (3 to 14 US$).

What determinesprices of CERs ?

> Likelihood Seller will deliver verifiable reduction on schedule.> Creditworthiness and experience of the project developer.> Technical and technological viability of the project.> Liabilities the Seller is willing to take in the event the project fails to deliver including penalties for non-delivery and willful default / gross negligence.> Vintages: in some markets, early vintages (until 2012) are priced higher because the Buyer’s willingness to pay in order to meet compliance.> Likelihood of host country approval.> Environmental and social compliance and additional benefits.ACME – Session 5 – Clean Development Mechanism - 36 / 39

OPPORTUNITIESFuture demand for CERs


CONCLUSIONNext steps

CDM is real> 225 projects registered and 60 methodologies approved;> In 2005 CDM projects transactions worth €1,9 billion.

Industrials in developing countries have a role to play> Prices for emissions reduction are increasing;> Buyers and Sellers are innovating ways of addressing risk;> Early entrants will have a clear advantage.

Challenges for CDM in the next years> DNA approval capacities;> High methodology rejection rates;> Annex 1 companies may only be interested in buying CER, not in investing in project (exception for some Japanese companies);> Gap between CER and EU allowance prices (50% even for registered projects);> Interpretation of national policies in baseline methodologies;> Availability of reliable and authentic data for establishing baselines.


CONCLUSIONEnd of session 5

Thank you for your attention…Any questions?


Kyoto and the Clean Development Mechanism (CDM)

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