Carbon Markets for Energy Access Projects
Carbon Finance through CDM and VCM
Financial payments for reducing greenhouse gas (GHG) emissions can be an additional source of funding for energy projects. This so-called carbon finance can be accessed by implementing a project under the requirements of the Clean Development Mechanism (CDM) of the Kyoto Protocol (Kyoto Protocol) or for the Voluntary Carbon Market (VCM). This page focuses on the possibilities and challenges of successful carbon finance for stove projects. The CDM provides a tool for accessing carbon credits for certified emission reductions of greenhouse gases (GHGs) in developing countries. The funds must be used to enable these reductions, which would otherwise not be possible.
The CDM is one of the three flexible mechanisms under the Kyoto Protocol; the others being Emissions Trading and Joint Implementation. All these mechanisms aim to achieve GHG reduction in a cost effective manner. While Emissions Trading and Joint Implementation are reserved for countries with binding reduction targets, the CDM allows the participation of countries without targets. Emissions reduction credits that have been achieved through the CDM in a renewable energy, or energy efficiency, project in a developing country can be sold to a country with commitments listed in Annex I of the Kyoto Protocol (Annex I Countries).
The CDM has two primary goals: to assist Annex I countries in achieving their reduction targets, and to contribute to sustainable development in the host countries. The criteria for sustainable development are defined by the host country’s national authority (the Designated National Authority – DNA).
The Clean Development Mechanism (CDM)
The CDM encompasses renewable energy, energy efficiency, and avoidance of GHG sources. Relevant GHGs are Carbon dioxide (C02), which also serves as reference value, Methane (CH4), Nitrous oxide (N20), Hydrofluorocarbons (HFCs), Perfluorocarbons (PFCs), Sulphur hexafluoride (SF6). Tiny particles like soot and sulfate aerosols are not covered by the Kyoto Protocol, although they do cause global warming. The global warming potential of each gas is measured in CO2 equivalents, which describe the global warming potential of each gas over a given time period compared to CO2. The calculation of the achieved CO2 reduction has to follow a methodology accepted by the CDM Executive Board (EB).
General CDM framework
The CDM Executive Board supervises the CDM and reports directly to the Conference of the Parties to the United Nation Framework Convention on Climate Change (UNFCCC) and the Meeting of the Parties of the Kyoto Protocol. The board is responsible for approving new methodologies related to baselines, to approve monitoring plans, to accredit independent verifiers, review project validation and verification reports, and to issue the CERs.
All countries that wish to participate in the CDM must (a) have ratified the Kyoto Protocol and (b) designate a national CDM authority. The Designated National Authority (DNA) evaluates and approves the projects and serves as a point of contact. It states that the project participants participate voluntarily in the project and confirms that the project activity assists the host country in achieving sustainable development. As each DNA can establish its own working procedures, the project developer should be well informed about the requirements of the national DNA.
The CDM requires special documents of which the Project Design Document (PDD) is the central one. The PDD describes the technology used in the project activity, the relevant project participants and project location(s). It defines the methodology used to calculate emission reductions, including the baseline, project boundary and leakages. The life time of the CDM-project is set, which can be ten years or seven years and can, if desired, be renewed twice. The PDD defines the anticipated emission reductions and the monitoring plan. It has to be validated by an independent operational entity (Designated Operational Entity, DOE) and is then submitted to the CDM-Executive Board for registration.
The preparation of the PDD is a complex task and has to follow the UNFCCC requirements. It is the key document that the host country, investors, stakeholders and DOEs will use to evaluate the project’s potential, and to judge its achievements. All aspects are important; the most challenging aspects are dealing with establishing the baseline and assessing the project’s ‘additionality’. A project activity is ‘additional’ if GHG emissions are reduced below those that would have occurred in the absence of the registered CDM project activity. This is the central point of the CDM. It means that a CDM project activity is additional if GHG emissions are reduced below those that would have occurred in the absence of the registered CDM project activity. A CDM project must not be a project that would have been implemented under the business as usual scenario. The fulfilment of the additionality criteria is vital for the successful registration of a CDM project. The difference between the GHG baseline emissions and GHG emissions after implementing the CDM project activity (project emission) is the emissions reduction.
Baseline emissions under the selected baseline scenario are calculated according to an approved methodology, (or maybe using a new methodology that is being introduced).
The process from project idea until registration as CDM project and final issuance of credits takes 6 month at a minimum; the procedures can easily take longer, possibly up to two years.
The CDM project cycle
All projects that aim to generate CERs under the CDM rules must meet the same criteria and complete the same steps. This process is commonly known as the CDM project cycle. Some of the activities in the CDM project cycle are the same as those for any other investment projects. However, the steps to generate CERs are both unique and mandatory, as shown in Table 1 below. The development of a CDM project documentation and the involvement of different institutions throughout the project cycle generate substantial costs. Some rough estimates for current levels are given in the table.
Transaction costs are particularly problematic when the volume of CERs being offered is relatively low. As a rule of thumb, it can be said that a project activity should generate at least 10 000 CERs to cover the costs for CDM preparation safely. If the emission reduction of a project activity is below that threshold, projects can be implemented as projects for the Voluntary Carbon Market.
Small Scale CDM Projects often contribute clearly to the sustainable development aspect of the CDM. But transaction costs associated with developing small-scale projects are high relative to the emissions benefits that may be available. Due to the combination of perceived risk factors and lack of economies of scale, small-scale projects are challenging to transact in the market.
Small projects qualify as small-scale if they comprise the following:
- Renewable energy project activities with a maximum output capacity equivalent of up to 15 megawatts (or an appropriate equivalent)
- Energy efficiency improvement project activities which reduce energy consumption by up to the equivalent of 60 gigawatt hours per year; and
- Other project activities limited to those that result in emission reduction of less than or equal to 60 kilotonnes of CO2 equivalent per year
|
Table 1: Estimates for mandatory steps in developing a CDM project (2008) | ||
|
Project Cycle |
Description |
Estimated costs |
|
Planning a CDM project activity Preparing the PDD |
Project participants employ a consultant for PDD writing, communication with DNA, EB, etc. The standard format for the PDD must be used |
Consultant: 30 – 40 person days, plus travel costs |
|
Getting DNA-approval from each party involved |
The written approval of the host country must include the confirmation that the project activity assists in achieving sustainable development. |
Depends on DNA regulation |
|
Validation |
Validation by the DOE is the independent evaluation of a project activity against the requirements of the CDM on basis of the PDD. |
10 000 – 14 000 € |
|
Registration |
The registration by the CDM EB is the formal acceptance of the validated project as a CDM project activity. |
< 15 000 tCO2 = no fee = 15 000 tCO2 = USD 0.10/CER > 15 000 tCO2 = USD 0.20/CER (max 350.000) |
|
Monitoring a CDM project activity |
Project participants collect all relevant data necessary for calculating emission reductions by the CDM project activity. |
10 000 € |
|
Verification and certification |
Verification is a periodic independent review and ex post determination of the monitored emission reductions and results in the certification of the emission reductions. It is carried out by a second DOE, that is different from the one that has validated the project. |
10 000 – 14 000 |
|
Issuance of CERs |
The EB will issue certified emission reductions equal to the verified amount. |
2% of the CERs issued must be paid as adaptation fee. Least developed countries are exempted. Depending on national regulations other fees may accrue. |
|
Distribution of CERs |
Consultant works out agreements of CER distribution among project participants. |
5000 – 10 000 |
|
Broker markets the CERs. |
To be negotiated | |
Programme of Activities (PoA)
The Programmatic Approach was officially established in 2007 by the adoption of Guidelines and Procedures for PoA by the CDM EB. Due to high transaction costs small single CDM projects had previously hardly been represented in the CDM portfolio. The PoA approach was designed in order to bring in the possibility for small projects. With the PoA approach the project approval process for many individual activities that are distributed over space and time are brought together.
A CDM PoA occurs at two levels: at the program level and at the activity level. At the program level, the PoA is the organizational and financial framework that provides structure to the activities, and is managed by a coordinating entity for a period of no longer than 28 years. At the program activity level, a single measure or a set of measures to reduce GHGs is applied to many plants/installations of the same type over the life time of the program. A CDM PoA is considered: "a voluntary coordinated action by a private or public entity which coordinates and implements any policy/measure or stated goal (i.e., incentive schemes and voluntary programs), which leads to GHG emission reductions or increase net GHG removals by sinks that are additional to any that would occur in the absence of the PoA, via an unlimited number of CDM program activities (CPAs)" (Annex 38, EB 32). On the other side, a CPA is more similar to a standard CDM project in the sense that both must comply with procedures and modalities of the CDM and each must include an activity that has a direct, real and measurable impact on emission reductions. By definition (Annex 38, EB 32), a CPA is: "a single, or set of interrelated measure(s), to reduce GHG emissions or result in net anthropogenic greenhouse gas removals by sinks, applied within a designated area defined in the baseline methodology".
Advantages of a PoA compared to a set of individual standard CDM projects:
| Multiplicity of activities to reduce GHG distributed in time and space | Numerous activities are participating in the program and resulting in GHG emission reduction in multiple sites over lifetime of the program. The sites could be located in one or more countries. |
| One managing / coordinating entity, many implementers | The program is coordinated or managed by one entity, which can be private or public, and does not necessarily achieve the reductions but promotes others to do so. The coordinating entity is responsible for the CERs distribution and communication with the EB. |
| Duration (PoA and CPA) | The length of the PoA is up to 28 years (60 for afforestation/reforestation projects (A/R)). The crediting period of a CPA is either a maximum of seven years (20 for A/R project acitivities) which may be renewed at most two times, or a maximum of ten years (30 for A/R) with no option for renewal. |
| Size | For Small-scale (SSC) programmatic CDM only the individual CPAs have to be under the SSC threshold, while the overall program can go beyond. |
| Monitoring and Verification | The total volume of emission reductions to be achieved by a program may not be known at the time of registration. Each CPA has to be monitored according to the methodology and sampling procedures applied for monitoring and verification purposes. |
| No registration of CPAs | After the registration of the PoA, individual CPAs are not required to request registration. Instead the DOE includes the CPA after a check that the CPA follows the rules for inclusion in the PoA. |
| Can run in more than one country | A PoA can run in more than one country provided that the Letter of Approval from each of the countries is obtained. |
Diadvantages of a PoA compared to a set of individual standard CDM projects:
| Starting date of CPA | In contrast to the standard CDM approach where the starting date of a project activity can be before the project registration, the earliest starting date of a CPA can be the registration date of a PoA. |
| Revalidation of the PoA due to methodology revision | The PoA provedures require that in the case the methodology is revised after registration of the PoA, the PoA has to be adjusted accordingly. All changes made to the PoA require reassessment and validation by the DOE and approval from the EB. |
The voluntary market
The compliance market regulated by the Kyoto Protocol or other mandatory reduction schemes, are not the only route to emissions trading. Voluntary Carbon Markets (VCMs) are developing rapidly. They function outside of the compliance markets and enable companies and individuals to purchase carbon offsets on a voluntary basis.
Companies and individuals are increasingly concerned about their environmental impact. Some will neutralise activities they cannot avoid by “offsetting” their own emissions. Individuals may seek to offset their travel emissions and companies claim they are ‘carbon neutral’ by buying large quantities of carbon offsets to ‘neutralize’ their own carbon footprint or that of their products.
They see voluntary offsetting as part of their corporate responsibility and/or as part of their image strategy. Emission offsets in this category are usually verified by independent agents and are commonly referred to as Verified Emission Reductions (VERs).
The VCM enables activities in unregulated sectors like aviation or maritime transport, or countries that have not ratified the Kyoto Protocol (such as the US), to participate in carbon trading. Companies can gain experience with carbon inventories, emissions reductions and carbon markets even if they are not yet required to accept mandatory commitments. This may facilitate future participation in a regulated ‘cap-and-trade’ system.
The voluntary market comprises more different project types than the compliance market. Because the voluntary market is not subject to the same level of scrutiny, management, and regulation as the compliance market, project developers are more flexible to implement projects that might otherwise not be viable (e.g. projects that are too small or too disaggregated). This provides opportunities for innovation and experiment.
Although VER projects are not necessarily required to go through the project cycle, they should be developed and documented according to CDM rules and procedures, for example, by using the PDD format to develop the project.
To provide evidence of its effectiveness, it is recommended that the project is validated, particularly as the voluntary offset market has been criticised for its lack of transparency, quality assurance and third-party standards. To address these shortcomings, several Standards have been developed on the Voluntary Carbon Market to ensure reliable emission reductions. Each standard has a slightly different focus, and none has so far managed to establish itself as the industry standard. A good overview of the Standards has been published by WWF in March 2008 (assets.panda.org/downloads/vcm_report_final.pdf).
It is possible for project developers to try to get into the premium market for small projects with high development benefits. The Gold Standard (GS) Foundation offers a quality label to CDM/JI and voluntary offset projects, fetching premium prices. Only renewable energy and energy efficiency projects with sustainable development benefits are eligible. The Gold Standard is endorsed by over 38 non-governmental organizations worldwide. Under www.cdmgoldstandard.org the relevant guidance and the PDD formats for the generation of Gold Standard CERs and VERs can be found.
Links to General Information
Small Scale CDM Project Activities
The World Bank: State and Trends of the Carbon Market 2009 (pdf, 656 kB)
Newsletter CDM Highlights www.gtz.de/climate
Small Hydro Power and Carbon Finance
A Guide to CDM and Family Hydro Power
Selected Small Hydro Power Carbon Finance Projects
Phu Mau hydropower project (Vietnam): small scale run-of-river hydropower plant; three cascades with a total installed capacity of 5.6 MW. Crediting period 05 Jun 09 - 04 Jun 16.
Sichuan provincial Longchi & Caoyuan Small-scale Hydro Power Bundle Project (China): two small-scale hydro projects - Longchi 5 MW + Caoyuan 4MW. Crediting period 28 Apr 09 - 27 Apr 16.
Iruttukanam Small Hydro Electric Project (India): small scale run-of-river, 3 MW. Crediting period 01 Jun 09 - 31 May 19.
e7 Bhutan Micro Hydro Power CDM Project (Bhutan): power generation capacity 70 kW. Crediting period 19 Aug 05 - 18 Aug 12.
Sanquhar and Delta Small Hydro Power Projects (Sri Lanka): two small-scale, run of river hydropower plants, each with an installed capacity of 1.6 MW. Crediting period 01 Jan 04 - 31 Dec 10.
Santa Lúcia II Small Hydropower Plant (Brazil): run-of-river small hydro plant with installed capacity of 7.6 MW. Crediting period 01 Oct 03 - 30 Sep 10.
Feasibility of CDM as a financing model (Case studies from Ethiopia)
PV Solar Home Systems and Carbon Finance
PV Solar home systems (SHS) are an eligable technology for carbon finance projects. However, their GHG savings (carbon credit) potential is small compared to overall PV system costs. There is only one SHS project registered under the CDM at this moment (November 2009), but several are in the CDM pipeline.
For further information and studies see the website of the Energy research Centre of the Netherlands.
Photovoltaic kits to light up rural households in Marocco: Up to now this is the only registered SHS CDM project. Crediting period: 01 Jan 07 - 31 Dec 16.
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