This page focuses on the possibilities and challenges of successful carbon finance. The Clean Development Mechanism (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.
Carbon Finance through Clean Development Mechanism (CDM) and Voluntary Carbon Market (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 or for the Voluntary Carbon Market (VCM).
The Clean Development Mechanism (CDM)
The CDM is one of three felxible 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 effiency prject in a developing country can be sold to a country with commitments listed in Annex I of the Kyoto Procol (Annex I Countries).
The CMD has two primary goals:
- to assist Ennex I countried 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).
Regarding energy related projects, the follwing activities are - amongst others - typical examples for CDM projects: end-use and supply-side energy efficiency improvement, renewable energy applicatoins, fuel switches, solvent and other product use, waste management and the provision of GHG sinks by afforestation and reforestation activities. 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 Certified Emissions Reductions (CERs) measured in tons of CO2 equivalents that are being reduced through the project in comparison to the baseline scenario.
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, with the choice between a fixed crediting period of ten years or a flexible crediting period of seven year which 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. A CDM project must not be a project that would have been implemented under the business as usual scenario. The fullfilment 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) equals the CERs generated.
Baseline emissions under the selected baseline scenario are calculated according to an approved methodology suitabele for the envisaged project type, (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 months at a minimum; the procedures can easily take longer, possibly up to two years.
As a new instrument to push the CDM for small-scale projects and make their management easier and more cost-effective, the Programme of Activities (PoA) was created in 2007.
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 (see Table 1). 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 (see below).
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
| Project Cycle
|| Estimated Costs
Planning a CDM project activity
Preparing the PDD
Project participants employ a concultant 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 by the DOE is the independent evaluation of a project activity against the requirement of the CDM on basis of the PDD.
|| 10.000 - 14.000 €
|| 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= $0.10/CER
> 15.000 tCO2 = $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 having validated the project.
|| 10.000 - 14.000 €
| Issuance of CERs
|| The EB will issue certified emission reductions equal to the verfied amount.
2% of the CERs issued must be paid as adaptation fee. LEast developed countries are exempted.
Depending on national regulation other fees may accrue.
| Distribution of CERs
A consultant works out agreements of CER distribution among project participants.
Broker markets the CERs
5.000 - 10.000 €
To be negotiated
The Voluntary Carbon Market (VCM)
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).
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.
-> VER Prices: Reports on VER market prices.
For technology-specific information on carbon financing please refer to the following pages: