Windfall profits from carbon trading

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opportunity/environment

Windfall proďŹ ts from carbon trading Projects aimed at reducing pollution and mitigating climate change are no longer mere investments for a good cause. They have become revenue generators, thanks to the Kyoto Protocol, an agreement by world governments to limit dangerous emissions /Vimarsh Bajpai

CDM Project Stages 2. Preparation of project documentation applying an approved methodology for calculating emission reductions (Project Design Document) 1. Project identiďŹ cation

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4. Host country approval

3. Validation of project documentation by environmental an auditor accredited by Clean Development Mechanism Executive Board (CDMEB)

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RF, a refrigerant producer, took up a project in 2005 to reduce the emission of HFC-23, a greenhouse gas (GHG) generated as a byproduct at its factory in Bhiwadi, Rajasthan. This effort reduced the emission of 3.8 million tons of GHG every year. Good show, right? But what happened next is more of interest to us. The company traded this reduction at Euro 10 a ton of emission saved or per CER (Carbon Emission Reduction) units, earning $53.2 million a year!

At the other end of the spectrum, Karnataka-based NGO SKG Sangha has set up biogas and vermi-compost plants for 10,000 rural families in the state. This reduces carbon dioxide (CO2) emissions substantially. The NGO sells these emission savings as Voluntary Emission Reduction (VER) units directly to international buyers and not through regulatory mechanisms, thus raising money for its programs.

Welcome to the world of carbon trading, where otherwise non-remu-

nerative projects aimed at reducing pollution, specifically carbon dioxide and other greenhouse gases, become money-spinners. Both SRF and SKG Sangha are among the hundreds of beneficiaries of the carbon trading business that Frost and Sullivan estimates to be worth $52 billion this year, and to touch $100 billion by 2010. Developing countries such as India are tapping the benefits of this market both through the highly regulated Clean Development Mechanism (CDM) or a more informal voluntary market.

The era of debate whether climate change is for real or not has drawn to an end and the fight to save environment has achieved a critical mass. This year’s Nobel Peace Prize, jointly shared by climate change activist and former US Vice President Al Gore and the Intergovernmental Panel on Climate Change (IPCC), has only underscored the need to contain global warming, which if left unchecked, could cause the biggest catastrophe mankind has ever witnessed.

Opportunity: Reducing Emissions “The Clean Development Mechanism is a voluntary activity to reduce green house gas emissions and everyone is eligible whether it is a big corporate, an NGO or an individual. You become eligible if the project meets the CDM eligibility criteria,” says CDM expert Dhirendra Kumar, Group Coordinator, Winrock International. Bharti Gupta Ra mola, Executive Director at PricewaterhouseCoopers feels that “early success in the CDM market has brought such projects within the investment decision-making process in a large number of medium and large corporations.”

While for Indian companies, carbon trade has opened up a new revenue stream, for NGOs, this has become a means for making grass-root level projects self-sustaining in the long run. “We want money to implement programs for poor rural women, and carbon trade has helped bring in funds," says D Vidya Sagar, President, SKG Sangha.

Carbon Trading in a Nutshell This is a unique trading system agreed upon by more than 170 countries in a bid to save our environment from further degradation. It is based on the premise that those who continue to pollute the environment should pay for their sins to those who make efforts to save it.

If you undertake a project to reduce pollution levels, you become eligible for selling the amount of greenhouse gas emissions saved as carbon credits. One credit equals to one ton of CO2 emission saved. Carbon credits are traded in the international market.

Credits earned through the Clean Development Mechanism are called Carbon Emission Reduction (CER) units. The process requires approval of the host country and registration with the UN Executive Board. The CDM is time consuming and expensive compared to another process which generates Voluntary Emission Reduction (VER) units. VERs are tradable at climate exchanges like the Chicago Climate Exchange or sold directly to end buyers. VERs have a much lower market value than CERs. Payments in the carbon market are made in the form of cash, equity, debt, convertible debt or warrants. Some parties pay in-kind, providing technologies to curb emissions.

7. Verification of generated emission reductions by an accredited verifier 5. Acceptance of project by the CDMEB (Registration) 6. Project implementation, monitoring and reporting

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8. Acceptance of verified emission reductions and issuance of credits by the CDMEB (Certification and Issuance)

9. End of contract period (May be post-2012)

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DARE.CO.IN The Kyoto Protocol At the heart of the carbon trading market lies the Kyoto Protocol. On December 1, 1997 more than 160 nations met in Kyoto, Japan, to negotiate limitations on emission of greenhouse gases for developed nations, as part of the multi-nation treaty – the United Nations Framework Convention on Climate Change (UNFCCC). The outcome of the discussions was the Kyoto Protocol, which came into force on February 16, 2005. The Protocol, ratified by more than 170 countries, is a legally-binding agreement under which industrialized countries have agreed to reduce their collective GHG emissions to a level that is 5.2% below their 1990 emission levels in the commitment period 2008-12. However, the US is yet to ratify the Protocol.

The Different Markets The carbon market is based on three mechanisms under the Kyoto Protocol: Emissions Trading, Joint Implementation and Clean Development Mechanism. These mechanisms are aimed at rewarding those who reduce emissions or remove carbon from the atmosphere at the cost of those who add GHG. While Emissions Trading and Joint Implementation are of concern to developed countries, Clean Development Mechanism is of particular interest to developing countries such as India.

Emissions trading or the allowance market is a trading system wherein

opportunity/environment DARE/carbon market 2005 Value ($million)

Volume (MtCO2e)

Value ($million)

Allowances Market EU-ETS New South Wales Chicago Climate Exchange UK-ETS Sub Total

321 6 1 0 328

7,908 59 3 1 7,971

1,101 20 10 NA 1,131

24,357 225 38 NA 24,620

Project-based Transactions Primary CDM Secondary CDM Joint Implementation Other Compliance Sub Total

341 10 11 20 382

2,417 221 68 187 2,893

450 25 16 17 508

4,813 444 141 79 5,477

TOTAL

710

10,864

1,639

30,097

Source: World Bank's State and Trends of Carbon Market 2007

* Metric ton of CO2 equivalent

developed countries or transition economies purchase carbon credits from other developed countries or transition economies to meet their GHG reduction targets. This has led to the development of the European Union Emission Trading Scheme (EU ETS), which is the largest sub-set of the carbon market. According to the World Bank’s State and Trends of the Carbon Market 2007 report, under the EU ETS, 1,101 tons of carbon dioxide equivalent was traded in 2006 with the allowance market valued at $24,357 million.

Joint Implementation (JI) involves project-based transactions wherein an emitter in a developed country buys carbon credits by implementing a GHG reduction project in another developed country. In 2006, this market was valued at $141 million.

The Greenhouse Effect and Global Warming Climate change, including the increase in global temperatures and the erratic pattern of climatic behavior, is being attributed to the enhancement of the greenhouse effect.

Certain naturally occurring gases such as CO2 trap the sun’s heat to keep the earth warm and habitable. They are called greenhouse gases (GHG) and the process of heat entrapment is the greenhouse effect.

Major GHG are Carbon dioxide, Methane, Nitrous Oxide, Hydroflurocarbons, Perflurocarbons and Sulphur Hexafluoride. However, over the last 100 years, large-scale industrial development involving burning of fossil fuel such as coal and petroleum products coupled with excessive deforestation has raised the level of GHG in earth’s atmosphere. This has led to the rise in earth’s average temperature (global warming) causing dramatic climate changes such as melting of glaciers, rise in sea levels, frequent hurricane activity, and prolonged droughts and floods.

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2006

Volume (MtCO2e)*

Clean Development Mechanism The clean development mechanism (CDM) provides for developed countries to pay for the implementation of emission reduction projects in developing countries. “CDM is a highly regulated process and involves a number of steps including initial evaluation, preparation of a project design document (PDD), validation and verification, host country approval and registration with the UNFCCC,” says Meenakshi Jain, Director, PositiveClimatecare, a CDM consultancy.

Gujarat Fluorochemicals was the first from India to register a CDM project at the UNFCCC in 2005. Indian companies have come a long way since then. Some of the majors include GMR Industries, JSW Steel, Tata Sponge Iron and Grasim Industries.

For CER trading, one can opt for either a fixed crediting period or a renewable crediting period. In case of fixed crediting, you will get CER credits for 10 years and after that your project might be operational but you will not receive CER benefits.

In the case of renewable crediting period, you will get the CER credits for 7 years and after that you can renew your crediting period by two more times. “This means for a total of 21 years, you can avail CDM benefits.

However, for availing CER benefits in each of the renewable periods, your project baseline need to be revisited,” adds Kumar.

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hat is the reason behind the increasing participation of Indian companies in carbon trade (CDM and the voluntary market)? Is it just money or more than that?

The possibility of additional revenue stream through CDM has played a significant role in making corporations look more closely at investments in low carbon technologies.

We must however salute the spirit of Indian entrepreneurs who went ahead with potential projects long before Kyoto Protocol was ratified and have maintained their faith in the carbon market despite facing hurdles. Extensive capacity building (including identification of project opportunities, technology, CDM financing sources, etc.) done by the Indian national CDM authority, CDM service providers, CDM financing agencies and CDM champions within the organisations, particularly in the case of large organisations is another facilitating factor.

How are Indian companies benefiting from the voluntary carbon market?

Indian companies are using the additional opportunity provided by the voluntary marEXECUTIVE DIRECTOR, kets mainly in two ways: PRICEWATERHOUSECOOPERS There are a large number of “early start” projects which have missed the UNFCCC deadline for retroactive claim of CERs. Once these projects are registered with the CDM Executive Board, they receive CERs from after the date of registration. For the period prior to registration, the emission reductions (once verified) are traded in the voluntary carbon markets. For a voluntary buyer, these represent good quality emission reductions as these arise from registered CDM projects.

There are various small scale emission reduction projects, which due to higher pre-registration expenditure and the long lead time associated with the regulatory process, cannot afford to go through the CDM process. These projects therefore look at voluntary market.

There are also cases where UNFCCC approved methodologies are not available, but the identified projects have GHG reduction potential and these then choose to sell in the voluntary carbon market.

BHARTI GUPTA RAMOLA,

Is the future of the voluntary carbon market brighter than that of the CDM, which is a highly regulated and expensive process?

Reduction in carbon footprint is a global initiative and is here to stay. The voluntary carbon market can be considered as an additional opportunity for GHG reduction. The voluntary carbon markets, which were in nascent stages until last year have now started showing signs of development because of the growing interest from both buyer and seller sides. It is true that the long and expensive CDM process may force project implementers/investors to look at the voluntary carbon market route. But this should not be seen as a comparison between the compliance and the voluntary market. The growth and robustness of the voluntary carbon market will be inextricably linked to that of the compliance carbon market. If anything, the voluntary carbon market will supplement the compliance carbon markets but will continue to derive its depth (and systems and procedures) from the compliance carbon markets.

How can an entrepreneur benefit from carbon trade?

The scope of carbon trading is very much defined in the Kyoto protocol, wherein any activity carried out by the investor results in GHG emission reduction beyond the business as usual scenario or the prevailing practices in the market is eligible for CDM due diligence and registration. Out of the six identified GHGs in the protocol, carbon dioxide is the most common one and is generated in almost all the industries which consume energy in one form or the other and thus energy efficiency and process change is one of the most common type of projects which can be taken up for GHG reduction. In addition to this, switching over to alternate fuels and cleaner technologies can also result in GHG emission reductions. With new trading avenues opening up, it is always possible to trade the emission reductions in voluntary markets if not in compliance markets under the Kyoto Protocol.

Tough methodologies for verification of the projects have been a dampener in getting more projects registered for CERs. “Methodologies for some projects such as those related to afforestation are so rigorous that only one such project, in China, has so far been registered for carbon credits,” says Ashutosh Pandey, Practice Head, Emergent Ventures, a CDM consultancy firm. “There are also cases where the UNFCCC approved methodologies are not available, but if the projects have

GHG reduction potential, they can choose to sell in the voluntary carbon market,” adds Ramola.

Asia dominates the seller side of the market while a majority of buyers are based out of Europe and Japan. As of November 8, 2007, a total number of 844 projects have been registered with the UNFCCC, out of which India led the pack with 288 projects, followed

by China and Brazil. But despite having the maximum number of projects registered under the CDM, India lags

behind China on the number of carbon credits issued to it. “This is because most of the projects in China curb emissions of HFC, which is a more potent gas compared to CO2. This fetches more CERs,” says Pandey. According to the World Bank report on State and Trends of Carbon market, in 2006, China dominated the CDM market on the supply side with a 61% market share of volumes transacted, down slightly from 73% in 2005. Next was India at 12%, recovering from 3% in 2005.

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World-wide share of CDM projects

Total Number of Projects: 844, as on November 8, 2007 Source: United Nations Framework Convention on Climate Change

Asia as a whole led with an 80% market share. Renewable energy projects rule the roost in India, followed by those relating to waste management. Chetan Agarwal of Winrock International, says “Community and bio-diversity projects have a bright future and entrepreneurs can make the most of it.” The average price of a CER during 2006 & 07 was Euro 10-15.

Voluntary Market High cost of development of a CDM project and also the rigorous regulations have led to a swift growth of the voluntary market for trading of carbon credits. “We found the CDM process expensive and cumbersome and therefore decided to directly trade our carbon credits in the international market,” say Vidya Sagar.

For voluntary markets, carbon credits are called voluntary emission reduction (VER) units. “For getting the VERs you need not undertake the registration, verification and certification, as in the case of CDM projects. The initial steps are pre-

requisite (such as development of project report) and it will be based on the VER buyers’ decisions and priority and not as per the Kyoto Protocol requirements,” clarifies Kumar.

“At the broadest level, the voluntary carbon markets can be divided into two main segments: the voluntary, but legally binding, cap-and-trade system that is the Chicago Climate Exchange (CCX); and the broader, non-binding, over the counter (OTC) offset market,” according to a report on the state of voluntary market by New Carbon Finance. The report estimates that in 2006, the global voluntary market was worth $91 million. Out of this, the OTC market was worth $54.9 million. The price of a VER varies considerably, and is usually 25-50% of CER value at any point of time.

Consultancy Business With more and more companies jumping into the carbon trading bandwagon, it is festival time for CDM consultancy business. As the process is a rigorous one and highly compli-

RICHARD SANDOR, FATHER OF CARBON TRADING The business of carbon trading has an entrepreneurial tinge. Thanks to Richard Sandor, who pioneered the idea of market-based solution to environmental problems.

This research professor at the Kellogg Graduate School of Management at Northwestern University, USA, founded the Chicago Climate Exchange (CCX), which is a self-regulatory exchange that administers the world’s first and North America’s only multi-national and multisector marketplace for trading greenhouse gas emissions.

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cated, most companies are looking for facilitators, who can act as links between sellers and buyers. Right from developing the initial project report to brokering a deal between the project developer and the buyer, consultancy business is booming in a big way.

With the sharp increase in the number of consultancies in the last few years, the fee has gone down significantly. However, the volume of CDM business has grown manifold.

Consulting fee may vary between Rs 2-5 lakh for developing the initial project report. A lot depends on the size of the project. Complex projects with difficult methodologies can fetch even more money. Most consulting firms charge a certain percentage of the CER revenue once the project becomes viable.

Beyond 2012?

Despite the big size of the carbon market and even bigger projections, the future is shrouded in uncertainty.

This is because the first Kyoto Protocol period will end in 2012. This is the very reason that most deals are limited only up to 2012. The US and Australia are yet to ratify the Kyoto Protocol. The US has asked China and India also to undertake emission cuts. This is a big bone of contention as the developing countries are unlikely to give in.

However, the World Bank, which is a major facilitator in the carbon credit market, recently launched a new carbon fund – the Carbon Partnership Facility (CPF), which will purchase emissions reductions for at least 10 years beyond 2012.

“The CPF is our specific response to the continued carbon market uncertainty post-2012, and will become operational when purchase commitments reach $500 million and similar sales commitments have been made.

It is designed to be regime-neutral, as its objectives are to promote a shift towards investments in long-term, low-carbon technologies where otherwise greenhouse gas emissions would be locked in for decades to come,” says Charles Cormier, Team Leader, Environment and Water Resources, DAR E World Bank.

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