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Climate Change : Carbon Finance and CDM

The Science
International Policy
Implications for energy
Opportunities in Renewable Energy
Carbon Finance and CDM.

Introduction
Carbon finance is a relatively new sector in finance that is derived from environmental concerns about greenhouse gas (GHG) emissions and their impact on climate change. It is an initiative developed from the Kyoto Protocol which aims at reducing GHG emission in the most cost efficient manner. In general, carbon finance refers to investments in projects to reduce GHG emission and creation of financial instruments that are tradeable on the carbon market. Three market mechanisms has been incorporated – International Emissions Trading (IET), and the two project-based mechanisms Joint Implementation (JI) and the Clean Development Mechanism (CDM).

International Emissions Trading and EU Emission Trading System
Emissions are traded in the form of emission allowances. Each allowance represents the right to emit one tonne of CO2 or an equivalent amount of other GHGs (t CO2e). Under IET, emissions allowance budget know as Assigned Amount Units (AAUs) are traded between nation states. To facilitate trading between single installations from carbon intensive industry sectors, the European Union has started an emission trading system (EU ETS) which trades EU Emission Allowance (EUAs) on the European Climate Exchange. Both the IET and EU ETS follow a cap-and-trade approach, where mandatory emission caps are set and related volumes of emission allowances are allocated to the participants. The trading regimes will encourage countries and companies to reduce their emission in order to sell AAUs and EUAs. A similar trading platform known as Chicago Climate Exchange has also been incorporated in North America. Unlike a mandatory trading regime in Europe, the Chicago Climate Exchange is a voluntary trading platform.

EUA (2008 Vintage) Price and Volume:

Recently, the World Bank has released a report (ABC Net, 2006), which has found that the international Carbon Market is now trading more than US$25 billion a year and that emissions trading quadrupled in year-on-year relative to 2005. Top-tier investment banks are also turning their attention to this business (i.e. AIG, Morgan Stanley, UBS, Fortis, Goldman Sachs, Barclay, etc).

Clean Development Mechanism (CDM)
The CDM is supervised by the CDM Executive Board (CDM EB) and is under the guidance of the Conference of the Parties (COP/MOP) of the United Nations Framework Convention on Climate Change (UNFCCC). It allows industrialized countries with a greenhouse gas reduction commitment (Annex 1 countries) to invest in projects that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries. In return, the projects will generate Certified Emission Reductions (CERs) which are tradeable. In order to receive CERs, each project has to pass a complex registration procedure with initial costs of between EUR 50,000 to EUR 250,000 depending on project type and size, and taking approximately 1-2 years to get from project concept stage to the actual registration of the project. In one of the key considerations to being registered as a CDM project, a project has to provide evidence of its additionality. This implies that a project would not have been implemented without the incentive to generate emission credits.

Up to November 2006, nearly 400 CDM projects have been registered with a reduction potential of nearly 700 million tCO2e until 2012 (expiry year of Kyoto Protocol). More than 1,200 further projects are in the pipeline, which equates to a reduction potential of about 1.5 billion tCO2e until 2012 (UNEP Finance Initiative).

Investment Opportunities in CDM Projects >>