- Australian companies may use the CDM to help meet future domestic emission reduction targets.
- Companies can invest in CDM projects in developing nations and participate in international carbon markets.
- The current European demand for CERs is an added incentive to engage with the CDM.
- Case studies show the kinds of opportunities CDM projects can present.
The Clean Development Mechanism (CDM) presents opportunities for Australian companies to participate in international carbon markets, even in the absence of the Carbon Pollution Reduction Scheme (CPRS). There is a potential link between the CDM and the CPRS in its current proposed form1 that may allow Australian companies to invest in CDM projects in developing nations2 in order to meet their future domestic emission reduction targets in a flexible and cost effective way.
The current European demand for carbon emission reduction credits creates an added incentive for Australian project developers, financial institutions and technology owners to engage in the business of generating, buying, selling and funding emission reductions under the CDM.
A number of Australian companies are already active in the CDM market and we provide some case studies as examples of the kinds of opportunities that companies may explore.
2 The Clean Development Mechanism
The CDM is one of three flexible mechanisms established under the Kyoto Protocol (Kyoto) that developed nations may use to help meet their agreed greenhouse gas emission targets. It provides the opportunity for developed nations to undertake emission reduction projects in developing nations, to earn certified emission reduction (CERs) credits. Each CER is tradeable and equivalent to a one tonne reduction of CO2.
Before a project can commence generating CERs, it must be registered with the CDM Executive Board (CDM EB), the body based in Geneva that supervises the CDM. The project owner must also obtain a letter of approval from the Designated National Authority (DNA) of the country in which the project is to be carried out. The thorough (and public) registration process is designed to ensure that all CERs generated are real, measurable and verifiable, and additional to any that would have occurred without the project.
Although Kyoto binds only nation-states, the private sector has been the dominant buyer of CERs in the project-based market. This is because many domestic emissions trading schemes targeting private sector emitters allow CERs to be recognised under the domestic scheme. This will most likely be the case in Australia if a scheme such as the CPRS in its current proposed form is introduced.3 In addition, CERs and derivative products are now actively traded on commodity markets (such as the European Climate Exchange4 and Nord Pool ASA5) by banks, utilities and investors wishing to include carbon assets in their energy-related product portfolios.
3 Programmatic CDM
Programmatic CDM is a mechanism by which a structured group of small CDM projects (CDM project activities) can be aggregated together into a formal program of activities. The aggregation of projects is designed to reduce administrative overheads, facilitate efficient roll out and up-scaling, and promote a high yield of CERs as well as strong local sustainable development contributions.
Once a program of activities has been approved and registered by the CDM EB (including a pilot project and an overall program plan), it is possible to add further CDM project activities to the program of activities without the need to repeat the registration process. All that is needed for the project to start generating CERs are the approvals of an independent third party auditor and the DNA, which significantly reduces the lead time for the approval process.
4 The CDM Market
In 2009, in the global primary CDM market (which involves buyers purchasing CERs directly from project developers), 211 million CERs were traded for a total value of US$2.67 billion. In 2009, in the global secondary market, 1.05 billion CERs were traded for a total value of US$17.54 billion. The secondary market involves the ongoing trading of CERs, largely in Europe.6
Click here to see the following charts which provide a snapshot of recent CDM activities and the major players:7
Figure 1 – Registered project activities by region (total 1,899)
Figure 2 – CERs issued, by host party (total approx 350 million)
Figure 3 – Investor parties
5 The Carbon Pollution Reduction Scheme
Under the proposed cap and trade version of the CPRS, emissions for stationary energy facilities and other large emitters would be capped and emitters would be granted a certain number of permits (or units) to emit up to this cap. These entities would be permitted to trade any excess permits they may have under this cap as well as offset credits such as CERs, as discussed below.
6 The link between the CDM and the CPRS
A key feature of the proposed CPRS is that it would allow for emissions units created under Kyoto such as CERs to be used for surrender in the CPRS, thereby creating a link between the proposed CPRS and the international CDM market.
Kyoto allows for CERs to be transferred within the international electronic registry system. The current design of the CPRS would allow for CERs to be transferred from a foreign registry to an account in the Australian registry, known as an ‘incoming international transfer’.
Under the current form of the CPRS, there are no restrictions on the volume of CERs that can be imported and used for compliance in Australia. Interestingly, this approach differs from the European Emissions Trading Scheme where certain limits are placed on CERs generated by certain project types such as nuclear facilities and large scale hydro electricity. Whether this approach will be adopted in Australia remains to be seen.
7 Opportunities for Australian companies
The link between the proposed CPRS and the CDM means that Australian companies may either purchase CERs in the international market to meet their targets under the proposed CPRS, or develop CDM projects offshore and use the CERs they will generate to facilitate compliance with the proposed CPRS.
Notwithstanding the delay to the introduction to the CPRS, Australian companies are still able to purchase and ‘bank’ CERs until the CPRS comes into force. CDM projects involve long lead times (due to such factors as the registration process), so parties interested in purchasing CERs directly from project developers in developing countries, rather than in the more liquid secondary market, may benefit from becoming involved in the CDM market sooner rather than later.
In addition, the scope for generating offset credits in Australia would be relatively limited due to the large number of industry sectors that would have a cap on their emissions under the proposed CPRS, including industrial processing, stationary energy (including electricity production), transport, waste and oil and gas fugitive sources.8 As such, the CDM remains one of the best-developed sources of low-cost offset credits that would be eligible for compliance under the proposed CPRS framework.
In summary, while the delay in the CPRS means that there is no immediate compliance requirement for Australian companies, there may be significant opportunities for Australian companies by being aware of the alternative compliance units available to them through the international market. Further, the current European demand for CERs creates an added incentive for Australian project developers, financial institutions and technology owners to engage in the business of generating, buying, selling and funding emission reductions under the CDM.
A number of Australian companies are already active in the CDM market, as the case studies below indicate. We would like to thank our clients Pacific Hydro and Cool nrg International for engaging us to act for them in relation to these projects and for allowing us to use them as examples.
8 Case study 1: Vaturu and Wainikasou – CDM hydro projects
The Vaturu and Wainikasou hydro power projects are two ‘run of the river’ power stations located in Fiji with a combined capacity of 9.5MW. They were developed by Sustainable Energy Limited, a joint venture at the time between Pacific Hydro and the Fiji Electricity Authority. The projects were registered with the CDM EB in October 2005.
Annual emission reductions for Vaturu and Wainikasou combined are expected to be 24,928 tonnes of CO2 and are achieved by displacing diesel generation from the national grid. The project is helping Fiji fulfil its goals of promoting sustainable development by:
- increasing employment opportunities to local people both during construction and operation in the area where the project is located, where permanent and reliable sources of employment are scarce
- improving roads maintenance and repairs as the project obtains economical stability
- diversifying the sources of electricity generation, and
- helping the Fijian Government achieve its commitment to environmentally clean and environmentally friendly energy production.9
The sale of CERs generated by the project to ABN Amro Bank London Branch was the first transaction for the sale of CERs involving an Australian entity.
9 Case study 2: Luz Verde – Programmatic CDM energy efficiency project
The Luz Verde project involves exchanging compact fluorescent light bulbs (CFLs) to replace incandescent light bulbs for low-income households across Mexico. The first CDM project activity involved distributing one million CFLs in the state of Puebla in November 2009, with a series of CDM project activities to be rolled out across Mexico, targeting at least 30 million CFLs. The project was registered with the CDM EB in July 2009, becoming the first project in the world to be registered as a Programmatic CDM project.
Each CDM project activity has a 10-year life and the cumulative effect of the entire program will be to cut Mexican carbon emissions by 7.5 million tonnes of CO2 equivalent. In addition, the project will save participating households a total of around US$165 million per year on their domestic electricity bills. Lighting accounts for 40% of household electricity consumption in Mexico. By handing in four incandescent bulbs and installing four CFLs, the people of Mexico may save around one week’s worth of income (on average up to US$23) in reduced power bills a year.10
The Australian project developer, Cool nrg International has sold approximately 252,000 Gold Standard CERs11 from the first CDM project activity to Eneco Energy Trade, a Dutch utility company.
ING Bank financed the first CDM project activity. The structure of this transaction was unique, with project financing based entirely on the forward revenue stream of CERs. The transaction was recently awarded the Environmental Finance Magazine ‘Carbon Finance Transaction of the Year 2010’.12