Monday, January 21, 2008

Towards Greener Tomorrow - Understanding Carbon Credit

Amidst growing concern and increasing awareness about the need for pollution control, the concept of carbon credit came in vogue as part of international Kyoto Protocol. India is largest beneficiary of carbon trading, claiming about 31% of the total world carbon trade through the Clean Development Mechanism (CDM), which is expected to rake in at least $5-10bn over a period of time. India is being heralded as the next carbon credit destination of the world. This article delves into the concept.

The Concept of Carbon credit came into existence as a result of increasing awareness about the need for pollution control. It took the formal form after the international agreement between 141 countries, popularly known as Kyoto Protocol. Carbon Credits are certificates awarded to countries that are successful in reducing the green house gases(CHG) emissions that cause global warming.

It is estimated that 60-70% of GHG emission is through fuel combustion in industries like cement, steel, textiles and fertilisers. Some green house gases like hydro fluorocarbons, methane and nitrous oxide are released as by-products of certain industrial process, which adversely affect the ozone layer, leading to global warming.

Kyoto protocol
The Kyoto Protocol is an international treaty to reduce GHG emissions blamed for global warming. The Protocol, in force as of 16 February, 2005 following its ratification in late 2004 by Russia, provides the means to monetise the environmental benefits of reducing GHGs.

Kyoto Protocol is a voluntary treaty signed by 141 countries, including the European Union, Japan and Canada for reducing GHG emission by 5.2% below 1990 levels by 2012. However, the US, which accounts for one-third of the total GHG emission, is yet to sign this treaty. The US agreed to reduce emissions from 1990 levels by 7 % during the period 2008 to 2012, says www.eia.doe.gov. But others would hasten to point out that the protocol is non-binding over the US until ratified.

The preliminary phase of the Kyoto Protocol is to start in 2007 while the second phase starts from 2008. The penalty for non-compliance in the first phase is E40 per tonne of carbon dioxide equivalent. In the second phase, the penalty will be hiked to E100 per tonne of carbon dioxide.

The Protocol and new European Union emissions rules have created a market in which companies and governments that reduce GHG gas levels can sell the ensuing emissions ‘credits’. These are purchased by businesses and governments in developed countries – such as the Netherlands – that are close to exceeding their GHG emission quotas.

For trading purposes, one credit is considered equivalent to one tonne of carbon dioxide emission reduced. Such a credit can be sold in the international market at a prevailing market rate. The trading can take place in open market. However there are two exchanges for carbon credit viz Chicago Climate Exchange and the European Climate Exchange.

The Kyoto Protocol provides for three mechanisms that enable developed countries with quantified emission limitation and reduction commitments to acquire greenhouse gas reduction credits. These mechanisms are Joint Implementation (JI), Clean Development Mechanism (CDM) and International Emission Trading (IET). Under JI, a developed country with relatively higher costs of domestic greenhouse reduction would set up a project in another developed country, which has a relatively low cost.

Under CDM, a developed country can take up a greenhouse gas reduction project activity in a developing country where the cost of GHG reduction project activities is usually much lower. The developed country would be given credits for meeting its emission reduction targets, while the developing country would receive the capital and clean technology to implement the project. Under IET mechanism, countries can trade in the international carbon credit market. Countries with surplus credits can sell the same to countries with quantified emission limitation and reduction commitments under the Kyoto Protocol.

The EBRD region – former centrally planned economies of central and Eastern Europe, Russia, the Caucasus and central Asia – is rich in possibilities for using the Protocol to reduce emissions and energy waste and costs. Such economies are highly energy inefficient: it takes twice as much energy to produce a unit of GDP in Hungary and Czech Republic as it does in Western Europe and 10 times as much in Russia and Ukraine.

Understanding Carbon Credits
Carbon credits are measured in units of certified emission reductions (CERs). Each CER is equivalent to one ton of carbon dioxide reduction. India has emerged as a world leader in reduction of greenhouse gases by adopting Clean Development Mechanisms (CDMs) in the past two years. Developed countries that have exceeded the levels can either cut down emissions, or borrow or buy carbon credits from developing countries.

But how is carbon credit defined? It is action that helps reduce the atmospheric concentration of CO2, such as fossil-fuel conservation and planting trees, defines Canadian Environmental Literacy Project (www.celp.ca). Carbon credits as defined by Kyoto Protocol are one metric tonne of carbon emitted by the burning of fossil fuels.

However, the text of Kyoto Protocol to the United Nations Framework Convention on Climate Change on http://unfccc.int shows no `credit’ in a simple search. “Tradable credits issued according to the amount of absorption of carbon and then sold to emission sources to offset their emissions,” is how www.watercorporation.com. au defines the phrase. “What polluting companies might use to pay for the maintenance of forests,” is the definition in the ecological glossary on projects.powerhousemuseum.com.

There are different types of carbon credit, you’d learn from an educative brochure titled `A Climate Change Projects Office Guide’ on www. dti.gov.uk. “Various types of carbon credits exist, each with different characteristics and potential value,” it begins, and classifies the credits under three heads.

First, `credits defined in the Kyoto protocol’include Assigned Amount Units (AAUs), Certified Emissions Reductions (CERs), Emission Reduction Units (ERUs) and Removal units (RMUs).

Second, `credits for specific emission trading markets to assist in achieving Kyoto targets’ including UK Allowances, and European Emission Trading Allowances (EAU).

Third, non Kyoto compliant credits’ under which are listed Emission Reductions (ERs) and Verified/ Voluntary Emission Reductions (VERs).

Trading In Carbon Credits (CC)
The concept of carbon credit trading seeks to encourage countries to reduce their GHG emissions, as it rewards those countries which meet their targets and provides financial incentives to others to do so as quickly as possible. Surplus credits (collected by overshooting the emission reduction target) can be sold in the global market. One credit is equivalent to one tonne of carbon dioxide emission reduced. CC is available for companies engaged in developing renewable energy projects that offset the use of fossil fuels.

Developed countries have to spend nearly $300-500 for every tonne reduction in carbon dioxide, against $10-$25 to be spent by developing countries. In countries like India, GHG emission is much below the target fixed by Kyoto Protocol and so, they are excluded from reduction of GHG emission. On the contrary, they are entitled to sell surplus credits to developed countries.

It is here that trading takes place. Foreign companies which cannot fulfill the protocol norms can buy the surplus credit from companies in other countries through trading.

Thus, the stage is set for Credit Emission Reduction (CER) trade to flourish. India is considered as the largest beneficiary of carbon trading, claiming about 31% of the total world carbon trade through the Clean Development Mechanism (CDM), which is expected to rake in at least $5-10bn over a period of time.

To implement the Kyoto Protocol, the EU and other countries have set up ‘cap and trade’ systems. Under these systems, companies are obliged to match their GHG emissions with equal volumes of emission allowances.

The Government initially allocates a number of allowances to each company. Any company that exceeds its emissions beyond its allocated allowances will either have to buy allowances or pay penalties. A company that emits less than expected can sell its surplus allowances to those with shortfalls.

Companies or countries will buy these allowances as long as the price is lower than the cost of achieving emission reductions by themselves.

Carbon Finance
‘Carbon finance’ is the term used for carbon credits to help finance GHG reduction projects such as the recent biomass conversion at Bulgaria’s PFS paper mill. The switch from hydrocarbon to biomass will reduce the mill’s GHG emissions, generating carbon credits being purchased for the account of the Netherlands government.

There are two categories of countries involved in carbon credit trading and finance:

(1) Developing countries which do not have to meet any targets for GHG reductions. However, they may develop such projects because they can sell the ensuing credits to countries that do have Kyoto targets. In the EBRD region these include Armenia, Azerbaijan, Georgia, Kyrgyz Republic, FYR Macedonia, Moldova, Turkmenistan and Uzbekistan. These countries are covered by the Protocol’s Clean Development Mechanism (CDM).

Industrialised countries which include OECD countries (the richest nations of the world) and countries in transition from centrally planned to open market economies. The latter include 13 of the EBRD’s countries of operation where the industrial base and other infrastructure are highly energy inefficient: Russia, Ukraine, Bulgaria, Czech Republic, Croatia, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. They are part of the Protocol’s Joint Implementation (JI) mechanism.

Will Carbon Credit be Next Black Bubble?
GLENEAGLES Plan of Action on `Climate Change, Clean Energy and Sustainable Development’ has a section titled `Financing the transition to cleaner energy’. Paragraph 22 (c) in that section speaks of promotion of dialogue on market-based instruments, fiscal or other incentives, and also “tradable certificates and trading of credits for reductions of emissions of greenhouse gases or pollutants,” as one learns at www.number-10.gov.uk.

It seems, therefore, appropriate that the Finance Minister, during his recent trip to the US, was responding to the World Bank’s call to join hands in climate change mitigation, though with a diplomatic line: “We would be happy to remain engaged in the dialogue for exchange of ideas,” rather than easily shrugging off saying that India was not a party to the Plan adopted by the G8 in July.

But Indian companies are more than engaged in emission trading and booking carbon credit.

A recent report informs that SRF Ltd and Shell Trading International have entered into a deal “for sale and purchase of 500,000 CERs (Certified Emission Reductions) to be delivered on or before April 1, 2007”. The move made a strong impact on the charts. Another report, commenting on Suzlon, the country’s leading manufacturer of wind turbine generators, has an analyst writing that wind energy is eligible for carbon credit benefits under the Kyoto Protocol for a decade from 2002.

After Chicago Climate Exchange and the European Climate Exchange, MCX (Multi- Commodity Exchange of India) is likely to be the third exchange in the world with a license to trade in carbon credits, informs yet another news report.

British Energy is the latest international energy producer to overhaul its in-house and external legal set-ups as rising carbon credit prices force the industry to review costs, notes a posting on www.thelawyer.com.

Emissions trading are not elaborately dealt with in the protocol. Article 17 in it gives the job of defining “the relevant principles, modalities, rules and guidelines, in particular for verification, reporting and accountability for emissions trading” to the CoP or Conference of the Parties.

“The Parties included in Annex B may participate in emissions trading for the purposes of fulfilling their commitments under Article 3.” Annex B shows a list of countries and `Quantified emission limitation or reduction commitment’, as a percentage of base year or period. Among the countries are those with limits that are above their current production; and the buffer or the `extra’ is what can be sold to other countries on the open market, as tradable credit. “So, for instance, Russia currently easily meets its targets, and can sell off its credits for millions of dollars to countries that don’t yet meet their targets, to Canada for instance. This rewards countries that meet their targets, and provides financial incentives to others to do so as soon as possible,”

That apart, carbon dioxide sinks such as forests earn credits. Please note that buying credits is no substitute to domestic action to reduce emissions. Of current bearing would be `Summary of the Seminar on Linking the Kyoto Project-based Mechanisms with the European Union Emissions Trading Scheme’ on www.iisd.ca; it traces the history of the protocol and ETS.The Saskatchewan Soil Conservation Association (http://ssca.usask.ca) has an interesting article by John Bennett to help “farmers understand the benefits and the risks of being short-changed” by carbon markets. He offers a `30-second science lesson’: “A plant takes solar energy and by the process of photosynthesis, transfers the carbon dioxide gas into carbon (organic matter) and then returns the oxygen to the atmosphere. The removed carbon, which is stored in the soil and measured as organic matter is the RMU (emission removal).”

How is price determined for carbon credit? How big is the market? These are questions you may like to probe further. It may be a clue to know that a recent alert spoke of India standing to gain $5 billion from carbon credit in seven years. Another estimate, from the UK angle, cited on www.dti.gov.uk pegs the size of the market “at between euro 4.6 to euro 200 billion by 2010, with the former estimate based on purchases of carbon credits limited to compliance only, and the latter estimate subject to international political developments.” A `truly liquid market’, it notes. What is however for sure is that nobody can assure you that carbon won’t become the next big black bubble.

Carbon Credit: Rs. 15,000-crore Investments Likely
The unfolding opportunity of carbon credits has caught the imagination of Indian entrepreneurs. The number of Indian projects, in the fields of biomass, cogeneration, hydropower and wind power, eligible for getting carbon credits, now stands at 225 with a potential of 225 million CERs (certified emission reductions.

Each CER stands for one tonne of carbon dioxide reduction.) “This is just the tip of the iceberg. If there is no uncertainty as to what will happen beyond 2012, the number could easily cross the 2,000-mark,” according to Mr. S.K. Joshi, Joint Secretary in the Union Ministry of Environment and Forests.

The Kyoto Protocol required the developed nations to reduce greenhouse-gas emissions of at least five per cent from 1990 levels during the commitment period of 2008-2012. On the sidelines of the 93rd Indian Science Congress, he told Business Line that it was estimated that the new opportunity could trigger flow of investments to the tune of Rs.15,000 crore. Projects approved by designated CDM (Clean Development Mechanism) in the developing countries could earn carbon credits and sell them to the countries that required reducing the greenhouse gas emissions under the international agreement. “We are not at all under any pressure. Going for cleaner production was good for our own interest. In that process our companies can benefit by selling the credits,” he said adding that any project that was set up after January 1, 2000, was eligible for CDM recognition.

In a bid to throw light on the subject, public sector energy utilities such as NTPC, ONGC and Power Grid and the Ministry of Environment and Forests recently held a national level seminar. The Ministry had already started a project to sensitise and encourage States to take a lead in this regard. Initially five States — Andhra Pradesh, Rajasthan, Karnataka, Punjab and Maharashtra were given seed funding to set up their own CDM facilities and spread the word. Now it has been extended to 15 States while the ultimate aim is to cover the whole country by the year-end.

Demand for Carbon Credits Will Grow
The demand for carbon credits is expected to grow for the following reasons:

Because of projected shortfalls and higher relative carbon abatement costs, it is anticipated that OECD countries will fail to meet their Kyoto target by 2012. The higher relative emissions abatement costs in these countries mean that they will find it attractive to buy carbon credits generated elsewhere.

Private companies in industrialised countries will increasingly be subject to ‘cap and trade’ mechanisms, such as the EU Emission Trading Scheme which started on 1st January 2005 (although this will initially cover only 50% of emissions). The EU scheme is separate from the Kyoto Protocol but the ‘Linking Directive’ of 2004 allows a European company to buy Kyoto Protocol Carbon Credits to comply with their obligations under the EU Emission Trading Scheme.

Governments will also have to buy Carbon Credits because the ‘cap and trade’ mechanisms will initially only apply to a fraction of each state’s economy and Governments are responsible under the Kyoto Protocol for meeting their country targets. OECD Governments and European companies subject to the EU Emission Trading Scheme will therefore be the main buyers of Carbon Credits.

Low-Cost Carbon Credits Available in EBRD’s Countries of Operations
The reference year used by the Kyoto Protocol for targets in emission reductions is 1990. Since then, emissions have dropped sharply in countries such as Russia and Ukraine, as a result of substantial real contraction of GDP. It is expected that the targets of 13 countries of operation with Kyoto Protocol will remain below their agreed maximum greenhouse emissions. These countries will therefore be likely sellers of carbon credits. High carbon and energy intensities mean high potential for low-cost emissions reductions (low relative investment cost per tonne of GHGs avoided).

Role Of EBRD
The main role of the Bank in the field of carbon finance is to act as financier of emission reduction projects. However, in keeping with its principle of ‘additionality’ - supporting and complementing the private sector rather than competing with it - the Bank can play a number of additional roles:

Carbon Funds: The EBRD is well positioned to purchase, for the account of third parties, carbon credits from GHG emission reduction projects. The Bank’s added value in this area stems from:

l The size and quality of emission and reduction projects. The Bank is the largest financier of private sector deals in the region, with preferred creditor status, a rigorous appraisal process, and integrity and ‘good governance’ requirements. It also has lengthy experience in energy efficiency and renewable energy projects.
l The importance of closely coordinating the project financing and carbon buying process
l Strong relationships with host country governments, and its ability to engage in policy dialogue to remove or alleviate obstacles to carbon trading and mitigate the ‘political’ risks inherent to the JI and CDM project cycles
l Its experience in managing funds from its shareholders for a variety of purposes (e.g. nuclear safety).
l Its ability to access donor funds to help develop and implement projects.
l In October 2003, the EBRD established its first carbon fund, the Netherlands Emissions Reductions Co-operation Fund, with the Dutch Government. The fund buys Joint Implementation Carbon Credits from its 13 countries of operations eligible for this mechanism. Its first transaction was the PFS biomass conversion.
l The Multilateral Carbon Credit Fund will become operational in 2006. The fund will buy carbon credits from investments under the European Union scheme as well as the Protocol’s Joint Implementation and Clean Development Mechanism. It will also aim to facilitate the direct trading of carbon credits between some of its shareholders (so-called Green Investment Schemes).

Donor Funding: The Bank can help Governments and companies in its region of operations overcome obstacles in emission trading by providing technical advice funded by donor governments. For example, as part of the Bank’s Early Transition Countries Initiative for its poorest countries of operation, donors have approved funding to help in development of complex CDM projects.

Business Opportunities For Private Sector
EBRD’s carbon finance activities create new business opportunities for the private sector in this emerging market as:
l Selling carbon credits increases the feasibility of emission reduction projects, which helps to attract new private investors
l By being the buyer of carbon credits in a transaction, the EBRD can provide comfort to private sector buyers that would not otherwise consider these projects

At last count in March 2006, India had 310 ‘eco-friendly’ projects awaiting approval by the UN. Once cleared, these projects can fetch about Rs. 29,000 crore in the next seven years. India’s carbon credit market is growing, as many players (industries) are adopting the Clean Development Mechanism (CDM).

US accounts for 30% of global emissions, while India makes for three per cent. Now, India can transfer part of its allowed emissions to developed countries. For this, India must first adopt CDM and accrue carbon credits. One carbon credit or Certified Emission Reductions (CERs) is equivalent to one tonne of emission reduced.

In India so far, 242 projects have been identified for generating CERs while a total of 318 projects have received clearance by the Ministry of Forestry and Environment. For the Indian carbon market — this has the potential to supply 30-50% of the projected global market of 700 million CERs by 2012.

Conclusion
Even as India is being heralded as the next carbon credit destination of the world, with maximum growth on this front happening in Maharashtra, Chhattisgarh and Andhra Pradesh, Gujarat is slowly emerging as the dark horse of the country on the back of rapid industrialisation through its recent oil refineries and power projects.

Between the end of 2005 and December 2006, 450 clean development mechanism (CDM)
projects had been submitted to the ministry of environment and forests, of which around 420 CDM projects have received government approval, which make up a total of 350 million carbon credits, said a source from the ministry. Of the 420 projects, around 20 are from Gujarat.

Corporate biggies like Reliance and Essar are already present in the state. And now, most carbon credit consultants, including a few international environment players planning to set up shop in the country, are eyeing the Gujarat market.

Of the approved companies from Gujarat, Torrent Power has the maximum number of credits to its name with 11 million credits followed by ONGC’s Hazira refinery with approximately two million credits, Indian Farmers Fertiliser Cooperative Ltd (Iffco) with 1.5 million credits, Essar Power with 0.5 million credits, Reliance Industries’ approval for its base in Gujarat close to 2,40,000 credits, and Apollo Tyres with 1,00,000 credits.

Others include United Phosphorus, Gadhia Solar, Tata Chemicals, Rolex Rings, Alembic and Fairdeal Suppliers, said the source.

“Going by the current rates, where carbon credits are measured in units of certified emission reductions (CERs) and each CER is equivalent to one tonne of carbon dioxide reduction, the value of one carbon credit could be anywhere between three Euros and six Euros, and with bank guarantee can go up to eight or nine Euros,” said Pranav Nahar, managing director of Eco-securities, which boasts of being the only international developer and trader of carbon credits to have a liaison office in India.

Carbon credit analysts confirm that at least two leading international players have already begun dialogue with the government to acquire permission to set up liaison offices in India.

However, in spite of the global interest in India for the CERs market, there is still some way to go before it catches up with the market leaders in the field. While China leads the pack with a market share of 60% in the carbon credit trading, India lags behind with around 15% market share, said a leading environment analyst.

Compounding to its woes is its high rejection rates from United Nations Framework Convention on Climate Change (UNFCCC)’s Kyoto protocol.

“In spite of being preferred by most companies in the UK, Germany, Japan and Denmark, the reason India is still not counted among the top three carbon credit nations is because of its project rejection rate, which is as high as 50%,” said Nahar.

He also added that just because the government approves projects does not mean that validators or the CDM executive board will do so.

“The projects do not get approval mostly due to the consultants hired by Indian companies who if not well versed with the Kyoto protocol will not be able to comply with the strict UNFCCC norms,” he added.

No comments: