Climate Change

Amit Bando November 13, 2009

Economics of Climate Change

Paradigm Shift from Projects to Programs

2

Agenda

How do we evaluate climate change projects?How do we evaluate climate change projects?

The current project cycle

Gaps in the evaluation process

From projects to programs

3

The Kyoto Protocol provides the basis for evaluating climate change projects

Kyoto Protocol (1997)

The Protocol creates legally binding obligations for 38

industrialized countries to return their emissions of

greenhouse gases to an average of 5% below their 1990 levels

by 2012

Marrakech Accords (2001)Define the principles of the Kyoto Protocol’s flexible

mechanisms: the Clean Development Mechanism (CDM),

Joint Implementation (JI) and Emissions Trading (ET)

4

The role of the Clean Development Mechanism (CDM)

Developed countries can

reduce emissions anywhere in the

world

They can count these reductions towards their own

targets

CDM allows

developed countries

to generate ‘carbon

credits’ (Certified

Emission

Reductions, CERs)

in developing

countries

Advantages for developed

countries:

relatively low-cost &

politically acceptable

Advantages for developing

countries:

inward investment,

environmental & technology

benefits

5

In 3 years, the CDM has sparked a $5 billion/year market

Number of Projects in the CDM Pipeline,January 2005 – February 2008

Compound Monthly Growth Rate = 13%

Approximately 3 billion CERs by 2012

Compound Monthly Growth Rate = 13%

Approximately 3 billion CERs by 2012

67 83 118 171275

440554 647

749883

1,1411,311

1,495

1,7591,885

2,285

2,593

2,8383,035

Jan05

Mar05

May05

Jul05

Sep05

Nov05

Jan06

Mar06

May06

Jul06

Sep06

Nov06

Jan07

Mar07

May07

July07

Sep07

Nov07

Jan08

6

How a CDM project generates carbon credits

Gre

enh

ou

se g

as e

mis

sio

ns

Historical Trend

Project startProject start

Carbon credits (CERs) represent the difference

between the baseline and actual emissions

Carbon credits (CERs) represent the difference

between the baseline and actual emissions

Time

7

‘Kyoto gases’ that can earn credits

There are over 30 atmospheric greenhouse gases…But only 6 attract carbon credits:

• Carbon dioxide (CO2)

• Methane (CH4)

• Nitrous oxide (N2O)

Relevant to bio-carbon & industrial projects

Relevant to industrial projects

• Perfluorocarbons (CxFx)

• Hydrofluorocarbons (HFCs)

• Sulfur hexaflouride (SF6)

8

Each of these gases has a different warming potential

Each of these gases has a different ‘radiative forcing’ capability and a different atmospheric residence time

Need for a ‘common currency’, so that all carbon credits are denominated in the same way

Solution: develop a relative scale, using CO2 as a reference gas

9

Global warming potential

Greenhouse Gas (GHG)


Global Warming Potential (GWP)


Carbon dioxideCarbon dioxide 11

MethaneMethane 2121

Nitrous oxideNitrous oxide 310310

PerfluorocarbonsPerfluorocarbons 6,500 – 9,2006,500 – 9,200

HydrofluorocarbonsHydrofluorocarbons 140 – 11,700140 – 11,700

Sulfur hexafluorideSulfur hexafluoride 23,90023,900

Relative scale – everything is measured relative to CO2

e.g. methane is 21 times more potent as a greenhouse gas

than CO2

e.g. sulfur hexafluoride is 24,000 more potent!

10

Global warming potential





Carbon dioxideCarbon dioxide 11

MethaneMethane 2121

Nitrous oxideNitrous oxide 310310

PerfluorocarbonsPerfluorocarbons 6,500 – 9,2006,500 – 9,200

HydrofluorocarbonsHydrofluorocarbons 140 – 11,700140 – 11,700

Sulphur hexafluorideSulphur hexafluoride 23,90023,900

Carbon credits are always expressed in terms of ‘carbon

dioxide equivalence’ (CO2e)

e.g. 1 tonne of CO2 = 1 tCO2e(= 1 carbon credit = 1 CER)

e.g. 2 tonnes of CH4 = 42 tCO2e(= 42 carbon credits = 42 CERs)

e.g. 2 tonnes of SF6 = 47,800 tCO2e(= 47,800 carbon credits

= 47.8 kCERs)

11

Additionality

It is essential that the project achieve environmental additionality – otherwise, it will not generate any carbon

credits!

However, the project developer must also usually demonstrate that, without carbon revenues, the project

would not be viable and/or commercially attractive – this is known as financial additionality

Environmental additionality – the project produces fewer greenhouse gas emissions than the baseline scenario

12

Additionality – benchmark analysis

Project without carbon revenue is profitable –

but not sufficiently profitable

compared with alternatives

Project without carbon revenue is profitable –

but not sufficiently profitable

compared with alternatives

Project without carbon element

Project with carbon element

Carbon revenue makes the

project attractive relative to investment alternatives

Carbon revenue makes the

project attractive relative to investment alternativesInvestment

threshold

Rev

enu

e /

NP

V /

IR

R

Choose an appropriate financial indicator and compare it with a relevant benchmark value: e.g. required return on

capital or internal company benchmark

13

Some examples of additionality

Capturing methane from an urban landfill and flaring it

— Carbon credits represent the only source of income for undertaking this activity

Capturing methane from an urban landfill and utilizing it to generate electricity

— Project developer would have to demonstrate that the electricity revenue alone would not make this project attractive

Building a large hydro project for the grid in Ethiopia

— Questionable additionality: there is already plenty of hydro activity in Ethiopia

?

14

Crediting period

CDM mitigation projects

• Project developers have two crediting period options:

– A maximum of 7 years, which can be renewed up to 2 times(i.e. a potential total crediting period of 21 years)

– A maximum of 10 years, with no option for renewal

CDM sequestration projects (forestry)

• Project developers have two crediting period options:

– A maximum of 20 years, which can be renewed up to 2 times(i.e. a potential total crediting period of 60 years)

– A maximum of 30 years, with no option for renewal

15

Crediting period

Gre

enh

ou

se g

as e

mis

sio

ns

Emissions under the baseline scenario

Emissions under the project scenario

Starting date of the crediting

period

Starting date of the crediting

period10 years No renewalNo renewal

A maximum of 10 years with no

option of renewal

16

Agenda

How do we evaluate climate change projects?

The current project cycleThe current project cycle



17

6 to 12 months 1.5 months Crediting period of the project

Pro

ject

D

evel

op

erD

NA

DO

EC

DM

Exe

cuti

veB

oar

d

Project feasibility

assessment / PIN

Project feasibility

assessment / PIN

CDM project development

/ PDD


/ PDD

Host country approval


Project validation

Project validation

Project registration


CER issuance

CER issuance

Project verification


The CDM project cycle

18


Pro

ject

D

evel

op

erD

NA

DO

EC

DM

Exe

cuti

veB

oar

d

Project feasibility

assessment / PIN

Project feasibility

assessment / PIN


/ PDD


/ PDD



Project validation

Project validation



CER issuance

CER issuance




19


Pro

ject

D

evel

op

erD

NA

DO

EC

DM

Exe

cuti

veB

oar

d

Project feasibility

assessment / PIN

Project feasibility

assessment / PIN


/ PDD


/ PDD



Project validation

Project validation



CER issuance

CER issuance




20


Pro

ject

D

evel

op

erD

NA

DO

EC

DM

Exe

cuti

veB

oar

d

Project feasibility

assessment / PIN

Project feasibility

assessment / PIN


/ PDD


/ PDD



Project validation

Project validation



CER issuance

CER issuance




21


Pro

ject

D

evel

op

erD

NA

DO

EC

DM

Exe

cuti

veB

oar

d

Project feasibility

assessment / PIN

Project feasibility

assessment / PIN


/ PDD


/ PDD



Project validation

Project validation



CER issuance

CER issuance




22


Pro

ject

D

evel

op

erD

NA

DO

EC

DM

Exe

cuti

veB

oar

d

Project feasibility

assessment / PIN

Project feasibility

assessment / PIN


/ PDD


/ PDD



Project validation

Project validation



CER issuance

CER issuance




23


Pro

ject

D

evel

op

erD

NA

DO

EC

DM

Exe

cuti

veB

oar

d

Project feasibility

assessment / PIN

Project feasibility

assessment / PIN


/ PDD


/ PDD



Project validation

Project validation



CER issuance

CER issuance




24


Pro

ject

D

evel

op

erD

NA

DO

EC

DM

Exe

cuti

veB

oar

d

Project feasibility

assessment / PIN

Project feasibility

assessment / PIN


/ PDD


/ PDD



Project validation

Project validation



CER issuance

CER issuance




25

Costs of a typical CDM project

Assumes a 10-year project.

Recurrent costs discounted at 3%

annual rate to express in present-value

terms.

Registration costs, Administration Fee

and Adaptation Fund Levy not included.

Assumes a 10-year project.

Recurrent costs discounted at 3%

annual rate to express in present-value

terms.

Registration costs, Administration Fee

and Adaptation Fund Levy not included.

Indicative CDM Cost Profile For A ‘Typical’ CDM Project

13,000

38,000

16,50010,000

34,000

53,000

PDD

Validation

InitialMonitoring

OngoingVerification

ByDOE

Ongoing Annual

Monitoring

Pre-RegistrationCDM Costs

Post-RegistrationCDM Costs

US$

51,000

67,50077,500

111,500

164,500

PIN

26

CER volumes from CDM projects

970,000

520,000

318,000

206,000170,00083,000 79,000 74,000 54,000 26,000 18,000

N 2O

Fugitive

em

issi

ons

Refore

stat

ion

Landfil

l gas

Energy

effic

iency

(power

)Hyd

roW

ind

Transp

ort

Biogas

Solar

Energy

effic

iency

(house

holds)

4.5m

HFCs

Average Annual CER Production by CDM Project-Type

27

Carbon revenues also vary on a project-by-project basis

Biom

ass

ener

gyW

ind

Hydro

Solar

Geoth

erm

al

Tidal

Biogas

Agricultu

re

Refore

stat

ion

Landfil

l gas

Coal m

ine

met

hane

Fugitive

Fossil

fuel

switc

h

Cemen

t

Transp

ort

PFCs

EE house

holds

EE indust

ry

EE ser

vice

sec

tor

EE supply

sid

e

Energy

distri

bution

379379

928928

543543

234234

1,2281,228

00

661661

330330762762

1,7111,711

4,1284,128

7,9347,934

3,0393,039

1,1011,101

1,1791,179

00 9191

1,8111,811

1313

827827

00

Standard deviation(kCERs by 2012)

Standard deviation(kCERs by 2012) Markers

indicate maximum, mean and minimum

project size within

each technology

28

Agenda



Gaps in the evaluation processGaps in the evaluation process


Limitations of current evaluation process Each project is evaluated in isolation

Benefits outside project boundary are discounted

“Additionality” is difficult to define

NPV/IRR is the single metric

Impacts of leveraging and collateral on asset value are not fully considered

Limitations of CDM market

Projects are f inanced sequentially s tart ing with those generating the most CERs at lowes t cos t

Bias towards funding larger stand-alone projec ts

Bias towards mit igation and away from adaptat ion

Monitoring is costly and often impractical -- f law in project design leading to implementation problems

Lack of uniform registry of CERs

Lack of an “enabling environment”

Regulatory and institutional support is often lacking

Evaluation methods and guidelines are complicated

Markets for CERs often very “thin” internationally

Small countries and marginal populations unable to participate in CDM

32

The crediting period is fixed

Gre

enh

ou

se g

as e

mis

sio

ns

Emissions under thebaseline scenario

Emissions under theproject scenario

7 years 7 years 7 years

Baseline must be reassessed by DOE at each

renewal


renewal

The baseline scenario may become less

favorable


favorable

33

Agenda




From projects to programsFrom projects to programs

34

Programmatic CDM offers new opportunities

Installation / unit size

Nu

mb

er o

f in

stal

lati

on

s / u

nit

s

Regular CDM

• Single site, stand-alone projects

• ‘Carbon upgrades’

Regular CDM

• Single site, stand-alone projects

• ‘Carbon upgrades’

Bundled CDM

• Bundling several projects under a single PDD

• All projects must be identified ex ante, and must start at the same time

Bundled CDM

• Bundling several projects under a single PDD

• All projects must be identified ex ante, and must start at the same time

Programmatic CDM

• Addresses the ‘long tail’ of small units

• Permits sector-wide transition to low-carbon economy

• Particular relevance to non industrial sector

Programmatic CDM

• Addresses the ‘long tail’ of small units

• Permits sector-wide transition to low-carbon economy

• Particular relevance to non industrial sector

Size-Distribution of Potential CDM Project Sites

smalllarge medium

35

Why not “optimize” the crediting period?

Gre

enh

ou

se g

as e

mis

sio

ns Emissions under the

baseline scenario

Emissions under theproject scenario

7 years


favorable


favorable


renewal


renewal

Leverage affects value of CERs

Incorporate collateral into evaluation models so that equilibrium determines leverage, not just rate of interest

Variations in leverage causes fluctuations in CER values In absence of interventions, leverage becomes too high in

boom times and too low in bad times “Natural buyer” hypothesis has been used in

Macroeconomics to study financial cycles -- used to model market for CERs

Provides guidance to regulators on when to restrict leverage

Figure 1: Overall Methodology for Energy Sector Analysis

Step 1

Step 2

Step 3

Step 4

Demand Forecast

Least-cost Generation & Transmission Expansion (Using

Horizon-year Plan) Planning Study

Costs and Benefits

Quantification

Energy Supply Incremental

Environmental Impacts

Economic Analysis

Sensitivity and Risk Analysis

R eg ressi o n M et h od

S im u lat ion M od els

Willingness -to-Pay

Spreadsheet Calculat ion

Bene fits Trans fer Method

Technology

Climate Change