Give an idea why The UNFCCC structured Carbon Credits business is a market failure.

1. Understanding the Carbon Credits Business Amit Gopal Chauhan 28 th March 2008 SIBER, KOLHAPUR

6. The Kyoto protocol Annex I Non-Annex I Not ratified

8. GHGs With GWPs under Kyoto Carbon dioxide GWP: 1 Hydrofluorocarbons GWP: 11,700 Methane GWP: 21 Sulphur hexafluoride GWP: 23,900 Nitrous oxide GWP: 310 Perfluorocarbons GWP: 9,200

9. GWP & Carbon Credits If one tonne of GHG emission is reduced then number of carbon credits issued will be equivalent to the GWP. 23900 Sulphur hexafluoride SF 6 11700 Hydrofluorocarbons HFCs 9200 Perfluorocarbons PFCs 310 Nitrous oxide N 2 O 21 Methane CH 4 1 Carbon dioxide CO 2 Global warming Potential Name Formula

11. Generating Carbon Credits GHG emissions Time Project commissioned “ With project” emission level “ Without project” emission level Carbon credits Project based emission reductions need to be calculated and verified 1 reduced Ton of Carbon Dioxide equivalent = 1 Carbon Credit hereafter they can be sold on the open market.

19. Registry systems under Kyoto

22. CDM Sectors Agriculture Afforestration and reforestation Waste Handling and disposal Solvent use Fugitive emissions from production and consumption of halocarbons and Sulphur hexafluoride Fugitive emissions from fuels Mining & Mineral Production Transport Construction Energy Distribution loss prevention Energy Efficiency in Industry (demand & supply) All types of Renewable energy

26. Steps is CDM PIN / PCN & PDD Development Host Country Approval Validation Verification Monitoring Implementation Registration Certification Project Developers / Consultant GOI / MOEF i.e. DNA DOE CDM EB Project Developers Project Developer + DOE DOE CDM EB Issuance of CERs CDM EB

37. How is CDM relevant for Businesses? By selling the emission reductions from a project to a Annex I party additional cash flows can be realised. Emission cap Actual emissions Buyer Carbon Credits Carbon value ( € ) Annex I party Emission reduction project The CDM project reduces the carbon emissions in the CDM country

38. Impact on the IRR of The Project IRR Benchmark Project return excluding CDM revenue Project return including CDM revenue CDM cash flow The gap between the project return and the required return on investment threshold The CDM cash flow increases the IRR of the project making it more interesting for investors. (2%-100%, diversification, offshore revenue stream) 12 % 15 % 16 %

43. Traditional project risks Threats to project Source: Miller and Lessard, 2000 Regulatory and political risks Operational risk Technical risk Social acceptability Market risk Financial risk Completion risk Not enough financing to complete project Project does not pass completion tests Project does not operate reliably Project does not meet regulatory commitments Community protests lead to permit denial or revocation Project boycotts Bankers reluctant to lend

45. Time frame and uncertainty ~33% formal review Up to 70% request for review Not known Variable Not known ~50% Rejection Level Up to 3 months Up to 6 mo, if reviewed 1-3 weeks 1 month – 3 years 2-6 months Up to 2 years Time frame Up to 2.5 months Up to 8 weeks LS Not requested Variable 30 days 3 weeks Consult. Request for review Registration Annex 1 approval LOA Validation Propose methodology Step

46. Time frame and uncertainty None Yet Up to 66% formal review Up to 75% request for review Not Known 26% rejected Rejection Level Up to 4 Months Up to 2 Months Up to 5 Weeks 2-4 Months Up to 4 Months Time Frame N/A Up to 1.5 Month 15 days N/A N/A Consult Formal review Request for review Issuance Verification Formal review Step

48. The CER Price Structure EURO 5 15 CER Price Counterparty & Default Risk Commissioning Risk Late Delivery Risk Underperformance Risk Asset Transfer Risk Baseline & CER Calculation risk Registration Risks Volatility risk International Transaction Log & Cap risk Hot Air & Supply Risk UNFCCC Policy Risk, Political Risks EU ETS market price

49. The Myth of the Carbon Credit High risk Medium risk No risk Delivery risk Low Medium high Price High risk Medium risk No risk Country- and project risk Small, medium & large sized companies Medium and large scale companies AAA rated companies Ownership Created by CDM projects Created by JI projects Allocated by Annex I countries: Real Commodity Existence CER Certified Emission Reduction ERU Emission Reduction Unit EUA European Union Allowance