1. Economics of Climate Change
Paradigm Shift from Projects to Programs
Amit Bando
November 13, 2009

2. Agenda
How do we evaluate climate change projects?
The current project cycle
Gaps in the evaluation process
From projects to programs
2

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)
3

4. The role of the Clean Development Mechanism (CDM)
Advantages for developed
countries:
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
relatively low-cost &
politically acceptable
Advantages for developing
countries:
inward investment,
environmental & technology
benefits
4

5. In 3 years, the CDM has sparked a $5 billion/year
market
Number of Projects in the CDM Pipeline,
January 2005 – February 2008
3,035
2,838
2,593
Compound Monthly
Compound Monthly
Growth Rate = 13%
Growth Rate = 13%
2,285
1,759
Approximately 3 billion
Approximately 3 billion
CERs by 2012
CERs by 2012
1,141
67
Jan
05
83
118
171
Mar May Jul
05
05
05
275
440
554
Sep Nov Jan
05
05
06
647
749
1,311
1,885
1,495
883
Mar May Jul
06
06
06
Sep Nov Jan Mar
06
06
07
07
May July Sep Nov Jan
07
07
07
07
08
5

6. How a CDM project generates carbon credits
Greenhouse gas emissions
Carbon credits (CERs)
Carbon credits (CERs)
represent the difference
represent the difference
between the baseline and
between the baseline and
actual emissions
actual emissions
Project start
Project start
Historical Trend
Time
6

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)
•
Perfluorocarbons (CxFx)
•
Hydrofluorocarbons (HFCs)
•
Relevant to biocarbon & industrial
projects
Sulfur hexaflouride (SF6)
Relevant to
industrial projects
7

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
8

9. Global warming potential
Greenhouse Gas
Greenhouse Gas
(GHG)
(GHG)
Global Warming
Global Warming
Potential (GWP)
Potential (GWP)
Carbon dioxide
Carbon dioxide
11
Methane
Methane
21
21
Nitrous oxide
Nitrous oxide
310
310
Perfluorocarbons
Perfluorocarbons
6,500 ––9,200
6,500 9,200
Hydrofluorocarbons
Hydrofluorocarbons
140 ––11,700
140 11,700
Sulfur hexafluoride
Sulfur hexafluoride
23,900
23,900
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!
9

10. Global warming potential
Greenhouse Gas
Greenhouse Gas
(GHG)
(GHG)
Global Warming
Global Warming
Potential (GWP)
Potential (GWP)
Carbon dioxide
Carbon dioxide
11
Methane
Methane
21
21
Nitrous oxide
Nitrous oxide
310
310
Perfluorocarbons
Perfluorocarbons
6,500 ––9,200
6,500 9,200
Hydrofluorocarbons
Hydrofluorocarbons
140 ––11,700
140 11,700
Sulphur hexafluoride
Sulphur hexafluoride
23,900
23,900
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)
10

11. Additionality
Environmental additionality – the project produces fewer
greenhouse gas emissions than the baseline scenario
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
11

12. Additionality – benchmark analysis
Revenue / NPV / IRR
Choose an appropriate financial indicator and compare it
with a relevant benchmark value: e.g. required return on
capital or internal company benchmark
Investment
threshold
Project without
carbon element
Project with
carbon element
Carbon revenue
Carbon revenue
makes the
makes the
project attractive
project attractive
relative to
relative to
investment
investment
alternatives
alternatives
Project without
Project without
carbon revenue
carbon revenue
is profitable –
is profitable –
but not
but not
sufficiently
sufficiently
profitable
profitable
compared with
compared with
alternatives
alternatives
12

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
13

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
14

15. A maximum of 10
years with no
option of renewal
Greenhouse gas emissions
Crediting period
Starting date of
Starting date of
the crediting
the crediting
period
period
e scen
baselin
der the
ons un
i
Emiss
ari o
Emissions under the project scenario
10 years
No renewal
No renewal
15

16. Agenda
How do we evaluate climate change
projects?
The current project cycle
Gaps in the evaluation process
From projects to programs
16

17. 6 to 12 months
CDM project
CDM project
development
development
// PDD
PDD
Host country
Host country
approval
approval
Project
Project
validation
validation
CDM
Executive
Board
DNA
Project
Project
feasibility
feasibility
assessment
assessment
// PIN
PIN
1.5 months Crediting period of the project
DOE
Project
Developer
The CDM project cycle
Project
Project
verification
verification
Project
Project
registration
registration
CER
CER
issuance
issuance
17

18. 6 to 12 months
CDM project
CDM project
development
development
// PDD
PDD
Host country
Host country
approval
approval
Project
Project
validation
validation
CDM
Executive
Board
DNA
Project
Project
feasibility
feasibility
assessment
assessment
// PIN
PIN
1.5 months Crediting period of the project
DOE
Project
Developer
The CDM project cycle
Project
Project
verification
verification
Project
Project
registration
registration
CER
CER
issuance
issuance
18

19. 6 to 12 months
CDM project
CDM project
development
development
// PDD
PDD
Host country
Host country
approval
approval
Project
Project
validation
validation
CDM
Executive
Board
DNA
Project
Project
feasibility
feasibility
assessment
assessment
// PIN
PIN
1.5 months Crediting period of the project
DOE
Project
Developer
The CDM project cycle
Project
Project
verification
verification
Project
Project
registration
registration
CER
CER
issuance
issuance
19

20. 6 to 12 months
CDM project
CDM project
development
development
// PDD
PDD
Host country
Host country
approval
approval
Project
Project
validation
validation
CDM
Executive
Board
DNA
Project
Project
feasibility
feasibility
assessment
assessment
// PIN
PIN
1.5 months Crediting period of the project
DOE
Project
Developer
The CDM project cycle
Project
Project
verification
verification
Project
Project
registration
registration
CER
CER
issuance
issuance
20

21. 6 to 12 months
CDM project
CDM project
development
development
// PDD
PDD
Host country
Host country
approval
approval
Project
Project
validation
validation
CDM
Executive
Board
DNA
Project
Project
feasibility
feasibility
assessment
assessment
// PIN
PIN
1.5 months Crediting period of the project
DOE
Project
Developer
The CDM project cycle
Project
Project
verification
verification
Project
Project
registration
registration
CER
CER
issuance
issuance
21

22. 6 to 12 months
CDM project
CDM project
development
development
// PDD
PDD
Host country
Host country
approval
approval
Project
Project
validation
validation
CDM
Executive
Board
DNA
Project
Project
feasibility
feasibility
assessment
assessment
// PIN
PIN
1.5 months Crediting period of the project
DOE
Project
Developer
The CDM project cycle
Project
Project
verification
verification
Project
Project
registration
registration
CER
CER
issuance
issuance
22

23. 6 to 12 months
CDM project
CDM project
development
development
// PDD
PDD
Host country
Host country
approval
approval
Project
Project
validation
validation
CDM
Executive
Board
DNA
Project
Project
feasibility
feasibility
assessment
assessment
// PIN
PIN
1.5 months Crediting period of the project
DOE
Project
Developer
The CDM project cycle
Project
Project
verification
verification
Project
Project
registration
registration
CER
CER
issuance
issuance
23

24. 6 to 12 months
CDM project
CDM project
development
development
// PDD
PDD
Host country
Host country
approval
approval
Project
Project
validation
validation
CDM
Executive
Board
DNA
Project
Project
feasibility
feasibility
assessment
assessment
// PIN
PIN
1.5 months Crediting period of the project
DOE
Project
Developer
The CDM project cycle
Project
Project
verification
verification
Project
Project
registration
registration
CER
CER
issuance
issuance
24

25. Costs of a typical CDM project
Pre-Registration
CDM Costs
Post-Registration
CDM Costs
53,000
US$ 164,500
Assumes a 10-year
Assumes a 10-year
project.
project.
34,000
111,500
10,000
77,500
67,500
16,500
38,000
51,000
13,000
Initial
Monitoring
Validation
Indicative CDM Cost Profile For
A ‘Typical’ CDM Project
Ongoing
Verification
By
DOE
Ongoing
Annual
Monitoring
Recurrent costs
Recurrent costs
discounted at 3%
discounted at 3%
annual rate to express
annual rate to express
in present-value
in present-value
terms.
terms.
Registration costs,
Registration costs,
Administration Fee
Administration Fee
and Adaptation Fund
and Adaptation Fund
Levy not included.
Levy not included.
PDD
PIN
25

26. CER volumes from CDM projects
4.5m
970,000
Average Annual CER Production by CDM Project-Type
520,000
318,000
206,000
170,000
En
So
e
la
(h rgy
r
ou e
se ffi
ho cie
ld nc
s) y
B
io
ga
s
W
in
Tr
d
an
sp
or
t
H
yd
ro
em 2 O
is
si
on
R
ef
s
or
es
ta
tio
La
n
En
nd
f
er
gy ill g
a
(p ef
ow fic s
er i en
)
cy
N
Fu
gi
tiv
e
H
FC
s
83,000 79,000 74,000 54,000
26,000 18,000
26

27. Carbon revenues also vary on a project-by-project basis
7,934
7,934
Standard deviation
Standard deviation
(kCERs by 2012)
(kCERs by 2012)
Markers
indicate
maximum,
mean and
minimum
project
size within
each
technology
1,811
1,811
4,128
4,128
3,039
3,039
1,711
1,711
928
928
543
543
661
661
1,228
1,228
379
379
1,101
1,101
330
330
0
0
827
827
1,179
1,179
0
0
91
91
13
13
0
0
B
io
m
as
s
en
er
g
W y
in
H d
yd
ro
G
So
eo
th lar
er
m
a
Ti l
d
B al
Ag io
g
R ric as
ef ul
o r tu
C
oa L est re
l m an ati
in dfi on
e ll
m ga
et s
Fo
ha
ss
Fu ne
il
fu giti
el
v
sw e
C itch
e
Tr me
an nt
sp
EE
or
ho P t
us FC
EE E eh s
o
E
se in lds
rv du
i
EE ce str
y
En
su sec
er
gy pp tor
di ly s
st
i
rib de
ut
io
n
234
234
762
762
27

28. Agenda
How do we evaluate climate change
projects?
The current project cycle
Gaps in the evaluation process
From projects to programs
28

29. 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

30. Limitations of CDM market

Projects are financed sequentially starting with those
generating the most CERs at lowest cost

Bias towards funding larger stand-alone projects

Bias towards mitigation and away from adaptation

Monitoring is costly and often impractical -- flaw in project
design leading to implementation problems

Lack of uniform registry of CERs

31. 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. Greenhouse gas emissions
The crediting period is fixed
Baseline must
Baseline must
be reassessed
be reassessed
by DOE at each
by DOE at each
renewal
renewal
Emissions under the
baseline scenario
The baseline
The baseline
scenario may
scenario may
become less
become less
favorable
favorable
Emissions under the
project scenario
7 years
7 years
7 years
32

33. Agenda
How do we evaluate climate change
projects?
The current project cycle
Gaps in the evaluation process
From projects to programs
33

34. Programmatic CDM offers new opportunities
Regular CDM
Regular CDM
Size-Distribution of Potential CDM Project Sites
•• Single site, stand-alone
Single site, stand-alone
projects
projects
•• ‘Carbon upgrades’
‘Carbon upgrades’
Bundled CDM
Bundled CDM
Number of installations / units
•• Bundling several
Bundling several
projects under a single
projects under a single
PDD
PDD
•• All projects must be
All projects must be
identified ex ante, and
identified ex ante, and
must start at the same
must start at the same
time
time
Programmatic CDM
Programmatic CDM
large
medium
Installation / unit size
small
•• Addresses the ‘long
Addresses the ‘long
tail’ of small units
tail’ of small units
•• Permits sector-wide
Permits sector-wide
transition to low-carbon
transition to low-carbon
economy
economy
•• Particular relevance to
Particular relevance to
non industrial sector
non industrial sector
34

35. Greenhouse gas emissions
Why not “optimize” the crediting period?
Baseline must
Baseline must
be reassessed
be reassessed
by DOE at each
by DOE at each
renewal
renewal
Emissions under the
baseline scenario
The baseline
The baseline
scenario may
scenario may
become less
become less
favorable
favorable
Emissions under the
project scenario
7 years
35

36. 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

37. Figure 1: Overall Methodology for Energy Sector Analysis
Step 1
Step 2
Step 3
Demand Forecast
R eg ressi o n
M et h od
Least-cost Generation &
Transmission Expansion (Using
Horizon-year Plan)
Planning Study
S im u lat ion
M od els
Costs and
Benefits
Quantification
W illingness to-Pay
Energy Supply
Incremental
Step 4
Environmental
Impacts
Economic Analysis
Sensitivity and Risk Analysis
Bene fits
Trans fer
Method
Spreadsheet
Calculat ion