The CDM: latest status of international rules and the CER market

1. National Office for Climate Change and Ozone Protection Hanoi, March 1, 2004 The CDM: latest status of international rules and the CER market Axel Michaelowa Hamburg Institute of International Economics, Germany a-michaelowa@hwwa.de www.hwwa.de/climate.htm

2. Structure of presentation • CDM rules • Methodology status • The unresolved additionality issue • The fragmented market • Competition between the mechanisms • Different domestic trading schemes • The EU linking directive • Share of CERs in total project revenue • Important stakeholders • Chances for Vietnam

3. Steps of international climate policy “Russian doll“ structure of agreements:

4. CDM ”valve“ Emissions trading JI CDM CERs AAUs, ERUs Tropical air? Country 1 Kyoto commitment Country 2 Kyoto commitment

5. The CDM maze changes COP/MOP 3 members can propose revision within 15 days to be donewithin 30 days elects 2% adap-tation tax Rulebook Baseline and monitoring methodologies elects Executive Board (10 members) decides on new rules within 4 months with-holds 4 industrial countries 5 develo-ping countries 1 AOSIS Currently 20 applications: 10 Europe 6 Japan 2 US 2 Asia comment new rules within 8 weeks accre-dits spot checks Certifier (OE) 3 members propose revision within 8 weeks Certifier Countries Stake-holder Observers is-sues comment within 30 days registers CDM pro-ject Project design document: Baseline Monitoring Approval Methodology if first of its kind Monitoring report Verification Project partners Validation orfor-warding of new metho-dology 37 applications pending CERs authorise Certifi-cation Involved countries Project partners Involved countries Involvedcountries

6. Baseline principles a) old coal fired power station 1200 g CO2/kWh. b) gas turbine 450 g CO2/kWh c) 850 g CO2/kWh

7. Case law and path dependency • The EB does not provide a basic set of rules beyond the Marrakech Accords text • Exception: small scale projects • All rules are developed by case law • Project pioneers have to propose a new rule (“methodology”) for each new project type • Higher validation costs • Delay of several months • Risk of refusal • The CDM regime is shaped by first proposers • Important role of validators, methodology panel and expert reviewers

8. Stringent decisions on baseline methodologies enhance quality Passed methodologies are very project-specific

9. Submissions of baseline methodologies: types

10. Submitted baseline methodologies • Multiple methodologies for same project type?

11. Approved baseline methodologies Rang Dong • Multiple methodologies for same project type! • EB starts consolidation/standardisation

12. 10th session of CDM EB states: As part of [...] determining the baseline scenario an explanation shall be made of how, through the use of the methodology, it can be demonstrated that a project activity is additional and therefore not the baseline scenario. The EB‘s additionality tests • Flow-chart / series of questions that lead to a narrowing of potential project options • Qualitative / quantitative assessment of different potential options and an indication of why the non-project option is more likely • Qualitative /quantitative assessment of one or more barriers facing the proposed project activity • Project type is not common practice in the proposed area of implementation, and not required by recent/pending legislation/regulations

13. Additionality tests - not comparable • Flow-chart / series of questions • Stringency depends on type of questions. Essentially no test, but could be framework for test • Why is the non-project option more likely? • Should essentially be the outcome of all tests applied, is no test in itself • Barrier assessment • The key issue is how important barriers are • Project type not common practice and not required by legislation • Only test which is objective, but does only specify necessary, not sufficient conditions for additionality. Still needs another test.

14. Stringency of tests • Series of questions: Unpredictable • Does question address the real barriers? • How will answers be evaluated? • Example from latest hydropower methodology • Barrier test: Level of barrier counts • There will be some barrier for every project. Otherwise everybody would start projects every day. The crucial issue is when a barrier would prevent a project (“decisive” barrier) developed by a capable developer. Can we capture this objectively? What level of barrier is decisive for project decision?

15. Current demand on the CDM and JI market (million $) • Pure CDM demand: about 600 million $, i.e. about 150 million t at current prices of 3-5 $/t CO2 • Price differentiation according to quality?

16. International market differentiation

17. National markets

18. The EU as driver of the CDM market • Decisions are taken jointly by Council of Ministers and European Parliament • Council position, January 2004 • No reference to entry into force of Kyoto Protocol • CERs accepted from 2005; conversion 1:1 • Cap and sinks competence of member states • EP environment committee position, Jan. 2004 • Hydro > 20 MW only under WCD criteria • CERs from 2005 • Linking with schemes in non-ratifying countries • Cap at 50% of necessary reductions

19. EU as CDM leader • Negotiations Council - Parliament, April 2004 • Likely: exchange of cap against limits of sinks • The survival of the Kyoto Mechanisms without Kyoto entry into force is guaranteed • Adoption of linking directive will spur private demand for CDM • Market impact • Depends on national allocation plans. UK plan is strong, Austrian, Dutch and German likely to be weak • Depends on government CER / ERU import regulations / fees

20. Technology D IRR Hydro 0.8-2.6 Wind 1.0-1.3 Bagasse 0.4-3.6 Energy Eff.-District Heating ~ 2.0 Gas Flare Reduction 2-4 Biomass 2-7 Municipal Solid Waste >5 Impact of carbon finance on project revenues at 3 €/t CO2 Source: PCF 2003

21. Thresholds for small-scale projects and transaction costs

22. The role of financial institutions • Packaging projects • Development of project pipelines • Portfolio generation • Financing projects • Project finance • Venture capital • Special mutual funds • Corporate finance • Lending • Bringing in expertise in checking viability of a project proposal • Due diligence • Insurance

23. Risks Source: Janssen 2001

24. Important stakeholders • Policymakers • Develop a CDM strategy • Priority sectors • SD criteria • Outreach • Get DNA operational • Decide on competences /rules • Decide on resources. Fees? • DNA staff • Ability to make objective decisions • Ability to market host country

25. Private sector • Project developers • Understand CDM incentive • Understand principles of CDM rules • Understand differences between technologies • Consultants • Understand CDM and are able to find their niche • Become able to deliver high-quality service according to CDM rules • Network with Annex B buyers /investors

26. Chances and challenges for Vietnam • Institutional homework done • Kyoto ratified, DNA set up • Interesting potential in several sectors • Gas flaring reduction • Renewable energy • Agricultural wastes • Hydro • Industrial energy efficiency • Forestry • Private sector remains to be integrated • Transparent rules for project approval remain to be defined

27. Thank you!Further information:www.hwwa.de/climate.htmor: climate@hwwa.de