Facing hell or heavenly marriage

Trade in carbon emissions credits could become the biggest environmental market in the world -- with wind power by far the most sought after bride. While it is still too early to pin down the precise points of linkage between wind and carbon credit trade, the exponential growth of the offset market is likely to redefine the context in which wind power is developed. But there are threats as well as opportunities to look out for

It looks like a marriage made in heaven. The carbon credits market needs a ready source of "avoided emissions" to fuel its explosive growth. The wind industry, which specialises in power stations that generate zero emissions, is an almost unrivalled source of high quality credits. But the industry needs a driver to take it beyond the premium priced green power markets of the West into the carbon intensive fuel economies of the developing world -- to precisely those areas where it will do the most good. The carbon market seems to offer just such a driver. In the new carbon world, wind and renewable energy projects are no longer evaluated alone in terms of kilowatt hours (kWh) produced, but also in the amount of carbon dioxide (CO2) emissions those kilowatt hours displace or offset. Thus, one kWh of wind-generated power in Poland, offset against a predominantly coal-fuelled national grid, is more valuable than one kWh of Dutch wind, offset against a mainly gas-fired grid.

So far so good, but this is where the big questions take over. Will this new means of monetising wind energy's environmental benefits have any real impact on project finance and capacity building? If yes, will that be to the sector's benefit or detriment? So far, the answers are unclear. First, warn wind players who have already become involved in the complexities of trade in the carbon credits market, the wind sector must grasp the challenges. These including a lack of international trading rules (box page 52), the limitations of the Kyoto Protocol's market-based mechanisms (next story) and global complications of assigning value to a "credit" of wind power.

Long term wind development in the carbon credits market calls for some kind of trade-off between different types of current wind market, believes Robert Kleiburg of Shell International Renewables: the premium-priced European markets, such as Germany; and markets such as in Poland and Sri Lanka, where the environmental benefits of wind plant can only be monetised currently through Kyoto's "flexible" market mechanisms -- Joint Implementation (JI), the clean development mechanism (CDM) and International Emissions Trading (IET).

Markets and values

"A developer would only sell the environmental value of Polish wind as tonnes of avoided CO2 because it couldn't be sold as green kilowatt hours in the Netherlands, for example," Kleiburg says. "If there was reciprocity between the Polish and the Dutch markets, it would be logical to use a tradable renewables certificate to sell it at a premium price on the Dutch or German markets. At the moment, it's simply a question of five euros per tonne of CO2 being better than nothing."

Kleiburg then raises the type of hypothetical question on CO2 equivalents (CO2e) that has shown wind players the complexity of what is at stake. "If there is a premium value on wind generated electricity in the western world, why is it so illogical to have a premium value on the same wind generated electricity in the developing countries?" he asks. "If you take German feed-in tariffs of one hundred to one hundred-twenty euro per megawatt hour and you express that in CO2e, it works out about two hundred euro per tonne CO2e, whereas the market price of a tonne CO2e is around five euro. Given that no government is going to pay two hundred euro for a tonne of CO2e when it can buy it for five, there is no mechanism at present to encourage the construction of a wind farm in wind rich regimes such as, for example, Brazil."

To create the demand necessary to build wind in wind rich regimes such as Brazil -- and thus to boost demand for wind energy as a whole, a robust international renewables certificates trade is needed, one which recognises broader environmental benefits over and above carbon, such as the renewable energy certificates system (RECS). Its "box of jewels" concept registers environmental benefits along with kilowatt hours, argues Kleiburg. "With an open market, I could go to areas such as Brazil and Russia, build my wind farm and because of the superior wind regimes I could then turn to credit buyers and give them the opportunity to ensure that their green dollars are invested where they are most effective."

Too good to be true

Along these lines, JI and CDM would at first seem to the perfect way around this international imbalance problem. "JI is a three way dance between the Dutch government, investors and the government of the host country," explains Adriaan Korthuis of Senter, the agency responsible for administering the Dutch credit procurement schemes. "The Dutch government buys attractively priced carbon credits, which it can set against its own emission reduction targets. Investors can tap into an additional revenue stream to finance projects, while the host government attracts foreign investment, decreases pollution and contributes to its own Kyoto obligations," he says.

The carbon credits generated by a project will typically be split between the two countries. But again JI and CDM are limited by the huge difference between the price of carbon offset and green kilowatt hours created by renewables support mechanisms, such as the feed-in laws in Germany and the eco-tax regime in the Netherlands.

Under the first round of the Dutch tender for emission reduction credits in Eastern Europe, ERUPT, the Dutch government paid around EUR 3-5 a tonne CO2 equivalent, points out Albert Jochems of Dutch energy consultancy Profin. This works out to about EUR 0.01/kWh, he adds. If the same power were sold on the Dutch green electricity market, it would get EUR 0.05-0.06/kWh. A green electricity producer, then, given the choice, is not going to sell the environmental benefits of a project in terms of carbon offset rather than green kilowatt hours. With this in mind, carbon offset is never going to provide more than "the icing on the cake of project finance" when a carbon credit price is only equivalent to an additional EUR 0.01/kWh, as Kleiburg says. Korthuis adds, "It will never make a bad project good."

The parallel existence of markets where the price of the same product -- a tonne of CO2e -- differs by a factor of ten is also a cause for anxiety in the wind industry. Jochems detects a worrying policy trend from setting renewables targets to "environmental benefits" targets. "It is vital that we don't let wind become reduced to its carbon offset value and remember the original rationale for renewable energy development -- security of supply and all the other social and environmental benefits," he says. And Kleiburg notes that in an open market, while onshore wind is currently a commercially viable supply option, the inclusion of refurbished large-scale hydro and co-fired biomass power generation in national schemes could seriously undermine wind's market position.

Value the offset

The underlying strength of emissions trading (ET) is that it encourages the deployment of resources where they displace the most CO2. For emissions trading to become a truly effective driver for renewables development, it will have to find a mechanism for rewarding the construction of wind in high offset areas, such as Poland. While most analysts question whether the carbon credit market will do this, Dutch utility Nuon believes it may have found such a mechanism.

Dutch green power consumers -- both domestic and institutional -- are already familiar with the principle of "branding" according to source technology, of paying more for wind generated power than biomass. Nuon would extend this principle into emissions trade through the inclusion of "carbon offset factors" in the retail price of the kilowatt hours it sells to parties mandated under an emissions cap.

If all power is labelled according to the CO2 produced or avoided in its production, then it will be possible to sell differentially graded and priced power. "That is what we are pushing for," says Nuon's Annemarie Goedmakers. "It is very complicated, however, and we are having difficulty getting industry and the government to see how this would work."

Nice in theory

As if the complexity of international negotiations was not enough, the Nuon mechanism requires the right regulatory framework. It works best with a trading system where the emissions from power companies are not capped. This allows the capped parties to set savings on indirect emissions -- switching from grey to green power -- against their direct emissions. Only the Dutch have suggested this route. Under the proposed EU wide trading plan, power companies are capped on their direct emissions, giving companies no incentive to buy offset-branded electricity.

Thus far, experience with real life trading is not encouraging. In Denmark, where power companies are capped, uncertainty about regulations resulted in only five deals being done in the first year of operation. Meantime the UK is following its own route entirely: power companies are excluded totally from carbon trading.

Lionel Fretz, UK director of renewables finance concern EcoSecurities, sees little to indicate that Britain's full ET launch in April will herald a new dawn in renewables finance. "The UK system will affect renewables development to the extent that emission reductions from overseas and uncapped countries are able to be used in the UK, and where they represent one of the least cost compliance options, it would result in financial flows to those projects, but I wouldn't put it any stronger than that."

Whether UK companies will look to finance overseas renewables projects to meet their domestic reduction commitments depends on who they are: "The UK situation is confused because the power generators aren't included in the scheme and they are the main renewables developers. And I can't see companies like Marks & Spencers going to Brazil to build a wind farm -- they'll just buy the credits from someone else who does. But if there was a trading scheme in which power companies participated, it would be a quite logical part of their business just to integrate their emissions related activities and then they could use credits generated from projects undertaken elsewhere."

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