Applying the Kyoto mechanisms in practice

Three "flexible" market based instruments form the pillars of carbon trade. They are laid out in the Kyoto Protocol: Joint Implementation (JI), the Clean Development Mechanism (CDM) and Emissions Trading (ET). Although differing in detail all three mechanisms are designed to ensure that the targeted greenhouse gas emissions reductions of a country or a company are achieved as cost effectively as possible by directing investment into areas where it commands the biggest returns in terms of reduced emissions -- the biggest bang for the buck.

JI refers to international projects aimed at reducing greenhouse gas emissions in countries with economies in transition (EITs) such as Eastern and Central Europe, whereas international emission reduction projects under CDM are hosted by developing countries. Emission trading schemes such as those currently being developed by various EU member states apply the same principle within the domestic economy: parties -- companies and institutions subject to an emissions cap -- who find it cheaper to reduce emissions by taking abatement measures -- cleaning up their act -- will earn credits which they can sell to industries where abatement is more costly. The EU trading mechanism due to start in 2005 will extend this principle across borders and thereby multiply its advantages in an International Emissions Trading (IET) scheme.

Direct drive?

As "project-based" mechanisms, both JI and CDM serve as fairly direct drivers for renewable energy growth. In the Netherlands, for example, the Dutch government has set up JI and CDM based schemes, labelling CO2 reductions as either Emission Reduction Units (ERU) or Certified Emission Reduction Units (CERU) and forming two procurement tender-based programs, ERUPT and CERUPT. Under both schemes, the Dutch government promises to buy the carbon emission reductions achieved by projects built abroad. Wind was an early beneficiary of ERUPT with a 60 MW wind farm in Poland developed by Dutch utility Nuon as one of five winners for funding under the first round of JI tenders, ERUPT-1, last year (Windpower Monthly, May 2001). ERUPT is already looking forward to its third round of tenders. While the results of the first CDM tenders for CERUPT projects in developing countries have yet to be announced, there are strong indications that wind will once again be among the beneficiaries.

The Dutch schemes are attracting great interest with the government reporting that the initial tender for its scheme to fund renewable energy and energy efficiency projects in developing countries in return for carbon credits -- CERUPT -- has attracted huge interest from project developers around the world.

Nor is there any shortage of funding. Last April, the Netherlands paid EUR 36 million for five projects worth a total of eight million tonnes of CO2 equivalent (CO2e), of which the Dutch can set four million tonnes against their national reduction target. The country is aiming to reduce its emissions by 6% a year on 1990 figures for the period 2008-2012, or some 50 Megatonnes (Mt) a year. In total the Netherlands has set aside funds for the purchase of some 30 Mt CO2e -- assuming a price of EUR 5/tonne. Of its targeted CO2 reductions, the Netherlands hopes to buy some 125 Mt CO2e as credits from abroad and is pushing to secure more than 50% of its total reductions in the form of international credits.

For project developers such as Nuon, JI is only part of a broader financing equation. "We're building wind in Poland partly for the ERU price paid by the government, and partly for the green kilowatt hours which we will sell on the Polish grid after our government commitment is met," explains Annemarie Goedmakers, renewables director at Nuon. For the project developer, the major advantage of JI is that government level co-operation smoothes the permitting process. Ominously, however, despite having all the necessary permits in place, the Nuon project is still unrealised because of difficulties finding a realistically priced long term power purchase agreement.

Still hazy

Much less is known about the particular principles and rules that will govern emissions trading schemes, largely because most of the important decisions -- nationally and internationally -- have yet to be taken. Specifically, it is unclear whether capped parties will be able to earn credits through direct investment in renewables plant abroad. If building foreign plant is permitted, investing in renewable energy with an eye to its offset value could become a significant factor.

For example, Dutch confectionery concern Perfetti-Van Melle, one of the first companies to set up a voluntary IET deal with the aim of achieving an emissions balance, decided to invest in Polish wind specifically because of its higher offset value. According to Albert Jochems of Dutch energy consultancy Profin, Van Melle "decided to build wind farms in Poland because green electricity realised in the Netherlands represents a carbon value of 0.6 kilogram per kilowatt hour, whereas in Poland it is 1.2 kilograms per kilowatt hour."

Wind perspectives

Abatement costs may offer another reason why ET could give more scope for wind project finance. According to Peter Vis, principal administrator of the European Commission's Climate Change Unit, the cost of emissions abatement -- of cleaning up your act rather than buying a credit -- will be higher than EUR 30 per tonne CO2e. Penalties could be in the region of EUR 50/tonne CO2e for the first Kyoto budget period of 2008 to 2012, and EUR 10/tonne CO2e for the second. At these prices, investing directly in renewable energy credits may become attractive.

Shell's Robert Kleiburg is sceptical, however. The potential depends on how the schemes are set up, he stresses, specifically whether JI/CDM credits are fully "fungible," whether they are interchangeable across markets. "In the case of full fungibility you will see prices much lower than thirty dollars a tonne CO2e, as there are many low-cost CO2 abatement opportunities in Eastern European and developing countries." believes Kleiburg.

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