China has proved a master in making full use of the Kyoto Protocol's Clean Development Mechanism (CDM). It is now the key player in this rapidly growing multi-billion dollar market, which allows developed countries to offset their carbon emissions through investment in clean energy projects in developing countries. China accounts for over 50% of wind projects built or approved for CDM status, according to the UN's CDM Executive Board, which oversees the project registration process. "CDM is a mixed bag," says Steve Sawyer of the Global Wind Energy Council. "It has not done a lot for wind power generally, but it has been good for wind in China."
Under CDM, projects in developing countries which reduce greenhouse gas emission are awarded certified emission reduction credits (CERs) with each credit equivalent to one tonne of carbon dioxide emissions saved. These credits are sold to companies or governments in industrialised countries, which use them to meet a portion of their Kyoto Protocol emission reduction commitments. This includes participants in the EU Emission Trading System (EU ETS). Under a UN linking directive, CERs can be used to meet some EU ETS obligations in addition to Europe's allocated Emission Allowance credits (EUAs).
By last month, 763 CDM projects expected to deliver well over two billion CERs were registered in the CDM project pipeline data base managed under the United Nations Environmental Program by Denmark's national laboratory at Risoe. In the first six months of 2007 alone, some 372 million CERs were traded in the market, says analyst Point Carbon, with a value of EUR 4.1 billion.
In all there are almost 2400 projects with or expecting CDM registration; 280, or 12%, are wind projects with a combined capacity around 11,200 MW across 18 countries. If all are successfully registered as expected, they will account for 6% of total CERs issued by 2012 -- up on the 2% of CERs issued to date in relation to wind projects.
The figures for China stand out a mile. While India tops the table for the number of planned CDM wind projects, 125 totalling 2862 MW, China's CDM wind portfolio is more than double the Indian capacity. Its 117 projects total 5960.5 MW (table page 56). Of these China projects, around 40% of them, accounting for 2305 MW, have been successfully registered so far.
Indeed, of the 1300 MW of wind plant, representing an investment of CNY 16.27 billion ($2.161 billion) installed in China last year alone, most of it is expected to get CDM status. Furthermore, virtually all of the new wind capacity due to be commissioned in China this year, estimated to be at least 1500 MW, is also banking on CDM registration. If the industry players who are claiming that actual installations will be almost double the official prognosis prove to be right, CDM registrations could be even higher -- and China would move well past the posts of its 5000 MW by 2010 wind goal.
China's wind CDM success, says Jane Ellis of the Organisation for Economic Co-operation and Development (OECD), is largely because there is strong renewable energy legislation at the national level. "CDM alone will not encourage investment," she says. "For most potential investors, generally, the project has to be attractive in the first place. CDM simply helps make those projects more attractive," she says. Sawyer agrees. China's Renewable Energy Law, which includes a target for 30,000 MW of installed wind capacity by 2020, part of a goal for 16% of the country's electricity to come from renewables by then, has been the key driver for wind power investment. Installed wind capacity was up to 2593.96 MW by the end of 2006 from less than 800 MW in 2004.
If it had not been for the CDM, however, little of this capacity would have been built on commercially viable terms, says Sawyer. He explains that CDM adds "around 10% to the rate of return for a wind project in China" and thus makes the difference between a project being commercially viable or not.
So far, around 90% of China's installed wind capacity consists of projects under 50 MW and developed outside the government's central program of wind power support. Electricity from these locally developed projects is sold at prices determined by the relevant regional authority. Of this 90%, around 85% has secured CDM money, says Sawyer.
For projects awarded building concessions by the central government, prices have come in at CNY 0.42-0.50/kWh ($0.056-0.066/kWh) for the last round of tenders (Windpower Monthly, November 2006), an improvement on those established in the previous three rounds. Local authorities, says Sawyer, seem to be setting prices at around CNY 0.55-0.65/kWh ($0.073-0.086/kWh).
"This seems to be just enough when combined with CDM money to make a project viable," Sawyer says. The recent wind power CDM carbon credit deal between the UK's Scottish and Southern Energy (SSE) and China's GD Power Development Co Ltd (Windpower Monthly, August 2007) is a case in point. It is estimated to add around CNY 0.09-0.1/kWh ($0.010-0.013/kWh) to the price GD will get for the electricity it generates over five years from the four 50 MW wind plants involved, which GD notes pushes those projects into commercial viability.
Due to its dominance in the CDM market, China has been the overriding influence when it comes to the price paid for CERs on the global market, says the World Bank. To maximise the full benefit of CDM, the Chinese government has established a minimum floor price for CERs, currently said to be EUR 8-9 or $10.40-11.70 per credit, a minimum value now fairly consistent across the whole market. The World Bank notes China's action has "been a major factor" in the stability of the CER trade market.
"Prices remained strong throughout 2006 despite the high volatility in the EUA market," it says in its State and Trends of the Carbon Market 2007 report published earlier this year. "Project-based emission reductions attracted, on average, a price of $10.90 for CERs (EUR 8.40), representing a 52% increase over 2005 level." In the primary CER market today, projects at an early stage command $10.40-12.40 (EUR 8-9.50) and registered project transactions command close to $14.7 or EUR 11.30, says the bank.
Prices in the secondary market for CERs, which is growing rapidly, have tended to be higher. Here the market largely consists of portfolios of guaranteed-delivery CERs offered by blue-chip sellers, with most, if not all, delivery risk assigned to the seller. Key players in this market are financial institutions, large energy players and speculators such as investor funds. Trade values in this secondary market in issued CDM credits doubled from 40 million credits and EUR 571 million in all of 2006 to 80 million and EUR 1.3 billion in the first half of 2007, notes Point Carbon.
While several commentators have called on the Chinese government to let the market decide the right price for CERs, its decision to control them is proving a vital safety net for wind project developers. While Sawyer is correct in saying that rates of CNY 0.55-0.65/kWh ($0.073-0.086/kWh) are often cited for wind projects developed at the local level, in reality the price eventually contracted is often lower, sometimes down to CNY 0.45-0.50/kWh ($0.06-0.066), bringing them in line with prices resulting from the central government's program of concession contracts for large wind projects, says Christiaan Vrolijk of Carbon Resource Management (CRM). The company's team, most from IT Power, are wind CDM pioneers having been involved in the first wind farm registered under the mechanism. That was a China project, the 25.8 MW Huitengxile facility in Inner Mongolia.
By May this year, Carbon Resource Management's portfolio of CERs and VERs (verified emission reductions traded on the voluntary market) under contract stood at 22 million, mainly for wind projects in China. "In China, project developers have only a faint idea of what prices they will get for the electricity at the start of a project," Vrolijk says. "You have to start building and often start generating before rates are fully agreed by the local authorities and contracts signed. Often tariffs are squeezed at the last minute." There is no ill-intent by the Chinese, he insists, but with wind already demanding a premium price, local authorities are reluctant to pay more than the rate for large concession projects and that, he says, "is fine and understandable."
He warns, however, that if purchase prices for wind power continue to be squeezed in China, wind developers could face problems, even with the CDM revenue currently available. The government can only go so far to help raise CDM income, he says. "While an actual minimum price is not stated publicly, one does apply to all CDM projects to make sure developers get value for money," he says. "However, if it is increased too much, there just would not be any buyers."
Vrolijk agrees with Sawyer that today's price for CERs is sufficient to add around 10% to the sales price of wind generated electricity. But with that typically adding just 1.5-2% to a project's internal rate of return, pushing overall project returns to the 8-8.5% mark that investors will accept, margins are slim, he notes.
In China, any project proposed for CDM registration with a value below its floor price simply will not be approved, although an exception may be made where the buyer also contributes technology or consulting services as part of the deal. Moreover, as well as final approval on price, the Chinese government has a veto on other terms of CDM project deals, including approval of the credit buyer. The government wielding its power in this way has not deterred many. China's CDM pricing policy has been "clearly acceptable to private European buyers who continued to show strong demand at that price range in 2006, although some Japanese buyers shied away at the top end of the range," says the World Bank.
Expectations are high that even more Chinese CDM wind projects will come off the drawing board rapidly, especially with the government still ruling out the introduction of higher fixed prices for wind power for the foreseeable future (page 20). At the same time, the oft-cited issue of extra costs for the CDM registration procedure is no longer a sizable barrier. Although the costs are significant, they are falling, say both Ellis and Sawyer.
Finding buyers for future carbon credits generated from Chinese wind projects is unlikely to be a problem, at least for now. Wind generated CERs might only account for a small proportion of the total credits sold by September, with wind-related deals done by around 45 of the 196 authorised buyers, but 13 of the top 20 CDM credit buyers, including the top five, have done wind deals (table next page). These 13 companies accounted for 78 wind projects currently with CER trade deals under their belt, 68 of which are in China. Including those companies outside the top 20, in total there were 137 wind projects with CER deals officially recorded at the end of August. Of these, 87 projects are in China.
Already those numbers are known to have swelled substantially, with French national utility EDF just one of the key buyers to have significantly increased its wind credit portfolio. Just recently it signed one of the largest wind CDM credit deals yet agreed. EDF's deal with China Longyuan Electric Power Group, a subsidiary of China's leading power producer, China Guodian Corporation, involves 18 wind projects totalling 945 MW located in eight provinces in northwest, northeast and southeast China. The CERs are rumoured to be worth more than EUR 70 million.
The Chinese firm will sell nine million CERs a year over a five year term to EDF Trading. The agreement brings China Longyuan's secured CDM credit agreements to 39 wind and biomass projects so far, with EDF and Austria's Kommunalkredit Public Consulting (KPC) its two main buyers. EDF Trading is also the buyer for the CERs from the 201 MW Jiangsu Dongtai wind project -- one of the large wind projects awarded a building concession by China's central government in 2005 (Windpower Monthly, December 2005). It was approved in August for CDM status. Comprising 134 Sinovel Wind 1.5 MW turbines, the project is being developed in Jiangsu Province, East China by Guohua (Dongtai) Wind Power Co. Ltd, part of Guohua Energy Investment Company, another of China's big main power companies. The wind farm is expected to generate 381,460 credits annually.
Bill Gates too
Meanwhile, new buyers are bursting onto the market virtually every week. Peony Capital, based in Beijing, is one of the latest, establishing a EUR 400 million carbon fund, specifically to invest in China. The fund -- with 25% financial backing from Microsoft billionaire Bill Gates and his wife Melinda -- plans to make equity investments in Chinese renewable energy projects, including wind plant, under the CDM framework, and then sell the carbon emission reduction credits created on the global market.
For many CER buyers, however, wind is not an attractive option. Ecosecurities, a leading company in the CER market, prefers to be involved in the early stages of CDM projects and is willing to provide advanced credit payments to help with construction costs. But it says the sums do not add up to make wind power worthwhile.
"Carbon finance is such a small proportion of wind project revenue so covering the capital costs is an issue," says the company's Paul Soffe, who was involved in its one and only wind deal, a 20 MW project in Jamaica developed by the UK's Renewable Energy Systems (RES). "Also wind projects tend to be small so the volume of carbon credits generated are less significant," he says.
While Soffe says Ecosecurities is still in discussions with some wind developers, he also cites the long timescales it takes to take a wind project from conception to operation as a key obstacle, while "another problem is that the big wind developers tend to work in developed countries and not developing countries." Its venture with RES, he says, was a test case in terms of the developer pursuing projects in developing countries. RES, he notes, has not gone down the CDM route since. "You could draw a conclusion that basically they feel they have enough business in North America and Europe and so it is not worth the risk yet in developing markets," Soffe says.
Mike O'Neill from RES confirms Soffe's supposition. Since the Jamaica project, RES has steered clear of developing countries. "There are two main reasons why," he says. "First, the time involved in developing projects in developing countries." The Jamaica plant took five years. "Second, our focus has been on our core markets, consolidating our position." These include North America, some parts of Europe and Australia. "However, we now have a very strong platform from which to explore new markets, which is our next step, and undoubtedly we will come across some CDM projects." China, he notes, could be an option. "China is one of those countries you just can't ignore, but it is not a step we would take lightly," he says. "It is very difficult for project development companies in countries like China, whereas manufacturers have found it easier because they clearly have something the Chinese want."
The 2012 cliff edge
So far there is no shortage of buyers for CER credits, but that could change. "An important question for wind in China is what will happen if no agreement can be made on a post-2012 climate framework or demand for CDM credits drops," says Ellis. Some uncertainty in this respect has been eased with news that the EU ETS is to continue post-2012 regardless of whether a more global post-2012 climate change agreement is reached. There are concerns, however, that CER demand by EU ETS participants could wane.
"The likely price outlook for CERs will be influenced by the demand and supply dynamics of EUAs and CERs in phase two, by the actual delivery of CERs and by competition to the EU from Japan and the voluntary markets," says the World Bank report. Last year, carbon funds saw CERs as "a relatively stable and safe haven compared to the highly volatile EUA market," it notes. "The only time this did not hold true was when EUA-II prices dipped to around EUR 11 ($14.30) earlier this year, and European buyers preferred to buy guaranteed secondary market CERs for around EUR 10 ($13). This behaviour suggests that there is support for a CER price of up to EUR 10 or so for primary forward contracts with non-firm delivery, with buyer preferences shifting to guaranteed secondary CERs when EUA-II prices fall below EUR 12 or so." Even so, it stresses: "China is still extremely attractive for buyers."
For China's government, CDM presents a win-win situation. "Yes, it wants to increase energy efficiency and reduce emissions, but China's primary objective is to grow a local industry," says Sawyer. It is managing to do that very successfully and at least-cost to itself by keeping the prices its state power companies pay for wind power relatively low within its domestic framework. The government achieves this by encouraging Chinese firms, without excluding foreign participation, to boost revenue through the CDM. Under China's CDM laws, only companies that are majority owned by a Chinese company are eligible for CDM registration.
This fine balancing act with a view to fostering development of a local industry is, says Sawyer, something the Chinese have become expert at, having taken the same route for other industries. The overall expectation, he says, is that while around 40 local wind turbine manufacturers have sprung up in China thanks to the renewable energy law's 70% local content mandate for wind plant, eventually five to six key manufacturers will emerge on top. In other words, China is partly using the CDM to pay for a free-for-all competition for budding wind turbine makers in which only the best will survive.
Chinese companies can already supply 1.5 MW wind turbines and are ramping up to build units of up to 3 MW. "It appears that by the end of this year Chinese wind turbine manufacturing capacity will be about 4 GW a year, so it does appear that use of imported technology will slow down," notes Sawyer. "Whether all of this local capacity is being used is unclear, but it's going full gang busters." He adds: "If three, four, or five key [Chinese] manufacturers emerge that's great, but I do not think they will be a major threat to the export market. I do expect they will take over China, but in reality the wind market in China, certainly up to 2020/2030, does not have any real limits."
Needless to say the few projects not going down the CDM route are almost exclusively those majority or wholly owned by foreign companies. Many of these are finding it tough to turn a profit. The ownership ruling, believes GWEC, is a key obstacle. "Many investors are still reluctant to cede the overall control to a still unknown or potentially inexperienced domestic partner," it says in a memorandum issued jointly with the Chinese Renewable Energy Industries Association and the Chinese Wind Energy Association.
The ownership restriction could result in projects either being delayed or not built at all, it says. "If CDM certification were provided to all projects, regardless of shareholder structures, this would result in even more projects being built in China, thereby enhancing the country's national and provincial tax revenue," it states.
In China, a tax of 2% is levied on wind and all other renewable energy CER revenue. "By having the market operate to the highest standards and with the newest technology, projects will generate even more carbon credits per megawatt installed, significantly reducing emissions and creating a reliable and predictable source of electricity," says GWEC.
CRM's Vrolijk agrees, noting the foreign ownership restrictions are also being applied to companies from Hong Kong, even though they come under Chinese jurisdiction. "We have two wind farm projects we are working on with a company in Hong Kong, but they are deemed foreign by the Chinese government and so not being given CDM status at present," he says. The Chinese authorities are "struggling with Hong Kong being China." While unprepared to name the company, he says it is proceeding with the project. "We are pushing for it to get CDM status and are confident this will work soon." The Hong Kong issue is likely to be resolved, he says, but while the government is considering relaxing the rules pertaining to other foreign firms, "I'm not sure there will be a quick resolution."
"What happens post 2012 is a key question," says Sawyer, agreeing with Ellis. Making full use of the carbon market "is the way to go," he says. "China is home to sixteen of twenty of the world's most polluted cities, a fact it is not too proud of, and it clearly wants to improve upon that," he says. "China does not want to be continually relying on importing coal from Australia. If there is no post 2012 agreement, in the power sector at least, we do have the answer and that's wind."