Carbon deals done but dangers lurk

Wind and carbon trade, true romance or shotgun wedding? That was the question we asked when this magazine looked at wind's relation with the infant business of carbon offset trade back in 2002. Two years on, as Russia's decision to ratify the Kyoto Protocol triggers its implementation, we take a look at how the marriage is getting along

The rapid growth of the carbon credits market has confounded its sceptics. Even before Russia's decision to ratify the Kyoto Protocol ensured that all the Green House Gas (GHG) emissions reductions agreed under it would become binding, it was clear that the market was more than just a theoretically bright idea. In September, forward trades in the EU Emissions Trading Scheme (EU ETS) passed one million tonnes for the month -- three months ahead of the market's launch date in January. Industry analyst Point Carbon expects some eight million tonnes to be traded in 2004, at a market value of around EUR 65 million. It further forecasts the value of the traded market could reach EUR 8 billion annually by 2007.

That the market's huge appetite for carbon offsets could be make or break for marginally viable wind projects, particularly in less developed countries, has long been accepted. As we wrote two years ago (Windpower Monthly, April 2002), carbon trading could be "the perfect driver to take wind beyond the premium priced green power markets of the West into the carbon intensive fuel economies of the developing world." In other words, marrying wind and carbon offsets is a cost effective means of making emission reductions where they will really count.

At the time, however, there was concern about whether the Kyoto market instruments, the so-called flexible mechanisms -- Joint Implementation (JI) and the Clean Development Mechanism (CDM) -- would prove too unwieldy and complex. One of the downsides to the "flex-mex" concept is that before the carbon offset value of a particular project can be established, the "baseline," or carbon value of the fuel it displaces, needs to be calculated -- a complicated and costly procedure. Could such costs be absorbed when carbon credits -- trading at no more than EUR 5-10 for a tonne of carbon displaced -- offer only a marginal revenue stream to project developers?

Filling the knowledge gap

Today that knowledge gap is starting to be filled by agencies which specialise in linking developing world projects with Western carbon credit purchase schemes, such as the Dutch government's Emission Reduction Procurement Tender (ERUPT) program and the World Bank sponsored Prototype Carbon Fund.

One such agency, Dutch Ecofys, based in Utrecht, assists project owners in eastern Europe and in developing countries, especially in Asia and Latin America, with getting their projects qualified for CDM/JI registration, says the company's Bob Schulte. "That means we develop the baseline, write the PDD, and take care of all the other required activities including selling the carbon credits," he says, referring to the project design document (PDD). "We do this on a success fee basis, so only when we are successful in registering the project and selling the credits we will charge a commission, a percentage of the carbon income."

Having facilitated a CDM deal whereby the Dutch government buys carbon credits from a 15 MW plant in Tamil Nadu, India, Schulte believes that wind, as a CDM technology, has some significant advantages. For a start, the monitoring technology is simple: "Basically, that's a kilowatt hour metre," he says. Wind's competitive position against fossil fuel generation also means that the revenue from selling the emission reduction credits can sometimes mean the difference between viability and non-viability, "particularly because the carbon revenue is very secure coming from a Western government or major company."

On the basis of its experience with the flexible mechanisms so far, Ecofys is convinced that the underlying principles and long term prospects of the carbon market are sound. "We have several projects in the pipeline at the moment, including more wind farms, and are actively expanding this portfolio. We believe that there will be a growing demand for reliable credits from developing countries to compensate for the growing emissions in the EU."

The Netherlands has proved to be a hotbed of activity for early carbon offset trade thanks to the Dutch government's decision in 1997 to invest EUR 425 million in a carbon credit procurement program as part of an effort to cut emissions by 40 megatons of CO2 equivalent by 2010. Last year, the ERUPT program extended its reach to New Zealand with the purchase of 530,000 emission reduction units (ERUs) from the 91 MW, Vestas equipped Te Apiti wind farm near Palmerston North on the North Island.

Apart from being the first JI, rather than CDM, project financed under ERUPT, Te Apiti also illustrates some of the possibilities and complexities of "flex-mex" deals. At present the North Island's very cheap electricity is generated from seasonally variable hydro on the South Island, backed up by natural gas. Under normal circumstances the offset value of this fuel mix would be too low to enable a carbon deal. In the case of Te Apiti, however, developer Meridian Energy successfully argued that under a "business as usual scenario" the island would be forced to build more coal powered generators already by 2005 as natural gas reserves run out. Te Apiti, it said, would forestall their construction and thus the offset value is that of the coal it displaces. Like other wind plant part financed under CDM or JI mechanisms, Te Apiti is a project that would not have been built without the offset revenue.

Making wind viable

Germany's Nordex, a wind turbine manufacturer, is as enthusiastic as Ecofys about the potential of carbon trade for improving the bottom line of wind projects in developing countries. Responding to news of the Russian ratification of the Kyoto Protocol, sales and marketing head Carsten Pedersen says that it could result in a "marked upturn in the demand for wind power, especially in the emerging markets."

Nordex has used carbon credit revenues twice to realise projects which would not otherwise have been viable, says the company's Ralf Peters. In Colombia, Nordex installed a 15 MW wind station for a regional utility, EPM. "It was only CO2 trading with the World Bank that made the project commercially viable," says Peters. A baseline study determined that the wind farm would displace roughly 1.2 million tonnes of CO2 emissions over its useful life of 21 years. As a result, EPM was able to sell the reduction of 800,000 tons of CO2 to the World Bank's Prototype Carbon Fund for EUR 3.24 million.

The company has now embarked on its second carbon credit project, this time in Europe. Nordex is involved in a Joint Implementation deal in Estonia involving Estonia, Finland and the purchaser of the Nordex turbines, Norwegian electric utility Vardar. Here Kyoto signatory Estonia will be transferring ERUs to the Finnish government and wind farm operator Vardar receive EUR 2.9 million from Finland for the avoidance of 500,000 tonnes of CO2.

The potential of the carbon market for financing such marginal projects has only begun to be tapped believes Pedersen. "Many potential wind farm operators are not aware of the opportunities they have within the framework of the existing provisions and offers, or are not familiar with the procedure, and therefore hesitate to start proceedings to obtain approvals," he says. To combat that ignorance, Nordex is taking a proactive role in pointing potential clients to companies such as Ecofys and the German agency TÜV Süd, which will provide its customers with advice on financing wind farm projects using CO2 trading instruments.

The positive experience of Nordex and Ecofys is borne out by an OECD survey, Evaluating Experiences with Electricity Generating GHG Mitigation Projects. It shows that in 2003 wind was joint leader with hydro in the number of megawatt developed in "electricity generating CDM type projects," with wind trailing hydro 20% to 22% in terms of credits expected to be generated.


It is not all plain sailing, says Schulte. With carbon prices currently hovering around no more than EUR 5 a tonne, there are real problems with satisfying one of Kyoto's basic criteria -- "additionality." For a project to be granted JI or CDM status it has to be shown that it would not have been built under a "business as usual" scenario.

Irrespective of a project's financial viability, low carbon prices can give rise to a Catch-22 situation, explains Schulte: "The low price for a carbon credit means that it provides only five to ten per cent extra income per kilowatt hour generated. That makes it difficult to demonstrate additionality -- to show that the project wouldn't have been built in a business as usual situation."

With environmentalists suspicious that the Kyoto mechanisms can provide a license for trading purely notional emissions savings, demonstrating "additionality" is a hot issue. Schulte, however, believes that the United Nations Framework Convention on Climate Change (UNFCCC) has got the balance wrong and is ignoring the reality on the ground.

"The UNFCCC's approach has been to develop a watertight set of rules and procedures to avoid mistakes at all costs. But in so doing they are frustrating a lot of good projects which should be accepted under CDM/JI but have difficulty in providing the right evidence. Okay, we don't have any free riders, congratulations, but we also have a lot of projects that should have been approved as JI/CDM project but are not accepted, which slows down the development of renewable energy projects in developing countries. So that is completely counterproductive with the original objective of the whole mechanism and the Kyoto-protocol," he says.

Another hurdle is formed by the high administrative costs involved in accessing carbon credit revenues under CDM/JI, says Christian Kjær from the European Wind Energy Association (EWEA). High costs mean that sale of carbon emission reduction units to gain extra earnings is not an option for smaller projects, yet it is smaller sustainable projects which the CDM is intended to stimulate.

Schulte agrees in part: "Because of the strictness of the validation process, the costs are considerable. But at Ecofys we still take up small projects of about ten to fifteen megawatt." Since Ecofys only earns money if it can sell credits at a profit, "you can conclude that we think the effort is worthwhile."

But there is definitely room for improvement. Schulte: "CDM is a long way from being as attractive as it could or should be. We think that once the procedures become clearer and we know what is required, the process of validation will be easier. The first couple of projects experienced changing rules and procedures along the validation process, it got stricter and stricter. We hope that the rules of the game will become transparent in the near future and that they will then not be changed for some time, because the greatest costs now are being made in adapting the PDD again and again to satisfy those validating projects or the UNFCCC. Higher market prices, will also decrease the impact of the transaction costs."


Whether and when those higher market prices materialise could be determined by the launch in two months of the European Union's internal Emission Trading Scheme, the EU ETS. If all goes to plan -- currently a big "if" -- some 13,000 industrial facilities across Europe, together responsible for 45-50% of the European Union's total CO2 emissions, will be swelling the ranks of existing market players. These companies having been allocated emissions rights under National Allocation Plans (NAPs) and will be trading any shortfalls or surpluses. A "linkage" directive means they will also be able to buy credits generated from JI and CDM projects to bring down their emissions units to the volume they have been allocated.

The impact of this new system will depend on the allocation of rights to the companies under their respective NAPs. An over-generous allocation of the right to release polluting emissions could produce a similar situation to that in the UK, where it is now clear that participants in a national emission trading scheme launched in 2002 have been able to bank millions of extra "hot air" credits while making relatively few real emissions reductions.

Should the EU over-allocate on the scale of the UK, it seems possible that the launch of EU ETS could seriously undermine the project-based market. At present, however, the European Commission appears to be taking a tough line on over-generous national allocations, while a recent survey by accountancy firm Ernst and Young suggests that the soon-to-be-capped companies expect the scheme to have a real impact on their emission management strategies. Of over 200 top companies surveyed from five major EU Kyoto signatories, 55% expect to be making significant investments in renewable energy projects in order to generate emission credits, with wind and biomass named as the most likely technologies. "Levels of forward planning varied among the respondents," says Ernst and Young's Michael Cupit, but there is certainly no expectation that the EU scheme will degenerate into a UK-style paper chase, he says.

Schulte, from Ecofys, hopes EU ETS unleashes sufficient new demand to force the UNFCCC to relax its validation rules for CDM and JI projects. "The EU-trading system will probably result in a growing demand for carbon credits and hopefully this will increase the pressure on the UNFCCC to make the necessary adjustments," he says.

There are real dangers, as well as potential, in wind's burgeoning relationship with carbon trade. EWEA's Kjær welcomes EU ETS as an "effective and potentially powerful tool," but he insists its limits should be recognised.

"It will not level the playing field between polluting and clean technologies, it cannot be a substitute for environmental or CO2 taxes," he warns. The market price of an emission reduction unit merely reflects the marginal cost of reducing CO2, the abatement cost, he argues. "Abatement costs are not the same as environmental, or pollution, costs," says Kjær.

In all the enthusiasm for carbon trading, another point that often gets forgotten is that the system is intended as a "burden sharing" mechanism to ease and spread the cost of reducing GHG emissions. As such, says Kjær, it is not in any way a full solution to the larger issue of developing new policies that will firmly establish renewable energy sources at the centre of the fuel mix.

wrong balance

He fears there is a real danger that fiscal recognition of wind power's environmental benefits could be reduced to its carbon offset value, with its contribution to electricity supply and national economies forgotten. As carbon gains ground, wind and other renewables are likely to be identified purely with their offset value in the minds of politicians and public -- with the result that renewables support policies are eroded, warns Kjær. "The main goal of policies to promote renewables is not to reduce emissions here and now, the main purpose should be to develop clean technologies and ensure that renewable energy in the future becomes a fully competitive source of power."

And there is the "low hanging fruit" problem. Before wind and carbon can settle into a steady relationship, the temptations of cheap one-off options for reducing emissions -- available to companies and governments for easy plucking -- have to be lived through. Fuel efficiency measures, such as building insulation and proper thermostats, are ways of generating emission credits that wind cannot hope to compete in pure carbon reduction terms.

Carbon trade, argues Kjær, is in reality a second best option to which the EU has resorted because a Europe-wide carbon tax has proved politically impossible to implement. "The price of a CO2 allowance is unlikely to ever reflect the external costs associated with pollution and emissions. Thus emissions trading can never replace other current and future [European] community initiatives aiming at internalising external cost, such as energy taxation."

For Kjær, there is a strong suspicion that the honeymoon days may be short-lived for wind projects seeking to lever additional income from sales of carbon reduction units. If his worst fears are realised, politicians will fail to understand the limited contribution carbon trade can play in furthering the use of renewables. That would make a mockery of the few successful wind industry demonstrations of the concept in practice -- and of the vision shown by the pioneers behind them.