Download CARBON CREDITS Burning of fossil fuels is a major source of

CARBON CREDITS
Burning of fossil fuels is a major source of industrial greenhouse gas emissions, especially for
power, cement, steel, textile, and fertilizer industries. The major greenhouse gases emitted by
these industries are carbon dioxide, methane, nitrous oxide, hydro-fluorocarbons (HFCs), etc,
which all increase the atmosphere's ability to trap infrared energy and thus affect the climate.
The concept of carbon credits came into existence as a result of increasing awareness of the need
for controlling emissions. The mechanism was formalized in the Kyoto Protocol, an international
agreement between more than 170 countries, and the market mechanisms were agreed through
the subsequent Marrakesh Accords. The mechanism adopted was similar to the successful US
Acid Rain Program to reduce some industrial pollutants.
Carbon credits are generated by enterprises in the developing world that shift to cleaner
technologies and thereby save on energy consumption, consequently reducing their Green House
Gas (GHG) emissions. Credits can be exchanged between businesses or bought and sold in
international markets at the prevailing market price. Credits can be used to finance carbon
reduction schemes between trading partners and around the world. For each tonne of carbon
dioxide (the major GHG) emission avoided, the entity can get a carbon emission certificate which
they can sell either immediately or through a futures market, just like any other commodity.
The certificates are sold to entities in rich countries, like power utilities, which have emission
reduction targets to achieve and find it cheaper to buy 'offsetting' certificates rather than do a
clean-up in their own backyard. Credits can be exchanged between businesses or bought and sold
in international markets at the prevailing market price. Credits can be used to finance carbon
reduction schemes between trading partners and around the world.
This trade is carried out under a UN-mandated international convention on climate change to help
rich countries reduce their emissions.
CLEAN DEVELOPMENT MECHANISM CDM /CARBON CREDITS
Introduction
Studies on climate change have underscored two points. First that atmospheric commons, namely
the Earth’s carbon absorbing capacity, is finite and depletable and that growth of GHG emissions,
even at their present level pose a threat to humankind.
Secondly, it has been established that per capita GHG emission is strongly correlated with
economic prosperity. Further, it is recognized that without increase in GHG emissions or access to
appropriate alternative technology options, developing countries would not be able to pursue their
socio-economic goals. Kyoto Protocol is a global cooperative attempt to address both these issues.
Kyoto Protocol
In December 1997, the Third Conference of Parties (COP) to the United Nations Framework
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Convention on Climate Change (UNFCCC) adopted the Kyoto Protocol. The protocol requires
developed countries (listed in Annex 1 of the protocol) to limit their Greenhouse Gas (GHG)
emissions to individual targets, resulting in on an average 5.2% reduction in the GHG emission
from their 1990 emission levels, in the commitment period 2008-12. The protocol for the first time in
the evolving climate change regime, provided for legally binding emission commitments by annex 1
parties. The protocol covers six main Greenhouse gases CO 2, CH4, N2O, Hydro-florocarbons,
Perflorocarbons and Sulphur Hexafluoride. The protocol provided three Co-Operative
Implementation Mechanisms (CIMs) to enhance flexibility and to facilitate development of cost
effective means of achieving the targets. These mechanisms are Joint Implementation and
Emission Trading, both of which are co-operative mechanisms applicable to Developed Countries
(Annex 1 countries) only. Clean Development Mechanism (CDMs) provides for co-operation
between Annex 1 (developed) countries and non annex 1 (developing) countries.
Kyoto's 'Flexible mechanisms'
A credit can be an emissions allowance which was originally allocated or auctioned by the national
administrators of a cap-and-trade program, or it can be an offset of emissions. Such offsetting and
mitigating activities can occur in any developing country which has ratified the Kyoto Protocol, and
has a national agreement in place to validate its carbon project through one of the UNFCCC's
approved mechanisms. Once approved, these units are termed Certified Emission Reductions, or
CERs. The Protocol allows these projects to be constructed and credited in advance of the Kyoto
trading period.
The Kyoto Protocol provides for three mechanisms that enable countries or operators in developed
countries to acquire greenhouse gas reduction credits

Under Joint Implementation (JI), a developed country with relatively high costs of
domestic greenhouse reduction would set up a project in another developed country.

Under the Clean Development Mechanism (CDM), a developed country can 'sponsor' a
greenhouse gas reduction project in a developing country where the cost of greenhouse
gas reduction project activities is usually much lower, but the atmospheric effect is globally
equivalent. The developed country would be given credits for meeting its emission
reduction targets, while the developing country would receive the capital investment and
clean technology or beneficial change in land use.

Under International Emissions Trading (IET), countries can trade in the international
carbon credit market to cover their shortfall in allowances. Countries with surplus credits
can sell them to countries with capped emission commitments under the Kyoto Protocol.
These carbon projects can be created by a national government or by an operator within the
country. In reality, most of the transactions are not performed by national governments directly, but
by operators who have been set quotas by their country.
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Clean Development Mechanisms (CDMs)
CDMs are of particular interest to developing countries, as it provides for investment in projects in
developing countries for their sustainable development, while generating GHG abatements that
may be transferred to the annex 1 countries towards meeting their targets under Kyoto Protocol.
The operational mechanism of CDMs involves an investment by a legal entity from an Annex 1
country in a project in Non Annex 1 country, which results in emission reductions. The investment
decision would include an agreement between the two parties and their respective countries on the
dispensation and transfer of the emission reductions resulting from the project. These emission
reductions have to be certified by an appropriate authority (the CDM Executive Board, provided for
under the protocol) and then these Certified Emission Reductions (CERs, commonly known as
carbon credits) can be used to meet Annex 1 commitments under Kyoto Protocol.
A project activity will be eligible for consideration as a CDM project if it is aligned with the national
needs and priorities and contributes to the sustainable development of the host country. Further,
the projects must fulfill the following criteria.
(i)
Voluntary participation by each party involved i.e it is not driven by any regulatory
compliance requirement;
(ii)
Real measurable and long-term benefits related to mitigation of climate change
effects.
(iii)
Reduction of emissions that are additional to any that would occur in the absence of
the project activity in question i.e. the Sponsor would not have undertaken the project
in a business as usual scenario and that in undertaking the project, the sponsor has
overcome barriers that may be related to investment, common practice/prevalence or
technology or other barriers.
(iv)
The activity must ensure access to environmentally sound technology needed by the
developing country.
Broadly, projects that contribute to credible and sustained reduction in GHG emissions qualify as
CDM projects. The following broad categories of projects have been recognized as CDM projects.
(i)
Renewable Energy Projects (Solar Power, Wind Power, Biomass based power,
small hydel etc);
(ii)
Fuel substitution ( e.g. coal to oil to gas to hydrogen in Power Plants, Manufacturing
Process Industries, automobiles etc);
(iii)
Energy Efficiency improvement and waste heat utilization projects;
(iv)
Other project activities that reduce anthropogenic emissions by sources;
(v)
Carbon sequestration projects (Forestry etc.);
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(vi)
Management of methane emissions from municipal landfills;
(vii)
Management of methane emissions from agriculture and cattle manure management;
and
(viii)
Fuel shift from liquid fuel to CNG/LPG in the transport sector.
The manner of transfer of CERs will depend on the nature of agreement between the contracting
parties. Some of the preferred modes adopted in various cases include:
(i)
Investment by an entity from one of the annex 1 country directly in a project, in lieu of
the CERs that are expected to accrue therefrom.
(ii)
The entity enters into agreement to purchase CERs from a developing country entity or
access the open market, as and when they are required to meet certain commitments.
(iii)
Many annex 1 governments are floating tenders for procurement of CERs
(iv)
There are multilateral institutions like the World Bank and IFC, who have been
engaged by annex 1 country governments and private sector corporations to purchase
carbon credits (CERs) on their behalf. The World Bank group has nearly US$ 1.06
billion of such funds for buying CERs. Similarly, there are other funds set up by EBRD,
JBIC and some governments.
(v)
Some of the MNCs and large corporates are themselves buying carbon credits.
(vi)
CDM provides for banking of CERs, wherein the emission reductions prior to 2008
may be banked for use in the commitment period in 2008-12.
STEPS IN CDM PROCESS
Stage I: Project Design Document (PDD) and Monitoring Plan preparation
The Project Sponsor shall be required to develop a CDM Project Design Document (PDD) for the
identified opportunities/candidate projects in the PDD format approved by CDM Executive Board.
This would inter alia, address the requirements of the Kyoto Protocol and the CDM Executive
Board’s (CDM-EB) procedures. The main tasks, in developing a PDD, would involve:
(i)
Preparatory work – data collection, review of policies;
(ii)
General description of the project;
(iii)
Delineation of project boundary and identification of leakages;
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(iv)
Assessment of various baseline methodologies and selection of the most appropriate
one. This would also include a scan of approved projects or approved methodology to
ascertain if there are approved methodologies which may be directly applied to this
project;
(v)
Development of a new baseline methodology, in the event none of the existing
approved/proposed baseline methodologies are found appropriate for the project;
(vi)
Application of the selected/developed baseline methodology to the project;
(vii)
Demonstration of various additionalities for the project;
(viii)
Estimation of project GHG emissions and absorption/abatement/avoidance including
direct/ indirect onsite/ offsite emissions;
(ix)
Assessment of various monitoring and verification (M&V) methodologies and selection
of the most appropriate one. This would also include a scan of approved projects or
approved methodologies to ascertain if there are approved methodologies which may
be applied to this project;
(x)
Development of a new M&V methodology, in the event none of the existing
approved/proposed methodologies are found appropriate for the project.
(xi)
Estimation of potential streams of CERs.
(xii)
Environmental Impact Assessment for the project;
(xiii)
Local stakeholder consultation;
(xiv)
Sustainability assessment of the project;
Stage II: Host country approval
Project Sponsor is required to secure a Host Country Approval from the Designated National
Authority (DNA) hosted at Ministry of Environment and Forests, GoI. This involves completion of a
Project Information Note in the format prescribed by Ministry of Environment and Forests and its
submission together with the PDD to Ministry of Environment and Forests. The Project sponsor
would be required to make a presentation to the DNA on an appointed date.
Stage III: Validation
Validation is the process of independent evaluation of a project activity by a designated operational
entity against the requirements of the CDM on the basis of the project design document. The
Project sponsor is required to appoint an independent third party for validation of the project. CDMEB has approved certain entities e.g. DNV, TUV, SGS etc. as Designated Operating Entity (DOE)
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for undertaking validation. The Validation process also involves a Public Disclosure of the project
for 30 days at the UNFCCC website. This is also organized by the validator.
Stage IV: Approval of Baseline Methodology by CDM –EB/Meth Panel
In the event a new baseline methodology is developed, the same shall be reviewed by the
Methodology Panel of UNFCCC/CDM-EB and on its recommendation, approved by CDM – EB. A
new baseline methodology should be submitted by the designated operational entity to the
Executive
Board
for
review,
prior
to
a
validation
and
submission
for registration of this project activity, with the draft project design document (CDMPDD), including
a description of the project and identification of the project participants.
Stage V: Project Registration
Registration is the formal acceptance by the Executive Board of a validated project as a CDM
project activity. Registration is the prerequisite for the verification, certification and issuance of
CERs related to that project activity. A validated project is required to be
registered with CDM-EB of UNFCCC. This is usually the responsibility of the Designated Operating
Entity. The Project sponsor is required to pay a registration fee.
Stage VI: Monitoring and verification
Verification is the periodic independent review and ex post determination by the designated
operational entity of the monitored reductions in anthropogenic emissions by sources of
greenhouse gases that have occurred as a result of a registered CDM project activity during the
verification period. Certification is the written assurance by the designated operational entity that,
during a specified time period, a project activity achieved the reductions in anthropogenic
emissions by sources of greenhouse gases as verified.
On registration of the project, the Project sponsor is required to appoint one of the DOEs as a
verifier. The verifier conducts an audit of the project activity after its commissioning
and its becoming operational, as per the approved monitoring and verification protocol (included in
the PDD registered with CDM-EB), to estimate and certify the actual volume
of ERs generated on account of the project activity. The sponsor may appropriately select
a verification cycle i.e. Annual, Half Yearly, Quarterly etc.
Stage VII: Issuance of CERs
The certification report, submitted by the DOE to CDM-EB/Registrar, shall constitute a request for
issuance to the Executive Board of CERs equal to the verified amount of reductions of
anthropogenic emissions by sources of greenhouse gases. The monitoring and verification entity,
after completing the process, submits its report to CDM EB, which constitutes a request for
issuance of Certified Emission Reduction (CERs). The CERs are issued as per the allocation plan
outlined to the CDM-EB at the time of Project Registration.
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Emission markets
For trading purposes, one allowance or CER is considered equivalent to one metric tonne of CO2
emissions. These allowances can be sold privately or in the international market at the prevailing
market price. These trade and settle internationally and hence allow allowances to be transferred
between countries. Each international transfer is validated by the UNFCCC. Each transfer of
ownership within the European Union is additionally validated by the European Commission.
Climate exchanges have been established to provide a spot market in allowances, as well as
futures and options market to help discover a market price and maintain liquidity. Carbon prices are
normally quoted in Euros per tonne of carbon dioxide or its equivalent (CO2). Other greenhouse
gasses can also be traded, but are quoted as standard multiples of carbon dioxide with respect to
their global warming potential. These features reduce the quota's financial impact on business,
while ensuring that the quotas are met at a national and international level.
Currently there are at least four exchanges trading in carbon allowances: the Chicago Climate
Exchange, European Climate Exchange, Nord Pool, and PowerNext. Recently, NordPool listed a
contract to trade offsets generated by a CDM carbon project called Certified Emission Reductions
(CERs). Many companies now engage in emissions abatement, offsetting, and sequestration
programs to generate credits that can be sold on.
How buying carbon credits can reduce emissions
Carbon credits create a market for reducing greenhouse emissions by giving a monetary value to
the cost of polluting the air. Emissions become an internal cost of doing business and are visible on
the balance sheet alongside raw materials and other liabilities or assets.
By way of example, consider a business that owns a factory putting out 100,000 tonnes of
greenhouse gas emissions in a year. Its government is an Annex I country that enacts a law to limit
the emissions that the business can produce. So the factory is given a quota of say 80,000 tonnes
per year. The factory either reduces its emissions to 80,000 tonnes or is required to purchase
carbon credits to offset the excess.
After costing up alternatives the business may decide that it is uneconomical or infeasible to invest
in new machinery for that year. Instead it may choose to buy carbon credits on the open market
from organizations that have been approved as being able to sell legitimate carbon credits.

One seller might be a company that will offer to offset emissions through a project in the
developing world, such as recovering methane from a swine farm to feed a power station
that previously would use fossil fuel. So although the factory continues to emit gases, it
would pay another group to reduce the equivalent of 20,000 tonnes of carbon dioxide
emissions from the atmosphere for that year.

Another seller may have already invested in new low-emission machinery and have a
surplus of allowances as a result. The factory could make up for its emissions by buying
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20,000 tonnes of allowances from them. The cost of the seller's new machinery would be
subsidized by the sale of allowances. Both the buyer and the seller would submit accounts
for their emissions to prove that their allowances were met correctly.
India is emerging as a serious player in the global carbon credits market. This has prompted EcoSecurities, originator, developer and trader of carbon credits, to set up office in India.
The Indian carbon credits market is estimated at $40-50 million. Could you elaborate on
this?
The Indian market is extremely receptive to Clean Development Mechanism (CDM), mooted under
the Kyoto Protocol. A number of ideas for CDM are being formulated and the Government is
monitoring several projects. At Eco-Securities, we are looking at a range of sectors — renewable
energy projects such as wind, hydro, biomass and industrial energy efficiency projects and HFC
reduction projects.
How do you measure Certified Emission Reductions (CERs) or carbon credits?
It varies from sector to sector. To get the baseline, you calculate the amount of emissions that
would be emitted in the absence of projects to take care of pollution. For instance, you measure
the number of megawatts versus emissions from a co-generation power plant and compare it with
a wind plant, which is a zero emission plant. One credit or CER is equivalent to one tonne of
emission reduced.
If the credit comes with a fixed unit value, what drives their future values during trade?
Basically, the credit enables companies to comply with emission reduction obligations. In Europe,
everyone is talking about the high prices in the allowances market. These companies need
allowances, if they don't they have to buy credits or pay a fine. So, it is basically a question of
supply and demand of allowances and credits. So what companies in Europe try to do is to reduce
their emissions internally — switch off the lights when they go home for instance. If they have two
allowances and emit three, then they try to reduce it back to two but when they cannot meet the
whole lot they go to the market.
So the value of the credit is not dependent on its intrinsic value but on the demand supply
situation?
It is a commodity. The price depends on how many need the commodity. It is dependent on
weather patterns. Majority of entities requiring credits are in Europe, followed by Japan and
Canada. So if there is a harsh winter and you have to generate much electricity to heat up homes,
then prices go up. At the beginning of 2005, the winter was very mild and it rained instead of snow.
There was a lot of water in reservoirs, which helped to generate hydroelectric power, which has low
carbon emission. At that point, the prices of carbon credits went down.
What people do is enter into long-term contracts with the promise of a certain number of credits.
Promises are subject to a variety of things - country risk, credit risk, political risk; also CDM risk.
These risks are what determine the price of carbon credits. That's why a promise to deliver CERs
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is different from buying allowances in the spot market. They are totally different contracts with
totally different price structures.
What has been the response globally to CDM?
The response to CDM has been tremendous. The number of projects formulated worldwide is
large. More than 1,000 potential projects have emerged but not all of them will fulfil the
requirements of the United Nation's CDM regulations. So far, 93 projects have been registered with
the CDM Executive Board.
Where does India stand in the offering of these credits and what is the interest towards
Indian credits?
Carbon credit is a carbon credit irrespective of where it comes from. Of course, entities would like
to deal with trustworthy counter parties or with developers or sellers in a country that is dynamic in
expediting the approval of these projects. Which is the case in India. So in that respect, there is
interest in working with Indian businesses because the Government has been pretty proactive.
For the carbon credits business, is such interest the equivalent of paper quality as normally
asked of financial instruments?
You apply the same relative discount between countries, which you apply to commercial paper and
it would reflect the price that is paid for credit from different countries. So in that respect there is a
differential. For example a project in Afghanistan is not going to get a lot in comparison to the
baseline price for one in India.
You have cited the need for better quality projects. Could you explain?
Basically, projects that fulfil the requirements of Kyoto Protocol. In India, gates have just opened for
CDM projects, so there is a bit of euphoria. The reality is that a lot of initiatives and ideas were
pushed into the CDM arena. All of these may not be eligible and may not get registered. By `quality
project' the first criteria we are referring to is that we look for projects that are serious and fulfil the
requirements, objectives and rules of CDM. Second, there are other attributes you expect from any
investment. We need counter parties with experience who are serious and committed to reducing
emissions and who take social and environmental obligations seriously.
Carbon credits basically seek to encourage countries to reduce their greenhouse gas (GHG)
emissions, as it rewards those countries that meet their targets and provides financial incentives to
others to do so as quickly as possible.
There is moolah to be made in all this. Surplus credits that are acquired by overshooting the
emission reduction target can be sold in the global market. One credit is equivalent to one tonne of
CO2 emission reduced. Carbon credits are available for companies engaged in developing
renewable energy projects that offset the use of fossil fuels.
The Multi-Commodity Exchange of India (MCX), the country’s leading commodity exchange, may
soon become the third exchange in the world with a licence to trade in carbon credits.
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The Chicago Climate Exchange (CCX), North America’s first and only multi-sector marketplace for
reducing and trading greenhouse gas (GHG) emissions, today announced a licensing agreement
with MCX. Many Indian companies have already been re-rated on the stock markets on the basis
of the bonanza that will accrue to them when carbon trading kicks off.
Under the agreement, the Chicago exchange will list mini-sized versions of its European Climate
Exchange (ECX) Carbon Financial Instruments (CFI) and Chicago Climate Futures Exchange,
Sulfur Financial Instrument futures contracts on the MCX trading platform.
At present, the trading in carbon credits takes place on two stock exchanges — the Chicago
Climate Exchange and the European Climate Exchange.
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