Emission Reduction Benefits

TO EXAMINE SOURCES OF GENERATING EMISSION REDUCTION BENEFITS AND VARIOUS
PREVAILING STANDARDS

Chapter 1
Emission Reduction Benefits

1.1 Introduction
This report examines various sources of Emission Reduction Benefits which is a result of
international treaties such as the Kyoto Protocol which set quotas on the amount of
greenhouse gases countries can produce. Countries, in turn, set quotas on the emissions of
businesses. The report also looks in to various standards which are prevalent all over the
world, with special context to India.

Now as the businesses (Industrial and Commercial) which are over their quotas buy Carbon
Credits or Carbon Offsets as commonly called all over for their excess emissions, while
businesses that are below their quotas can sell their remaining credits. By allowing credits to
be bought and sold, a business for which reducing its emissions would be expensive or
prohibitive can pay another business to make the reduction for it. This creates great demand
to service providers in terms of technological and financial consultant. The role of these
parties is also looked in to the report.

Emission Reduction Benefits generated as carbon credits or carbon offset can be exchanged
between businesses or bought and sold in international markets at the prevailing market price.
There are exchanges for : the Chicago Climate Exchange and the European Climate
Exchange and in India we have Multi Commodity Exchange (MCX).


The concept of ERB came into existence as a result of increasing awareness of the need for
pollution control. It was formalized in the Kyoto Protocol, an international agreement
between 169 countries. ERB are certificates awarded to countries that are successful in
reducing emissions of greenhouse gases. ERB are a tradable permit scheme. They provide a
way to reduce greenhouse gas emissions by giving them a monetary value. A credit gives the
owner the right to emit one tonne of carbon dioxide. For trading purposes, one credit is
considered equivalent to one tonne of CO2 emissions. Such a credit can be sold in the
international market at the prevailing market price.


Emission Reduction Benefit (ERB) is a financial instrument aimed at a reduction
in greenhouse gas emissions. ERB are measured in metric tons of carbon dioxide-
equivalent (CO2e) and may represent six primary categories of greenhouse gases. One carbon
offset represents the reduction of one metric ton of carbon dioxide or its equivalent in other
greenhouse gases. In other words ERB is a credit granted upon request by an emission source
who voluntarily (e.g. VCS/VER) or under regulations (e.g. CDM/CER) reduces emissions
beyond required levels of control. An Emission Reduction Benefit (ERB) represents the legal
ability to emit regulated pollutants in an amount equal to the quantity specified when
the ERB was granted. ERB in the form of CER (certified emission reduction) or VER
(verified emission reduction) can be sold, leased, banked for future use, or traded in
accordance with applicable regulations established. ERBs are intended to provide an
incentive for reducing emissions below required levels, and to establish a framework to
promote a market based approach to pollution control (main emphasis on GHGs emission).

1.2 Financial Aspect of Emission Reduction Benefit
There are two markets for ERB. In the larger, compliance market, companies, governments,
or other entities buy ERB in order to comply with caps on the total amount of carbon dioxide
they are allowed to emit. In 2006, about $5.5 billion of ERBs were purchased in the
compliance market, representing about 1.6 billion metric tons of CO2e reductions.

In the much smaller, voluntary market, individuals, companies, or governments purchase
Voluntary Emission Reduction (VER) to mitigate their own greenhouse gas emissions from
transportation, electricity use, and other sources. Many companies offer ERBs as an up-sell
during the sales process so that customers can mitigate the emissions related with their
product or service purchase. In 2008, about $705 million of ERBs were purchased in the
voluntary market, representing about 123.4 million metric tons of CO2e reductions.

ERBs are typically achieved through financial support of projects that reduce the emission of
greenhouse gases in the short or long-term. The most common project type is renewable
energy, such as wind farms, biomass energy, or hydroelectric dams. Others include energy
efficiency projects, the destruction of industrial pollutants or agricultural by-products,
destruction of landfill methane, and forestry projects.

NATIONAL INSTITUTE OF CONSTRUCTION MANAGEMENT AND RESEARCH PAGE 3


ERB has gained appeal and momentum mainly among consumers in western countries who
have become aware and concerned about the potentially negative environmental effects of
energy-intensive lifestyles and economies. The Kyoto Protocol has sanctioned offsets as a
way for governments and private companies to earn ERB which can be traded on a
marketplace. The protocol established the Clean Development Mechanism (CDM), which
validates and measures projects to ensure they produce authentic benefits and are genuinely
"additional" activities that would not otherwise have been undertaken. Organizations that are
unable to meet their emissions quota can offset their emissions by buying CDM-approved
Certified Emissions Reductions (CERs). Obtaining CER/VER is a cheaper and more
convenient alternatives to reducing one's own fossil-fuel consumption. Offsets are viewed as
an important policy tool to maintain stable economies.

One of the hidden dangers of climate change policy is unequal prices of carbon in the
economy, which can cause economic collateral damage if production flows to regions or
industries that have a lower price of carbon - unless carbon can be purchased from that area,
which offsets effectively permit, equalizing the price.

There are several avenues through which a country can earn carbon credits and also trade
in the same.


A quick review of different ERB standard (to be covered in detail later in the report)

1.3 Introduction To Various Prevailing Standards
1.3.1 Clean Development Mechanism (CDM)

This is a mechanism through which a developed country sets up a venture in developing
country reducing carbon emissions as an alternative to more expensive emission reductions in
their own country. CDMs are useful as they help the developed countries to lower the cost for
emission reduction and enable the developing countries to achieve technology transfer and
sustainable development. What is crucial to the understanding of ‘approved’ CDMs is that for
any project to be approved by the CDM executive board, the project should result in reducing
the greenhouse gas emissions not mandated by law or regulatory authority but should be able


to achieve additional emission reduction from what it would have anyways contributed to
sans the project or statutory compliance. For instance switching to unleaded petrol is not
reducing emissions voluntarily it as per the stated norms however setting up a waste heat
recovery plant that saves energy will surely earn some CERs to the factory. The cost of
technology involved in taking up such projects are humungous, thus carbon financing is
critical to the development of any CDM project. These projects are undertaken in developing
countries, which has a twin benefit a) it would reduce the cost of setting up the project in a
developing nation and b) it would provide the developing nation with technology input and
sustainable development; besides it would also earn the developed nation Certified Emission
Reductions (CERs). There is a primary CER market wherein the trades are conducted through
emission reduction purchase agreement (ERPAs) and the secondary market for CERs that
involve trades in generic issued or guaranteed delivery CERs that have been traded in
previously. CERs are in the form of certificates, just like a stock. If a project generates energy
using wind power instead of burning coal, and in the process saves (say) 25 tonnes of carbon
dioxide per year, it can claim 25 CERs (One CER is equivalent to one tonne of CO2 reduced).

1.3.2 Joint Implementation (JI)

Joint Implementation projects are expected to take place in ‘economies in transition’, where
there are caps set in for emissions. Emission reductions are awarded as Emission Reduction
Units (ERUs) which come from the host country’s pool of assigned emission credits known
as Assigned Amount Units (AAUs). In JIs the total amount of emission credits does not
change, whereas CDM projects must provide for additional emission reductions to what it
would otherwise have occurred. The Joint Implementation projects are supervised by the
Joint Implementation Supervisory Committee (JISC).

1.3.3 Emissions Trading

Kyoto Protocol introduced the concept of ‘cap and trade’ system. Simply put carbon dioxide
emissions would be capped and the right to emit could be traded. For instance, for Country A


required reduction in carbon emission are 10 units and can generate 20 units of carbon
emission at price P (which is the affordable price), whereas Country B has required reduction
in carbon emissions as 10 units but at price P it can only reduce 5 units. CDM provides
Country B with an opportunity to generate 5 units of carbon emissions in the country and will
trade the rest 5 units from Country A. Thus the net cost of financing emission reductions
would come down considerably leaving both the countries in the win-win position. EU
Greenhouse Gas Emission Trading System (EU-ETS) is an offspring of the cap and trade
system, others being UK Emissions Trading Group (ETG), Chicago Climate Exchange
(CCX), and the New South Wales Greenhouse Gas Reduction Scheme. The EU-ETS is the
largest greenhouse gas emissions trading scheme in the world. It implements a mandatory
"cap and trade" system in 27 EU member countries. The EU carbon market is estimated to be
worth Euro 90 billion – approximately $131 billion a year and the cap and trade system has
been reasonably able to meet its objective of carbon emission reduction whereas the emission
levels have gone up for the rest of the world. As per a Bloomberg report the global carbon
market is expected to reach US$2trillion by 2025. Apart from the primary market of trading
in carbon credits, there are two other markets prevalent.

1.3.4 Gold Standard (GS CDM/VER)

The Gold Standard is the world’s highest quality standard for carbon emission reduction
projects with added sustainable development benefits and guaranteed environmental integrity.
The Gold Standard label certifies projects under the Clean Development Mechanism (GS
CER credits) as well as for the voluntary offset market (GS VER credits). GS projects
employ renewable energy or energy efficiency technologies and actively seek local
participation in project design, resulting in demonstrable sustainable development
benefits.The Gold Standard established a registry in March 2008 to create, track and enable
trade of GS VERs and CERs. numerous publicly accessible reports create utmost
transparency on more than 200 GS projects in over 30 countries. The Gold Standard is
officially endorsed by 42 non-govrnmental organizations, including WWF and Greenpeace.
GS projects generate premium prices in the market and developers profit from a fair priced


niche market with substantial demand currently growing. Buyers of GS credits reduce CDM-
specific and reputational risks.

1.3.5 Voluntary Carbon Standard (VCS)

Launched in November 2007, the VCS marks the end of a two year consultation with the
industry, NGOs and carbon market specialists. Led by The Climate Group, the International
Emissions Trading Association (IETA) and the World Business Council for Sustainable
Development (WBCSD), the VCS provides a robust, global standard for voluntary offset
projects. It ensures that carbon offsets can be trusted and have real environmental benefits.

The VCS is leading the efforts for a market-wide voluntary registry. Unless a credit is
registered in one of the four VCS registries, it does not meet the VCS definition of a
Voluntary Carbon Unit (VCU). This creates a robu system of transparent voluntary offset
credits and provides a clear chain of ownership.

1.3.6 VER+ Standard

VER+ is the TÜV SÜD standard for VER projects, which is in line with the requirements of
Kyoto Protocol for CDM or JI projects. The catalogue of the VER+ Standard criteria includes
eligibility, additionality, permanence, exclusivity, avoidance of double-counting,
environmental and social criteria, a defined ex-post crediting period and a conservative
methodological calculation approach.

TÜV SÜD, a UN accredited independent verifier, is one of First Climate’s technical
partners. In 2007, TÜV SÜD established the BlueRegistry, a robust database for VER+
credits. To date, BlueRegistry has incorporated 18 carbon projects and has issued almost 1.8
million VER+ credits.


1.3.7 Social Carbon Methodology

Social Carbon is a methodology developed by the Brazilian non-profit Instituto Ecológica
based on seven years of fieldwork in the Amazon region by a multidisciplinary team of
researchers. The social carbon concept arose from the need to ensure that reducing emissions
of greenhouse gases makes a substantial contribution to sustainable development. It is
founded on the principle that transparent assessment and monitoring of the social and
environmental performance of projects can improve their long-term effectiveness, and thus
add value to the VERs generated.

This progressive methodology directly involves the local population in the project design and
assessment processes, supporting the community in the achievement of its own goals and
aspirations. Furthermore, the Social Carbon methodology requires continuous monitoring of
social and environmental benefits over the project lifetime.

1.3.8 Climate, Community and Biodiversity (CCBS)

The CCB standard developed by the CCBA (Climate, Community & Biodiversity
Alliance) is a global partnership between leading companies, NGOs and research institutes
seeking to promote integrated solutions to land management around the world and
develop voluntary standards for multiple-benefit land and forestry projects. These projects
deliver compelling benefits for the climate, biodiversity and the community.

The standard evaluates land-based carbon mitigation projects in the early stages of
development and fosters the integration of best-practice and multiple-benefit approaches into
project design and evolution. The projects simultaneously address climate change, support
local communities and conserve biodiversity and therefore promote excellence and
innovation in project design. The CCBS is the highest quality standard for land management
and forestry projects and therefore part of First Climate’s portfolio.


1.4 A Note On Voluntary Markets
A voluntary carbon market exists outside the compliance market that is outside the Kyoto
compliant mechanism.. The carbon credits generated outside the compliance mechanism are
verified and traded in the global over the counter market for greenhouse gas emissions and
are called verified emission reductions.

1.5 A Note On Secondary Market
The secondary market for carbon credits is a very active market. At present the secondary
market of carbon credits involves European Union Emission Trading System (EU ETS),
Chicago Climate Exchange, European Climate Exchange, Nord Pool (Norway, Denmark,
Sweden, Finland) etc. The two prime categories of carbon instruments that can be traded in
the marketplace will be 1) carbon allowances or the offset credits and 2) allowance
derivatives. Carbon derivatives would be mainly swaps, options & futures that would allow
companies to lock in pricing on carbon units. While the idea of trading the emissions rights
and having trade is carbon derivatives is the basic intention of price discovery and liquidity,
the hostility with regard to the term derivatives itself is very visible and prominent, more so
after the financial crisis of 2008-09. While in the several bills passed on the derivatives issue,
demanding more regulatory requirements and shunning few of the derivatives, the idea of
carbon derivatives is not at all welcomed, including stalwarts like George Soros who called
the emissions trading for climate control as ‘ineffective.’

1.6 ERB Exchange Market
In 2009, 8.2 billion metric tons of carbon dioxide equivalent changed hands worldwide, up
68% from 2008, according to the study by carbon-market research firm Point Carbon, of
Washington and Oslo. But at EUR94 billion, or about $135 billion, the market's value was
nearly unchanged compared with 2008, with world carbon prices averaging EUR11.40 a ton,
down about 40% from the previous year, according to the study The global carbon market is
dominated by Europe, where companies that emit greenhouse gases are required to cut their
emissions or buy pollution allowances or ERB from the market. Europe, which has seen
volatile carbon prices due to fluctuations in energy prices and supply and demand, will
continue to dominate the global carbon market for another few years, as the U.S. and China--
the world's top polluters--have yet to establish national emission-reduction policies.



The first mandatory, market-based cap-and-trade program to cut CO2 in the U.S., called the
Regional Greenhouse Gas Initiative, kicked into gear in northeastern states in 2009, growing
nearly tenfold to $2.5 billion, according to Point Carbon. California plans to start a cap-and-
trade program in 2011, but on the whole, the U.S. carbon market is largely a voluntary market
dominated by financial players and companies that want to hedge their exposure to potential
future emission-reduction rules.

The goal of ERB market is to allow market mechanisms to drive industrial and commercial
processes in the direction of low emissions or less carbon intensive approaches than those
used when there is no cost to emitting carbon dioxide and other GHGs into the atmosphere.
Since GHG mitigation projects generate credits, this approach can be used to finance carbon
reduction schemes between trading partners and around the world.

There are also many companies that sell ERB to commercial and individual customers who
are interested in lowering their carbon footprint on a voluntary basis. These carbon off
setters purchase the credits from an investment fund or a carbon development company that
has aggregated the credits from individual projects. The quality of the credits is based in part
on the validation process and sophistication of the fund or development company that acted
as the sponsor to the carbon project. This is reflected in their price; voluntary units typically
have less value than the units sold through the rigorously-validated Clean Development
Mechanism.

With the commencement of the European Union Emission Trading Scheme (EU ETS), the
earliest derivatives markets on over-the-counter (OTC) and exchange-traded carbon emission
credits took off in Europe in 2003 and early 2005 respectively, with trading mainly of
products on European Union Allowances (EUAs) under the EU ETS. Trading of CER
derivatives started later because Clean Development projects under the CDM of the Kyoto
Protocol needed time to develop. The earliest exchange-traded CER derivatives were
launched in mid-2007 in Europe. Later on we can see Indian counterpart as Multi Commodity
Exchange (MCX) and National Commodity and Derivative Exchange (NCDEX) playing
there role from 2008. A chart is being shown depicting the trading growth.



1.7 ERB allowances
Under the Kyoto Protocol, the 'caps' or quotas for Greenhouse gases for the developed Annex
1 countries are known as Assigned Amounts and are listed in Annex B.

In turn, these countries set quotas on the emissions of installations run by local business and
other organizations, generically termed 'operators'. Countries manage this through their own
national 'registries', which are required to be validated and monitored for compliance by
the UNFCCC. Each operator has an allowance of credits, where each unit gives the owner the
right to emit one metric tonne of carbon dioxide or other equivalent greenhouse gas.
Operators that have not used up their quotas can sell their unused allowances as ERB, while
businesses that are about to exceed their quotas can buy the extra allowances as credits,
privately or on the open market. As demand for energy grows over time, the total emissions
must still stay within the cap, but it allows industry some flexibility and predictability in its
planning to accommodate this.


By permitting allowances to be bought and sold, an operator can seek out the most cost-
effective way of reducing its emissions, either by investing in 'cleaner' machinery and
practices or by purchasing emissions from another operator who already has excess 'capacity'.

Since 2005, the Kyoto mechanism has been adopted for CO2 trading by all the countries
within the European Union under its European Trading Scheme (EU ETS) with the European
Commission as its validating authority. From 2008, EU participants must link with the other
developed countries who ratified Annex I of the protocol, and trade the six most significant
anthropogenic greenhouse gases. In the United States, which has not ratified Kyoto,
and Australia, whose ratification came into force in March 2008, similar schemes are being
considered.

1.8 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 ermed 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. However, geologists
from Cass Business School are skeptical on this program, arguing that the introduction of
ERB does little to encourage companies to reduce emissions and instead allows the
existence of 'carbon cowboys'.



§ 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.

1.9 Emission Trading
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 (CO2e).
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 five exchanges trading in carbon allowances: the Chicago Climate
Exchange, European Climate Exchange, Nord Pool, PowerNext and the European Energy
Exchange. 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 one of the exchanges

Managing emissions is one of the fastest-growing segments in financial services in the City
of London with a market estimated to be worth about €30 billion in 2007. Louis Redshaw,
head of environmental markets at Barclays Capital predicts that "Carbon will be the world's
biggest commodity market, and it could become the world's biggest market overall.



1.10 Setting A Market Price For Carbon
Unchecked, energy use and hence emission levels are predicted to keep rising over time.
Thus the number of companies needing to buy credits will increase, and the rules of supply
and demand will push up the market price, encouraging more groups to undertake
environmentally friendly activities that create ERB to sell.

An individual allowance, such as a Kyoto Assigned Amount Unit (AAU) or its near-
equivalent European Union Allowance (EUA), may have a different market value to an offset
such as a CER. This is due to the lack of a developed secondary market for CERs, a lack of
homogeneity between projects which causes difficulty in pricing, as well as questions due to
the principle of supplementary and its lifetime. Additionally, offsets generated by a carbon
project under the Clean Development Mechanism are potentially limited in value because
operators in the EU ETS are restricted as to what percentage of their allowance can be met
through these flexible mechanisms.

Yale University economics professor William Nordhaus argues that the price of carbon needs
to be high enough to motivate the changes in behavior and changes in economic production
systems necessary to effectively limit emissions of greenhouse gases.

Raising the price of carbon will achieve four goals. First, it will provide signals to consumers
about what goods and services are high-carbon ones and should therefore be used more
sparingly. Second, it will provide signals to producers about which inputs use more carbon
(such as coal and oil) and which use less or none (such as natural gas or nuclear power),
thereby inducing firms to substitute low-carbon inputs. Third, it will give market incentives
for inventors and innovators to develop and introduce low-carbon products and processes that
can replace the current generation of technologies. Fourth, and most important, a high carbon
price will economize on the information that is required to do all three of these tasks.
Through the market mechanism, a high carbon price will raise the price of products according
to their carbon content. Ethical consumers today, hoping to minimize their “carbon
footprint,” have little chance of making an accurate calculation of the relative carbon use in,
say, driving 250 miles as compared with flying 250 miles. A harmonized carbon tax would
raise the price of a good proportionately to exactly the amount of CO2 that is emitted in all
the stages of production that are involved in producing that good. If 0.01 of a ton of carbon
emissions results from the wheat growing and the milling and the trucking and the baking of
a loaf of bread, then a tax of $30 per ton carbon will raise the price of bread by $0.30. The



“carbon footprint” is automatically calculated by the price system. Consumers would still not
know how much of the price is due to carbon emissions, but they could make their decisions
confident that they are paying for the social cost of their carbon footprint.

The social cost of carbon is the additional damage caused by an additional ton of carbon
emissions. ... The optimal carbon price, or optimal carbon tax, is the market price (or carbon
tax) on carbon emissions that balance the incremental costs of reducing carbon emissions
with the incremental benefits of reducing climate damages. ... [I]f a country wished to impose
a carbon tax of $30 per ton of carbon, this would involve a tax on gasoline of about 9 cents
per gallon. Similarly, the tax on coal-generated electricity would be about 1 cent per kWh, or
10 percent of the current retail price. At current levels of carbon emissions in the United
States, a tax of $30 per ton of carbon would generate $50 billion of revenue per year.

1.11 How Buying ERB Can Reduce Emissions

ERB 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.

For 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 ERB 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 ERB on the open market from organizations
that have been approved as being able to sell legitimate ERB.

We should consider the impact of manufacturing alternative energy sources. For example, the
energy consumed and the Carbon emitted in the manufacture and transportation of a large
wind turbine would prohibit a credit being issued for a predetermined period of time.

§ 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
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.

1.12 Creating Real ERB

The principle of Supplementary within the Kyoto Protocol means that internal abatement of
emissions should take precedence before a country buys in ERB. However it also established
the Clean Development Mechanism as a Flexible Mechanism by which capped entities could
develop real, measurable, permanent emissions reductions voluntarily in sectors outside the
cap. Many criticisms of ERB stem from the fact that establishing that an emission of CO2-
equivalent greenhouse gas has truly been reduced involves a complex process. This process
has evolved as the concept of a carbon project has been refined over the past 10 years.

The first step in determining whether or not a carbon project has legitimately led to the
reduction of real, measurable, permanent emissions, is understanding the CDM methodology
process. This is the process by which project sponsors submit, through a Designated
Operational Entity (DOE), their concepts for emissions reduction creation. The CDM
Executive Board, with the CDM Methodology Panel and their expert advisors, review each
project and decide how and if they do indeed result in reductions that are additional.



1.13 Different Role Players for ERB Implementation
There are opportunities created for different business like Risk Management
(Corporate/Banks/Insurance Companies), Project Financing Companies, Portfolio
Management and IT Players are depicted by the table below.


1.13.1 Risk Management for Companies

Companies must realize that CO2 risk management will emerge as an important factor in
their decision-making. For individual companies the most important risk Categories resulting
from emission reduction targets are as follows:

• Cash flow risks such as increased expenditure on measures aimed at reducing CO2 or
the purchase of emission allowances.
• Market perception risks which may influence market capitalization.
• Capital cost risks such as more stringent credit conditions as a result of altered credit
risk ratings.
• The drawing up of emission inventories and measures taken to increase energy
efficiency in future, play important roles in the financial rating process.

To understand the potential carbon risks, companies should have in place a robust and
accurate GHG inventory which details past, current, and projected future emissions. They
should understand the marginal abatement cost options available from different GHG
mitigation strategies and the tools that are available to achieve compliance within different
GHG regulatory regimes.

1.13.2 Risk Management from Bank’s Perspective

Offering new products and services to reduce the risk of emissions trading for corporate
customers is a new business challenge for banks. Furthermore, banks hold stakes in the
companies affected by trading. Consequently, the risks and opportunities for those companies
are also risks and opportunities for the banks. The complexity of emissions trading requires a
wide range of products and services that effectively hedge against risks emerging from the
Kyoto Protocol and the European trading scheme.

1.13.3 Portfolio Management Perspective

Banks can offer the service of Emission Allowances portfolio management while taking over
the responsibility of their clients’ emission allowance accounts. The most striking advantage



of such a service is that it is not necessary to set up internal expertise in the affected
companies, thus resulting in lower transaction costs. This can be a part of Derivatives desk as
the products they can offer are derivative instruments such as Futures, Options and Swaps
and any other structured products.
• Futures: The purchase of emission allowances to be supplied in the future at a fixed
price – currently the most common type of market-traded allowance.
• Options: A guarantee of the right to purchase or sell allowances at a fixed price within
a defined period of time.
• Swaps: The exchange of payment obligations so that different allowance currencies
can be exchanged.

Structured products: It can be a combination of any of the above linked to insurance products
or interest rates or basket of currencies and so on.

1.13.4 Project Finance Perspective

An emission trading also offers potential business in the field of project finance – providing
project developers with the chance to generate additional income sources by investing in
energy-efficient technology. This applies to JI and CDM projects, where the inclusion of
emission credits in the analysis of a project’s credit quality could become imperative. In
principle, the securitisation of these cash flows could either help to reduce the financing
needs of a project developer or reduce the re-financing costs by embedding them into interest
rate derivatives. Accordingly, emission certificates could help plant developers with new
financing mechanisms, thereby leading to more sophisticated structures as the market
expands.

1.13.5 Risk Management from Insurance Perspective
Insurance Products cover the legal obligation to reduce greenhouse emissions resulting in
new liabilities, fines and penalties resulting from a breach of law would not be covered under
Insurance policy. Inappropriate or inadequate management of climate risks, resulting in a
failure to protect a company’s interests would affect the decision of the Insurance Company.



1.13.6 IT Players

Setting up emission data management systems, Trading, and clearing systems, research and
development activities which can deliver end to end solutions for emission management
Emission Exchanges: A platform to be built to facilitate faster and transparent carbon trading
system along with margining and risk management tools in place.

a) Traders/Brokers/Investment Banks: Carbon trading dash boards can be created for
Front office where it is traded, Mid office where risk mitigating tools are implemented
along with reporting for senior management at regular intervals and for back office
where trade confirmations/ affirmations and reconciliations are done .

b) Registries: They maintain data of all debits and credits in the book entry form and act
as custodians for Carbon credits. Bigger opportunity is towards setting up local
registries, national registries, and international registries.

c) Clearing Registries: They maintain data of all the transactions traded on the exchange
and act as counterparty for both sell and buy, thereby mitigating counterparty risks to
ensure smooth settlement system, which helps to build the investors confidence in the
entire carbon trading system.

d) Banks for carbon settlement: They maintain various types of accounts on behalf of
investors and brokers (House Accounts and Non-house accounts) and facilitate
smooth transfer of book entries across banks, which are specifically designated for
carbon settlement. Apart from the above, an effective and efficient emission
measuring system to calculate emissions resulting from variables such as soil
cultivation, fire management, fertilizer application, climate, different plant is the need
of the hour. Further it is required to set up research and development activities on
sustainable technologies to result in carbon reduction.



Chapter 2
Sources of Emission Reduction Benefits
2.1 Introduction to The Sources of ERB
Following are the sources which will fetch the Emission Reduction Benefits and can be
formulated by either CDM or VCS or any other assistance to get a feasible project.
• Renewable energy - wind, solar, biomass, biofuel, hydel and tidal
• Methane capture from landfill
• Fuel switching - coal to natural gas
• Industrial gases - modification of production process
• Agricultural - methane reduction from animal waste)
• Energy efficiency - buildings, industrial, CFL
• Forestry - afforestation and reforestation
• Transport - biodiesel, improved fuel efficiency

Following is a graph showing different sources of earning ERBs


It is learnt that ERB create a market for reducing greenhouse emissions by giving a monetary
value to the cost of polluting the air. This means that carbon becomes a cost of business and
is seen like other inputs such as raw materials or labor.
By way of example, assume a factory produces 100,000 tonnes of greenhouse emissions in a
year. The government then enacts a law that limits the maximum emissions a business can
have. So the factory is given a quota of say 80,000 tonnes. The factory either reduces its
emissions to 80,000 tonnes or is required to purchase carbon credits to offset the excess.
A business would buy the carbon credits on an open market from organisations that have
been approved as being able to sell legitimate carbon credits. One seller might be a company
that will plant so many trees for every carbon credit you buy from them. So, for this factory it
might pollute a tonne, but is essentially now paying another group to go out and plant trees,
which will, say, draw a tonne of carbon dioxide from the atmosphere.
As emission levels are predicted to keep rising over time, it is envisioned that the number of
companies wanting to buy more credits will increase, which will push the market price up
and encourage more groups to undertake environmentally friendly activities that create for
them carbon credits to sell. Another model is that companies that use below their quota can
sell their excess as ‘carbon credits.’
The possibilities are endless; hence making it an open market.

2.2 Description Of Sources Of ERB

What we need next is various means of reducing green house gasses and covering them into
carbon credit/carbon offsets and finally gain emission reduction benefits.

A brief introduction of various means to attain ERB is given below:

2.2.1 Renewable Energy : commonly include wind power, solar power,

hydroelectric power and bio-fuel. Some of these offsets are used to reduce the cost
differential between renewable and conventional energy production, increasing the
commercial viability of a choice to use renewable energy sources.



RENEWABLE SOURCE CATEGORISATION IN
ENERGY INDUSTRY

Energy Industries

Energy Recovery from
Renewables
Efficiency wastes

Zero
Hydropower
Emissions

Tidal ,
Wind Solar Biomass
Geothermal etc.

2.2.2 Cogeneration plants generate both electricity and heat from the same
power source, thus improving upon the energy efficiency of most power plants which
waste the energy.

Following is the table which shows the targeted benefit from cogeneration thus enabling

carbon credits thus ERBs.

Table Showing Typical Cogeneration Performance Parameters.


2.2.3 Fuel efficiency and Energy Efficiency ( EE) projects
replace a combustion device with one which uses less fuel per unit of energy provided.
Assuming energy demand does not change, this reduces the carbon dioxide emitted. A
table is shown below which shows different ways in which we can implement fuel
efficiency projects so as to claim for ERBs.
In developing countries, there exist many EE improvement opportunities in the
current and future economies These opportunities could potentially be fully realized
by making use of the CDM mechanism, as CDM is evolving in the direction to better
accommodate EE projects. Inthis section, we propose potential end-use EE options
that are suitable, or have the potential for PoAs. EE options for bundled CDM and
stand-alone CDM projects are also discussed for comparison purposes. The examples
discussed in this section, including end-use EE options for the household, service,
industrial, and transportation sectors, are common projects and are technologically
available. They are suited for new installations or for retrofits. Options for household,
services, industrial, and transportation end-use energy efficiency are discussed
respectively. The options presented in this section do not mean to be an exhaustive list
of all energy efficiency options that have CDM potential, as many new technologies,
innovative ideas, and EE projects specifically fitting local needs could also be well-
qualified for CDM. It is up to the CDM project and methodology developers to come
up with energy efficiency projects suitedfor local conditions and future development
needs. In general, EE can be improved through changes in three different categories:

a) Process and design change. A complete or partial change to the elemental
processes may result in less energy-intensive products. Examples include
changing the recipe of a cement blend so it requires less heat per output unit, or
changing the orientation and natural ventilation of a building in order to very
significantly reduce its energy intensity. Technological change. This includes
equipment upgrade and installation of new hardware based on more efficient
technologies (e.g., better insulation for buildings, more efficient household
appliances, replacing old boilers, changing burners, better isolated furnaces,
steam/heat recirculation systems, etc.).



b) Fuel-switching, distributed generation, and renewables. Fuel-switching,
renewables, and distributed generation are not typically considered EE measures,
nor are they part of demand-side management. They are sometimes even
considered as supply-side projects; however, use of these technologies does
reduce requirement for fossil fuels and does improve overall efficiency. For
instance, switching from coal or residual fuel oil to NG or biomass generally
increases the combustion process efficiency.

c) Cogeneration units, with distributed generation, reduce energy waste and improve
the utilization of heat production. As well, small applications for renewables
reduce the need for fossil fuel combustion. Most decisions for fuel-switching,
installation of cogeneration kits in the industrial sector, and small applications for
renewable energy in the household and service sectors depend on end-user
actions, and are often considered as part of EE upgrade projects. These projects
carry de facto characteristics of end-use EE and are suitable for ERB.

2.2.4 Energy-efficient buildings reduce the amount of energy wasted in
buildings through efficient heating, cooling or lighting systems. In particular, the
replacement of incandescent light bulbs with compact fluorescent lamps can have a
drastic effect on energy consumption. New buildings can also be constructed using
less carbon-intensive input materials.

Green buildings in India have increased from 20,000 square feet area in 2004 to 275
million square feet in 2009. In total, there are 315 buildings that are registered as
green buildings in India. The Indian market has witnessed more investments for
commercial buildings to go green. These buildings include IT parks, hospitals,
airports, and educational institutions.

The total number of green buildings in India is expected to be more than 2,000 by
2012. An average investment for a green building is around $10.7 million, and the
total investment in green buildings is expected to be around $42.6 billion by 2012.



Interest benefits on loan by banks for green projects, more incentives and regulations
are likely to push the acceptance of green buildings in India. Bureau of Energy
Efficiency (BEE) is introducing an energy performance index for the rating of
buildings. The parameter for ratings will be energy consumption in kilo watt per hour
per square meter per year. Ratings will vary for different climatic conditions. BEE is
also making it illegal to sell any electric appliance without energy star marks by
January 7, 2010.

The market potential for green building materials is estimated to be about $40 billion
by 2012.

The cost of green buildings is 3 to 8 percent more than a conventional building, but
the cost recovery is high and breakeven can be achieved in a period of three to five
years. Reduction in operational costs is very high and benefits are enormous from
breakeven.


Some of the commercial green buildings in the country are Sapient, Accenture, Nokia
Siemens Network, Pearson, ITC Building, Wipro Campus, Patni Campus in Gurgaon,
Green Boulevard, knowledge Boulevard at Noida and Hiranandani BG Building, K.
Raheja group, and Enercon India Pvt Ltd Kalpataru building in Mumbai. Chennai also
has a good number of green buildings.

The end users are willing to pay more for green buildings. A greener flat has become
a high-class symbol. Tenants are ready to pay more, due to low operational costs and
societal values.

Indian carbon offsets are very sensitive to the fluctuation of prices. With China and
Vietnam offering CERs at lower, more fixed prices, the threat of India getting
outpriced intensify. Project rejection rate is high for India. Even after getting the
approval from government, around 50 percent of the cases get rejected from the CDM
executive board.

MCX is the exchange dealing with carbon trading in India. It provides price signals
for carbon delivery in the next five years. The exchange is only for Indians and Indian
companies. People who have bought or sold carbon will have to give or take delivery
in the month of December, because that is the time to meet the norms in Europe. Spot,
Plain Forward, and Forward with advanced payment are three types of deal structure
followed for carbon trading.


Offsets adhering to standards contribute to the positive mindset of buyers. A number
of standards exist for carbon offsets, including the VCS, Green-e, and the Gold
Standard. In India, two green building rating systems are followed, LEED by IGBC
and GRIHA by TERI. LEED is famous among the ratings, and the credits earned
through LEED ratings can be traded in the carbon market.

Big sellers in the Indian market are Public Sector Units (PSUs) such as the National
Thermal Power Corporation (NTPC), Indian Oil Company (IOC), Railways, and
private sector companies such as the Reliance group and the Tata Group. Different tax
is levied in different states for CDM.

2.2.4.1 Carbon Credits through Green Buildings

Buildings are a major source of CO2 emissions, and contribute around one-third of
the same. With an increase in the number of green buildings, there is an expected rise
in the opportunities for carbon credits, offsets, and profits offered by these buildings.

The use of solar water heating systems, glass panels to allow natural light inside the
building, rainwater harvesting, environment-friendly building materials and
specifications, waste minimization, maximizing energy use in buildings, water
conservation and efficient measures, and energy-efficient equipment can the help real
estate developers and owners earn a good amount of carbon credits.

A single project does not account to a considerable number of emission reductions,
which makes it difficult for the real estate developers to register and earn profits. The
following options are available for real estate developers to trade carbon profits.


Technopolis is India's first green building in information technology, is helping the
developers earn up to €1 35,000 per year. SBI is seeking advice on the usage of
energy-efficient devices in its buildings. SBI also wants to improve its bottom-line by
revenue through carbon credits. In the hotel industry, orchid group of hotels at
Mumbai and New Delhi are referred as green hotels. ITC Sonar registered 1886
tonnes of CERs at the time of inauguration and was verified by UNFCCC to be
eligible for carbon trading and it earned the hotel revenue of RS. 1.47 million.
Currently, with modification, the hotel is expecting a saving of about Rs. 8.3 million
per year through the project. Olympia Technology Park in Chennai is earning
immensely from carbon trading. Common wealth games will help organizers earn
revenues by sale of carbon credits.

Down the Road

In order to make the bottom line more attractive through carbon trading, the Indian
real estate developers are likely to shift toward green buildings. Benefits such as low
interest rates, low operational cost, and higher rental value are expected to drive this
market.

More number of innovations is expected in the voluntary markets. Newer models will
be developed to accommodate the carbon credits earned by green buildings. Major
activities to go green are taking place in Indian metros. This trend is expected to
continue, due to the growth in energy consumption and changing lifestyle. A major
shift will be witnessed, with the real estate developers moving toward rural areas.
Land availability and abundant natural resources will push the real estate developers
to start greener building projects in rural areas and earn carbon credits.


The green building offsets are expected to gain more importance in the future. CII-
IGBC has come up with a Rs. 4 billion green fund to support the development of
green buildings. Steps are being taken to include green buildings into the federal cap-
and-trade system. California has adopted standards that require benchmarking and
disclosure of energy consumption in commercial buildings. Other developed countries
will adopt similar standards. The global carbon demand will increase the carbon offset
prices. More global standards are expected to be set, in order to eliminate problems
such as double counting (for example, utility companies and real estate developers
asking for credits for reduction in electricity usage). More transparency in procedures
will build confidence in the market. Many new financial instruments will be derived
for making profits. Some countries might up with bilateral carbon trade agreements.
Real estate developers will see their active counterparts improving bottom-line and
are expected to go green.

Wake up call (Nation Planners & Developers):

Go Green, Garner Greenbacks

Green buildings help to reduce carbon dioxide emissions through low consumption of
energy. The global carbon offset trading market stood at around US $100 billion in
2008. Globally, buildings account for 39% of total energy usage and 38% of the
carbon dioxide emissions. Green buildings use 30% lesser energy than the
conventional buildings and thus help to reduce CO2 emissions. Reduction of each ton
of CO2 will lead to generation of one Certified Emission Reduction (CER) valued at
around US $16 in the United States and around US $22 in Europe.

2.2.5 Destruction of industrial pollutants: Industrial pollutants such
as hydrofluorocarbons (HFCs) and perfluorocarbons (PFCs) have a GWP many
thousands of times greater than carbon dioxide by volume, because these pollutants
are easily captured and destroyed at their source, they present a large and low-cost
source of carbon offsets. As a category, HFCs, PFCs, and N2O reductions represent
71% of offsets issued under the CDM.



2.2.6. Land use, land-use change and forestry: Land use, land-use
change and forestry (LULUCF) projects focus on natural carbon sinks such as forests
and soil. Deforestation, particularly in Brazil, Indonesia and parts of Africa, account
for about 20% of greenhouse gas emission. Deforestation can be avoided either by
paying directly for forest preservation, or by using offset funds to provide substitutes
for forest-based products. There is a class of mechanisms referred to as REDD
schemes (Reducing emissions from deforestation and forest degradation), which may
be included in a post-Kyoto agreement. REDD credits provide carbon offsets for the
protection of forests, and provide a possible mechanism to allow funding from
developed nations to assist in the protection of native forests in developing nations.


2.2.6.1 Forest carbon services and their markets

The carbon services provided by all different forestry activities, provided the
calculations are sound, can be marketed. Under the CDM however, as of yet, only two
project activities are eligible: afforestation and reforestation. Carbon services
provided by other forestry activities can thus not result in Certified Emission
Reductions (CERs) issued by the UNFCCC. The official market developed as
instrument of the Kyoto Protocol, is however only a part of the entire carbon market.
There are many concerned companies, organisations and citizens that want to
compensate for their greenhouse gas emissions voluntarily, without being bound
under the Kyoto Protocol. All these actors buy on the voluntary carbon market.
Sellers on the voluntary market are projects in forestry and renewable energy that as
of yet are not eligible in their CDM category. The Kyoto Protocol (and also the CDM)
is further developed through continuous negotiations of its parties. Many project
activities that have shown to result in reliable greenhouse gas reductions on the
voluntary market will in future be included in the official regulations. The voluntary
market can be seen as an experimental garden for the official market.

Suitability of Land Categories, Potential Area, and Activities Under CDM


2.2.6.2 Additionality of Forest as ERB project activities

One of the most difficult aspects of the CDM is often said to be the additionality
criterion. This means that only forest carbon services resulting from a project that is
additional to any that would occur in the absence of the certified project activity can
be claimed. An example of not meeting the additionality criterion would be to claim
carbon credits for a reforestation activity that has long been planned and has sufficient
budget to be implemented. Through a financial, technological or other barrier analysis
the project has to proof it that the project activity would not happen without the use of
the CDM.

2.2.6.3 Criteria and carbon quantification methodologies

It is important to realise that this program is foremost a reforestation program that has to meet
all the technical criteria, like budgeting, mapping, site-species matching, nursery set-up and
market analysis of sound Vietnamese reforestation planning. Developing a CDM component
for the program, will add international criteria to fulfill during program planning and
implementation: financial transparency, clarification of land-rights, environmental impact
assessment and carbon calculations and monitoring. In the end of course there will be an
additional product to sell: the Certified Emission Reductions (CER). In order to reach that
point at which the program can start to sell, an extensive approval and registration process in
the host country and at the UNFCCC has to be completed. Logically additional criteria and
the registration and approval process bring additional stakeholders to the reforestation
program.

2.3 Some more ERB sources shall be discussed as follow:

2.3.1 BIO DIESEL - CARBON TRADING POTENTIAL

• Reduction in GHG (CO2)

• 1 Ton bio-diesel avoids Appx 3 ton CO2e

• Certified Emission reduction (CER) 1 ton of CO2e

• 1 CER @ US $ 5

• 75 p/ liter additional revenue



[B20/B100- types of bio diesel developed from Jatropa]

2.3.2 SOLID WASTE MANAGEMENT- CARBON TRADING POTENTIAL

There are definite linkages between sanitation and climate change. All human activities
including defecation release green house gases (GHGs) and are causing to global warming
and climate change. The Climate Change Market Based Mechanisms allow developed
countries to invest in carbon emission reduction (CER) projects in developing countries and
these credits can be traded and sold. This is the first environment investment and credit
scheme. The present focus is largely on “toilets” and “safe disposal of excreta”. Little or no
attention is being paid to liquid and solid waste management. There has also been very
limited focus on “recycling and reuse” and on extraction of the economic value of waste.

2.3.3 BIO- GAS - CARBON TRADING POTENTIAL

Types of Biomass Projects
Collection of generated methane
Methane Reduction
Effluent Treatment
Direct Combustion (Bagasse, etc.)
Liquid Fuel

Roughly, 1 mwh of power is generated using 1-1.5 tonnes of biomass. Thus, a 7.5 mw
plant, operating at 100 per cent capacity, would need 65,700-98,550 tonnes of biomass
per annum. If the raw material is purchased at Rs 800 per tonne, the plant spends Rs 0.80


per k Wh on it. If bought at Rs 1,200 per tonne, the plant will spend Rs 1.20 per k Wh on
its raw material. Thus, the economics and sustainability of these plants are determined
by the price of biomass used. It comes out to be worth ERB consideration.

There are a variety of biomass projects to generate electricity from agricultural residues
like rice husk, cotton sticks, chilli waste, mustard sticks and wood of 24 such projects
are in the process of being validated/registered with the CDM Board. They constitute
about 44 per cent of Indian CDM projects, 57-odd in all, listed on the UNFCCC website
as on September 9, 2005. But projects are small, and add up to only nine per cent of
CERs India could sell through its projects.

If all the 24 biomass projects are cleared, India could sell roughly 700,000 CERs, earn
Rs 16 crore per year (at US $5 per CER). Privately owned, these would generate 3-12
megawatt (mw) of power, selling it mostly to state electricity boards. The Indian
government has been promoting these projects through its Union ministry of non-
conventional energy sources (MoNES), and many states now have a power purchase
policy under which they will buy biomass-generated power at rates varying from Rs 2.25
in Uttar Pradesh to Rs 3.32 in Rajasthan per unit generated. The CDM credit, roughly Rs
14-15 lakh per mw per year, gives additional benefits for plants to operate.

The first registered project is in Rajasthan, by privately-owned Kalpataru Power
Transmission Ltd. It will sell the Netherlands government a total of 313,743 CER s over
7-10 years. At US $5 per CER, the company will get roughly Rs 1 crore per year for
carbon credits sold. It sources raw material from farmers mustard sticks, agricultural
residues like rice husk or even saw dust. It sells power to the Rajasthan state electricity
board. The project design document does not specify the rate, but the state purchase
policy for biomass-generated power is Rs 3.32 per unit. In this way, the state uses
electricity from renewable sources, replacing coal and so saving carbon dioxide
emissions.



Following is a graph comparing Biomass & Biogas projects and other ERB projects.

Some more pictorial views of generation of ERB are shown for easy reference:


Some more ERB sources-Its Project Type, Description, Co-Benefits and more


Chapter 3
Study of Prevailing Standards
3.1 CARBON MARKET STANDARDS

There are several types of carbon markets operating throughout the world, and the differences
may be confusing. The markets can be divided into two basic types:

1. Compliance markets (associated with countries that have ratified the Kyoto treaty)

2. Voluntary markets (operating in countries that have not ratified the Kyoto treaty, such as
the U.S.).

There are significant differences in these markets, both in terms of how they operate and
market prices for carbon credits. In this report the following standards have been discussed in
detail.

Compliance or Regulated or market standard

1.) CDM
2.) JI
Voluntary market standard

1.) VCS
2.) VGS


3.) VER+
4.) World Bank Carbon Finance Funds

The standards have been discussed on following grounds:

1. History and purpose
2. Project process
i.Outline of the project process
ii.Establishing additionality
iii.Establishing a baseline
iv.Methodologies
3. Financial issues

3.2 CLEAN DEVELOPMENT MECHANISM

3.2.1 History and purpose
The CDM was an important feature of the negotiations leading up to the Kyoto Protocol.
Some governments desired flexibility in the way that emission reductions could be achieved
and proposed international emissions trading as a way of achieving cost-effective emission
reductions. At the time it was considered a controversial element and was opposed by
environmental NGOs and, initially, by developing countries who felt that industrialised
countries should put their own house in order first and feared the environmental integrity of
the mechanism would be too hard to guarantee (see Environmental Concerns below).
Eventually, and largely on US insistence, the CDM and two other flexible mechanisms were
written into the Kyoto Protocol.

The purpose of the CDM was defined under Article 12 of the Kyoto Protocol. Apart from
helping Annex 1 countries comply with their emission reduction commitments, it must assist
developing countries in achieving sustainable development, while also contributing to
stabilization of greenhouse gas concentrations in the atmosphere.

To prevent industrialised countries from making unlimited use of CDM, the framework has a
provision that use of CDM be ‘supplemental’ to domestic actions to reduce emissions. This



wording has led to a wide range of interpretations - the Netherlands for example aims to
achieve half of its required emission reductions (from a BAU baseline) by CDM .

3.2.2 Project Process

i.Outline of the project process
An industrialised country that wishes to get credits from a CDM project must obtain the
consent of the developing country hosting the project that the project will contribute to
sustainable development. Then, using methodologies approved by the CDM Executive Board
(EB), the applicant (the industrialised country) must make the case that the carbon project
would not have happened anyway (establishing additionality), and must establish a baseline
estimating the future emissions in absence of the registered project. The case is then validated
by a third party agency, called a Designated Operational Entity (DOE), to ensure the project
results in real, measurable, and long-term emission reductions. The EB then decides whether
or not to register (approve) the project. If a project is registered and implemented, the EB
issues credits, called Certified Emission Reductions (CERs, commonly known as carbon
credits, where each unit is equivalent to the reduction of one metric tonne of CO2e, e.g. CO2
or its equivalent), to project participants based on the monitored difference between the
baseline and the actual emissions, verified by the DOE.

ii.Establishing additionality
To avoid giving credits to projects that would have happened anyway ("freeriders"), rules
have been specified to ensure additionality of the project, that is, to ensure the project reduces
emissions more than would have occurred in the absence of the project. At present, the CDM
Executive Board deems a project additional if its proponents can document that realistic
alternative scenarios to the proposed project would be more economically attractive or that
the project faces barriers that CDM helps it overcome. Current Guidance from the EB is
available at the UNFCCC website.

Additionality is a much contested. There are many rival interpretations of additionality:

1. What is often labelled ‘environmental additionality’ has that a project is additional if
the emissions from the project are lower than the baseline. It generally looks at what
would have happened without the project.



2. Another interpretation, sometimes termed ‘project additionality’, the project must not
have happened without the CDM.
A number of terms for different kinds of additionality have been discussed, leading to some
confusion, particularly over the terms 'financial additionality' and 'investment additionality'
which are sometimes used as synonyms. 'Investment additionality', however, was a concept
discussed and ultimately rejected during negotiation of the Marrakech Accords. Investment
additionality carried the idea that any project that surpasses a certain risk-adjusted
profitability threshold would automatically be deemed non-additional. 'Financial
additionality' is often defined as an economically non-viable project becoming viable as a
direct result of CDM revenues.

Many investors argue that the environmental additionality interpretation would make the
CDM simpler. Environmental NGOs have argued that this interpretation would open the
CDM to free-riders, permitting developing countries to emit more CO2e, while failing to
produce emission reductions in the CDM host countries. WWF have undertaken a study of
additionality in 2007, finding that for about 40% of projects the additionality is questionable
(p.44) and in one survey 86% of the participants affirmed that “in many cases, carbon
revenues are the icing on the cake, but are not decisive for the investment decision”.

It is never possible to establish with certainty what would have happened without the CDM
or in absence of a particular project, which is one common objection to the CDM.
Nevertheless, official guidelines have been designed to facilitate uniform assessment, set by
the CDM Executive Board for assessing additionality.

iii.Establishing a baseline
The amount of emission reduction, obviously, depends on the emissions that would have
occurred without the project minus the emissions of the project. The construction of such a
hypothetical scenario is known as the baseline of the project. The baseline may be estimated
through reference to emissions from similar activities and technologies in the same country or
other countries, or to actual emissions prior to project implementation. The partners involved
in the project could have an interest in establishing a baseline with high emissions, which
would yield a risk of awarding spurious credits. Independent third party verification is meant
to avoid this potential problem.



iv.Methodologies
Any proposed CDM project has to use an approved baseline and monitoring methodology to
be validated, approved and registered. Baseline Methodology will set steps to determine the
baseline within certain applicability conditions whilst monitoring methodology will set
specific steps to determine monitoring parameters, quality assurance, equipment to be used,
in order to obtain datas to calculate the emission reductions. Those approved methodologies
are all coded. "AM" stands for "Approved Methodology," "ACM" stands for "Approved
Consolidated Methodology," "AMS" stands for "Approved Methodology for Small Scale
Projects" and so on. All the approved methodology are listed in the UNFCCC home page. If a
project developer can not find an approved methodology that fits in his/her particular case,
the project developer may submit a new methodology to the Meth Panel, and if approved the
new methodology will be converted to an Approved Methodology.

3.2.3 Financial Issues

With costs of emission reduction typically much lower in developing countries than in
industrialised countries, industrialised countries can comply with their emission reduction
targets at much lower cost by receiving credits for emissions reduced in developing countries
as long as administration costs are low.

The IPCC has projected GDP losses for OECD Europe with full use of CDM and Joint
Implementation to between 0.13 and 0.81% of GDP versus 0.31 to 1.50 Climate Change 2001
- Synthesis report.

The price depends on the distribution of risk between seller and buyer. The seller could get a
very good price if it agrees to bear the risk that the project's baseline and monitoring
methodology is rejected; that the host country rejects the project; that the CDM Executive
Board rejects the project; that the project for some reason produces fewer credits than
planned; or that the buyer doesn't get CERs at the agreed time if the international transaction
log (the technical infrastructure ensuring international transfer of carbon credits) is not in
place by then. The seller can usually only take these risks if the counterparty is deemed very
reliable, as rated by international rating agencies.



3 JOINT IMPLEMENTATION
Joint Implementation (JI) enables a country with a Kyoto Protocol emission reduction target
(i.e. industrialised nations and those in transition to a market economy listed in Annex I to the
Kyoto Protocol) (Annex I Parties) to meet part of its emissions reduction target by carrying
out or financing sustainable development project activities to reduce greenhouse gas
emissions in another Annex 1 country (Host Country). It is one of the "flexibility
mechanisms" established under the Kyoto Protocol.

JI is effected by the transfer of emission reduction units (ERUs) equal to the emission
reductions made by JI project activities in the Host Country, from the Host Country to the
other Annex I Party (Investor Country). Under JI, an Investor Country may authorise legal
entities (e.g. companies) to participate in JI projects on its behalf. If an Annex 1 country
wishes to participate in a JI project (as a Host Country or a Non-Host Country) it must inform
the United Nations Framework Convention on Climate Change (UNFCCC) Secretariat of (i)
its designated focal point for approving JI Projects (its JI Focal Point); and (ii) its national
guidelines and procedures for approving JI projects.

There are two tracks for getting approval for a JI project depending on how advanced the
Host Country’s implementation of the monitoring and inventory requirements of the Kyoto
Protocol have been:

Track 1

These procedures apply when the Host Country meets all of the eligibility requirements
related to the transfer and acquisition of ERUs. The relevant eligibility criteria include
requirements that the Host Country has:

Ratified the Kyoto Protocol;*

• calculated their assigned amount, as referred to in Articles 3.7 and 3.8 and Annex B of the
Protocol in terms of tonnes of CO2 equivalent emissions;*
• in place, a national system for estimating emissions and removals of greenhouse gases
within their territory;



• in place, a national registry to record and track the creation and movement of units issued
under the flexibility mechanisms and annually reports such information to the UNFCCC
secretariat; *
• Submitted its most recent annual report on emissions and removals to the UNFCCC
secretariat.
If all of the criteria above are met, the Host Country will be able to apply its own procedures
for assessing the JI project and will then be able to issue and transfer ERUs to the Investor
Country, without recourse to any international body for approval. However, it is open to a
party that satisfies

all of the eligibility criteria for Track 1 to undertake Track 2 projects, and this has tended to
be market practice to date.

Track 2

These procedures apply when the Host Country does not meet all of the eligibility
requirements for Track 1, but has fulfilled the requirements marked "*" above. Under Track
2, the JI Supervisory Council (JISC) (the body set up to supervise the verification procedure
of JI) assesses projects according

to the procedures it administers. After projects are approved under the JI process, Host
Countries are able to issue and transfer ERUs to Non-Host Countries. If the minimum
eligibility requirements set out above are not met by a Host Country, ERUs may not be issued
in relation to a JI project in that Host Country.

3.3.2 Project Process
i. Outline of the project process

An Investor Country participant who has identified a project located in an Annex 1 country
and evaluated its eligibility and viability as a JI project activity will, if the project is to be
carried out as a Track 1 project, contact the Host Country JI Focal Point in order to ascertain
the procedures to be followed. The intending participant may in any event prepare a Project
Idea Note (PIN) summarising the project’s technical and financial characteristics. The PIN is
not compulsory but may be useful. At this stage, a request may be made (using the PIN) to
the Host Country for a Letter of Endorsement (LoE), indicating the Host Country’s
preliminary support for the project. Buyers of ERUs often require LoEs before they will



consider entering into contractual negotiations. However, many Annex 1 Parties may only
approve a Track 1 project in circumstances in which a memorandum of understanding is in
place between the Host Country and the Investor Country relating to co-operation between
the countries.

Full project documentation will then be prepared, including a Project Design Document
(PDD). The PDD contains a description of the project; the basis for determining the
emissions that would occur without the project (the baseline) and plans for monitoring the
reductions. As is the case of PDD’s under the Clean Development Mechanism, the PDD must
be validated by an independent entity. In the case of a Track 1 Project, the independent entity
must be an entity acceptable to the Host Country. In the case of a Track 2 Project, the entity
must be an Accredited Independent Entity (AIE) accredited by the JISC. The independent
entity will review and validate the baseline study and other aspects of the PDD. In all cases JI
projects must demonstrate that emissions reductions are additional to those that would
otherwise occur in a "business as usual" scenario.

Once a PDD has be validated it will be presented to the Host Country with a request to issue
a Letter of Approval. The Letter of Approval confirms the Host Country’s approval for the
transfer of ERUs. The project will be implemented in the Host Country according to the
specifications outlined in the PDD.

The Investor Country participant is required to monitor the project to identify the emission
reductions. Monitoring reports are issued to the Independent Entity.

The Independent Entity verifies the emission reductions.

Verification reports are submitted to the Host Country and the Investor Country’s JI Focal
Point. The Host Country then directs its national registry to convert specified assigned
amount units (AAUs) into ERUs within an account in that registry in accordance with the
procedures determined by it. ERUs may only be issued under Track 1 in where the Host
Country has complied with the Marrakesh Accords. ERUs may only be issued under Track 2
where the Host Country has complied with JISC verification procedures.

The Host Country will transfer ERUs from its registry account to the national registry
account of the Investor Country participant. Joint Implementation entails a number of
variations in procedures and specific risks depending on whether the project is undertaken
under Track 1 or Track 2 and the Host Country. Notably, there is an ongoing reliance on the



Host Country not only to approve the project activities but also to effect the conversion of
AAUs and transfer of ERUs. The ability of the Host

Country to transfer ERUs is (under Track 1) also dependent on the Host Country having
performed its treaty obligations, notably in relation to commitment period reserve obligations
under Article 17 of the Kyoto Protocol.

ii.Establishing additionality.

JIAG argues that the necessarily subjective and thus controversial establishment of project
additionality can be replaced by rules that ensure a conservative establishment of project
baselines. The integrity of JI is guaranteed since for the issuance of one ERU the host country
has to cancel one AAU. In addition, additionality is superfluous since the guidance on
baseline setting and determining the baseline scenario2 already provides sufficient guarantee
on the concerns that the additionality concept tries to address. Nevertheless if the Project
Participant or Host Country wishes to do so, it can integrate an additionality test in the
project. This additionality test should be based on guidance issued by the JISC and assessed
by the AIE.

iii.Establishing a baseline (Criteria for baseline setting)
1. The baseline for an Article 6 project is the scenario that reasonably represents the
anthropogenic emissions by sources or anthropogenic removals by sinks of greenhouse gases
that would occur in the absence of the proposed project. A baseline shall cover emissions
from all gases, sectors and source categories listed in Annex A, and anthropogenic removals
by sinks, within the project boundary.

2. A baseline shall be established:

(a) On a project-specific basis and/or using a multi-project emission factor;

(b) In a transparent manner with regard to the choice of approaches, assumptions,
methodologies, parameters, data sources and key factors;

(c) Taking into account relevant national and/or sectoral policies and circumstances, such as
sectoral reform initiatives, local fuel availability, power sector expansion plans, and the
economic situation in the project sector;



(d) In such a way that emission reduction units (ERUs) cannot be earned for decreases in
activity levels outside the project activity or due to force majeure;

(e) Taking account of uncertainties and using conservative assumptions.

3. Project participants shall justify their choice of baseline.

iv. Methodologies
Until recently, it has been unclear amongst host countries whether JI baselines and
monitoring methodologies would simply be based on CDM approved methodologies, or
whether they would have to follow the methodologies exactly. Recent language in the
UNFCCC Working Paper Guidance on Criteria for Baseline Setting and monitoring (Para 15
and 22) specifies that project participants may either (i) apply Methodologies for baselines
and monitoring approved by the CDM Executive Board or (ii) establish a baseline that is in
accordance with Appendix B of the JI guidelines. With the latter, selected elements or
combinations of approved CDM baseline and monitoring methodologies may be used for
Track II JI projects.

If a project developer selects option (i), then baseline and monitoring methodologies across
different projects would likely be consistent. If option (ii) were selected, this would raise the
potential for inconsistencies across different JI projects of a similar type. This inconsistency
is caused by the lack of a centralised methodology approval body for JI projects – unlike the
CDM EB. Rather, for JI it is up to Accredited Independent Entities (AIE) to assess the
baselines and monitoring plans based on the criteria in Appendix B of the JI guidelines.
Hence, the AIEs have a larger responsibility than the designated operational entities (DOEs)
in the CDM.

Criteria for Baseline Setting and Monitoring, the approaches to baseline setting and
monitoring are likely to vary more under JI and be more dependent on any national
guidelines that host countries develop.

Moreover, methodologies for some potential CDM project types have yet to be developed
and/or approved by the CDM Executive Board. The implies that for certain JI projects types
not yet covered by approved CDM methodologies, new baseline and monitoring
methodologies will need to be verified by the AIEs e.g. for district heating projects; the built
environment; and energy efficiency projects. Again, this raises the strong possibility that
projects from these sectors in different countries which use different AIEs to validate the



baseline and monitoring methodologies will not be consistent. This problem may even arise
across projects within a single host country that has several AIEs.

These issues are likely to be exacerbated when it comes to Track I JI, when national
governments are allowed to establish their own guidelines for approval of projects and
baseline and monitoring methods.

Under Track I, there is no creation of emissions rights as with CDM, and it is a zero sum
game. It is in the host country’s interest to ensure that the JI project generates effective,
measurable and sustainable reduction emissions. This responsibility has been designated to
AIEs.

Though the JISC does not have the same mandate as the CDM EB, once the JISC approves of
a project with a specific baseline methodology in a sector not covered by the CDM approved
methodologies, then it will be desirable for all other projects in that sector to use baseline
methodologies that are consistent with that project. This would create a more centralised
approach to methodologies that would also serve to reduce the transaction costs of project
participants identifying and developing baseline methodologies on an ad hoc basis.

Overall, there is likely to be more variability in the baselines and monitoring approaches in JI
than there is in the CDM. This could result in discrepancies in the number of ERUs that are
actually generated across similar projects, particularly given the lack of a centralised
decision-making body. Rigorous approval procedures under the JISC could help to reduce
such discrepancies. With regard to Track I JI national guidelines on baselines and monitoring,
concerted collaboration and co-ordinated efforts across different countries would help to
reduce the costs of developing national guidelines and would ensure that there is a greater
degree of consistency across projects as well as countries. Facilitative guidelines could be
developed to aid in the design of, and investment in, JI projects.

3.3.3 Financial issues
Buyers

The buyers of ERUs are most likely to be those companies and countries that are, or will
become subject to, emission reduction commitments and have relatively high costs of
reducing emissions domestically. Early buyers may be prepared to take a certain risk, buying



options or futures, in order to obtain low cost emission credits that are likely to qualify for the
Kyoto Mechanisms.

Even though the procedures for JI projects are still to be formally established, some early
trades of potential ERUs are already occurring. Major ERU buyers to date have been the
World Bank’s Prototype Carbon Fund (www.prototypecarbonfund.org) and the Netherlands’s
ERUPT program (www.senter.nl). Under the ERUPT’s tender programmes, contracts to date
have amounted to 11 million ERUs.

Countries that have entered into specific JI project agreements to date include Latvia, the
Czech Republic, Hungary, Poland, Bulgaria, Romania, Estonia, Slovakia and New Zealand.
A number of countries, including Sweden, Finland, Denmark, Italy, Austria, Spain, Portugal
and Japan are also entering this market as buyers.

Prices

Prices of ERUs in the carbon market so far have ranged widely. The World Bank's Prototype
Carbon Fund prices range between US$3.5 and US$5 per tonne CO2, while the Dutch
Government's ERUPT tenders prices have ranged between €5 and €9 per tonne CO2. Up-to-
date information on the price of carbon credits can be obtained from potential buyers, brokers
and trader or via the CCPO.



3.4 VOLUNTARY CARBON STANDARD

Work to develop the Voluntary Carbon Standard was initiated by The Climate Group, the
International Emissions Trading Association and the World Economic Forum in late 2005.
Version 1 of the VCS was released on 28 March 2006 as both a consultation document and a
pilot standard for use in the market. VCS version 2 was released in October 2006 as a
consultation document and did not replace Version 1 as the market standard. 150 written
submissions were received from carbon market stakeholders on VCS versions 1 and 2.

After the release of version 2, a 19 member Steering Committee was established to consider
all of the stakeholder comments and develop the final standard. Within the Committee seven
technical working groups provided advice on VCS governance, additionality, validation and
verification, registries, land use change and forestry, general policy issues and performance
standards.

The World Business Council for Sustainable Development joined the initiative as a founding
partner in 2007. After two years of work, VCS 2007 was released on 19 November 2007.

Scope

Standardize and provide transparency and credibility to the voluntary offset

market.

Enhance business, consumer and government confidence in voluntary offsets.

Create a trusted and tradable voluntary offset credit; the Voluntary Carbon Unit. (VCU)

Stimulate additional investments in emissions reductions and low carbon solutions

Experiment and stimulate innovation in emission reduction technologies and offer lessons
that can be build into future regulation.


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