What is Kyoto Protocol and CDM?

A series of international negotiations started during the late 1980s owing to concerns regarding climate change. The United Nations Framework Convention on Climate Change (UNFCCC) was signed at the United Nations Conference on Environment and Development in Rio de Janeiro in 1992. The Convention established the Conference of Parties (COP) / Meeting of Parties (MOP) as its supreme body with the responsibility to oversee the progress towards the aim of the convention. Subsequently, during COP 3 in Kyoto, Japan, a legally binding set of obligations for 38 industrialized countries and 11 countries in Central and Eastern Europe was created, to return their emissions of Greenhouse Gases (GHGs) to an average of approximately 5.2% below their 1990 levels over the commitment period 2008 – 2012. This is called the Kyoto Protocol, which amidst a host of uncertainties finally came into force on 16 February 2005.

What are Kyoto’s Flexibility Mechanisms?

The Kyoto Protocol recognizes six main greenhouse gases, each with different impact on the global climate – carbon dioxide, Methane, Nitrous Oxide, Hydro-fluorocarbons, Perfluorocarbons, and Sulphur Hexafluoride. The common ‘currency’ of the Kyoto Protocol targets is one metric tonne of carbon dioxide equivalent (tCO2-e). Based on the principle that the effect on the global environment is the same regardless of where GHG emissions reductions are achieved, countries may meet their targets through a combination of domestic activities and use of the Kyoto Protocol ‘Flexibility Mechanisms.’ These are designed to allow Annex I countries to meet their targets in a cost-effective manner and to assist developing countries in particular to achieve sustainable development. There are three Kyoto Protocol Flexibility Mechanisms -- Joint Implementation - JI (Article 6); Clean Development Mechanism - CDM (Article 12); and International Emissions Trading - IET (Article 17).

What is CDM?

Clean Development Mechanism (CDM) is one of the flexible mechanisms following the Kyoto Protocol. Article 12 of this protocol states all the regulating framework of the CDM. The CDM offers industrialized countries the possibility to engage in economically and environmentally competitive emission reduction projects in developing countries. Through the CDM, certified emission reductions (CERs) will be generated. Projects that will be implemented through the CDM have to fulfill additional criteria that will be defined by a national framework of the host countries (developing countries, where the project will be implemented). A CDM project has a pre-defined project-cycle that was defined by the UNFCCC, the official executive institution concerning these questions. India is seen as one of the Non-Annex I countries offering the largest potential for CDM development, besides China and Brazil.

What types of projects can be undertaken under CDM?

-Renewable energy

-Energy efficiency (waste management, industrial processes, switching to alternative fuels, oil/gas)

What is CDM project development?

Any developer can initiate and implement a CDM project if there exists any emission reduction potential or an option to sequester carbon. To get it accredited as a CDM project, several requirements must be fulfilled such as following a pre-defined project cycle, preparation of certain documents (PCN, PDD, Monitoring plan etc.); highlighting certain characteristics like “additionality” criteria in terms of emission reductions, social and economic aspects, approval from certain institutions in the host country Designated National Authority (DNA); and validating and contacting buyer country DNA. Companies typically hire a consultant to facilitate the process of a CDM project development.

What is feasibility check of a CDM project?

The preliminary assessment aims at giving the project developer an idea, if basic requirements to be a CDM project are fulfilled. This is done in terms of regulative compliance and in an economic feasibility check. The preliminary assessment will not be sufficient to find an investor.

What is Project Concept Note (PCN) and Project Design Document (PDD)?

The PCN demonstrating a complete planning of a project in terms of all required CDM criteria is given to interested parties that may buy/invest in CERs from the project. If buyer is subsequently interested, he signs a letter of intention to buy all or a certain amount of emission reductions (ER). PDD is the principal document used by project participants to get a CDM project approved. Its format is outlined in Appendix B of the Modalities and Procedures of the CDM.

What is Designated National Authority?

The Seventh Conference of Parties (COP-7) to the UNFCCC decided that parties participating in CDM should designate a National Authority for CDM and as per the CDM project cycle, a project proposal should include written approval of voluntary participation from the Designated National Authority of each country and confirmation that the project activity assists the host country in achieving sustainable development. Accordingly, the Central Government constituted the National Clean Development Mechanism (CDM) Authority for the purpose of protecting and improving the quality of environment in terms of the Kyoto Protocol.

What about Designated Operational Entity?

Services of DOE are required in the validation and verification phases. The project cycle requires a validation by a first DOE in the pre-registration phase and a verification of a second DOE before the issuance of the CER. Small scale CDM projects require one DOE only.

What is the institutional framework for CDM?

-          - Developing country: Project Developer

-          - Annex-1 country: Buyer, Investor

-          - Approval of project: Designated National

          Authority (DNA)

-          - An institution that verifies the essential

          prerequisites for CDM projects: Operational

          Entity (OE)

-          - An institution which certifies the emission

          reduction: Operational Entity (OE)

-          - An institution which issues CERs: Executive

          Board (EB)

What is CDM project cycle?

Step-1: Identify a project idea

Step-2: PIN and PDD development

Step-3: Approval by DNA

Step-4: Validation by OE/Registration by EB

Step-5: Monitoring by entities

Step-6: Verification and certification by OEs

Step-7: Issuance of CERs by EB

What is the procedure for submitting CDM Project Reports to the National CDM Authority?

The National CDM Authority is a single window clearance for CDM projects in India. The project proponents are required to submit one soft copy of Project Concept Note (PCN) and Project Design Document (PDD) through online form and 20 hardcopies each along with two CDs containing all the information in each of them. The project report and CDs should be forwarded through covering letter signed by the project sponsors. The project report submitted should be properly bound. The National CDM Authority examines the documents and if there are any preliminary queries the same are asked from the project proponents. The project proposals are then put up for consideration by the National CDM Authority. The project proponent and his consultants are normally given about 10-15 days notice to come to the Authority meeting and give a brief power point presentation regarding their CDM project proposals. Members seek clarifications during the presentation and in case they feel that some additional clarifications or information is required from the project proponent the same is informed to the presenter. Once the members of Authority are satisfied, the Host Country Approval (HCA) is issued by the Member-Secretary of the National CDM Authority.

 What are the eligibility criteria for CDM?

The purpose of the clean development mechanism

(CDM) is defined in Article 12 of the Kyoto Protocol to the United Nations Framework Convention on Climate Change. The CDM has a two-fold purpose: (a) to assist developing country Parties in achieving sustainable development, thereby contributing to the ultimate objective of the Convention, and (b) to assist developed country Parties in achieving compliance with part of their quantified emission limitation and reduction commitments under Article 3. The project proposal should establish the following in order to qualify for consideration as CDM project activity:

Additionalities

- Emission Additionality: The project should lead to real, measurable and long term GHG mitigation. The additional GHG reductions are to be calculated with reference to a baseline.

- Financial Additionality: The procurement of Certified Emission Reduction (CERs) should not be from Official Development Assistance (ODA)

Sustainable Development Indicators

It is the prerogative of the host Party to confirm whether a clean development mechanism project activity assists it in achieving sustainable development. The CDM projects should also be oriented towards improving the quality of life of the poor from the environmental standpoint. Following aspects should be considered while designing CDM project activity:

- Social well being: The CDM project activity should lead to alleviation of poverty by generating additional employment, removal of social disparities and contribution to provision of basic amenities to people leading to improvement in quality of life of people.

- Economic well being: The CDM project activity should bring in additional investment consistent with the needs of the people.

- Environmental well being: This should include a discussion of impact of the project activity on resource sustainability and resource degradation, if any, due to proposed activity; bio-diversity friendliness; impact on human health; reduction of levels of pollution in general

- Technological well being: The CDM project activity should lead to transfer of environmentally safe and sound technologies that are comparable to best practices in order to assist in upgradation of the technological base. The transfer of technology can be within the country as well from other developing countries also

Baselines

The project proposal must clearly and transparently describe methodology of determination of baseline. It should confirm to following:

- Baselines should be precise, transparent,  

  comparable and workable

- Should avoid overestimation

- The methodology for determination of baseline

   should be homogeneous and reliable

- Potential errors should be indicated

- System boundaries of baselines should be

   established

- Interval between updates of baselines should be

   clearly described

- Role of externalities should be brought out

   (social, economic and environmental)

- Should include historic emission data-sets

   wherever available

- Lifetime of project cycle should be clearly

   mentioned

The project proponent could develop a new methodology for its project activity or could use one of the approved methodologies by the CDM Executive Board. For small scale CDM projects, the simplified procedures can be used by the project proponent. The project proposal should indicate the formulae used for calculating GHG offsets in the project and baseline scenario. Leakage, if any, within or outside the project boundary, should be clearly described. Determination of alternative project, which would have come up in absence of proposed CDM project activity should also be described in the project proposal.

Commerce of CDM Projects

The CDM revenue has its attractiveness in that it is additional to the normal stream of income from the project activity and does not affect the later in any way. This diversification of the revenue streams helps in minimizing the risks associated with the project itself. This income stream from selling the creditable emission reductions from emission reduction projects have beneficial effect on the project’s financial structure. In the Indian context for instance, CDM revenue from a wind electric generator typically helps the promoter to at least meet his annual operation and maintenance costs.

CDM Project Financing

Per the Guidebook to Financing CDM Projects report by EcoSecurities, financing requirements of a CDM project depend on the project type. For instance, the capital costs of renewable energy projects can vary from around US$1,000/MW for generation of electricity from landfill gas to US$10,000/kW for solar home systems using photovoltaic cells. Likewise, the costs during the planning of a CDM project can vary significantly depending on specific feasibility studies that may be required (e.g. at least 12 months of wind resource monitoring for a wind turbine project), as well as country-specific, technology-specific and location-specific requirements for permits and licenses, environmental impact assessment and stakeholder consultation. Finally, costs during operation can vary from very low levels for some renewable energy projects using free resources such as the sun and wind, to relatively high levels for projects dependent on purchase of fuel or other inputs.

Here are a few general observations about CDM project financing:

-    CDM-specific project costs are usually smaller than the non-CDM specific project costs

-    The largest cost is incurred at construction (including purchase of plant and equipment, etc)

-    Annual operation costs are usually low in relation to construction costs, although they may exceed construction costs over the lifetime of the project

-    Costs during the planning stage are usually financed by equity

-    Costs during construction may be financed in a variety of ways – for example by various combinations of equity and debt

-    CDM projects may have ‘conventional’ revenue streams (such as electricity sales, or sales of other outputs) in addition to CER revenues

-    Costs during operation are covered by the conventional revenue (if any) and CER revenue of the project

-    Remaining conventional and CER revenues are used first to repay debt (if any) and lastly to provide a return on equity

Typical CDM-specific Project Costs

In addition to the costs that would be incurred by a project regardless of whether or not it was registered as a CDM project, certain specific costs are associated with the various stages of the CDM project cycle, as set out below:

*US$0.10/CER for the first 15,000 CERs per year and US$0.20/CER for any CERs above 15,000 CERs per year (max US$350,000). The minimum shown here has been calculated as 15,000 CERs/year over a single 7-year crediting period.

** As for large scale, unless total annual average emission reductions over the crediting period are below 15,000 tCO2-e, in which case no fee is payable. Maximum calculated as 25,000 CERs/year over 7-year crediting period.

Notes: In addition to the costs shown above, a number of governments may charge a fee for the approval of a CDM project.

While most of the costs listed above are one-off costs incurred during the planning phase of the project, the costs of ongoing verification and the SOP Admin fees are incurred whenever issuance of credits for a project is required.

It should be noted that the upper ends of the cost ranges, in particular for large-scale PDDs and new methodologies, represent a ‘worst case’ scenario where an extremely large, complex project is being developed. On the other hand, the upper end of the range for registration costs represents a project with annual emission reductions of 182,500 tCO2-e/year over a 10-year crediting period, which is not unusual and is far exceeded by some of the larger projects. Therefore, for large projects with emission reductions beyond this level, SOP-Admin fees will eventually exceed the up-front registration fee.

Sources: CCPO, 2005; UNEP, 2004 and EcoSecurities Market Information.

Finance Availability for CDM Projects

Planning phase:

-  Government tenders and carbon funds: which will often pay a proportion of these costs in return for a contract to purchase some or all of the resulting CERs (see section 7 below for information on both government and private sector funds)

-   Private sector CDM project developers: who may cover part or all of the CDM-specific costs in return for a contract to purchase some or all of the resulting CERs

-   Project hosts: either public or private sector entities which provide their own internal funds to develop projects with which they have an association as, for example, landowner, fuel supply provider, or off-taker of the non-CER outputs of a project

Construction phase:

-  Lenders: who may provide limited recourse debt to relatively large projects with secure revenue streams and relatively low risks, or to other projects with recourse to a financially strong sponsor

-  Private sector CDM project developers: who may be able to finance (usually smaller) projects with their own equity

-  Project hosts: who may be able to finance (usually smaller) projects from their own internal funds

-  Equipment suppliers: who may provide assets on lease or credit

-  CER buyers: who may provide up-front payments against future CER deliveries

Financing Models for CDM Projects