55484 10 Years of Experience in Carbon Finance Insights from working with the Kyoto mechanisms 10 Years of Experience in Carbon Finance Insights from working with the Kyoto mechanisms This volume is a product of the staff of the International Bank for Reconstruction and Development/The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Execu- tive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Copyright Statement: The material in this publication is copyrighted. 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Contents Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .v Abbreviations & Acronyms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii 1. Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.1 What is carbon finance all about?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.2 How is the World Bank contributing? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 3. Origins & Implementation of the Clean Development Mechanism and Joint Implementation . . . . . . . . . . 17 3.1 The Kyoto Protocol & the Marrakesh Accords . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 3.2 The project cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 3.2.1 From a project idea to a carbon finance project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 3.2.2 Validation: independent audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 3.2.3 Registration: regulatory approval. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 3.2.4 Monitoring & carbon asset creation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 3.3 Methodologies: the measuring stick. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 3.4 Additionality: ensuring environmental integrity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 3.5 The particular case of Joint Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 4. Experience on the Ground . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 4.1 Building and sustaining capacity: a necessary condition. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 4.2 Geographic reach: broad but uneven. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 4.2.1 Why isn't there more activity in least developed countries? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 4.3 Sector coverage: diverse with untapped opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 4.3.1 Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 4.3.2 The special case of forestry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 5. The Benefits of Carbon Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 5.1 An important catalyst of development finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 5.2 Greenhouse gas mitigation & sustainable development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 iii YEARS OF EXPERIENCE IN CARBON FINANCE 6. The Need to Scale Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 6.1 Programmes of Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 6.2 Green Investment Schemes (GIS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 7. Conclusion: An Experience worth Building On . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 8. Postscript ­ Building on 10 Years of Experience: Where the World Bank Goes from Here . . . . . . . . . . . . . 91 Annex 1 ­ World Bank Funds & Facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Annex 2 ­ Key Elements of an Emission Reductions Purchase Agreement (ERPA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 Annex 3 ­ World Bank Social and Environmental Safeguard Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 Annex 4 ­ Example of Simplified Modalities for Demonstrating Additionality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 Annex 5 ­ CDM Guidance on Government Policies (E-/E+ Policy Guidance) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 Annex 6 ­ Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 Annex 7 ­ Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 Annex 8 ­ Report's Methodology & Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 Figures Figure 1 ­ Carbon finance: provides an additional revenue stream. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 2 ­ Value of CDM & JI transactions (per year). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 3 ­ World Bank's carbon finance portfolio by country . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 4 ­ How project-based mechanisms work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Figure 5 ­ Steps in CDM process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Figure 6 ­ World Bank project development costs by technology ($/expected ton of CO2 reduced) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Figure 7 ­ Cost of CDM validations (World Bank experience) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 8 ­ Length of CDM project registration process (from start of validation). . . . . . . . . . . . . . . . . 34 Figure 9 ­ Request for registration by year: EB decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Figure 10 ­ Estimation of costs associated with lost CERs due to increased delays at registration . . . 28 Figure 11 ­ Delays in CDM validation and registration (according to share of projects) . . . . . . . . . . . 29 Figure 12 ­ CDM Project implementation cycle. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Figure 13 ­ Cost of CDM verifications (World Bank Experience). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Figure 14 ­ Number validations and verifications processed: to date and projected. . . . . . . . . . . . . . . . 34 Figure 15 ­ CDM approved methodologies by sectoral scope. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Figure 16 ­ Sectors targeted by methodology submissions by the World Bank. . . . . . . . . . . . . . . . . . . . 36 Figure 17 ­ The tool for the determination and assessment of additionality . . . . . . . . . . . . . . . . . . . . . . 40 Figure 18 ­ Geographic distribution of global CDM and JI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 Figure 19 ­ Geographic distribution of World Bank CDM and JI projects . . . . . . . . . . . . . . . . . . . . . . . 51 Figure 20 ­ Comparison of GHG emissions and global CDM portfolio shares by region. . . . . . . . . . 51 Figure 21 ­ Technology distribution of CDM (until March 2010) ­ global CDM. . . . . . . . . . . . . . . . 59 Figure 22 ­ Technology distribution of JI (April 2010) ­ global JI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Figure 23 ­ Technology distribution of World Bank portfolio (by technology type) . . . . . . . . . . . . . . 60 Figure 24 ­ Global GHG emissions by sector (2005 data) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 iv Contents Carbon finance at the World Bank Figure 25 ­ Multiple benefits delivered by BioCF projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 Figure 26 ­ Origin of capital financing in World Bank CDM projects . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Figure 27 ­ Ratio of investment to net present value of ERPA in the World Bank CDM portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Figure 28 ­ Average price and volumes transacted in primary project-based Kyoto flexibility mechanisms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Figure 29 ­ Contribution of CDM & JI towards meeting GHG commitments: comparison with selected countries' emissions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Figure 30 ­ Average monthly prices of CER, pCER & EUAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 Figure 31 ­ Distribution of CDM PoAs (by technology and region) ­ by number of projects. . . . . . 81 Figure 32 ­ Distribution of PoAs by host country. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Figure 33 ­ AAU primary transactions up to December 2009 by country (162.7 Mt) . . . . . . . . . . . . . 84 Tables Table 1 ­ From project idea to registration: the World Bank experience. . . . . . . . . . . . . . . . . . . . . . . . . . 19 Table 2 ­ Projects submitted for validation between 2003 and 2010: rejection rate . . . . . . . . . . . . . . . 25 Table 3 ­ Quantification of lost revenues from CDM approval delays: hypothetical project examples. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Table 4 ­ CDM registration and rejections: GHG implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Table 5 ­ Reasons for verification corrections and/or issuance review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Table 6 ­ Request for issuance statistics: impact on CERs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Table 7 ­ Regional summary table. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 Boxes Box 1 ­ World Bank experience as a pioneer in carbon finance transactions . . . . . . . . . . . . . . . . . . . . . . 15 Box 2 ­ World Bank approach to assessing CDM/JI project performance risks . . . . . . . . . . . . . . . . . . . 21 Box 3 ­ JI Track 1 & Track 2. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Box 4 ­ Expectations and experience with "early-mover" JI projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 Box 5 ­ The Hungary Pannongreen Biomass Project: A JI project alongside the EU ETS . . . . . . . . . . 45 Box 6 ­ Bangladesh Solar Homes Systems (SHS) project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Box 7 ­ Addressing CDM barriers facing LDCs: Lessons from the Community Development Carbon Fund (CDCF) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 Box 8 ­ The CDM and HFC-23 projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Box 9 ­ Plantar project in Brazil: pioneering structured finance around carbon revenues . . . . . . . . . . 71 Box 10 ­ Building on synergies between the Global Environment Facility, Montreal Protocol & carbon finance to scale-up climate action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 Box 11 ­ Providing solutions for solid waste management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Box 12 ­ Community Development Carbon Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 Box 13 ­ Overview of Programmes of Activities (PoAs) under the CDM . . . . . . . . . . . . . . . . . . . . . . . . 78 Box 14 ­ The Uganda Municipal Composting Programme of Activities. . . . . . . . . . . . . . . . . . . . . . . . . . 79 Box 15 ­ The CDM PoA "liability" clause . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 v Acknowledgements This report was prepared by a World Bank team con- the World Bank carbon funds and members of the World sisting of Martina Bosi (team leader), Scott Cantor Bank Host Country Committee for their much appreci- and Felicity Spors, with important contributions from ated insights and feedback. Philippe Ambrosi, Marcos Castro, Javier Freire Coloma, Kari Hämekoski (now at the Nordic Environment The process followed to conduct the work underpinning Finance Corporation), Alexandrina Platonova-Oquab, this report is outlined in Annex 8. Monali Ranade, and Zenia Salinas. For more information, please feel free to contact the The report benefitted greatly from the valuable com- World Bank Carbon Finance Unit at helpdesk@carbon- ments and suggestions from four peer reviewers with finance.org. significant experience and expertise in carbon finance and the Kyoto mechanisms: Hans-Georg Adam, Jane The full version of this report can be found on the website Ebinger, Christiana Figueres, and Johannes Heister. The of the World Bank's Carbon Finance Unit under Publica- team is also grateful for the support and input of many tions and Reports: www.carbonfinance.org other World Bank colleagues throughout the research and drafting process. Sincere thanks go to participants in Washington, DC, May 2010 vii viii Abbreviations & Acronyms AAU Assigned Amount Unit DOE Designated Operational Entity ACM Approved Consolidated Methodology EB Executive Board AIE Accredited Independent Entity EC European Commission AIJ Activities Implemented Jointly ECX European Climate Exchange AMS Approved Methodology for Small-Scale EE Energy efficiency Projects EF Emission factor ANR Assisted natural regeneration ER Emission reduction A/R Afforestation/reforestation ERPA Emission Reductions Purchase Agreement BAU Business as usual ERU Emission Reduction Unit BioCF BioCarbon Fund ETS Emissions Trading Scheme CBP Community Benefits Plan EU European Union CCS Carbon capture and storage EUA European Union Allowance CDCF Community Development Carbon Fund EU ETS European Union Emissions Trading CDM Clean Development Mechanism Scheme CDMF Chinese Clean Development Mechanism FCPF Forest Carbon Partnership Facility Fund FMNR Farmer managed natural regeneration CER Certified emission reduction FX Foreign exchange CFL Compact fluorescent lamp GHG Greenhouse gas CFU Carbon Finance Unit (of the World Bank) GIS Green Investment Scheme CH4 Methane GWP Global warming potential CHP Combined heat & power HFC-23 Trifluoromethane C/ME Coordinating/managing Entity IBRD International Bank for Reconstruction and CMM Coal mine methane Development CMP Conference of the Parties Serving as the IEA International Energy Agency Meeting of the Parties IPCC Intergovernmental Panel on Climate CNG Compressed natural gas Change CO2 Carbon dioxide IRR Internal rate of return CO2e Carbon dioxide equivalent JI Joint Implementation COP Conference of the Parties JISC Joint Implementation Supervisory CPA CDM Programme Activities Committee CPF Carbon Partnership Facility KM Kyoto mechanism CSI Cement Sustainability Initiative LDC Least developed country DNA Designated National Authority LFG Landfill gas ix YEARS OF EXPERIENCE IN CARBON FINANCE LoA Letter of Approval PSU Public sector undertakings LULUCF Land use, land use change and forestry RE Renewable energy MOP Meeting of the Parties REDD Reduced emissions from deforestation and MRV Monitoring, reporting and verification degradation MtCO2e Million tons carbon dioxide equivalent RIT Registration & issuance team MW Megawatt RMU Removal unit N 2O Nitrous oxide sCER Secondary certified mission reduction NPV Net present value SF6 Sulfur hexafluoride NSS National Strategies Studies Program SSC Small-scale OECD Organisation for Economic Co-operation tCO2e Ton of carbon dioxide equivalent and Development tCER Temporary certified emission reduction O&M Operation and maintenance UCF Umbrella Carbon Facility PE Project entity UN United Nations pCER Primary certified emission reduction UNDP United Nations Development Programme PCF Prototype Carbon Fund UNEP United Nations Environment Programme PDD Project design document UNFCCC United Nations Framework Convention on PFC Perfluorocarbons Climate Change PHRD Japan Policy and Human Resources Devel- VER Verified emission reduction opment Fund WB World Bank PIN Project idea note WDR World Development Report PoA Programmes of Activities PP Project Participant x Abbreviations & Acronyms Executive Summary Under the Kyoto Protocol to the United Nations Frame- past into future designs, making full use of the experi- work Convention on Climate Change (UNFCCC), the ence and learning that has been gained. This will mean industrialized countries (so-called "Annex I" countries) building upon the successes of the current CDM and adopted quantified emission reductions obligations. Col- JI regulatory frameworks, addressing weaknesses, and lectively, these obligations amount to a reduction of 5.2 abandoning what is not working. This publication seeks percent against 1990 levels over the five-year commit- to make a constructive contribution to this debate, in ment period from 2008 to 2012. Countries can meet full respect of the ongoing international climate change their obligations through domestic actions and par- negotiations, by providing insights and recommenda- tially through one of the Protocol's three market-based tions from a practitioner's experience and perspective. (a.k.a., flexibility) mechanisms, i.e., International Emis- sions Trading, Joint Implementation ( JI), and the Clean Development Mechanism (CDM). The CDM and JI are The role of the World Bank: a practitioner's two project-based mechanisms targeted at greenhouse perspective gas (GHG) reducing projects in developing countries and Annex I countries, respectively (with the focus of JI being Addressing climate change, both mitigation and adapta- on countries with economies in transition). The Kyoto tion, is a critical pillar of the development agenda. For the Protocol and its mechanisms provide the backdrop for World Bank, addressing climate change is intrinsically carbon finance activities. Carbon finance is the generic linked to its mission of poverty reduction and the sup- name for the revenue streams generated by projects from port of sustainable development in its client countries. the sale of their greenhouse gas emission reductions, or Carbon finance is part of a larger response to leverage from trading in carbon permits. existing development finance and complements other Marking the 10th anniversary of the establishment financial instruments focused on mitigating and adapting of the World Bank Prototype Carbon Fund (PCF)--the to the impacts of climate change. world's first global carbon fund--this report seeks to take The role of the World Bank has been to catalyze a stock of the World Bank's experience of working with the global carbon market that reduces the cost of achieving Kyoto Protocol's project-based mechanisms over the past GHG reductions, supports sustainable development, decade. The CDM, as the much larger system in terms of and reaches and benefits the poorer communities of the projects, emission reductions and host countries, is the developing world. Starting with the PCF, which became basis for much of the report's discussion. JI is also discussed. operational in April 2000 with an initial capitalization Policy-makers and negotiators are working on advanc- of $135 million, the World Bank carbon finance activi- ing the policy framework and the regulatory structures ties helped catalyze a then nascent carbon market and to mitigate GHGs at greater scale. Furthering the use of pave the way for the increased participation of public market instruments should incorporate the lessons of the and private buyers. The carbon market has since become 1 YEARS OF EXPERIENCE IN CARBON FINANCE more dynamic, with CDM/JI transactions totaling $27 ect pipeline. The World Bank has worked with project billion from 2003 to 2009. Today, the World Bank has entities to further develop them to the stage of a carbon $2.5 billion in capitalized funds (grouping fund partici- finance transaction and official recognition as a CDM or pants from 16 governments and 66 firms)1. Its portfolio JI project. The experience has shown how carbon finance is wide-ranging, spanning 57 developing countries and revenues can enhance the overall financial viability of economies in transition and 23 different technologies in GHG reducing projects and, because payments are per- projects as diverse as energy-efficient lighting in Senegal, formance-based, create positive incentives for good man- brick-making in Bangladesh, solid waste management in agement and operational practices to sustain emission Mexico, wind power in China, and reforestation of the reductions over time. Carbon finance operations have River Nile Basin. The World Bank experience is therefore demonstrated opportunities for collaboration across sec- relevant to a broad set of stakeholders. tors, and have served as a catalyst for the incorporation At the same time, the World Bank portfolio includes of climate-friendly technologies into projects relating to a significantly greater share of projects hosted in Africa rural electrification, renewable energy, energy efficiency, (i.e., more than 20%) than the global CDM experience urban infrastructure, waste management, forestry, and (i.e., 2%), providing important learning and experience water resource management. on extending the reach of carbon finance to the poor- Clearly, not all project ideas make it all the way to an est developing countries. Moreover, the World Bank has approved CDM or JI project. For example, more than made a significant contribution to the development of half of the World Bank's approved project ideas were sub- methodologies (i.e., about 40% of approved CDM meth- sequently discontinued and exited the pipeline, with 211 odologies) that define project eligibility, the calculation of remaining active projects in the portfolio. the emission baseline, and the monitoring requirements for different types of project activities. Through this work Key insights and lessons from developing carbon finance the World Bank has helped open up new areas of carbon transactions include: finance activities for the market, as once a methodology is approved, it can be used by any other similar project The greater the carbon revenues, the greater the poten- meeting the relevant criteria. With its partners in the tial for stimulating and leveraging GHG-mitigating carbon funds and in host countries, the World Bank has activities. Carbon revenues result from: (i) the vol- continuously sought to expand the opportunities from ume of credits generated, which are highly dependent carbon finance and extend its reach to more sectors and on the greenhouse gas intensity of the baseline (from more countries. which emission reductions are calculated); (ii) the carbon price, influenced by overall market trends and the risk of the carbon credits; and importantly, Developing carbon finance transactions: (iii) the length of the purchasing period, which has many good ideas, but not all are successful typically been limited as few buyers are engaging in long-term purchasing (due to the deadline and brevity Since the beginning of its engagement in carbon finance, of the Kyoto Protocol's first commitment period). the World Bank has reviewed more than 1,000 project Successful CDM/JI projects have features similar to ideas. Of these, more than 500 made it into the proj- those of more typical development projects: (i) a com- mitted champion (within the company or govern- 1 This report draws on experience from the Prototype Carbon Fund, ment); (ii) strong project design and planning from BioCarbon Fund, Community Development Carbon Fund, Carbon the start; (iii) solid project financing; and (iv) clear Fund for Europe, Danish Carbon Fund, Italian Carbon Fund, Neth- erlands Clean Development Carbon Facility, Netherlands European potential to meet objectives (in this case, reduce Carbon Facility, Spanish Carbon Fund and Umbrella Carbon Facility. GHG emissions). 2 Executive Summary Carbon finance at the World Bank The main reasons for discontinuing previously in the global CDM pipeline. However, rules, modalities, approved project ideas have been: (i) the challenges and procedures, which were developed to ensure a rigor- of project financing (i.e., inability to reach financial ous project approval process and the issuance of credible closure); (ii) delays in project implementation (e.g., emission credits, have inadvertently resulted in excessive due to the time and procedures required to obtain delays and bottlenecks. The long timeframe associated necessary approvals and licensing from relevant with the CDM approval process (now amounting to national authorities); (iii) CDM/JI regulatory delays approximately 18 months) is undoubtedly reducing the and frequent changes in the rules and procedures in impact of the CDM. These delays have a disproportion- the regulatory structures (e.g., changes in approved ate impact due to the relatively short Kyoto commitment methodologies); (iv) an insufficient carbon finance period, as well as the shorter private sector investment revenue stream; and (v) challenges in clearing the due horizon. Moreover, the transaction costs (i.e., validation diligence screening processes. and verification costs) have increased over time for both Upfront financing barriers for low carbon, but capital- large and small scale projects. The lost carbon finance rev- intensive, project alternatives (e.g., renewable energy) enues associated with regulatory delays are estimated at are common in developing countries. Carbon finance 800 million. This sum does not appear to buy commen- alone, as an incremental financing tool, cannot easily surate environmental benefits (i.e., avoided non-eligible overcome these barriers when accessible underlying tons) resulting from the intensive regulatory scrutiny. financing is not available. Long-term forward con- The international community, the CDM Executive tracts would be more common if there were post-2012 Board, and the UNFCCC secretariat (which supports policy clarity, and would enhance the contribution the work of the CDM Executive Board) have started to of carbon finance. Moreover, better ways need to be examine how to streamline registration and issuance pro- found to exploit and leverage the synergies between cesses. Improvements are urgent because the viability of (or the blending of ) different financial instruments many CDM projects--particularly those that are small (e.g., commercial loans and public climate and devel- and/or depend most on carbon finance revenues--is opment financing mechanisms) and carbon finance. reaching a breaking point with the increased transaction For those projects that have secured financing, it is costs caused by the data and documentation require- becoming clear that the bulk of the work associated ments and delays. The CDM regulatory risks are indeed with CDM projects and programs actually takes place starting to consume more and more of the CDM benefits after registration. In fact, successful project imple- to project entities. mentation and CER delivery--which is the key test for carbon finance--often take more time than origi- Recommendations for achieving a more efficient and effec- nally anticipated and require sustained efforts. Suc- tive regulatory process include: cessfully adhering to the relevant methodologies and procedures defined in the monitoring plan is key. Efforts need to be made without delay to enhance confidence in the performance of the Designated Operational Entities as well as their accountability. In The project cycle: achieving environmental particular, enhanced capacity and better communica- integrity, efficiency and effectiveness tion with the Executive Board is much needed along with the establishment of a robust appeals process. The CDM, developed through a "learning-by-doing" Streamlining the regulatory system should eliminate approach, has achieved impressive results. There are cur- the current duplication of quality checks undertaken rently more than 2,000 registered CDM projects and during the approval process and enable significantly more than 2,700 projects that are expected to be registered faster registration and issuance processes. Enhancing Executive Summary 3 YEARS OF EXPERIENCE IN CARBON FINANCE efficiency, while also ensuring environmental effec- and investment appraisal criteria. All these factors make tiveness, could be achieved by moving towards the the task of assessing a specific project's additionality very automatic registration of successfully validated proj- challenging from a global perspective, and subject to ects and applying a small discount to their claimed questioning. At the same time, the CDM regulatory risks emission reductions (as a form of "environmental can make it very difficult to use the expected CDM rev- integrity" levy). These could subsequently proceed enues as indicators of the projects' financial viability to to automatic issuance of Certified Emission Reduc- leverage the necessary underlying project finance. tions (CERs) for successfully-verified emission reduc- In addition, while some approved methodologies tions. Random spot checks on projects could further have been widely used and have facilitated the uptake of enhance confidence in the environmental effective- many projects, too many methodologies are overly com- ness of such a streamlined system. plex, conservative, and restrictive, thereby limiting their The entire burden (and costs) of delays should not be applicability. borne by project entities. Successfully registered proj- ects should be allowed to start generating CERs from Recommendations for achieving a more efficient and effec- the date of their submission for registration (rather tive assessment of methodologies and additionality include: than the date of registration). Regulatory reliability is needed in the form of more Review the implementation of the concept of addi- predictable and objective rules and guidance. Provid- tionality to reconcile the reality that good and effective ing for periodic reviews and revisions of CDM rules, emission reducing projects need to also be technically procedures, and methodologies is critical to reflect and financially solid, with the need to ensure environ- evolving practical realities and maintain the environ- mental integrity. This means moving away from the mental integrity of the system. But the process, tim- current additionality assessment that focuses on indi- ing, and triggers to initiate such reviews should be vidual investment decisions, and towards objective clear at the outset. and more easily verifiable technical criteria wherever possible. This could include the use of standardized baselines together with automatic additionality clear- Methodologies and additionality: in need of ance for activities meeting clear criteria and/or imple- simplified and pragmatic approaches mented in clearly specified geographic regions or under other circumstances. Environmental integrity of the Kyoto project-based Simplify baseline methodologies through greater mechanisms is critical for the overall climate regime, as standardization wherever possible, such as standard- well as for the carbon market, which is seeking confidence ized emission factors in the power sector, or default in the environmental quality of carbon assets. The CDM (deemed) values for energy-efficient equipment; such and JI seek to preserve environmental integrity through elements can already be found in some of the approved the demonstration of additionality, i.e., providing evi- methodologies. Ambitious yet realistic stringency lev- dence that a CDM/JI project's emission reductions are els of these standardized baselines need to be achieved additional to what would occur without CDM/JI. While through an acceptable and pragmatic balance between an attractive concept in theory, the demonstration of (i) environmental integrity (and conservativeness), additionality has turned out to be very challenging to and (ii) environmental effectiveness (i.e., the ability to implement and evaluate objectively in practice. The chal- stimulate more GHG-reducing activities). lenges stem from the fact that each individual project faces Collaborate with practitioners and industry/sector its own specific policy, regulatory, and economic circum- specialists to ensure that methodologies, particularly stances and each project entity uses different approaches monitoring requirements, build on and are consis- 4 Executive Summary Carbon finance at the World Bank tent with existing industry/sector practices, standards versely, weak capacity is a key reason for project ideas and/or reporting guidelines, and are tailored to con- being discontinued. At the host government level, capac- texts on the ground. ity to create enabling environments and clear regulatory frameworks to attract carbon finance is critical. As the world looks towards the post-2012 period and considers The specific case of Joint Implementation: ways to stimulate greater amounts of GHG mitigation in opportunities & challenges a way that supports host countries' transition to low car- bon growth, it is important to build on the capacity that The World Bank was an "early-mover" with JI projects has been created over the past decade. acting ahead of regulatory clarity at both the international In the global CDM experience, China's role is striking, level (with the verification procedures developed by the JI as its share in the CDM portfolio is proportionally larger Supervisory Committee or "JI Track 2" procedures) and than its share in overall GHG emissions from non-Annex the national level ("JI Track 1"). As JI benefits from the I countries. China's success can be attributed to various safeguard provided by the overall national emission caps factors, including a GHG-intensive electricity grid and of the JI countries, the original intentions were for a sim- a large growing economy, which offer many opportuni- pler instrument. However, the situation for JI has turned ties for emission reductions. Another important factor out to be more complex than originally anticipated. In to highlight is the capacity developed in China and the the countries that later joined the European Union (EU), overall CDM support structure to facilitate CDM activi- JI has faced challenges mainly due to the interplay with ties, which together have contributed to the country's the EU Emissions Trading Scheme (EU ETS) and con- overall successful implementation capacity. The world's cerns regarding double counting. and the World Bank's carbon finance activities have not JI provides for a greater role for national authori- been limited to China and the other large players (India, ties, and with it, creates substantial requirements for the Brazil, etc.), but it is clear that there is potential to extend host government in terms of capacity and institutions. JI the mechanisms' reach more broadly. experience to date shows that it takes time and resources To date, the renewable energy sector--critical for to build national systems, institutions, and capacities as countries' low carbon development--has attracted the governments must develop rules to manage new national largest number of CDM projects. This is true for both carbon assets. These rules include procedures and guide- the entire CDM pipeline and among already registered lines for project approval, issuance and transfer of Emis- projects. Waste management and industry are the two sion Reduction Units (ERUs). This has resulted in an other most popular sectors. The volume of CERs issued additional host country risk associated with JI projects to date is largest for industrial gas projects, although their compared to the CDM. In addition, the different require- share is expected to dissipate at the end of the commit- ments and approaches adopted by each JI host country ment period, when other projects move to the issuance of make it more complex for project developers seeking to their respective CERs. navigate different countries. Sectors not reaching their full potential include trans- portation, energy efficiency, and forestry. Although the transport sector comprises nearly a quarter of all global Experience on the ground: capacity building GHG emissions, it represents less than 1 percent of the crucial for geographic & sector reach CDM and JI portfolio. This reflects the challenges that technology-shift projects face in overcoming the cur- One of the main factors for successful carbon finance rent additionality approach and the reality that trans- projects has been committed champions with the capac- portation choices are driven by users, which are typically ity to implement and follow through with projects. Con- very difficult to assess. Despite its inherent attractive- Executive Summary 5 YEARS OF EXPERIENCE IN CARBON FINANCE ness, demand-side energy efficiency, particularly at the tainable land and forest management given reliance on household level, is difficult to implement in practice natural resources in many LDCs. Through dedicated due to the range of well-documented barriers not cap- efforts by the BioCarbon Fund and the Community tured in technology cost curve analyses complicating Development Carbon Fund and the sustained support additionality demonstrations when reviewing invest- from World Bank operations, the World Bank portfolio ment analysis. Forestry, limited by being covered under includes about one fifth of its projects in Africa. the CDM only by afforestation and reforestation (A/R) Efforts are needed to remove the CDM-specific bar- activities, is also inhibited by the temporary designation riers that are preventing it from reaching LDCs and to of its credits and significant technical challenges associ- contribute to sustainable development and poverty alle- ated with demonstrating compliance with the CDM viation more meaningfully. Many of these measures are land-related rules2. necessary for scaling up and enhancing the CDM's over- all effectiveness. At the same time, the host countries themselves need to strengthen their efforts to make use Reaching least developed countries (LDCs)3 of the CDM. The CDM, as a market-based instrument, has logically Recommendations for removing CDM-specific barriers to focused first on the lowest abatement cost opportuni- enhance the outreach of the CDM to LDCs include: ties--a sign that the price signal works. Such opportuni- ties consist of single-source projects able to generate large Simplify procedures for project approval and issuance. volumes of emission reductions, and projects located in The practical reality of LDC contexts must be taken countries with the best (perceived) enabling environ- into account. Reducing transaction costs and delays is ments and capacity. LDCs with relatively low levels of vital for making small-scale projects viable. emissions at present, have largely been by-passed by the Simplify methodologies. Requirements to demon- CDM experience to date. strate the project's additionality and monitoring need It is clear that there is no substitute for good gover- to be adapted to smaller projects with less capacity nance and enabling environments at the level of the host and less available data. country. This requires continued and enhanced capacity Account for unmet energy demand. The CDM meth- development. odologies currently underestimate the potential to The potential role of carbon finance in LDCs must reduce GHG emissions from the power sector and be considered in the context of those countries' specific must be adjusted to reflect the real energy demand situation and needs. The CDM has the potential to con- (and not just historical grid-connected energy supply) tribute, for example, to broader sustainable development for meeting basic needs in LDCs. A realistic energy by helping to meet the energy deficit with lower GHG- baseline could provide opportunities for the CDM to intensive activities, as well as to contribute to more sus- help provide new energy services using lower GHG- intensive options. Increase eligible land activities in the CDM and rem- 2 A study of BioCarbon Fund lessons learned from A/R CDM is edy "temporary" crediting in the afforestation/refor- under preparation; it aims to shed light on challenges project devel- estation sector. The forestry and agriculture sectors opers have encountered for effective project preparation and imple- mentation and also on opportunities the mechanism has brought to represent a large CDM opportunity in many LDCs, the forestry sector. but most land use activities, including agriculture, are 3 The United Nations defines these countries through the three not eligible in the CDM. In addition, CDM forestry dimensions of a country's state of development, namely, its income level, its stock of human assets and economic vulnerability. There are projects are penalized with "temporary" credits (not 49 LDCs with 33 in Africa. See www.unohrlls.org recognized in some markets like the EU Emissions 6 Executive Summary Carbon finance at the World Bank Trading Scheme), thereby depressing the demand and $100 billion in underlying low carbon investment. Still, price for these credits. the leverage potential of carbon finance has not yet been Provide training in programmatic approaches (i.e., fully explored, and must be further exploited to help through Programmes of Activities). Programmatic mobilize both climate and development finance on a approaches could unlock some of the mitigation larger scale. potential of the CDM in LDCs, but further develop- In addition to their contribution to meeting GHG ment of program rules, simplification and capacity commitments cost-effectively, the Kyoto mechanisms building is needed. have generated other noteworthy benefits. There are many examples of how they have contributed to sustainable development in host countries. The CDM has supported The Kyoto mechanisms: challenging, yet rich & basic development needs and broader socio-economic successful experience co-benefits, such as improving energy access and services as in the case of the Nepal biogas project, which has so Working with the Kyoto mechanisms has been chal- far installed close to 20,000 biogas plants in the country, lenging and improvements are needed. Nevertheless, and providing solutions to waste management challenges the experience has been rich in learning and proven to as seen in several landfill gas recovery projects. The Kyoto be successful. The mechanisms have provided an impor- mechanisms have also played an important role in con- tant catalyst for development finance while simulta- tributing to technology transfer and even more to tech- neously supporting GHG mitigation and sustainable nology diffusion, such as the solar home system project development. in Bangladesh and the energy-efficient lighting projects. By adding to project revenue through the sale of emis- Forestry projects, such as the soil conservation project in sion reductions, carbon finance can increase the bankabil- Moldova, have demonstrated the synergies between car- ity of projects, thereby enhancing the creditworthiness of bon sequestration and the promotion of other environ- the borrowing entity and reducing its cost of borrowing. mental services and improving rural livelihoods. It provides a means of leveraging new private and pub- It is also important to note the Kyoto mechanisms' lic investment into projects that reduce GHG emissions. contribution to raising climate change awareness and to Experience shows that carbon finance, alone or in com- building capacity in developing countries to use carbon bination with other policy and finance instruments, has finance to support GHG-reducing project activities. An made a difference in favor of climate action and catalyzed integral component of the World Bank's carbon finance a shift of much larger amounts of (essentially private) activities has been to contribute to the strengthening of financial and investment flows to accelerate low carbon the capacity in developing countries; it remains an area development in developing countries. This is the case for that needs to be sustained and enhanced. many renewable energy projects, including hydro, wind, and biomass. The United Nations currently estimates that by the Scaling-up with a programmatic approach: end of the Kyoto Protocol's first commitment period in opportunities through Programmes of Activities 2012, the CDM and JI will have delivered over 1 Gigaton & Green Investment Schemes and approximately 0.2 Gigaton of offsets respectively, thereby making an important contribution to meet- The urgent need to scale up mitigation efforts is widely ing the Kyoto Protocol's emission obligations. Between accepted. Approaches to a successful scaling-up are ex- 2002 and 2009, transactions, in the form of forward pected to include a combination of policy-based and contracts, covered about 2.2 billion CDM credits worth technological interventions to be defined by country- some $25 billion, leveraging more than an estimated specific circumstances and capacities. Strategically, aggre- Executive Summary 7 YEARS OF EXPERIENCE IN CARBON FINANCE gated programs could become good vehicles to scale-up While the current focus of PoAs is on aggregating system, subsector, or sector-wide mitigation efforts. The micro activities (e.g., cooking stoves, solar homes), World Bank has been actively exploring various scaling-up scaling-up will also require including aggregating opportunities: (i) technology-specific intervention, such projects of larger size (e.g., individual hydro schemes as compact fluorescent lamp (CFL) market transforma- or mini co-generation schemes). tion activities; (ii) GHG-specific intervention, such as programs by rural development agencies to accelerate In the same host countries as JI, Green Investment deployment of household bio-digesters to capture and Schemes (GIS) involve the earmarking of revenues gener- utilize methane emissions from animal waste; (iii) indus- ated by the sale of Assigned Amount Units (AAUs) for try-specific intervention, such as the reduction of gas use in environmentally-related projects ("greening"). The flaring by the petroleum industry; and (iv) system-wide GIS have emerged over the past two years as a potentially intervention, such as coordinated city-wide GHG miti- effective vehicle for programmatic approaches by offering gation activities across waste, transport, and energy end- transactional benefits: it allows stronger upfront finan- use sectors. cial leveraging with timing flexibility for the "greening" Under the CDM and JI, Programmes of Activities activities (that can occur later and beyond 2012). GIS (PoAs) offer a welcome means to move from an ad-hoc experience in Central and Eastern European countries project-by-project approach to a more coherent program- offers interesting insights: (i) the GIS implies a much matic approach that could enable the CDM and JI to larger role for host countries and requires significant make progress towards reaching their full potential, while implementation capacity; (ii) GIS success is contingent also better supporting host countries' transition towards on careful consideration of program design and disburse- low carbon development. While there has been signifi- ment arrangements to ensure efficient implementation of cant interest in PoAs, proof of concept is still underway, "greening" activities; and (iii) timing flexibility of "green- with the World Bank and others testing its implementa- ing" activities require careful consideration of enforce- tion on the ground. ment and remedy provisions. If successful, GIS may offer fertile ground to test pro- Some preliminary insights and recommendations on PoAs grammatic/sector-based approaches for GHG mitiga- are nonetheless emerging: tion (e.g., in energy efficiency), which could be relevant for other market-based mechanisms as well as for public Capacity building is needed in host countries to be funding mechanisms. able to assess opportunities and develop the necessary infrastructure and support for PoAs. Careful consideration must be given to the design of Looking ahead a PoA (including the integration of future CDM rev- enue streams in the PoA's financing) and the coordi- Stabilizing atmospheric concentrations of GHG to pre- nating entity's administrative and technical capacity. vent dangerous human-induced climate change will Clarification of rules are needed to facilitate imple- require dramatic scaling-up of efforts. A suite of instru- mentation, and more testing is needed. ments and sound policies are needed; with market-based Scaling-up through PoAs will demand simplification instruments having demonstrated that they can be part of methodologies and additionality. It will also mean of the policy-makers' tool box. There are three main fac- moving away from seeking to precisely measure every tors that will determine and influence the extent to which ton of GHG emission reduced (at each project site) it will be possible build on the experience with market- to estimating with proper justification and confidence based instruments over the past decade and make them the total GHG impact of the PoA. more efficient and effective instruments in helping to 8 Executive Summary Carbon finance at the World Bank meet the climate change and development challenges that throughout the world over the past 10 years are a lie ahead: remarkable accomplishment. Along with ambitious emission targets and necessary changes to the mecha- Policy clarity: Clarity on the post-2012 international nisms, the effectiveness of carbon finance, both in terms climate change regime, as well as on countries' plans to of GHG mitigation and its contribution to sustainable use market-based mechanisms to meet domestic GHG development, will be enhanced if it can build on syn- objectives, is urgently needed. This could happen ergies with host country policies and other financial either through a more efficient globally harmonized instruments. Capacity in developing countries needs market or through more complex fragmented markets. to be sustained and enhanced to provide an enabling In the absence of such clarity--which creates demand environment that allows carbon finance to better for emission reductions--the carbon market and car- leverage climate-friendly investments. Moreover, the bon finance risk losing momentum. Perhaps more evolution of the market-based mechanisms will benefit serious, is the real danger of not being able to sustain, from greater engagement from developing countries to and of even losing the capacity developed over the past ensure that the mechanisms better integrate the practi- decade in so many countries, organizations, and com- cal realities and offer meaningful opportunities to sup- panies in terms of integrating GHG considerations port low carbon development priorities. into policy and investment decision-making processes, and sustaining emission reductions over the long term. The lost opportunities would exacerbate the challenge Building on 10 years of experience: where the of mitigating climate change over the coming years. World Bank goes from here Mechanism reforms: The CDM appears be hitting a limit in terms of the volumes of project activities Through this report, the World Bank is celebrating its first which can be processed in a reasonable timeframe, decade of involvement in carbon finance. Looking back largely because of its rules and procedures and insuf- at the road traveled, it has been a fascinating journey of ficient capacity. The Kyoto mechanisms' achievements discovery of how market mechanisms can set in motion have provided an important base on which to build. In investments and behaviors that dramatically change the order to scale-up and expand their reach, meaningful way we look at development opportunities in the World and expeditious changes are needed. The international Bank's client countries. community, CDM Executive Board, and UNFCCC As the report documents, it has been a difficult jour- Secretariat are taking important steps in that direction ney at times but one that has been highly rewarding and and follow-through will be critical. At the same time, in which we have learned a lot. Today, the global commu- countries are assessing options and developing strate- nity has a much better idea of not only what works and gies to mitigate GHG emissions and move towards low does not work, but also what can be done to let market carbon development. Taking the Kyoto mechanisms to mechanisms reach their full potential to achieve climate the next phase, whether that is through reforms and/ change mitigation at the scale required to address effec- or new mechanisms, requires consolidating all the tively the global challenge our planet faces. "learning-by-doing" and rich experience over nearly a Strengthened by the rich experience harnessed over decade, and making necessary changes to reduce trans- the past decade and convinced of the need to continue action costs, and to enhance clarity and predictability its support for mitigation actions, the World Bank pro- to enable better leveraging of carbon finance revenues. poses to embark on its next ten years of carbon finance. Sustained capacity building and enhanced engage- There is still a lot more to learn from the portfolio of proj- ment with developing country partners: The Kyoto ects we manage as we continue to help project entities mechanisms, their institutions, and the capacity built Executive Summary 9 YEARS OF EXPERIENCE IN CARBON FINANCE bring these projects to full implementation and deliver the Facilitating technical roundtable discussions, bringing emission reductions they are expected to generate. together rule makers (e.g., UNFCCC), those respon- While the global community strives to put in place an sible for applying the rules (DOEs), project or pro- international climate regime post 2012, the World Bank gram entities, and other stakeholders; will continue its work to expand the scope, scale and Providing a forum for host countries--through its range of climate change mitigation activities in the vari- Host Country Committee--to advise the World ous sectors of its clients' developing economies. Filling the Bank on its carbon finance activities and share experi- climate finance gap will require that both the public and ence on the ground; and private sectors get engaged on a significantly larger scale Facilitating participation of developing country sell- than heretofore. The private sector has indeed a key role in ers and regulators in forums such as Carbon Expo to financing mitigation through carbon markets and related bring them in direct contact with "the market"; instruments; official flows or international funding will be an important complement to build capacity, correct Going beyond such informal initiatives, the Forest market imperfections, and target areas overlooked by the Carbon Partnership Facility, established in 2008, is an market. encouraging example of pioneering work undertaken How it proposes to move forward matters. Build- by a strong partnership of more than 50 countries, dedi- ing on its experience serving as a market maker (in the cated to tackling the complex issue of REDD (Reducing very early days), and a contributor to the global experi- emissions from deforestation and forest degradation) ment that the first commitment period of the Kyoto and beyond (REDD+) along with other REDD initia- Protocol has provided, the World Bank recognizes that tives. Building not only knowledge, but also trust and the best chance for using carbon markets to achieve suc- confidence among all stakeholders involved, has proven cessful large-scale GHG mitigation in the future will be a critical to moving forward on the difficult REDD+ partnership between all countries involved. Thus in addi- agenda. tion to continuing to "learn by doing", as is still required In addition the World Bank seeks to build on the in many respects, doing so in close partnership with all achievements of and lessons from its existing carbon stakeholders will help find better solutions that address funds, especially the BioCarbon Fund and the Commu- the urgent and critical challenges of climate change. nity Development Carbon Fund, to better support the As a participant committed to making the carbon development needs of the least developed countries. markets work, the World Bank proposes to continue its informal bridge-building work whenever desirable by, for example: 10 Executive Summary Introduction 2.1 What is carbon finance all about? Indeed, the Kyoto Protocol provides that the industri- alized countries (referred to as Annex I countries under The Kyoto Protocol4 to the United Nations Framework the UNFCCC) can meet their quantified emissions Convention on Climate Change (UNFCCC) pro- obligations through (i) domestic actions (e.g., standards, vides the backdrop for carbon finance activities. Carbon taxes, subsidies, domestic emissions trading); and par- finance is the generic name for the revenue streams gen- tially through one of the Protocol's three market-based erated by projects from the sale of their greenhouse gas mechanisms, i.e., International Emission Trading, Joint emission reductions (see Figure 1) or from trading in car- Implementation ( JI), and the Clean Development Mech- bon permits. It sets the basis for an innovative scheme to anism (CDM). meet the GHG emissions objetives from industrialized Marking the 10th anniversary of the establishment countries through a global carbon market. of the World Bank Prototype Carbon Fund (PCF)--the world's first global carbon fund--this report seeks to take stock of the World Bank's experience of working with 4 The Kyoto Protocol was adopted in December 1997 and entered these market-based mechanisms over the past decade. It into force on February 16, 2005. shares insights and recommendations from the perspectives FIGURE 1 Carbon finance: provides an additional revenue stream = Annual Carbon Payments = Other Sources of Revenue from Service or Production Cash = Debt Servicing in Debt Carbon revenues Equity Operating revenues Construction Yrs 0 1 2 3 4 5 6 7 8 ........................................... Cash out 11 YEARS OF EXPERIENCE IN CARBON FINANCE of a practitioner, a carbon market player, a manager of the climate change challenge also supports the developing carbon fund portfolios, and an active contributor to the countries' transition to low carbon development. regulatory process in terms of developing methodologies as well as providing assessments, analysis, and recommen- dations in response to the regulators' call for inputs. 2.2 How is the World Bank contributing? Carbon finance is now a proven tool to support green- house gas mitigation. Market mechanisms, such as the Addressing climate change, both mitigation and adapta- CDM for greenhouse gas (GHG) mitigation projects tion, is a critical pillar of the development agenda and is hosted in developing countries, and JI for projects located intrinsically linked to the World Bank's mission of pov- in economies in transition, have demonstrated that they erty alleviation and support of sustainable development can complement and leverage other resources to unlock in its client countries. low carbon investment by overcoming barriers, driving For the World Bank, carbon finance is part of a larger innovation, and creating a revenue stream that sustains response to leverage development finance, and there- projects over time. fore complements other financial instruments. Thus, the Kyoto mechanisms, developed under a "learning-by- insights gained from the World Bank's carbon finance doing" philosophy, have exceeded expectations, not only initiatives are not only part of the larger global effort to in terms of the number of projects, but also in terms of combat climate change, but also go hand in hand with the awareness and capacity building that they have gener- the World Bank's efforts to reduce poverty and improve ated. They have certainly provided significant experience living standards in the developing world. in the development, evaluation, implementation, and monitoring of GHG reduction projects. The international community is entering into a new chapter of climate change mitigation that demands "Climate change is a development, economic, scaling-up all the mechanisms and tools at its disposal, and investment challenge. It offers opportunity for including carbon finance. Such scaling-up requires ana- economic and social transformation...That is why lyzing the rich learning that has been gained over the past addressing climate change is a critical part of the decade, consolidating it, and making necessary adjust- development agenda." ments to enhance effectiveness and efficiency. --Robert B. Zoellick, World Bank President This report seeks to provide an objective assessment, UN Climate Change Conference,Bali based on practical operational experience, of the achieve- December 2007 ments as well as of the challenges that have been faced and that persist. It examines and explains the discrepan- cies between expectations and theoretical concepts, on the one hand, and practical reality, on the other. It also In April 20005, the World Bank, along with the gov- draws on concrete project experience to provide practical ernment and private sector partners in the Prototype suggestions and recommendations to improve efficiency Carbon Fund (PCF), established the world's first global and effectiveness without compromising environmental integrity. It is hoped that this work can be a constructive con- 5 The establishment of the PCF followed earlier carbon finance pre- tribution to policy-makers and other stakeholders with paratory and capacity building work undertaken in the late 1990s, responsibilities for advancing existing regulatory struc- when the World Bank engaged in a program of National Strategy Studies (NSS) and Activities Implemented Jointly (AIJ). The capital- tures and frameworks to mitigate GHG emissions on a ization of the PCF increased to $180 million in 2002 and now stands much greater scale. It is important that their response to at $220 million. 12 Introduction Carbon finance at the World Bank FIGURE 2 Value of CDM & JI transactions (per year)* (US$ billion) $7.9 billion 8 $6.9 billion World Bank Other $5.9 billion 6 4 $3.0 billion $2.6 billion WB 2 market 31% 14% 15% 39% 5% 3% 4% 1% share 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 *vintages up to 2012. Source: State and Trends of the Carbon Market (WB). carbon fund6, with an initial capitalization of $135 mil- Since the PCF, the World Bank has created a whole lion. It was perceived as a bold move at the time, especially family of funds and facilities (see Annex 1)--currently given that the entry-into-force of the Kyoto Protocol capitalized at approximately $2.5 billion, and involv- occurred 5 years later, in 2005. ing participants from 16 governments and 66 firms. The The carbon market, in general, and the CDM in par- World Bank's approach to carbon finance and its engage- ticular, have come a long way since the early pioneering ment in carbon markets has been guided by 3 main days of the PCF (see Box 1). The PCF effectively helped objectives: catalyze what was then a nascent market for emission reductions into a vibrant carbon market. The CDM mar- Ensure that carbon finance contributes to sustainable ket had virtually no transactions in 2002, but growth was development, beyond its contribution to global envi- stimulated in 2005 by the Kyoto Protocol's entry-into- ronmental efforts; force, and the beginning of the EU Emissions Trading Assist in building, sustaining, and expanding the mar- Scheme (EU ETS). The PCF helped pave the way for the ket for GHG emission reductions; and increased participation of public and private buyers, that Strengthen the capacity of developing countries to have dominated a much more dynamic carbon market. benefit from the carbon market. This is a welcome development and clearly part of the success story of the mechanisms. From 2003 to 2009, The World Bank, through its carbon funds, has one of CDM/JI transactions totaled $27 billion, as illustrated the largest portfolios in terms of the number of projects. in Figure 2. A marked decline in CDM/JI transactions in 2009 was largely due to the global economic downturn, 6 The PCF, as well as the subsequent World Bank carbon funds, is a "compliance" fund, whereby fund participants do not receive financial the emergence of competing carbon assets (Assigned returns, but rather receive their pro rata share of emission reductions Amount Unit, AAUs), and the approaching end of the generated by the fund portfolio in return for their financial participa- Kyoto Protocol's first commitment period in 2012, which tion in the fund. 7 For more information on the performance of the carbon market, is closing the window for many new projects that would please see Kossoy and Ambrosi, 2010, State and Trends of the Carbon otherwise enter the JI/CDM pipeline7. Market 2010, The World Bank. Introduction 13 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 3 World Bank's carbon finance portfolio by country World Bank active projects n = 211 6 26 8 6 9 14 8 4 7 7 7 6 10 Country with active 11 project Projects in country, # if >5 It is arguably one of the players with the longest history, ect portfolio in terms of both geographic and sector cov- as well as possibly the one with the most diversified proj- erage (Figure 3) and type of technology (Box 1). 14 Introduction Carbon finance at the World Bank World Bank experience as a pioneer in carbon finance transactions From the early beginnings of the PCF in 2000, the World Bank carbon finance to the poorest developing countries. In several has established a 10-year track record of developing carbon countries, identified in the figure below, the World Bank carbon finance transactions with an active portfolio of different carbon finance activities facilitated the registration of their first CDM assets secured through contracts to purchase emission reduc- project. tions, paying for them annually or periodically once they have been verified by a third party auditor and (in most cases) is- Similarly, the World Bank carbon funds have pioneered many sued as Kyoto-compliant assets. (See Annex 2). These carbon first-of-their-kind technologies: they were the first to register 2 assets are: projects in 7 different technology categories , thereby opening the door for the subsequent registration of 411 (mostly non- CERs: Certified Emission Reductions from CDM projects; World Bank) projects. ERUs: Emission Reduction Units from JI projects; The World Bank has also taken an active role in contributing to AAUs: Assigned Amount Units associated with project activi- the bottom-up rule-making for the CDM by providing inputs to ties in JI host countries; the CDM regulatory body (the Executive Board), and develop- tCERs: Temporary Certified Emission Reductions associ- ing new methodologies. To date, the World Bank has contrib- ated with CDM forestry projects; and 1 uted to the development of 52 different methodologies across VERs: Verified Emission Reductions associated with some 12 sectors. More recently, the World Bank has also engaged early carbon finance transactions. VERs are paid upon suc- intensively in the policy discussion to develop programmatic cessful verification by an independent auditor, with the aim approaches for scaling-up and extending the reach of carbon of subsequently being converted into a Kyoto asset (i.e., finance transactions. This has been combined with actively CER, ERU, tCER or AAU). testing and implementing the concept, as demonstrated by Today, the World Bank continues to assist in the building, the inclusion of 17 CDM Programmes of Activities (PoAs) in its sustaining, and expanding of the market for GHG emission pipeline and portfolio, including the registration of the first PoA reductions and to contribute to host countries' sustainable de- in Africa (and third in the world). velopment. The portfolio is diversified and wide-ranging, span- The pioneering spirit continues, with the establishment of 2 fa- ning 57 developing countries and economies in transition and cilities focused on the post-2012 period: the innovative Forest 23 different technology types as diverse as energy-efficient Carbon Partnership Facility (www.forestcarbonpartnership.org) lighting in Senegal, efficient brick making in Bangladesh, solid and the Carbon Partnership Facility (www.carbonfinance.org). waste management in Mexico, wind power in China, and refor- estation of the River Nile Basin. At the same time, the World Note: The Félou regional hydro power project registered in May Bank portfolio includes a significantly greater share of projects 2010 is registered as a project by the UNFCCC in Mali, Sen- hosted in Africa than the global CDM experience, providing egal and Mauritania as the entity distributing power to these important learning and experience on extending the reach of three countries is managed by their collective governments. Philippines Mauritiana Moldova Uganda Guyana Albania Brazil China Peru Mali 2005 2006 2007 2008 2009 2010 Nepal Bolivia Tunisia Ecuador Ethoipa Senegal 1 The difference between VER transactions and transactions involving Kyoto assets is that the buyer pays upon delivery of a verified emission reduc- tion and thus assumes the Kyoto regulatory risks (i.e., of converting to a Kyoto asset). The prices paid for VERs are thus lower than prices paid for CERs. 2 Based on UNEP RISØ categories, http://uneprisoe.org/ Introduction 15 Origins & Implementation of the Clean Development Mechanism and Joint Implementation 3.1 The Kyoto Protocol & the Marrakesh The "Clean Development Mechanism," which Accords allows the transfer of Certified Emission Reductions ("CERs") to Annex I countries from projects located The ultimate objective of the UNFCCC, adopted in 1992, in non-Annex I countries under Article 12 of the is the "stabilization of greenhouse gas concentrations at a Kyoto Protocol; level that would prevent dangerous anthropogenic inter- "Joint Implementation," which consists of the trans- ference with the climate system." It provides the overall fer, on a project-by-project basis, of Emission Reduc- framework for governments' collective efforts towards tion Units ("ERUs") among Annex I countries under climate change mitigation, following "common but differ- Article 6 of the Kyoto Protocol; entiated responsibilities" based on "respective capabilities." "International Emissions Trading," which allows the The Kyoto Protocol to the UNFCCC (adopted in trading of Assigned Amount Units ("AAUs") and 1997 and entered-into-force in 2005), provides for spe- other Kyoto Protocol credits (including CERs and cific quantified emission obligations for industrialized ERUs after they have been generated by a project) countries (including countries with economies in transi- among Annex I countries under Article 17 of the tion from Central and Eastern Europe). These countries, Kyoto Protocol. "Assigned Amounts" refers to the referred to as Annex I countries under the UNFCCC quantity of GHGs that a party to the Kyoto Proto- (and listed under Annex B in the Kyoto Protocol), have col is allowed to release into the global atmosphere collectively agreed to reduce their GHG emissions by as calculated on a yearly basis in Annex B of the approximately 5% below 1990 levels on average during the Protocol. Protocol's first commitment period from 2008 to 2012. This essentially translates to a 5-year emissions budget for The first two mechanisms, which generate CERs and each Annex I country called Assigned Amounts. Devel- ERUs, are "project-based," in that they enable Annex I oping countries have no quantified emissions obligations. countries to purchase ERs from projects that reduce or The Kyoto Protocol provides that Annex I countries sequester GHG emissions in economies in transition have flexibility on the domestic policies and measures and non-Annex I countries. Each individual CER, ERU, they wish to implement to meet their respective emis- and AAU equates to one metric ton of carbon dioxide sions obligation. They may also meet some proportion of equivalent (tCO2e) and is of equal weight for the pur- their quantified emission obligation through three mar- pose of meeting the emissions obligations of Annex I ket-based mechanisms ("Kyoto Mechanisms"), namely: countries. 17 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 4 How project-based mechanisms work Annex I country compliance Creating emission reductions Domestic CERs/ actions CERs/ CERs/ Emission ERUs ERUs ERUs Reductions Emission cap $ $ (ERs) Baseline Developing Country Assigned country/economy in emissions emissions Amount Projects transition benefits Units emissions from technology and financial flows The rationale behind the adoption of market-based and environmental licenses), although new elements are instruments as a key element in policy-makers' tool box added, such as the preparation of a project design docu- to meet GHG objectives stems from the fact that (i) the ment (PDD), the validation of the project, and the verifi- costs of mitigation are not evenly distributed across sec- cation of emission reductions (Figure 5). In theory, these tors or around the world; and (ii) the impact of a ton can be undertaken concurrently with the normal devel- of GHG emitted in the atmosphere is insensitive to the opment of a project, but it has not always been possible location where it occurs. Given that capital is not unlim- to do so in practice, since delays in the CDM, as well ited, it makes sense to provide flexibility to seek to miti- as JI, have lengthened the overall project cycle. In some gate GHG emissions where it is most cost-effective to cases, reaching the implementation stage takes longer do so. Figure 4 seeks to illustrate how the project-based than expected, particularly when projects occur in envi- mechanisms work in the context of meeting the overall ronments with low capacity or complex regulatory or GHG obligations of industrialized countries. Reductions approval procedures. of emissions from an eligible CDM/JI project below a Not all project ideas can be converted into CDM or baseline can be used towards meeting the obligations of JI project activities as there are more project ideas than Annex I countries, or their entities. there is financing available. While the Kyoto Protocol created the mechanisms and outlines the main principles, the rules and modalities for the implementation of the Kyoto mechanisms (dis- 3.2.1 From a project idea to a carbon finance cussed later in the report) took some time to assemble. project They were finalized in 2001, through the adoption of the 2001 Marrakesh Accords8. In the context of its carbon finance activities, the World Bank reviews every project idea note (PIN) proposed 3.2 The project cycle 8 The 2001 Marrakesh Accords (FCCC/CP/2001/13/Add.2) can be found on the UNFCCC website: http://unfccc.int/resource/ The CDM and JI9 project cycles are similar to usual proj- docs/cop7/13a02.pdf 9 CDM and JI operate under distinct regulatory frameworks. How- ect investment cycles (i.e., they include such steps as fea- ever, the underlying work to develop a carbon finance transaction is sibility studies, seeking financing, obtaining construction essentially the same. 18 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank FIGURE 5 Steps in CDM process The PIN provides a project description and initial estimation of the project's Preparation of Project GHG reductions. Often prepared by the Project Entity and submitted to potential Idea Note (PIN) carbon buyers. Preparation of Project The PDD provides all the technical documentation of the project including a more Design Document (PDD) precise estimation of the project's GHG reductions and proves the additionality. Validation is the process of independent evaluation of a project activity on the Validation of PDD by DOE basis of the PDD by a third-party auditor, also known as a designated operational entity (DOE), against the requirements of the CDM. Issuing of HC Letter of The host country government approves the transfer of the ERs from the Approval (LoA) project through a LoA. Registration is the formal acceptance by the CDM Executive Board (EB) of a Registration of PDD validated project as a CDM project activity. This step is a prerequisite for the by the CDM EB verification, certification and issuance of the CERs related to that project activity. Verification is the period independent review and ex-post determination by the Verification of Monitored DOE of the ERs as monitored and reported by the Project Entity during the given Emission Reductions verification period. Certification is the written assurance by the DOE that, during a specified time Issuance of Emission Reductions period, a project activity achieved the ERs as verified. The CDM EB reviews and approves this certification and subsequently issues CERs. Source: Based on JI project cycle template provided by Global Carbon and information on the UNFCCC website. for inclusion in its carbon finance pipeline. It has now the challenges of project financing (the main reason reviewed more than 1,100 PINs, about half of which have for abandoning a project is typically the inability to been retained for inclusion in its pipeline of projects. The reach financial closure); main reasons for not accepting PINs related to uncertain- ties concerning the eligibility of the proposed idea as a TABLE 1 From project idea to registration: the CDM or JI project and the capacity of the project entity World Bank experience to turn the idea into reality. Subsequently, approximately Attrition Rate* 40% of the approved PINs "survived" and became "active projects" in the World Bank portfolio or pipeline (with As of March 1, 2010 the remaining 60% dropping out of the pipeline)10, as Number of PINs reviewed 1,151 indicated in Table 1. Project Ideas accepted 534 The significant drop-out rate between approved PINs Number of active projects 211 and active projects can be attributed to: Number of projects that will be sent for Registra- 67 tion/Determination Number of projects in process of Registration/ 75 10 Other carbon finance portfolio managers have also reported the expe- Determination rience of reviewing large numbers of project ideas to ultimately pursue a smaller subset. For example, the Nordic Environmental Finance Cor- Number of projects that are Registered/Finally 69 poration (NEFCO) reports having evaluated 200 investment proposals Determined** through the Baltic Sea Region Testing Ground Facility (TGF) to ulti- * PoAs are considered a single project mately develop a portfolio of 13 projects. (http://nefco.org) ** 21 of the 69 Registered/Determined projects have issued Origins & Implementation of the Clean Development Mechanism and Joint Implementation 19 YEARS OF EXPERIENCE IN CARBON FINANCE implementation delays due to the time and proce- those found in successful development projects more dures required to obtain the necessary approvals and generally: licensing from relevant national authorities; the challenges of the changing CDM or JI method- A committed champion: Someone within the com- ologies and requirement to adhere to each new guid- pany or government who enthusiastically promotes ance after project development and regulatory delays; the progress of the project through its critical stages an insufficient carbon finance revenue stream in a mar- to obtain resources and/or active support from top ket where the value of emission credits is not clearly management. External technical assistance may be defined beyond 2012; and necessary when facing low capacity, but temporary the challenges of clearing due diligence screening pro- consultants do not make effective champions. cesses, including meeting the World Bank social and Strong project design & planning from the start: environmental safeguards (Annex 3). This includes feasibility studies as well as financial and methodology assessments early in the project cycle. It is also the case that a few projects were eventually Detailed upstream financial and technical due dili- withdrawn from the World Bank pipeline and, later devel- gence must be completed on project ideas, and early oped by another project developer or buyer. consideration must be given to monitoring require- About one-third (69) of the World Bank active proj- ments that will arise once the project is operational ects have been registered with the CDM Executive Board (or commissioned) and ready to generate emission (EB) or finally determined as JI projects. The remainder reductions. either have been submitted for registration and are await- Strong project financing: Projects must make finan- ing a decision (67) or are in the process of being submit- cial as well as technical sense to lead "to real, measur- ted (75). This statistic is slightly below that of the global able and long-term benefits related to mitigation of CDM pipeline where about 40% of the projects have climate change" as per the Kyoto Protocol. Further- been registered, mainly due to the longer time spent in more, like other investment decisions, CDM/JI proj- validation on average (discussed later). ects are also affected by the issues and challenges of the To date, all World Bank projects that were validated overall investment climate in host countries. and submitted for registration have been successfully reg- Clear potential to meet objectives (in this case) istered (the success rate for all the projects submitted for reduce emissions: Projects that have the ability to registration by the CDM is 96.5% according to UNEP reduce large volumes of GHG reductions relative to RISØ). The ultimate goal is, of course, to register (or their baseline are more likely to attract investors and "finally determine" in the case of JI) all the projects in the carbon asset buyers. Also, larger projects are better pipeline and to generate emission reductions which can able to absorb the fixed CDM transaction costs. be issued. Risk assessment Features of a successful project While there are evidently close parallels to be drawn What are the features or circumstances of a project between more typical development projects and CDM/ that make it more likely to become a successful CDM JI projects, it is also clear that CDM/JI projects, while or JI project activity? From our experience of looking providing additional benefits in the form of carbon at more than 1,100 project ideas and actively working finance, also involve additional risks. In addition to the on more than 200 projects, it is possible to outline four usual political and technical/commercial business risks, key "success" factors. These key features closely mirror there are specific CDM/JI risks. There is no single or uni- 20 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank World Bank approach to assessing CDM/JI project performance risks A project's expected emission reductions are outlined in its The tool evaluates a project's expected future emission reduc- project design document (PDD). However, the actual perfor- tions performance using six risk categories: (i) Financial Risk; mance of a project and its emission reductions can be affected (ii) Technology & Implementation Risk; (iii) Social & Environmen- by a variety of factors. To estimate what will be the actual emis- tal Risk; (iv) Methodology, Monitoring & Verification Risk; (v) sion generation and issuance, the World Bank conducts a risk Host Country Regulatory Risk; and (vi) Additionality Risk. These assessment of each project. A project's estimated emission categories were identified based on the World Bank's collec- delivery evolves through its lifecycle. tive experience and represent the key drivers of a project's emission credit issuance probability. The first three risk cat- The World Bank's project performance risk assessment tool egories are common to any project finance activity, while the estimates project risk on the basis of historical performance next three risks are specific to carbon finance activities. The of projects with similar characteristics, enhanced by project- tool also takes into account the "Business Environment Risk," specific assessments. Qualitative inputs, based on knowledge which reflects risks such as poor governance, civil war, and of the specific circumstances of each project, are also taken sovereign default. These can affect project implementation, into account. performance, and thus the expected emission reductions to be generated. form way (or tool) to assess risks from CDM/JI projects. developing a new methodology, as was the case partic- Box 2 provides an overview of the World Bank's approach ularly in the early days of the Kyoto mechanisms; and for performing a risk assessment of the performance of developing a Project Design Document (PDD)11, individual CDM or JI projects. which includes the project description i.e., the base- line methodology, monitoring methods/plan, GHG emission calculations, a statement of environmental Project preparation phase impact, and any stakeholder comments received. The World Bank carbon funds typically get engaged in carbon finance transactions at the inception stage, i.e., at Signing of the Emission Reductions Purchase the time when a project idea is developed. They are there- Agreement (ERPA) fore focused on the "primary" segment of the market for CERs (and ERUs). Once a project idea is approved in the Every project has its own specificities. However, in the World Bank pipeline, it enters a phase of project prepara- World Bank's experience, it takes, on average, roughly tion where, on the one hand, the standard World Bank two years from project idea acceptance to the signing of due diligence is conducted, and on the other, the carbon an ERPA. But the timeline for signing the ERPA can vary asset is developed according to CDM/JI rules. This may for different sellers and buyers (and has varied within the involve the following: World Bank portfolio) and depends on the willingness and expectations of both buying and selling parties. Signing the working with the project entity to assist it in its efforts ERPA earlier in the project development cycle, when there to secure financial closure; are more uncertainties and risks, implies a relatively lower ensure the proposed project is developed in accor- dance with the CDM/JI rules (e.g., ensuring that 11 See UNFCCC CDM website: http://cdm.unfccc.int/index. proper baseline measurements and data gathering are html; the UNEP "CDM Information and Guidebook" is also a good done according to CDM methodologies); reference. Origins & Implementation of the Clean Development Mechanism and Joint Implementation 21 YEARS OF EXPERIENCE IN CARBON FINANCE price; and signing later when there is greater certainty The differences in unit project costs largely correlate with on the project's prospect, typically resulting in a higher project size. Unsurprisingly, the project development unit price. With a legal commitment the World Bank typically cost for large projects, and notably the industrial gas proj- actively engages with the project entity to support the ects13, are very low due to the large volume of expected project's progression through the CDM/JI project cycle. emission reductions from these projects. In other words, technologies that provide for larger scale projects gener- ate more emission reduction credits, thereby spreading Costs the fixed costs. In terms of the costs of developing a carbon finance trans- action from PIN up to the signing of an ERPA, the expe- 3.2.2 Validation: independent audit rience of each project developer, buyer or project entity itself will likely be different and there is no standard The validation, conducted by an accredited Designated reference. Operational Entity (DOE), is the process of indepen- From the World Bank carbon funds, costs associated dently evaluating a project activity on the basis of the with the preparation of a project, including due diligence Project Design Document (PDD) against the CDM work, have amounted on average to about $200,000 per requirements14. This step is critical to maintaining the project (excluding additional regulatory costs for valida- environmental credibility of the system, as it essentially tion and periodic verifications, and excluding any capacity serves to check every project, through desk review as building work12). Project preparation costs vary with the well as a site visit, so as to correct any errors, and in the countries in which they are undertaken, the capacity of extreme, remove non-CDM compliant project proposals the project entity, the type and size of the project, and the from the CDM pipeline. complexity of the due diligence work. Figure 6 shows the unit cost (per expected ton of CO2 reduced) according In practice, a DOE's validation decision typically goes to different types of projects in the World Bank portfolio. through 3 internal levels of review: The audit team reviews the PDD and supporting documentation, conducts a site visit, and produces a validation protocol with their assessment and FIGURE 6 World Bank project development costs recommendation. by technology ($/expected ton of CO2 reduced) 12 The World Bank and other organizations have done a lot of work Industrial gases on capacity building to enable host countries and the local private sec- tor to understand the Kyoto mechanism, and to assess carbon finance Hydro opportunities. This work is difficult to quantify and not included in Methane avoidance the project preparation cost estimate, but has clearly been critical and beneficial to all market players involved in the CDM (and JI). Landfill gas 13 The First Tranche of the World Bank Umbrella Carbon Facility consists of 2 large HFC-23 projects in China. Biomass energy 14 This section focuses on the CDM process, but it should be noted Wind that the JI process is similar, with the term "determination" used instead of validation. Under JI, the determination is performed by $0 $0.20 $0.40 $0.60 $0.80 Accredited Independent Entities. 15 The UNFCCC uses the term "project participant". An entity can Source: World Bank, 2009 (from 53 World Bank registered become a project participant before or after registration of a CDM CDM projects considered) project, but must always have a letter of approval from a Kyoto Proto- col Party before it can do so and subsequently receive CERs from that project. (CDM Rulebook, http://cdmrulebook.org/69) 22 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank Once all questions are addressed by the project entity15 This may be in part because validation (and verification) based on clarifications and additional supporting doc- prices are not based on the size of the project, but rather umentation, a draft validation report is produced by on its degree of complexity, and small projects are often the audit team. The draft validation report is then sent in sectors that tend to be more complex to validate (e.g., for an independent internal technical review by certi- a small-scale dispersed solar home system project is more fied sector experts, who will clear it or issue further complex than a single large industrial facility). requests for information. Any additional request has The increase in DOE costs and the extended time it to be responded to by the audit team and/or the proj- takes to complete validations have been driven by sev- ect participants and then cleared by the sector experts. eral factors such as: (i) a sharp increase in the demand Once the document has been cleared, it will be finally for DOE services; (ii) the lack of, and competition for, checked for completeness and consistency before a CDM experts; (iii) CDM regulatory demands, volatil- final validation report is issued (additional requests ity16, and restrictions; (iv) risks (reputational, financial); could come from this last check). and (v) insufficient systematic support from the CDM EB and the UNFCCC Secretariat (for example, the The time required to complete a project's valida- validation and verification manual was only finalized in tion has increased over the past years. It currently takes November 2008). Another important factor has been the approximately 12 months, on average, to complete, with increasingly vocal concerns of stakeholders and the CDM some variability depending on the project. The costs of validation for individual projects have been on an upward 16For example, methodologies have been revised over time with trend (see Figure 7), reaching on average $28,000. More- more stringent requirements, provoking surges in submission prior to changes. As a CDM project and its PDD are developed closely follow- over, small-scale projects have not been exempted from ing an approved methodology, when methodologies are about to be the trend of increasing validation costs. In fact, they changed (which can be frequent), project developers that are devel- have been increasing faster than for larger projects, even oping a project using that methodology typically rush to submit their projects to avoid having to make significant changes to the project though the intention from the Marrakesh Accords was or its documentation, as these can be costly and can have significant to simplify procedures for small-scale CDM projects. impacts on the project if methodology changes are significant. FIGURE 7 Cost of CDM validations (World Bank experience) $40 $30 Thousands $20 $10 $0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Large Scale Small Scale Linear (Large Scale) Linear (Small Scale) Note: Inflation-adjusted (2010 dollars) /$ exchange rate calculated as spot FX rate on day of transaction Source: World Bank portfolio and pipeline (2010). Origins & Implementation of the Clean Development Mechanism and Joint Implementation 23 Years of experience in carbon finance EB regarding the too often unsatisfactory quality of vali- letter of approval (LoA) for each proposed CDM proj- dations. Increased scrutiny at registration by the CDM ect18. Indeed, while there is considerable variation among EB and enacted DOE suspensions,17 (thus creating sig- countries regarding the time required to secure an LoA, nificant reputational risks) are resulting in more detailed it takes more than 5 months on average (UNEP RISØ questions and documentation requests at the validation 2010). stage. In the World Bank's experience, these requests are In 2009, validations of World Bank projects have sometimes excessive. taken, on average, longer than the average time for a proj- The World Bank recognizes that some of the delays ect in the global CDM pipeline (Figure 8). Explanations during validation may not be caused by DOEs them- can be found by looking at the characteristics of the few selves. Once DOEs request documentation, project specific projects that took an unusually long time to vali- participants may not always be prompt in responding to date and influenced the average performance of the World these requests, thereby slowing down the validation pro- Bank's smaller validation sample, such as the Uganda Nile cess. Experience shows that weak capacity at the project Basin Reforestation project which took more than 800 entity level has a clear impact on the validation timeline. It is also the case, as discussed later, that some of the docu- mentation requested is simply not adapted to reality in 17 Since late 2008, four DOEs have been suspended at various times by the CDM EB, with two of them reinstated to date. Together, some host countries, such as in least developed countries these four DOEs are involved in more than 60% of the global CDM (LDCs) or for some types of projects such as micro-scale pipeline. 18 The DNA must issue the necessary statements that the project or small-scale projects. There may also be delays at the entity participates voluntarily in the project and must confirm that level of the host country CDM Designated National the project activity assists the host country in achieving sustainable Authority (DNA) who is responsible for providing a development. FIGURE 8 Length of CDM project registration process (from start of validation) CDM as a whole World Bank 700 700 Validations Registration Validations Registration Sample Size Sample Size 600 600 191 500 500 190 170 400 400 170 180 Days Days 192 300 100 300 107 65 76 200 200 82 47 195 195 247 289 341 341 169 197 278 332 494 244 100 100 61 400 368 382 572 41 5 24 10 8 15 1 0 0 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010 Note: Purposely exclude projects that went to re-evaluation Source: UNEP RISØ 24 origins & implementation of the clean Development Mechanism and Joint implementation Carbon finance at the World Bank days to validate. The characteristics of this project and a TABLE 2 Projects submitted for validation few others that took a long time to validate include: between 2003 and 2010: rejection rate weak project entity capacity, which is a critical factor; Rejected at validation* relatively new sectors and methodologies, as well as # of projects that have completed validation 2,251 country contexts with which DOEs were not yet very Projects receiving negative validation 148 familiar and where there were no (or limited) prec- Percentage 7% edents from which to draw; Source: UNEP RISØ, March 2010 changes in methodology during the course of valida- *excluding validations terminated prior to completion & validations with- tion; and drawn delays linked to the DOEs (i.e., DOE suspension, lack of capacity, frequent changes in auditors). which can be used to offset the emission obligations of the Annex I countries that have ratified the Kyoto Pro- As regards the environmental effectiveness of the vali- tocol21, as well as the emissions of installations covered in dation process, one (albeit insufficient) indicator is the the EU ETS, and in any other domestic emissions trading rate of rejection. Not all projects submitted for validation scheme recognizing CERs as a compliance asset. receive a positive outcome. As outlined in Table 2, the But there is room for improvement in this process. As DOEs have rejected 7% of the projects that underwent acknowledged by the CDM Executive Board (EB) in its validation between 2003 and 2010. Key issues at the vali- November 2009 EB's annual report that was discussed at dation stage usually relate to (i) the applicability of the the Copenhagen climate negotiations: CDM methodology; (ii) the baseline; and especially (iii) the determination of a project's additionality. The challenge for the Board, and the [secretariat] as part of its support structure, remains unchanged: to efficiently implement and administer the mech- 3.2.3 Registration: regulatory approval19 anism while ensuring its environmental integrity. (FCCC/KP/CMP/2009/16, paragraph 10) For CDM projects, the largest risks associated with the registration process are twofold: (i) rejection; and Indeed, the current situation contrasts with what was (ii) delay. As noted earlier, the World Bank has a good envisioned by the 2001 Marrakesh Accords22 where 8 track record regarding registration (i.e., no rejection); and weeks was the agreed timeline to complete the registra- so does the CDM in general (i.e., success rate of 96.5%). tion of a project (except in the case of requests for reviews The largest risk for the World Bank and other projects in --discussed later). Projects seeking to be registered cur- the global CDM pipeline is delay, which can be signifi- rently need, on average, 6 months to complete the CDM cant and have important implications. registration process. The assessment of the registration process and its delays must be made against the backdrop of the fact that there are now more than 2,100 registered CDM 19 This section focuses on the CDM experience. Registration is projects, which in itself is a testament to the impressive referred to as "final determination" under JI rules. 20 See, for example, Haites 2004, Rahman et al. 2010, or Dhakal 2001. amount of interest and action the CDM has generated on 21 Annex B of the Kyoto Protocol lists the countries with quantified the ground. It surpasses general expectations at the time the emission obligations. All Annex B countries have ratified the Kyoto Kyoto Protocol and the Marrakesh Accords were agreed20. Protocol, with the exception of the United States. (http://unfccc.int) 22 See the modalities and procedures for a Clean Development A successful registration means that the validated Mechanism as defined in Article 12 of the Kyoto Protocol: FCCC/ project becomes a CDM project and can generate CERs, CP/2001/13/Add.2, paragraph 41. Origins & Implementation of the Clean Development Mechanism and Joint Implementation 25 YEARS OF EXPERIENCE IN CARBON FINANCE The completeness check by the UNFCCC secretar- tinize individual projects at validation and on that basis iat--marks the point at which projects having received process the registration of successfully validated projects. a positive validation by the DOE are submitted to the However, the Marrakesh Accords have provided for the CDM EB for registration--was not a step originally envi- possibility to request reviews of the registration of a proj- sioned in the Marrakesh Accords' CDM modalities and ect activity when deemed warranted by either (i) a party procedures. This completeness check is currently taking involved24 in the project activity, or (ii) at least 3 mem- approximately 3 months to perform. In addition to under- bers of the EB. The parameters for reviewing a request for staffing at the UNFCCC secretariat23, a key reason for registration are set as follows: such delay is the deliberate use of the completeness check as an additional quality control on the technical content The review by the Executive Board shall be made in accor- of the project submission (i.e., an additional check on the dance with the following provisions: successfully validated project), rather than simply focus- ing on the completeness of all the documentation. It shall be related to issues associated with the validation In addition to the challenges at the validation and requirements. completeness check stages, CDM projects have been It shall be finalized no later than at the second meeting experiencing increasing delays even after passing a suc- following the request for review, with the decision and the cessful validation and completeness check. It was originally envisioned that the CDM EB would 23 See Annex 12 of report from February 2010 meeting of the CDM focus its activities on the more executive functions of Executive Board (EB 52). 24 There are usually two Parties involved in a CDM project activity: broader CDM policy and guidance, and would largely (i) the host Government; and (ii) the Annex I Government (that rely on the independent and accredited DOEs to scru- authorizes the participation of the Annex I buyer). FIGURE 9 Request for registration by year: EB decisions 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2004/05 2006 2007 2008 Request registration year in the letter from the DOEs Share of projects registered automatically Share of projects with request for review and no review Share of projects that had a review Share of projects rejected or withdrawn Source: UNEP RISØ, March 2010 26 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank reasons for it being communicated to the project partici- going through the CDM approval process (in terms of pants and the public (3/CMP.1, Annex, paragraph 41). staff resources), it is also important to take into account the impact of the delays. Registration delays push back the It is understood that the review process was intro- date on which a project can start generating CERs, which duced to ensure that all projects are credible and to avoid effectively reduces the potential volume of CERs that crediting non-eligible projects. Concerns over the quality can be transacted, as the majority of CER buyers seek to of the DOE's work have prompted the EB, particularly in purchase CERs for compliance with the Kyoto Protocol's recent years, to make frequent use of the provisions for first commitment period ending in 2012. These delays can reviewing a request for registration. In its 2009 annual therefore be particularly costly. Table 3 seeks to illustrate report, the EB acknowledged that it has been "...required the financial impact of the increases in CDM approval to review an unacceptably high proportion of projects" to delays for individual projects through hypothetical exam- ensure environmental integrity. ples: a loss of revenue amounting to 277,000 for a small Roughly 50% of all CDM projects (i.e., 1,091 out of project to 1.1 million for a large project, assuming a price 2,256 projects) had requests for review at registration, but of 9.5 per CER. Not quantified here, but also critical, is that overall figure masks the yearly evolution (Figure 9). the impact the delays are having on a project's cash flows. In fact, while approximately 90% of projects submitted Thus, the more a project relies on CDM revenues for for registration in 2004/2005 were registered automati- its financial viability (or said differently, the more "addi- cally by the CDM EB, this proportion has consistently tional" is a project), the greater the weight that CDM decreased and has shrunk to 30% in 2008--the last date regulatory risk has on its overall risk profile. for which a complete set of data is available for this sta- At the aggregate level of the entire CDM, the value of tistic. This means that out of all the projects requesting lost CERs associated with the increase in approval delays registration in 2008, the EB decided to review the request observed since 2008 is estimated to be around 800 mil- for registration for 70% of them. By 2008, less than 7% of lion (Figure 10). all projects submitted for registration had been rejected There are also implications in terms of cost of and denied registration. money, with revenues today worth more than revenues In addition to the direct transaction costs associated tomorrow, as well as important broader implications in with validations and the costs to project participants of terms of potentially causing loss of interest and possible TABLE 3 Quantification of lost revenues from CDM approval delays: hypothetical project examples Small project Average project Large project Annual emission reductions (tCO2e) 50,000 100,000 200,000 2-year ERPA volume (tCO2e) 100,000 200,000 400,000 3-year ERPA volume (tCO2e) 150,000 300,000 600,000 Price of CERs (Euros) 9.50 9.50 9.50 Value of 2-year ERPA (Euros) 950,000 1,900,000 3,800,000 Value of 3-year ERPA (Euros) 1,425,000 2,850,000 5,700,000 Impact of 7-month* additional delay in registration: Loss of revenue in first year (Euros) 277,083 554,167 1,108,333 As % loss for a 2-year ERPA 29% 29% 29% As % loss for a 3-year ERPA 19% 19% 19% Assumption: projects are commissioned and generating emission reductions * 7 month delay represents the average time increase for registration from 2004­2007 to 2008­2009 Origins & Implementation of the Clean Development Mechanism and Joint Implementation 27 YEARS OF EXPERIENCE IN CARBON FINANCE the registration process. The EB therefore requested the UNFCCC secretariat to review validation reports, and FIGURE 10 Estimation of costs associated with lost CERs due to increased delays at registration also set up a Registration and Issuance Team. Validation Registration ~17 However, it is becoming very clear through the World Bank's work with a diverse group of project entities, that s along with the transaction costs and the relatively short o nth 7.0 7m Kyoto commitment period, the increasing timeframe ~10 associated with the CDM approval process has become 2.4 Estimate of overall cost difficult to fit into typically shorter private sector invest- of increased delay 800 10.1 ment decision-making processes. This is undoubtedly 7.1 million reducing the impact of the CDM. The excessive delays contribute to the CDM regulatory risks and have a sub- 2005­2007 2008­2009 stantial negative impact for project entities seeking to implement GHG-reducing projects. Note 1: Average months to achieve registration is taken from UNEP RISØ Note 2 : Estimate of lost revenue due to delay is calculated by taking the average expected tons per month from projects registered in 2008 & Recommendation: To compensate for the regulatory 2009 (11,250 tC02e) and multilying 6.6 months, (i.e., difference between the 2005­2007 average and the 2008­2009 average.) This is then delays that are not the fault of project entities, the date on multiplied by the total number of project registered over the period which a successfully registered project can start earning 2008­2009 (1,114) and by 9.5 Euros as a proxy for the pCER price over the 2008­2009 period to arrive at 785,787,750. CERs should be moved from the date of actual registra- tion to the date on which it is submitted for registration. The EB, it must be noted, has not ignored this issue of delays and has been introducing timelines for the pro- lost opportunities to stimulate more GHG-friendly cessing of projects to increase predictability. The EB is projects. also currently in the process of developing procedures for an appeals process that should assist in (i) ensuring and maintaining due process; and (ii) providing an incentive Conclusions and recommendations on to promote good performance by the CDM regulatory registration stage bodies (DOEs and the EB). The CDM EB is seeking ways to improve the registration and issuance procedures, The saying that the CDM is a "victim of its success" may as requested by the 2009 Copenhagen26 decision on the indeed be true. The current regulatory bottlenecks and CDM (i.e., Decision 2/CMP.5). The UNFCCC Secre- delays at the level of projects requesting CDM registra- tariat is also seeking to improve the effectiveness of its sup- tion are (at least partly) due to the huge influx of projects port to CDM and JI, as per the Draft CDM Management submitted during 2008 and 2009, which was difficult Plan 201027. to absorb in a system that performs multiple checks on From the perspective of the practitioner seeking to projects. develop CDM projects, all these developments are wel- It is also true that there have been some legitimate 25 See for example Wara and Victor (2008) and Michaelowa and Puro- concerns regarding the performance of DOEs and some hit (2007). vocal critics25 arguing that registered CDM projects 26 The Fifth Session of the Conference of the Parties serving as the were not all additional and should not all have been reg- meeting of the Parties to the Kyoto Protocol (CMP 5) took place in istered. The increased delays at registration coincided Copenhagen in December 2009. 27 See Annex 12 of the report from the 52nd meeting of the CDM with the decision by the CDM EB to intensify scrutiny Executive Board (EB 52) which took place in February 2010: available of DOE validation reports as a means of strengthening at http://cdm.unfccc.int/EB/052/eb52rep.pdf 28 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank FIGURE 11 Delays in CDM validation and registration (according to share of projects) % of projects registered in a given year by how long it took 100% 8% 11% 8% 23% 11% 40% 46% 47% 23% 58% 50% 40% 46% 46% 47% 27% 28% 19% 7% 9% 5% 0% 2005 2006 2007 2008 2009 2010 <200 days 200­400 days 400­600 days 600+ days Note 1: Includes both the time of validation and registration Note 2:Purposely excludes projects that went for re-validation Note 3: From PDD publishing to registration date in UNEP RISØ come and necessary to maintain interest and confidence, requesting CDM registration, (either through outright and must remain of the highest priority. As shown in project rejections or modifications to claimed emission Figure 11, a minority of projects make it through the reductions) 15 MtCO2e did not enter the carbon mar- CDM regulatory approval process in less than a year. Pro- ket, representing 3.8% of the CERs associated with all the portions need to be inverted: in the not too distant future, projects requesting registration. Looking at 2009 alone, only a minority of projects should be processed in more the year when scrutiny at registration has been greatest, than a year. the impact of the CDM EB enhanced scrutiny at regis- The costs associated with these delays are significant tration (and outright rejections) was slightly greater on and are consuming more and more of the CDM benefits. avoided non-eligible tons, amounting to 6% of the CERs It is important to examine whether this enhanced and associated with all the 2009 registration requests. intensive scrutiny at registration is efficient and effec- It is becoming essential to improve the CDM regula- tive and is indeed translating into commensurate envi- tory system and to achieve a better model to balance the ronmental benefits. While it is beyond the scope of this critical need of ensuring environmental integrity with report to undertake such a comprehensive assessment, the a regulatory process that is streamlined, appropriately analysis below suggests that the current scrutiny burden staffed, clearer in its decisions and interpretation, and placed on projects seeking registration may be too heavy- generally more predictable. handed compared to the benefits achieved, and with too many compliant projects being penalized and delayed. Recommendations: Based on the current CDM regulatory As shown in Table 4, the environmental benefits result- model, increased effectiveness would require, inter alia: ing from the intensive scrutiny at registration--in terms of ensuring that CERs are denied for non-eligible proj- Incentives to enhance the capacity of DOEs to carry ects--are, in the end, rather small. From 2004 to 2010, out high-quality validations. Payments for re-submis- as a result of the increased scrutiny at the stage of projects sions, and clear and efficient appeals procedures to Origins & Implementation of the Clean Development Mechanism and Joint Implementation 29 YEARS OF EXPERIENCE IN CARBON FINANCE TA B L E 4 CDM registration and rejections: GHG implications Registration Statistics 200­2010*** Avg tons /year % Requested for registration (by volume; tCO2e) 419,986,920 100.00% Registered (by volume; tCO2e) 404,161,866 96.23% Put under review (by volume; tCO2e) 67,681,065 16.12% Rejected by EB (by volume; tCO2e) 15,581,318 3.71% Volume changed in review process (by volume; tCO2e) 243,736 0.06% Total non-eligible tons rejected by EB at the registration stage 15,825,054 3.77% Euro value of non-eligible tons (assumes 9.50 per ton) 150,338,013 Euros Note: Only accounts for issuance requests that have completed the review process. Source: IGES Database: April 1, 2010 establish due process28 on DOE performance must be ever, experience clearly shows that the bulk of the work combined with closer interaction between the DOEs associated with CDM projects (and CDM Programmes and the EB29, along with intensified training and of Activities31) actually takes place after registration, with capacity development of DOEs. Restoring trust in the the monitoring and verification procedures as illustrated performance of DOEs is critical to both the environ- in Figure 12. Project implementation, which often takes mental integrity of the CDM and how it is perceived, more time than originally anticipated, can also occur after as well as to speeding up validations and enhancing registration. the efficiency (and reducing duplications) of the over- The key document in project implementation is the all CDM registration process. monitoring plan32, a document which is designed during Move from the current review system involving mul- the development of a project's PDD, prior to registration. tiple checks per project to one based on automatic The plan specifies the variables that must be monitored, registration of successfully validated projects. Such a change in registration procedure could be accom- panied by a CER discount on each project (a sort of 28 The CDM is only now-- following the December 2009 decision environmental integrity levy to compensate for the 2/CMP.5 on the CDM taken in Copenhagen-- starting to look into developing procedures for considering appeals brought forward by system's possible non-eligible CERs). At the same stakeholders directly involved in a CDM project. Such appeals can time, spot checks on a limited number of projects relate to the performance of DOEs, as well as to decisions taken by the would reduce the risk of gaming. CDM Executive Board. 29 Some (e.g., Schneider 2007) have argued that the independence of DOEs, and with it the confidence in the integrity of their assessments, could be strengthened if the CDM Executive Board, through the 3.2.4 Monitoring & carbon asset creation UNFCCC secretariat, selected and paid the DOEs. It not clear that such an arrangement would be effective in practice. In other auditing areas, auditors are not typically paid by the regulator. In addition to securing financing and timely commission- 30 This is the same for JI. 31 Programmes of Activities are discussed later in the report. ing, successful CDM project implementation and CER 32 Paragraph 56 of Annex H of the Marrakesh Accords states that the issuance (and corresponding carbon finance payment to implementation of the plan is an obligation of a project developer project entities) depend on successfully adhering to the or project operator and a condition for the issuance of CERs. Para- relevant methodologies and monitoring procedures.30 graph 60 of the same Annex further specifies that a project operator be equipped to issue a report detailing how this plan has been imple- Once a project has been registered, many project enti- mented and how much emission reduction is generated within the ties feel that the CDM component is completed. How- crediting phase at the end of every monitoring period. 30 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank FIGURE 12 CDM project implementation cycle Monitoring and reporting: The project owner carries out monitoring of the project according to the monitoring plan in the registered PDD, reports the monitoring results to the DOE. Issuance if RIT Verification and Certification of ERs: The CDM project enters the Verification and review positive Monitoring Certification stage after the project owner submits the monitoring report. Verification and EB accept means the periodic independent review and ex-post determination on the registered CDM project made by the DOE applying methods prescribed in the monitoring plan. Certification means the written permits issued by the DOE on the basis of the verified emission reductions. The certification report is issued to the participants of the project, the relevant parties and the EB. Issuance of CERs: CERs mean the Certified Emission Reductions of greenhouse Verification/ gases. The certified report is submitted by the DOE to the RIT for review. The RIT Certification makes a recommendation upon which the EB issue CERs. Legend: CER: Certified Emission Reduction RIT: Registration and Issuance Team PDD: Project Design Document DOE: Designated Operational Entity ER: Emission Reductions EB: Executive Board the frequency of monitoring, and the manner of quality plan, which sometimes differs from the typical business- control. as-usual (BAU) practice. The main barrier to successful project implementation The series of processes to obtain issued CERs starts and a cause for questions during the verification process with the project participants' submission of the monitor- (and questions and reviews at the stage of requesting ing report to the DOE for the verification process. During CER issuance) stems from the fact that the implementa- this process, the DOE will check if the monitoring plan tion of the monitoring plan requires support from many has been fully carried out in accordance with the PDD members of an organization, but the knowledge and and the reported emission reduction has been achieved. understanding of the benefits of the CDM is often kept The cost of a verification, as experienced by the to one or two persons in an organization with different World Bank, currently amounts to about $20,000, a responsibilities. cost that has been increasing over time (as has the cost In many projects, the personnel assisting with project of a validation), with little distinction between small registration, and therefore the personnel with knowledge and large-scale projects (see Figure 13). This is a recur- of the CDM and its procedures, are different from those ring cost for every subsequent verification performed who have responsibilities for implementing the project on a project. and the monitoring plan. The importance of adhering The typical reasons for the regulator's intervention, exactly to the requirements specified in the PDD's moni- in terms of verification correction and/or review, appear toring plan has often been underestimated. to reflect, in part, the lack of awareness about the impor- This is illustrated by inaccuracy in terms of calibra- tance of following the monitoring plan to the letter; they tion, timing, or inconsistencies between the monitor- are summarized in Table 5. ing plan and evidence or procedures assessed by DOEs Based on a successful verification, the DOE certifies at verification. Additionally, there is often insufficient the emission reductions by issuing a certification report training to enable those personnel with responsibilities and requests the CDM EB to issue the verified amount for collecting key process parameters to do this with the of CERs (request for CERs issuance). If no concerns are precision and frequency expected from the monitoring raised by at least three EB members, CERs are issued Origins & Implementation of the Clean Development Mechanism and Joint Implementation 31 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 13 Cost of CDM verifications (World Bank experience) $30 $20 Thousands $10 $0 2002 2003 2004 2005 2006 2007 2008 2009 2010 Large Scale Small Scale Linear (Large Scale) Linear (Small Scale) Note: Inflation-adjusted (2010 dollars) /$ exchange rate calculated as spot FX rate on day of transaction automatically after the review period. In some cases, the Conclusions and recommendations on CDM EB may put a request for issuance under review. monitoring Interestingly, project types are not evenly affected by the CDM review process at issuance, with biomass, N2O Improvements in the regulatory process are necessary decomposition, biogas, methane recovery and utilization, and many are under consideration. But in view of the and hydro power projects having been most affected and higher number of projects that will be entering the issu- delayed by reviews at issuance33. ance process in the next few years, it is urgent to fast- Such reviews can lead to one of three scenarios: track improvements and enhance efficiencies. Indeed, as (i) CERs are issued in the requested amount; (ii) a cor- illustrated in Figure 14, looking at all the projects that rection in the volume of emission reduction may be are registered, and those that are currently undergoing applied; or (iii) in the worst case scenario, the issuance validation and will be seeking registration, it is possible may be rejected altogether. The latter two possibilities to anticipate a huge wave of verifications and requests for have obvious consequences for a project's cash flow. issuance in the not too distant future. However, as with review cases at registration, review cases at issuance rarely lead to rejection of issuance. Of all 33 For example, for hydro projects there are often discrepancies requests for issuance completed to date, 21% have received between the plant load factor (i.e., the actual output of a power plant a request for review, while less than 1% have been rejected. over a period of time) stipulated in the PDD and verified power gener- ation, which can be due to an unusual rainfall amount. Another com- As is the case at the registration stage, the multiple checks mon issue relates to discrepancies between the accuracy of meters and to reach issuance are causing delays and impacting proj- calibration frequencies found in the PDD and what is done in prac- ect entities' revenues. The World Bank currently estimates tice. There are general problems of compliance with monitoring on the ground. that projects without a request for review take close to 100 34 There is no general rule on the duration of the monitoring/report- days from the day of submitting a request for issuance ing period and the frequency of requesting CER issuance. Typically a to the time of actual CER issuance. And this is the case single calendar year is perceived as the optimum for World Bank proj- ects. Projects generating large volumes of CERs can also better absorb for every request for issuance, with each project typically the transaction costs associated with more frequent verifications and making more than one request for issuance34. issuances. 32 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank TABLE 5 Reasons for verification corrections and/or issuance rejections Reason Explanation Too high uncertainty surrounding Certain parameters require random sampling for measurement. Sampling is typically required for sampling data collected for some parameters that cannot be measured continuously through on-line instrumentations for reasons such parameters. as impracticality or cost. Common examples are the measurement of gas concentration in residual biomass or exhaust gas of a power generation plant. Inherently, a parameter measured through random sampling involves a certain degree of uncertainty in its results. It is, however, necessary to ensure that the possible error (or uncertainty) in the measurement is small in comparison to the result of the measurement in order for the data to be useful. Therefore a certain confidence level of data needs to be reported, but this level is sometimes not provided. Calculation method conveyed in the Many monitored parameters require a combination of direct data reading and report estimation. monitoring plan not applied. This is common in the monitoring of a thermal output in projects that generate heat as a form of energy. Care must be taken when identifying how to calculate thermal output in the monitoring plan since calculation methods vary from project to project. Monitoring frequency not adhered In general, more frequent data collection is recommended. However, there are situations where data to. are difficult to obtain. For example, fuel purchase records may consist of daily receipts from various vendors that may not correspond to actual fuel use within the same month. In such situations, it is often best to use annual data, and the lower value between recorded fuel use and fuel purchase should be applied to ensure conservativeness. Calibration frequency not appropri- Several projects were put under review at issuance due to a difference between the frequency of ate. calibration as specified in the monitoring methodology and plan compared to the actual implementa- tion. In many cases, the delayed calibration is insignificant in terms of the total amount of CERs that are altered; however, in some cases, delays in calibration can be significant. A positive development is the EB's recently issued "Guidelines for assessing compliance with the calibration frequency re- quirements." Use of accuracy indicators by The use of accuracy indicators by equipment manufacturers may differ from the monitoring plan, the equipment manufacturer that since the monitoring plan must comply with approved methodologies that are often written for more do not match the monitoring than one technology type. plan. Missing documentation Often reflects that CDM know-how is not fully appreciated by multiple employees and that there is a lack of standard monitoring procedures to clearly identify what is required in terms of data collec- tion and what is sufficient evidence. This will test the CDM system and its ability to issue Recommendations: CERs as we approach the end of the Kyoto Protocol's To facilitate project implementation and verifications: first commitment period. Governments and private enti- ties will be seeking the CERs from their CDM projects Project entities should carefully integrate their CDM to meet their compliance obligations associated with project's monitoring plan into their operational work the Kyoto Protocol. Project entities will need the car- plan and ensure that relevant staff is familiar with the bon finance revenues to sustain their CDM projects and CDM monitoring requirements. This may require ensure ongoing GHG reductions. Reducing regulatory training. timelines and CDM-related costs will require streamlin- CDM monitoring requirements specified in method- ing the project cycle up to, and including issuance. All ologies should be reviewed and revised as appropriate efforts to enhance clarity and practicality in rules, proce- to ensure that, to the extent possible, they build on, dures, and documentation requirements are steps in the and are consistent with, actual sector/industry and right direction. country practices. Origins & Implementation of the Clean Development Mechanism and Joint Implementation 33 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 14 Number validations and verifications processed: to date and projected Number of Requests 8000 Issuance Registration 7000 6000 5000 4774 4000 1950 3000 2000 2403 2712 1000 0 Processed To be processed (Sept. 2004 ­ Feb. 2010) (March 2010 ­ Dec. 2012) Source: UNEP RISØ N.B. "To be processed": includes projects in validation as of March 2010. Issuance figures are conservative and assume only one issuance request per project during the 2010-2012 period. To facilitate verifications: non-eligible CERs. According to data on overall The concept of materiality35, which is an impor- CDM issuance requests (Table 6), in the end, only tant auditing concept, should be incorporated into approximately 0.25% of CERs requested for issuance the CDM's guidance on verification. Without such were denied. This suggests that current delays, which guidance, as is currently the case, all issues revealed are poised to increase with the increased number of during verification--significant or insignificant for expected requests for issuance, and associated costs the calculation of emission reductions--are treated (to the regulatory body and to the project entity) with the same level of scrutiny. In order to express an do not appear to be matched by commensurate envi- opinion on data or information, an auditor needs to ronmental benefits. It is thus recommended that to form a view on the materiality of all uncertainties. improve the effectiveness and efficiency of the CDM A materiality threshold would provide guidance to regulatory system: DOEs on what constitutes a material discrepancy, The CER issuance process should be streamlined so that they can concentrate their work on areas that and move towards the automatic issuance of suc- are more likely to lead to materially misleading errors (i.e., those with material impacts on claimed emission reductions). 35 Materiality is defined in the glossary of the International Account- ing Standards Board's "Framework for the Preparation and Presenta- tion of Financial Statements" as: Information is material if its omission To enhance the effectiveness and efficiency of verifica- or misstatement could influence the economic decisions of users taken tions and issuances: on the basis of the financial statements. Materiality depends on the It is important to look at the effectiveness of the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or current scrutiny at issuance in terms of its impact cutoff point rather than being a primary qualitative characteristic on the environment, measured by the detection of which information must have if it is to be useful. 34 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank TA B L E 6 Request for issuance statistics: impact on CERs Request for Issuance Statistics 2005­2010 % CERS that went through request for issuance 398,081,509 100.00% CER issuance put under full review (by volume; tCO2e) 14,854,316 3.73% CER issuance completely rejected (by volume; tCO2e) 768,203 0.19% CERs issued but reduced from original request (by volume; tCO2e) 215,103 0.05% Total non-eligible tons found by EB at issuance (by volume; tCO2e) 983,306 0.25% Euro value of non-eligible tons at issuance (assumes 9.50) 9,341,407 Euros CER issuances requested (by # of requests) 1,618 100.00% CER issuances requested for review (by # of requests) 336 20.77% CER issuance requests rejected (by # of requests) 14 0.87% Note: Only accounts for issuance requests that have completed the review process Source: IGES Database: April 1, 2010 cessfully verified reductions with random spot first methodology approved in the fall of 2003. More- checks. over, both the successful (i.e., approved) and unsuccessful As per the recommendations for improving the provided rich learning experiences that are shared with all registration process, the capacity of DOEs to carry stakeholders. out high quality verifications should be enhanced From the beginning of the World Bank's involvement through increased interaction with the EB to in carbon finance, the development of methodologies restore trust in their performance. was, and continues to be, an important component of its activities. In fact, 53 CDM approved methodologies, including forestry methodologies, have been submitted 3.3 Methodologies: the measuring stick for approval by or include contributions from the World Bank; this represents more than 40% of the 120 approved Methodologies are central to the project-based mecha- CDM methodologies. Figure 16 shows the many sectors nisms. A methodology clarifies the approved procedures targeted by the World Bank in its methodology submis- to define project eligibility, to calculate the baseline and sions, including methodologies for both small- and large- project emissions, and to monitor emission reductions scale projects37. from a project activity over time. The development of Under the CDM (and JI), methodology development methodologies is critical in order to expand the reach of occurs through a "bottom-up" process where individual the CDM/JI, since each new methodology has the poten- project participants, accompanied by a concrete project tial to unleash a new path for a different type of project/ example, develop and submit a methodology for approval activity to access carbon finance. by the CDM EB38. The development of methodologies Currently there are over 120 active36 and approved CDM methodologies, covering a wide variety of proj- 36 The term "active" excludes the approved methodologies that were ect types and technologies. Figure 15 presents the total subsequently subsumed in a new consolidated methodology and later number of approved methodologies according to the became no longer usable. 37 The CDM specifies size thresholds for small-scale CDM projects sectoral scope they cover. This is a significant and note- that are to benefit from simplified modalities and procedures (see worthy development, considering that the CDM started CDM website http://cdm.unfccc.int/methodologies/SSCmethodol- with an absolute blank slate of methodologies, with the ogies/index.html). Origins & Implementation of the Clean Development Mechanism and Joint Implementation 35 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 15 CDM approved methodologies by sectoral scope Energy industries (#1) Manufacturing industries (#4) Afforestation and reforestation (#14) Chemical industries (#5) Waste handling and disposal (#13) Energy demand (#3) Fug. emissions from halocarbons and SF6 (#11) Fug. emissions fuels (#10) Metal production (#9) Transport (#7) Agriculture (#15) Energy distribution (#2) Mining/mineral production (#8) Solvent use (#12) Construction (#6) 0 10 20 30 40 # of submissions World Bank submissions Rest of CDM Submissions can be viewed as a public good since once a methodology FIGURE 16 Sectors targeted by methodology is approved it can be used by any other project developer. submissions by the World Bank There are no patents or fees that go to compensate meth- odology developers. As such, there is no clear first mover advantage for those that champion methodologies, but 14% 3% 24% there are costs and risks. In the World Bank's experience, a new methodology costs approximately $125,000 for 7% both large- and small-scale projects (with higher costs 3% 10% typically experienced for methodologies for afforesta- 3% 4% tion and reforestation), and takes approximately two 4% 24% 4% years to develop from inception to approval. The costs and resource demands (e.g., in terms of staff time) can be high; there is also a 50% risk that the methodology may Afforestation Biomass Cement Coal bed/ and/or Energy Fossil fuel mine methane reforestation Efficiency switch 38 In order to ensure that CDM baseline and monitoring methodolo- Fugitive Landfill Methane PFC + SF6 gies are practical and reflect project realities, methodologies are based Emissions avoidance on concrete projects and developed directly from practitioners who Renewables and recovery submit them to the CDM Executive Board (and the Board's Method- ology Panel) for its approval. This was to avoid a theoretical top-down approach which may be disconnected with reality on the ground. 36 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank be rejected39 (based on experience of overall methodolo- lying project to be registered. This is particularly true gies submitted for approval). in the context of the iterative methodology approval Many existing methodologies are still not broadly process where the conservativeness and stringency of applicable, limiting the opportunity for greater num- the various elements of a proposed methodology tend bers of projects and associated GHG reductions. There to increase with each iteration. More widely applica- is a handful of clear exceptions, including the two meth- ble methodologies can be more expensive to produce odologies (large-scale and small-scale) directed at grid- (e.g., demanding more data and justification) and connected electricity generation from renewable sources; lengthier to get through the approval process, as well together, they have been used by almost 60% of all reg- as riskier in terms of obtaining final approval. istered CDM projects. However, out of a total of 70 As a result of editing by the CDM Methodology existing large-scale CDM methodologies and excluding Panel and/or the UNFCCC secretariat, a methodol- methodologies that were approved within the last year40, ogy may become difficult to apply, even in some cases, 21 (i.e., 30%) have not yet been used even once. In other to the underlying project case. The intention of the words, not even the project developer who submitted the methodology approval process is to guarantee its envi- new large-scale methodology has been able to apply it to ronmental credibility. However, methodology editing a project. For small-scale projects, excluding small-scale is typically not checked by practitioners in the field afforestation and reforestation (AR) and methodologies and against field conditions (particularly in LDCs), that are under a year old, approximately 20% have never thereby limiting the applicability of methodologies. been used once. Small-scale AR methodologies appear The World Bank-- and others--has seen how modi- particularly unfavorable with only one methodology hav- fications required or made by the CDM regulator can ing any associated projects out of a total of 6 approved affect the suitability of a methodology for even the methodologies. underlying project. Consultation with appropriate In addition to methodologies that have never been experts prior to finalizing the text for an approved used, the majority of approved methodologies have only methodology could assist in increasing the applicabil- been used by one or two projects. The fact that so many ity of some methodologies. methodologies are rarely or never used is certainly an indi- Methodologies, which are typically developed dur- cation of sub-optimal use of limited resources. It largely ing the concept stage of a project, are not sufficiently reflects limitations of the bottom-up approach that, while flexible to accommodate evolving project designs. In providing flexibility and opportunities for methodologies response, the CDM EB created "consolidated meth- of all types of projects to be considered, results in fewer odologies" for some types of projects, some of which general and broadly applicable methodologies. have been used extensively. In the World Bank's experience, there are four main Defining what is "conservative enough" is a matter of reasons why a new methodology may become difficult to subjective interpretation. It is important that method- apply to a broad number of projects: ologies be environmentally credible. Perfect accuracy is very often not possible and/or would be too costly, There is little incentive for project developers to sub- so methodologies need to remain "conservative." This mit a broadly applicable methodology. Given the principle is generally well accepted, but it raises the CDM's bottom-up approach to methodology devel- questions of what is sufficiently "conservative" in the opment, the costs associated with the methodology development are borne by the project developer. Therefore, the aim of a methodology developer is 39 In the last 10 methodology rounds the rejection/withdrawal rate has been closer to 60% indicating it is becoming harder to secure to simply get the methodology through the CDM approval for new methodologies. approval process in a form which will allow the under- 40 Excludes AM84,AM85,AM86,AM87 Origins & Implementation of the Clean Development Mechanism and Joint Implementation 37 YEARS OF EXPERIENCE IN CARBON FINANCE calculation of GHG emission reductions in the face This could be achieved through predictable and appro- of uncertainty. Many stakeholders, including the priate revision timelines. World Bank, have noted that the tools that control risks and define uncertainty, such as the application of the concept of materiality, could help reduce the Recommendations on methodologies costs involved in submitting broader methodologies by streamlining project assessment and enhancing Looking forward, it will be important to build on current consistency, transparency, and predictability. EB efforts and the very rich body of methodology experi- ence to develop practical and simplified methodologies Clear incentives to develop broader and more widely that strike a balance between providing a reasonable assur- accessible methodologies are missing, slowing down ance of their conservativeness and maintaining incentives innovation and consequently the implementation of to develop CDM projects. Moreover, the experience projects that can contribute to climate change mitigation and lessons from the CDM methodologies on how to (or sequestration). It is time, as requested by the Parties determine emission baselines and how to count emission in the 2009 Copenhagen 2009 decision on the CDM (2/ reductions from different types of mitigation and seques- CMP.5), to consider a more top-down approach based tration activities can usefully inform Parties in the devel- on greater standardization of baselines, benchmarks, opment of their own domestic mitigation plans (such as and default values where appropriate. Such an approach developing countries' Nationally Appropriate Mitigation should build on and draw from already approved Actions42) and any new market-based mechanism43. methodologies. It is also important to seek a better balance between Recommendations: the need to continuously improve methodologies and the need for regulatory reliability and predictability. Once Simplify and broaden the scope of baseline method- a methodology has been submitted, it can be revised ologies through greater standardization where pos- numerous times. While it is certainly important to cor- rect and improve methodologies, too frequent revisions 41 The current grace period is 8 months but the EB can implement changes without grace periods, as was the case at EB53 (March 2010) to methodologies have resulted in increasing uncertainty for top-down (i.e., regulator initiated revision) methodology revisions and time delays in project submissions. to ACM0013 and ACM0015. The approved consolidated method- For example, to date, the two most popular method- ologies for grid connected fossil fuel fired power plants (ACM0013) and for clinker production in cement kilns (ACM0015). ologies, i.e., the large- and small-scale methodologies for 42 The 2007 Bali Action Plan under the UNFCCC envisages, under grid-connected electricity generation from renewable clause 1(b)(ii), enhanced national/international action on mitigation sources, have been revised 11 and 15 times, respectively. of climate change, including, inter alia, consideration of Nationally Appropriate Mitigation Actions by developing country parties in the This means that these methodologies, on average, have context of sustainable development, supported and enabled by tech- been modified several times per year, every year. These nology, financing and capacity building, in a measurable, reportable revisions can cause difficulties and delays in project PDD and verifiable manner. 43 In the context of the recent UNFCCC negotiations on the post- preparation, when such changes are significant. 2012 climate regime, there have been proposals for moving beyond Methodology revisions made to reflect changes in the CDM through "sectoral market mechanisms" where credits for the EB's interpretation of rules or guidance are particu- emission reductions would be issued once a country reports perfor- mance that exceeds an agreed sectoral emission objective, i.e., the larly difficult to anticipate, and without a sufficient grace baseline. The idea of "sectoral trading mechanisms" is also explored period41, have significantly affected several projects (see for example, the EU Council conclusions on the EU position undergoing validation (considering that a validation for the Copenhagen Climate Conference, 21 October 2009). How- ever, to date, the developing countries have not participated actively period lasts about 12 months). Providing greater reliabil- in these discussions and no decision has been taken on any such new ity is becoming a critical matter for project developers. mechanism. 38 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank sible and appropriate, such as standardized emission Work, together with practitioners and industry/ factors in the power sector, benchmarks44 or default sector specialists, to ensure that methodologies and (deemed) values for energy-efficient equipment45; particularly monitoring requirements build on and these elements can already be found in some of the are consistent with existing industry/sector prac- proposed and approved methodologies. tices, standards and/or reporting guidelines and are Ambitious yet realistic stringency levels of such stan- tailored to contexts on the ground. The EB's recent dardized baselines need to be achieved through an efforts to assess and improve the applicability of some acceptable and pragmatic balance between (i) environ- methodologies, through co-operation with industrial mental integrity (and conservativeness) and (ii) envi- associations or working groups representing multiple ronmental effectiveness (i.e., ability to stimulate more stakeholder interests are a step in the right direction. GHG-reducing activities). Enhance predictability for methodology revisions. UNFCCC Parties' submissions (March 2010) to Providing for periodic reviews and revisions of meth- assist the UNFCCC Subsidiary Body for Scientific odologies is critical to maintaining environmental and Technological Advice in its task46 to recommend credibility of methodologies. However, the process, modalities and procedures for the development of stan- timing, and triggers to initiate such reviews should be dardized baselines that are broadly applicable, while clear at the outset. providing for a high level of environmental integrity and taking into account national circumstances offer practical and promising ways forward. 3.4 Additionality: ensuring environmental Mobilize resources to help advance such work and integrity secure the necessary collaboration that would ben- efit the entire CDM and help extend its reach. For Environmental integrity is essential for the overall cli- instance, the World Bank's post-2012-focused Car- mate regime, as emission reduction/sequestration credits bon Partnership Facility includes, in addition to a are used to meet compliance with emission commitments carbon fund, a separate carbon asset development and effectively offset the emissions of Annex I countries. fund dedicated to helping advance this type of work. Economic efficiency is also essential, as capital is scarce Initial methodology work includes developing a prac- and needs to be allocated where there is real environmen- tical methodology for energy efficiency in buildings. tal value. Confidence in environmental integrity is also This is a challenging sector to tackle as government critical for the carbon market to ensure credibility of the norms, such as building codes, have low compliance carbon assets being traded. In the context of the CDM and the sector comprises a large number of stakehold- (and JI), environmental integrity is preserved through the ers including the owners of individual homes, multi- concept of additionality. occupant and multi-purpose buildings. Despite the huge mitigation potential and the importance of this 44 For example, the World Business Council for Sustainable Develop- sector for developing countries' sustainable develop- ment Cement Sustainability Initiative (CSI), along with the consult- ing group Ecofys, has developed a sector-based benchmarking CDM ment and their transition to low carbon growth, this methodology based on benchmarks for plant performance derived sector has largely been bypassed by the CDM thus far. from the CSI's global cement database on CO2 and energy perfor- Increase efforts to better engage and develop capac- mance. The methodology is currently under review by the CDM EB. 45 For example, the approved small-scale methodology for efficient ity with host country representatives. This will be lighting (AMS.II.J), based on the World Bank's methodology submis- essential to ensure workable methodologies based on sion, is based on the use of conservatively-defined deemed (stipulated) standardized baselines aggregated at an appropriate energy savings associated with each compact fluorescent lamp (CFL) replacing an inefficient incandescent lamp. sectoral or geographic level, as well as to ensure data 46 As requested by the December 2009 Copenhagen 2/CMP.5 deci- availability and compatibility with practical realities. sion on the CDM (FCCC/KP/CMP/2009/L.10). Origins & Implementation of the Clean Development Mechanism and Joint Implementation 39 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 17 The tool for the determination and assessment of additionality STEP 1: Identification of alternatives to the project activity consistent with mandatory laws and regulations STEP 2: Investment analysis STEP 3: Barrier analysis Does sensitivity analysis conclude that the Is at least one alternative scenario, proposed CDM project activity is unlikely to be other than proposed CDM project activity, N N not prevented by any of the the most financially attractive or is unlikely to be financially attractive? identified barriers? Y Y optional STEP 4: Common practice analysis N No similar activities can be observed, or if similar activities are Project is observed; but essential distinctions between the proposed CDM Project is additional project activity and similar activities can reasonably be explained? not additional Source: CDM Rulebook The Kyoto Protocol stipulates that CDM projects must linked process of determining baselines: (i) project-spe- result in "reductions in emissions that are additional to any cific; and (ii) standardized (often called `performance that would occur in the absence of the certified project activity standards', or `multi-project'). Under the CDM, a project- [i.e., the CDM project]" and that JI projects provide "a specific approach has been pursued. The CDM Executive reduction in emissions...that is additional to any that would Board issued a "Tool for the determination and assess- otherwise occur." The challenge in proving additionality lies ment of additionality"47 (so-called "Additionality Tool") therefore in determining the scenario that represents "what to serve as guidance to demonstrate (for project entities) would have occurred otherwise", something that is coun- and to assess (for DOEs and the CDM EB) a project's terfactual and cannot, by definition, be verified. Providing additionality. confidence in the environmental integrity of any GHG The Additionality Tool (Figure 17) is an effort to market-based instrument is essential. However, proving establish a consistent approach across different projects. "additionality" under the CDM has proven challenging to implement and to evaluate objectively in practice. 47The Executive Board has periodically modified and updated The literature typically refers to two broad design the Tool. At the time of writing this report, version 5.2 of the Tool approaches to evaluating additionality and the closely (approved at EB 39) was being used. 40 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank The Tool requires project entities to explain how and Renewable projects such as wind, hydro, biomass (with- why the project is additional, and therefore not the base- out CH4), where it is likely that the CDM's economic line scenario, by applying a combination of several tests. impact on the internal rate of return is small (i.e., Essentially, a project has to demonstrate that either (i) it between 1­3%) and where there are links with sectoral is less profitable than the most attractive alternative or policies, in particular the setting of differentiated tariffs. a benchmark (investment analysis); and/or (ii) it must End of pipe projects such as waste gas or heat utili- overcome prohibitive barriers (barrier analysis). It must zation projects, where a waste product has a financial also demonstrate that it is (iii) not "common practice". value that could make the project viable even without Evidence must be provided to prove the validity of a base- the CDM. line scenario and clarify why the proposed project is not Industrial sector projects such as cement production, itself the baseline scenario. where the production process improvement results in Despite the development of the Additionality Tool, increased profitability even without the CDM. demonstrating a project's additionality has been very challenging and continues to be a subject of debate The two other aspects of additionality demonstration between project entities and CDM regulators as well as that are often questioned by the CDM regulators are: among stakeholders48. This is illustrated by the fact that (i) the prior consideration of the CDM (i.e., providing additionality is the overwhelming reason for denying evidence that the CDM was not a simple afterthought the registration of a proposed project. More than 70% of to seek more revenues); and (ii) the links with govern- project rejections have been justified on the grounds of ment sectoral policies that provide incentives to either additionality (IGES 2010). GHG-intensive or low GHG-intensive technologies (or In theory, from an investment perspective it should be so called "E policy" under the CDM. See Annex 5). fairly straightforward to distinguish between non-addi- Projects that have the least difficulties in demonstrat- tional (i.e., "economic") and additional ("non-economic") ing additionality are the gas capture types of project (e.g., projects by applying a financial screening criterion (such as capture of industrial gases and landfill gases) where there an x% internal rate of return). In effect, over time, there has is no valuable by-product associated with the capture of been increased reliance on the use of investment analysis the gas. In other words, without the revenue stream of the (over the barrier analysis) within the Additionality Tool, CDM, the project proponent would have no economic as it is perceived to be more objective given its quantitative incentive to capture the waste gas. The projects that pro- nature. However, the investment analysis is the single most vide valuable by-products, in addition to GHG reduc- frequent reason for denying CDM registration. tions, such as energy savings or power are often vital to Within the investment analysis, the definition of host countries' sustainable development, but demonstrat- financial benchmark is causing the most problems when ing their additionality can be more challenging under the assessing additionality, as it is inherently dependent upon current CDM additionality approach. underlying assumptions. In the World Bank's experience, CDM supporters and critics alike agree that determin- it has been common to see project entities genuinely ing additionality on a project-by-project basis to assess the puzzled by the repeated (and time consuming) questions individual investment decisions is inherently qualitative on the assumptions used for determining their financial and a matter of judgment49. As described by Schneider benchmark. (2007), "The fundamental challenge is that the question Despite efforts by CDM EB to provide additional guid- as to whether a project would also be implemented with- ance to clarify requirements for defining financial bench- marks, this has not translated into fewer projects being put 48 For example, see Schneider (2007) and Michaelowa and Purohit under review. The majority of projects that appear to be (2007) and Wara and Victor (2008) affected by closer financial benchmark scrutiny include: 49 Ibid. Origins & Implementation of the Clean Development Mechanism and Joint Implementation 41 YEARS OF EXPERIENCE IN CARBON FINANCE out the CDM is hypothetical and counter-factual--it well as the carbon market. It is urgent to make changes to can never be proven with absolute certainty." The World ensure that the concept of additionality is implemented Bank's experience also confirms the constant challenge in a more practical, workable, and transparent manner. of demonstrating additionality on a project-by-project As a first step, it is encouraging that in Copenhagen in basis, considering the broad spectrum of specific policy, 2009, the Parties to the Kyoto Protocol are aware of the and the regulatory and economic circumstances in host need for improvements, as evidenced in the call towards countries that need to be taken into account. Moreover, "the enhancement of objectivity and transparency in the project entities of different types, such as companies approaches for demonstration and assessment of additional- listed on stock markets, government agencies, or small- ity and selection of the baseline scenario..." scale operations in LDCs, use different approaches when It is critical to review the implementation of the they make investment decisions depending on the specific concept of additionality to reconcile (i) the reality that country and sector context, the type and scale of activity, good and effective climate-reducing projects need also and access to financing. In the case of investment analyses, to be technically and financially solid, with (ii) the need appraisal criteria used by different entities may include, to ensure environmental integrity. This means moving for example, net present value (NPV), payback period, away from the current additionality assessment focused return on average capital employed, and impact on oper- on individual investment decisions, and towards objec- ating cash flows and budgets, all complemented by differ- tive and more easily verifiable technical criteria wher- ent approaches for risk assessment and sensitivity analysis, ever possible, including through standardized baselines and/or other company-specific performance criteria. All accompanied by automatic additionality for activities these factors make the task of assessing a specific project's meeting clear criteria and/or implemented in clearly spec- additionality based on investment analysis very challeng- ified geographic regions and under other circumstances. ing from a global perspective50, and thus constantly sub- Where appropriate, such baselines could be developed ject to questioning. to combine the baseline and additionality assessment The assessment of the project-by-project additional- in an environmentally ambitious way while also provid- ity contributes to a high CDM regulatory risk, which is ing much needed objectivity and predictability. There often perceived as a significant hurdle for project devel- is one such precedent in the approved methodology for opers. Project ideas are not scarce, but their financing is. energy-efficient refrigerators51. Such a move would also The CDM regulatory risk can make it very difficult to use help streamline project approval procedures (valida- the expected CDM revenues as indicators of a project's tion and registration). Decisions on standardized base- financial viability to help convince financiers and lend- lines accompanied by automatic additionality need to ers and thus enable leveraging of the necessary underly- be accompanied by a clear, transparent, and predictable ing finance. The CDM regulatory risks are in fact having review process to ensure that the determination of what is the largest impact on those projects that depend most on additional evolves over time with practical realities. carbon revenues for their financial viability. Changes are In its recent submission to the CDM EB on recom- needed to solve this problematic implication of the cur- mendations for simplified modalities for demonstrating rent additionality approach. additionality of small-scale renewable energy and energy 50 See for example, the World Bank Response to the EB call for Pub- Recommendations for demonstration and lic inputs at its 53rd meeting regarding the draft "Tool to calculate the assessment of additionality weighted average cost of capital (WACC)", April 23, 2010. (www.car- bonfinance.org) 51 The approved methodology (AM0070) for the manufacturing It cannot be emphasized enough that environmental of energy-efficient refrigerators uses the same threshold level for the integrity is essential for the CDM, the climate regime, as additionality test and the determination of baseline emissions. 42 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank JI Track 1 & Track 2 efficiency projects (April 2010), the World Bank pro- posed a flow chart-based, yes/no assessment that projects JI Track 1: Under the Track 1 process, the determination could use to prove automatic additionality (the submis- of the eligibility of the project, as well as the monitoring and verification of emission reductions, is subject to national sion is included in Annex 4). The suggestion is to base the rules and procedures only. Parties can use Track 1 if they assessment on widely published documentation or pub- meet the six eligibility criteria outlined in the Marrakesh Ac- licly available country-specific or sector-specific national cords. level information and data available in the host country. JI Track 2: Modalities and procedures for JI Track 2 were If done well, such improved additionality rules will launched by the Joint Implementation Supervisory Commit- help streamline the approval process and help maintain tee (JISC) in October 2006. Track 2 can be used when interest in the CDM as an environmentally credible the host country does not comply with all the eligibility re- and workable carbon finance mechanism that can work quirements of the Kyoto Protocol for JI. It consists of (i) a verification procedure (i.e., determination and verification) in tandem with other instruments and policies to help by the Independent Entity accredited (AIE) by the JISC, and developing countries meet their sustainable development (ii) subsequent reviews by the JISC. Thus, the JI Track 2 objectives and move towards low carbon growth. to some extent mirrors the CDM procedures. This "CDM- like" procedure does not, however, require JI projects to follow approved CDM methodologies and/or submit new methodologies. 3.5 The particular case of Joint Implementation For both Tracks 1 and 2, the host country is responsible for issuing and transferring the ERUs. The JI project cycle and the key concepts of methodology and additionality are comparable to the CDM, but there Source: JI Rulebook, www.jirulebook.org are important distinctions between these two Kyoto proj- ect-based mechanisms: JI projects are implemented in "capped environments" by an international regulatory body called the Joint where host countries' emissions obligation, deter- Implementation Supervisory Committee ( JISC). Box mined by their respective Assigned Amount under the 3 outlines the main differences between Track 1 and Kyoto Protocol, serves as a means of securing environ- Track 2 as well as the limited use so far of the regula- mental integrity. Any transfer of the emission reduc- tory flexibility. tions (ERUs) from a JI project needs to be reflected in an equivalent deduction of the same host country's In the global JI pipeline, there are 98 finally deter- Assigned Amount Units (AAU) to maintain the cap. mined JI projects under Track 1 and 16 under Track 2 This situation provides an incentive to the host coun- (UNEP RISØ 2010). There are 174 more projects in the try to ensure that there is no exaggeration of the emis- JI pipeline (under Track 2). The World Bank JI experience sion crediting, and thus lessens the risk that emission is based on a portfolio that includes 16 projects located in reductions from individual projects would be inflated. 8 JI host countries, covering diverse technologies such as The Marrakesh Accords provide for 2 tracks for JI district heating, wind power, gas flaring reduction, steel projects: Under JI Track 1, projects are approved at the mill rehabilitation, forestry, and biomass. Half of these national level by the relevant host country JI authority projects have been finally determined to date. Section 4 ("designated focal point"), following national guide- provides an overview of the geographic and technology lines. This provides greater opportunity for flexibility distribution of JI projects. according to different national circumstances. Under This experience can also be characterized as one of early JI Track 2, the project approval process is overseen involvement in JI. Soon after the Kyoto Protocol, many Origins & Implementation of the Clean Development Mechanism and Joint Implementation 43 YEARS OF EXPERIENCE IN CARBON FINANCE Expectations and experience with "early-mover" JI projects Originally, the World Bank, as well as others, anticipated that However, early movers were not directly accepted under JI projects would be more straightforward to develop and exe- Track 2 by the JI Supervisory Committee (JISC). The JISC, cute because of the safeguard provided by the overall national established in October 2006, opted to largely build on the emissions cap of the JI countries. body of CDM procedural and methodology experience. It de- liberated on the merits of recognizing the early JI movers, but However, the Marrakesh Accords did not provide for a prompt in the end decided not to accept the (ad hoc) project docu- start for JI, as it did for CDM. This meant that, unlike the CDM mentation provided by the early-mover JI projects as being which could generate CERs prior to 2008, JI credits--Emis- equivalent to the project document templates and guidance sion Reduction Units (ERUs)--could only be generated during developed by the JISC. This turned out to be challenging and the Kyoto Protocol's commitment period starting in 2008. But overburdening for many early-mover JI projects, as re-doing projections indicated that the emissions of several Central & the documentation was far from a simple copy-paste exer- Eastern European countries would amount to less than their cise. Such retrofitting can be very costly and bring additional Assigned Amount for the 2008­2012 commitment period. risks, as arguments, assumptions, and methodologies used This "AAU surplus" could be used to reward pre-2008 emission to prepare the original documentation did not fit neatly with reductions from JI projects. the Track 2 requirements and required re-determination of the early project by the AIEs. This prompted the World Bank and others to work with JI host countries and develop "early-mover" JI projects. For example, The World Bank PCF aimed to experiment with both Track 1 and the World Bank's PCF signed the first JI Emission Reductions Track 2. However, in the end and after looking at all possibili- Purchase Agreement (ERPA) with Latvia in 2000. ties, it concluded that it was either not feasible, or too costly or too risky to select the Track 2 procedure. Furthermore, some Early-mover JI projects (i.e., their project documentation, the host countries (e.g., Czech Republic, Hungary, Poland, and Ro- determination of the baseline and additionality, the monitoring mania) supported their early movers under Track 1 by accept- protocols, and the ex-ante calculations of emission reductions) ing available documentation and determination reports without were therefore based on expected JI rules and guidelines, any modifications. Thus, after having examined the options and which in reality took longer to develop and put in place than implications, all PCF JI projects have followed Track 1. had been originally foreseen. of the Central and Eastern European countries became caps and the greater role and responsibilities given to attractive because they had significant emission reduction national authorities (compared to the CDM). potential, given CO2-intensive energy and industrial sec- tors. These countries also had, in general more capacity and data and their enabling environment seemed to satisfy 1. Interplay between EU ETS & JI investors and project developers. Box 4 outlines our experi- ence with early-mover JI projects. Many of the Central and Eastern European countries that were originally expected to host JI projects subsequently joined the European Union. With the adoption and JI insights implementation of the EU Emissions Trading Scheme (EU ETS), the most promising sectors for JI activities in In reality, the situation for JI projects turned out to be the EU Member States became covered by the EU ETS. much more complex than originally anticipated. There Although JI and the EU ETS can be complementary, the are a number of insights emerging from the JI experience, interplay between the two mechanisms has proven to be which reflect the particularities of this project-based challenging, particularly regarding the need to ensure mechanism in the context of overall national emission no double-counting of emission reductions. Indeed, EU 44 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Carbon finance at the World Bank The Hungary Pannongreen Biomass Project: A JI project alongside the EU ETS The Pannonpower Group has owned and operated the Pécs JI project from firewood, woodchips, sawdust, and agricultural power plant since 1962, and until the early 2000s operated byproducts harvested in forestry operations that fulfill the re- four combined heat and power (CHP) units using locally-mined quirements of sustainable forestry management in Hungary. coal. Pannonpower faced major investment requirements to meet the tightening limits on SO2 emissions (from 2005) while Today, with the help from carbon finance, Pannongreen is one also needing to extend the life of the plant. Pannonpower evalu- of the largest renewable energy facilities in Central Europe and ated a wide range of alternatives including different mixes of has significantly increased Hungary's renewable electricity gen- fuels and technologies. Without carbon finance, the baseline eration. study indicated that the most financially attractive alternatives As an "early mover", the project was finally determined as a would have been either (i) the continued operation based on Track 1 JI project based on Hungarian JI guidelines. The Pan- coal with a scrubber; or (ii) a fuel switch to natural gas. The nongreen project was developed before Hungary's accession option of a fuel switch to biomass came a distant third. to the EU and the finalization of the EU ETS. The Hungarian Without the Government's support for renewable energy and authorities included the project in a JI reserve of their country's the carbon revenues from JI (through the ERPA signed in 2003 National Allocation Plan (NAP) for Phase 2 (2008­2012) of the with the World Bank PCF for the sale of 1.2 million tons of CO2e EU ETS. A portion of the EU allowances, which are backed up reductions starting in 2008), the company would not have de- by AAUs, was thus set aside, allowing the Pannongreen Bio- veloped the Pannongreen biomass project to replace one of mass JI project to earn ERUs alongside Pannonpower's com- the coal-fired units. The renewable biomass is supplied to the mitments under the EU ETS. Member States can include in their National Allocation EU ETS, challenges emerged. The link between these Plans (NAP) a JI Reserve, which was originally expected projects' emission reductions and the emissions from the to be the mechanism to secure the credits associated with power sector (covered by the EU ETS) caused concerns the reductions from early-mover JI projects. However, about double-counting. in the end, the NAP, which requires the approval of the Despite these difficulties, there are some JI projects European Commission, did not guarantee that all early JI where the interplay between the EU ETS and JI seems to projects would be specified in the respective country's JI have reached a good balance (see example in Box 5). reserve, or that there was sufficient allocation to cover all emission reductions generated by the early JI projects. In fact, through the political NAP approval process, some 2. Delay in the development of guidelines early projects within the World Bank portfolio ended up being omitted from the JI reserves. In some of these cases, The development of the Track 2 JI guidance and procedures it was possible to agree on AAU transfers as replacements by JISC naturally took some time. This is still an ongoing for the expected ERUs. process as JISC is seeking to respond to the lessons learned It must be noted that while the prospects for JI were from the experience of practitioners and regulators (e.g., reduced, for many otherwise potential JI projects, the EU the development of a JI Determination and Verification ETS offered a more efficient mechanism based on carbon Manual). As noted in Box 3, in parallel, JI Track 1 offered assets (EU allowances) with lower risk and thus valued the host countries the opportunity to develop their own at a higher price than JI credits (Emission Reduction guidelines for the approval of JI Track 1 projects. Due to Units). For others, however, such as projects in demand- the lack of capacity and/or political will, the development side energy efficiency which are not covered under the of national JI Track 1 procedures was much lengthier than Origins & Implementation of the Clean Development Mechanism and Joint Implementation 45 YEARS OF EXPERIENCE IN CARBON FINANCE expected, but are now in place in many host countries (e.g., to account for and manage these new national assets, Ukraine, Romania, Poland). including domestic procedures and guidelines for project In the meantime, in the face of regulatory uncertainty, approval and issuance and transfer of ERUs. Some coun- JI AIEs typically referred to the CDM guidelines and tries initially had limited resources to do so and decided methodologies, even though the JI modalities and pro- to mostly rely on the regulatory work of the JISC. In oth- cedures under the Marrakesh Accords made no reference ers, such as Russia, the development of JI approval proce- to any precedence to be given to decisions made under dures was not considered a priority and became a serious the CDM. This may have undermined the flexibility of bottleneck for investors engaged in early-mover projects. the (fundamentally different) JI mechanism where emis- At the time of drafting this report, Russia--the coun- sion reductions are generated in a capped environment. try expected to have the largest JI potential--had not Furthermore, rather general Track 1 guidelines eventually yet issued any Letter of Approval for JI projects, despite emerged in several host countries and referred directly or having hosted JI activities for several years, although indirectly to Track 2 guidance, thereby providing little this is poised to change soon52. Other countries, such as basis to stimulate innovation (e.g., new approaches and Ukraine, were rather efficient in their development of methodologies) under JI Track 1. The lengthy regulatory national JI Track 1 guidelines. development for both JI tracks also delayed the adoption What many had not foreseen is that JI projects are of a programmatic approach, with the JISC adopting Pro- associated with an extra host country risk compared to grammes of Activities procedures (as under the CDM) the CDM, because host governments develop their own only in 2009. This programmatic approach may provide JI guidelines and are responsible for the issuance and opportunities for a number of smaller GHG mitigation transfer of ERUs. This makes JI vulnerable (or at least projects, while minimizing the transaction costs, but perceived as such) to political changes in these countries. there is little time before the end of 2012 to stimulate sig- In addition, the different requirements and approaches nificant activity. adopted by each JI host country make it more complex for project developers seeking to navigate different countries. A key insight from the JI experience is that institu- 3. Host country responsibilities & regulatory risk tion building, setting up systems, and developing regu- latory frameworks to manage emission assets take time JI provides for a greater role for national authorities and, and require support for capacity building. Capacity with it, creates substantial requirements for the host then needs to be sustained to limit host country regula- government in terms of capacity and institutions. It was tory risks and to enable host countries to be effective in originally expected that under JI Track 1, the host gov- attracting carbon finance activities that help meet their ernments would have clear incentives to develop their development priorities. own guidelines for the approval of JI projects that would provide for flexibility, simplicity, and expediency, as national authorities are much more aware of their coun- 52 The issuance of Russia's first Letter of Approval is imminent. The try's circumstances. second set of rules was approved by the Russian government at the However, JI experience to date shows that it takes beginning of 2010 and the first tender for project proposals was closed in March 2010. The first approvals are expected to be issued in May time and resources to build national systems, institu- 2010. However, the rules for issuance and transfer of ERUs remain tions, and capacities as governments must develop rules unknown. 46 Origins & Implementation of the Clean Development Mechanism and Joint Implementation Experience on the Ground As the World Bank's World Development Report 2010 finance projects within the World Bank's carbon finance on Development and Climate Change (WDR 2010) puts portfolio: it, "Climate change policy is not a simple choice between a high-growth, high-carbon world and a low growth, low Transforming solid waste management: Carbon carbon world--a simple question of whether to grow or finance is providing critical incentives across the to preserve the planet." developing world to recover otherwise released meth- The Kyoto mechanisms are one means of contribut- ane gas. It is also helping municipality authorities and ing to both the world's need to mitigate global emissions landfill managers around the world to apply state-of- of GHGs and host countries' aspirations for low carbon the art technology to produce electricity using landfill development. The CDM, in particular, has generated gas. One cannot over-emphasize the importance of substantial flows supporting climate-friendly projects, this sector for sustainable development at a time when including many intrinsically linked to sustainable devel- urbanization is accelerating at a fast pace. opment, such as clean energy and forestry projects. It Use of renewable energy in the iron and steel indus- has been a rich "learning-by-doing" experience with tre- try in Brazil: Carbon finance was critical in sup- mendous capacity built around the integration of GHG porting the Brazil Plantar Project, consisting of three considerations in decision-making processes and focused CDM projects covering the supply chain, in becom- efforts to monitor and measure the performance of proj- ing the only one producing pig iron entirely from ect activities over time. The system is not perfect, and renewable plantations. It is a sustainable development changes are needed, but it has accomplished a lot. It has model that authorities now seek to replicate in Brazil. achieved a solid foundation of technical and regulatory Micro projects in Africa and LDCs: Carbon finance capacity that has been built around practical project can make the difference to overcome the first invest- experience. Many projects have been enabled by carbon ment barrier and finance local energy efficiency finance. programs. Through the CDM, it has been possible The CDM and JI project-based approach has sparked to reach micro-level end-use energy-efficient activi- the imagination of both local and international entrepre- ties targeted at households. Energy efficient lighting neurs to seize opportunities to offset GHG emissions and programs stimulated by the CDM are taking place mitigate climate change. In a variety of different cases, the in many developing countries, including Senegal, Kyoto mechanisms have succeeded in launching project Rwanda, and Bangladesh. Micro-scale activities aimed ideas and attracting capital. The world needs to build on at improving access to energy for cooking and heat- and amplify these gains. Such scaling-up will require put- ing, such as the Nepal Biogas project, are other CDM ting the conditions in place so that many more of these examples that can be replicated. activities on the ground can be stimulated by the market Forestry: Carbon finance, as being demonstrated mechanisms. Below are four examples of such carbon by the BioCarbon Fund, can help reforest degraded 47 YEARS OF EXPERIENCE IN CARBON FINANCE lands, rehabilitate poor soil conditions, and improve post-2012 period and considers ways to stimulate greater environmental conditions as a whole; socioeconomic amounts of GHG mitigation in a way that supports host conditions are also usually improved through a vari- countries' transition to low carbon growth, it is impor- ety of means including incomes from planting and tant to appreciate all that has been built over the past maintenance work, as well as from by-products of decade. the reforestation activities or timber. The Facilitating Indeed, in the early days of the carbon market, lim- Reforestation for Guangxi Watershed Management ited knowledge of and experience with the mechanisms in Pearl River project in China, the Moldova Soil was a real problem for most developing countries and Conservation project, and the Uganda Nile Basin economies in transition. It prevented many countries Reforestation project piloted the CDM in the for- from being effective players in this emerging market. To estry sector; they are now serving as a basis for replica- help overcome the lack of experience and capacity, many tion in their countries and can be used for replication governments and organizations53 have engaged actively in elsewhere. capacity building to assist host countries in participating effectively in the carbon market. Still, the Kyoto mechanisms have not reached all sec- A critical and significant component of the World tors, regions, and countries in the same way, with some Bank carbon finance activities has consisted in provid- largely being by-passed. This section provides insights ing capacity building and technical assistance to its client into the experience on the ground and seeks to identify countries. The aim has been to contribute to the elabora- key areas of success and the challenges that remain. tion of a more equitable market mechanism that benefits all countries with carbon mitigation potential. Over the years, the World Bank has carried out several capacity 4.1 Building and sustaining capacity: building programs aimed at supporting CDM/JI host a necessary condition countries' efforts to develop an enabling environment for project-based carbon transactions (Annex 3 outlines the The WDR 2010 assesses that "there is scope for develop- main carbon finance development programs over the past ing countries to shift to lower-carbon trajectories with- decade). out compromising development, but this varies across Capacity development in general is not static; it countries and will depend on the extent of financial and needs to be sustained and to evolve. This is also true for technical assistance from high-income countries." This carbon finance capacity development. Carbon finance certainly applies to carbon finance and the experience capacity development approaches and programs have with the Kyoto mechanisms. evolved over the years as a reflection of the (i) evolving The Kyoto mechanisms generated interest and enthu- circumstances of the international regulatory frame- siasm as well as achievements, but nowhere was imple- work, (ii) the growing knowledge base on carbon mar- mentation particularly easy. Learning-by-doing has ket instruments, (iii) the evolving capacity needs, and meant developing knowledge and capacity to test and (iv) the increased level of engagement from CDM/JI implement. As noted earlier, one of the key factors for host countries. successful carbon finance projects has been committed Key areas targeted by the World Bank's capacity devel- champions with the capacity to implement and follow opment work since the very inception of the Kyoto's flex- through with projects. Conversely, weak capacity is a ibility mechanisms include: key reason for having abandoned project ideas. At the government level, capacity to create enabling environ- ments and clear regulatory frameworks to attract car- For example UNEP's CD4CDM program at the global level or 53 bon finance is critical. As the world looks towards the CAF's Latin American Carbon Program (PLAC) at a regional level. 48 Experience on the Ground Carbon finance at the World Bank Supporting strategic assessments and analytical work Lessons learned from accumulated experience in pro- at the national and sectoral level, aimed at raising viding capacity building assistance include: awareness across stakeholder groups, reaching out to relevant decision-makers, and facilitating engagement In many countries across regions, basic awareness, of the private sector in project identification and infrastructure, and practitioner networks have been development; created in terms of carbon finance, particularly for the Strengthening institutional arrangements at the purposes of the Kyoto mechanisms. However, there is national level, including support for the establishment still a need for such support in some regions, especially of Designated National Authorities/focal points or in Sub-Saharan Africa and Central Asia. Such support CDM/JI promotion offices; needs to be customized so that countries come up to Assisting in CDM/JI project portfolio identification speed as soon as possible while laying the foundations and development, in particular in sectors bypassed by for the use of carbon market instruments as they con- the market due to methodological challenges; tinue to evolve. Fostering market development through a variety In order for smaller developing countries to benefit of global and regional knowledge sharing fora and from the carbon market, it is essential to focus capac- business development platforms, such as the annual ity development efforts in priority sectors, involve Carbon Expo54, the World Bank's flagship event for corresponding key sector stakeholders, and foster the carbon market stakeholders. adoption of programmatic approaches to tap into dis- persed, small-scale GHG emission reduction options. Moreover, the World Bank established, alongside its Support in activities such as development of sector carbon funds, a Host Country Committee (HCC, com- baselines, creating a reliable information base, and prised of 61 members), a formal network of national car- strengthening adequate institutional arrangements, bon finance focal points comprising representatives of continues to be crucial. countries hosting project activities of one or more of the As substantial scaling-up of mitigation activities is World Bank administered carbon funds. The role of the likely to be one of the key considerations of a post- HCC has included providing advice and recommenda- 2012 climate change regime, it is increasingly impor- tions to the World Bank's carbon funds on issues related tant to also focus on capacity building programs that to project selection criteria and project portfolio develop- advance large-scale mitigation, including through ment; regulatory and methodological aspects arising from programmatic approaches. The need to reach out to the evolving regulatory framework of the UNFCCC; col- distinct practitioner and stakeholder groups in host laboration aimed at streamlining processes of the CDM/JI countries has grown significantly. project development and implementation cycle; and devel- With discussions and expectations of changes in the opment and improvement of vehicles for capacity develop- climate regime in the post-2012 period, developing ment, knowledge exchange, and information outreach. countries face challenges to access relevant knowledge, The capacity building efforts of the World Bank and and translate such knowledge into relevant actions. In others have helped achieve significant progress in terms many respects, this situation resembles the early stages of helping CDM/JI host countries enter the project- of the carbon market, with the following differences: based carbon market segment. Several countries in Asia (i) today, there is a group of advanced developing and Latin America successfully established key condi- countries with practical know-how in carbon finance tions needed for attracting and utilizing carbon finance. However, considerable effort is still needed in some coun- 54The annual Carbon Expo is jointly organized by the World Bank, tries and regions that have not yet benefited much from the International Emissions Trading Association (IETA) and Koeln- the carbon market. messe. www.carbonexpo.com Experience on the Ground 49 YEARS OF EXPERIENCE IN CARBON FINANCE from which other countries can learn; (ii) these coun- 4.2 Geographic reach: broad but uneven tries host national and/or regional organizations with deep technical expertise, which can serve as knowl- The CDM and JI have reached many countries around the edge hubs and partners; and (iii) many innovations world in terms of institutions, with 139 countries having in carbon finance originate in developing countries, established CDM Designated National Authorities and making peer-to-peer learning, and south-south, as 35 countries with JI national focal points (including both well as (two-way) north-south, exchanges an essential Annex I and non-Annex I countries). In terms of projects, element of future capacity building initiatives. This 77 countries are hosting at least one CDM project and should provide an enhanced foundation for any tran- 15 countries are hosting at least one JI project. The dis- sition towards a scaled-up use of carbon finance and tribution of CDM and JI projects has varied significantly carbon markets to assist host countries in a shift to low between countries, as shown in Figure 18. carbon development. In terms of number of projects, the World Bank port- Along that line, as carbon finance capacity build- folio has achieved a better geographic diversification, than ing programs expand in terms of scope and reach, it the global CDM experience. Of course, the distributions is important to move implementation from a retail change when considering emission volumes, with China face-to-face approach to a more efficient wholesaling taking the lion's share due to larger project sizes, includ- approach where capacity building programs can be ing the World Bank's 2 HFC-23 projects (see Figure 19) delivered through means such as virtual platforms and What emerges from the global CDM experience is the regional hubs/organizations. This is important for notable dominance of China, whose share is proportion- efficacy in the use of limited resources, sustainability ally larger than its share in overall GHG emissions from of capacity interventions, and for extending the reach non-Annex I countries (see Figure 20). China's success of still needed capacity development support. can be attributed to various factors, including a GHG- FIGURE 18 Geographic distribution of global CDM and JI Global CDM Global JI (by # of projects, 4,968) (by # of projects, 288) 2% 1% 1% 18% 17% 4% 37% 40% 12% 5% 7% 25% 14% 15% Africa Middle East China India Russia Ukraine Czech Republic Poland Other Asia L. America E. Europe/C. Asia Bulgaria Hungary Others* *Others include Lithuania, Estonia, Romania, Latvia, Lithuania, Slovakia, Germany, France, Sweden & New Zealand Source: UNEP RISØ March 2010 CDM and JI Databases 50 Experience on the Ground Carbon finance at the World Bank intensive electricity grid as well as a large growing econ- ties in China have not only consisted of such large proj- omy that offers opportunities for emission reductions. ects; in fact, the Chinese CDM experience is very diverse There are also many large projects, which are better suited in terms of size (with many small-scale projects) and for the CDM, as transaction costs can be spread over sectors. An important factor to highlight is the capacity larger volumes of emission reductions. But CDM activi- developed in China to facilitate CDM activities. FIGURE 19 Geographic distribution of World Bank CDM and JI projects World Bank's CDM portfolio World Bank's JI portfolio (by # of projects, 195) (by # of projects, 16) 2% 13% 19% 19% 24% 7% 13% 5% 21% 25% 28% 13% 13% China India Other Asia Latin Bulgaria Poland Russia E. Europe/C. Asia Africa Middle East America Ukraine Czech Republic Others (Hungary, Latvia & Romania FIGURE 20 Comparison of GHG emissions and global CDM portfolio shares by region Middle East 7% Middle East 8% Middle East 1% 100% Africa 3% Europe/C. Asia 1% Africa 12% Africa 12% L. America 14% Europe/C. Asia 3% Europe/C. Asia 3% Other Asia 10% L. America 22% L. America 15% India 16% Other Asia 17% Other Asia 19% India 9% India 8% China 29% China 36% China 55% 0% % of Non-Annex 1 2005 Emissions % of Non-Annex 1 2005 Emissions % of Global CDM (w/LULUCF)* (w/o LULUCF)* (by volume)** 24.9 Gt 19.9 Gt *CAIT, World Resource Institute 2005 data; GDP% out of $23.4 trillion USD **UNEP RISØ March 2010 CDM Database ­ Global CDM volume of ERs generated before end of 2012 without risk/delay adjustment 3.2Gt Experience on the Ground 51 YEARS OF EXPERIENCE IN CARBON FINANCE China was not the first out of the gate in the CDM The world's and the World Bank's carbon finance activ- race (Latin American countries were the initial hosts of ities extended beyond China. Other large players (India, CDM projects). However, early on, as in many other Brazil, etc.) emerged as CDM leaders. However, it is clear countries, the World Bank engaged with Chinese author- that there is potential to extend the mechanisms' reach. ities on carbon finance by providing technical assistance. Each CDM/JI project has its own specificities, but China made a cautious start in the CDM, systematically some general trends, observations, and insights have been evaluating the World Bank's proposals and conducting a gained from the World Bank's operational experience major study on the implications of the CDM for China spanning the various regions of the developing world. (finalized in 2003). This study followed the Chinese Pre- Table 7 gathers the World Bank carbon finance special- mier's announcement at the 2002 Johannesburg World ists' insights of the key opportunities and challenges for Summit on Sustainable Development that China would carbon finance project activities in different regions. participate in carbon markets. While Africa, and least developed countries (LDCs) The Chinese strategic and systematic approach to in general, represent a very small share of the global CDM CDM has been striking. A distinct feature of the Chi- pipeline, it is worth noting that Africa is hosting more nese approach to the CDM has been the hands-on role of than 20% of the World Bank's CDM projects55. The fol- the Designated National Authority (DNA) in the entire lowing section examines in greater detail the challenges project process. In the initial years, the DNA would often facing LDCs which constrain their potential to benefit organize industry/sectoral workshops to introduce com- more fully from the Kyoto mechanisms. panies to CDM methodologies and opportunities, and to the World Bank. The World Bank was encouraged to work with a shortlist of companies to bring forward 4.2.1 Why isn't there more activity in least projects, based on their financial status, etc. In 2003, developed countries (LDCs)? the Chinese government asked the World Bank to con- sider projects in 3 different areas: energy efficiency, coal The potential role of carbon finance in LDCs must be mine methane, and run-of-river hydro. Gradually, China considered in the context of these countries' specific situ- engaged with the World Bank's various carbon funds, ations and needs. Provided rules are changed, the CDM including the PCF, BioCF, and CDCF. As a last step, the could contribute to broader sustainable development in DNA reviewed the PDD and proposed term sheets as a poor countries, especially in Sub-Saharan Africa, given condition of issuing Letters of Approval, often employ- the huge energy deficit in the region. Africa has the lowest ing its own experts to review the assumptions and sectoral electrification rate of all regions with only about a quar- coefficients. The Chinese authorities' capacity develop- ter of households having access to electricity. In Africa ment efforts and its overall CDM support structure alone, more than 500 million people lack access to elec- can be credited for contributing to the country's overall tricity, with rural electricity access rates as low as 2%56. impressive project implementation capacity. In the absence of new policies, the number is expected to The China's policy framework evolved over 2004 and rise. To meet their lighting and other basic energy needs, 2005. Interim guidelines for CDM eligibility were issued many households continue to depend on fossil fuel-based first, and then HFC-23 projects provided the opportunity sources such as kerosene, or traditional biomass such as for considering CDM taxes (especially for industrial gas firewood (which often has serious impacts on health, eco- projects). The World Bank supported China in developing of the China CDM Fund, and in establishing tax thresh- 55 However, projects in Africa tend to be, on average, of much smaller olds that were later included in the revised (October 2005) size than in other parts of the world, as discussed in the section on Least Developed Countries, making the continent's contribution to the guidelines that still prevail. World Bank's expected volume of emission reductions relatively small. 56 2008. Lighting Africa--Annual Report 52 Experience on the Ground Carbon finance at the World Bank TA B L E 7 Regional summary table Representation Representation in global CDM in WB pipeline pipeline and and portfolio General portfolio (unless (CDM unless Comments/ otherwise noted) otherwise noted) Key opportunities Key challenges observations All Latin 838 projects 54 psrojects Large countries have America 17% 28% been a success (Mexico, Brazil, Peru) largely because of access to external capital resources Project entities tend to be for investment more technically advanced and have interest in CDM Brazil 350 projects 11 projects An increasingly clean and have data available 7% 6% energy grid is a chal- lenge to set baselines for reductions from energy projects All East Asia 2,590 projects 49 projects Strong capacity at host Even with strong data & Pacific 53% 25% country & PE levels collection capacity continued difficulty to obtain reliable data China 1,961 projects 26 projects GHG intensive grids leads Language proves a 40% 13% to opportunities for reduc- challenge for DOEs tions; strong data collec- and investors tion capacities All South 1,276 projects 32 projects Opportunities for a few High risk environment The government of India East Asia 26% 16% large programs that could considers carbon markets be registered before to be private sector driven 2012 and made little effort to India 1,251 projects 14 projects Access to external capital Public sector projects build capacity of the Pub- 25% 7% resources for investment in India are slow to lic Sector Undertakings develop (PSUs). All Africa 120 projects 46 projects Energy efficiency, rural Lack of underlying Technical and institutional 2% 24% electrification w/ renew- financing for projects; capacity. Complexity of ables (on & off grid) work in countries is the CDM process, and expensive raising its stricter requirements Large scale PoAs to transaction costs; make some of the carbon reduce gas flaring in oil limited biomass and finance interventions unat- producing countries hydro in the region tractive. Forestry sector Eastern 288 JI projects 16 JI projects 100% Heterogeneous climate Interplay with EU The status of Belarus and Europe/ 100% policy & priorities as well ETS; sometimes slow Kazakhstan under the Central Asia 11 CDM projects 5% as established national establishment and Kyoto Protocol and the 30 CDM projects institutional; GIS & pro- unpredictable imple- role of Turkey in any future <1% grammatic JI mentation of national agreements remains un- JI procedures clear. They could make a sizeable new contribution to supply. Experience on the Ground 53 YEARS OF EXPERIENCE IN CARBON FINANCE Bangladesh Solar Homes Systems (SHS) project has seen the registration of many SSC projects58--with The IDCOL Shakti SHS project helps poor, rural households not most SSC projects in the category of renewable electric- connected to the grid to access renewable solar electricity. ity generation for a grid--few have been implemented in The target 200,000 households have no electricity and use LDCs. The CDM-related transaction costs have proven kerosene and batteries charged from small generators to to be insensitive to the size of the project and have actu- electrify their houses. With the help of carbon finance, IDCOL ally been increasing over time (see Section 3). has introduced micro financing to allow poorer households In order to gain economies of scale, project develop- to purchase solar panels. The SHS-generated electricity supports increased economic activity in rural businesses ers also typically favor markets with larger potential for and enables use of technologies such as television, comput- projects and those with enabling environments. In this ers, and radios. sense, it is important to note that the projects underly- ing carbon finance transactions are investments which are sensitive to--and facilitated by--the local investment cli- mate, governance, legal frameworks, and opportunities to access capital at reasonable cost. nomic productivity and the environment). Energy poverty LDCs, who have smaller economies and often less is also directly linked to economic poverty as lack of access attractive enabling environments, have not seen a lot of to energy stunts economic growth and productivity. In CDM activity within their borders. While the aim of a fact, in their assessment of the potential for low carbon market instrument is to achieve a given objective in the energy projects for development, de Gouvello et al. (2008) most cost-effective manner, many have raised concerns concluded that "Sub-Saharan Africa has an unprecedented regarding the strikingly uneven geographic distribu- opportunity: choosing a cleaner development pathway via tion of CDM projects around the developing world. For low carbon energy alternatives that can reduce GHG emis- example, the UNEP RISØ data indicate that there are sions and at the same time meet current suppressed energy only 55 projects in the entire CDM pipeline located in demand and future needs more efficiently and affordably." an LDC country (i.e., approximately 0.9% of the total). This is also true for other LDCs. For example, the The World Bank project pipeline includes a better rep- Solar Home Systems project in Bangladesh (see Box 6) resentation, with 31 CDM projects in LDCs, represent- is an example of how carbon finance is contributing to ing about 17% of the World Bank's total project pipeline, the diffusion of clean technologies, and expanding energy largely thanks to focused mandates and efforts of the access for the poor. Community Development Carbon Fund (CDCF) and More than two-thirds of the population in Sub-Saha- the BioCarbon Fund (BioCF), and the overall impor- ran Africa depend on natural resources for their sustenance tance of Africa and LDCs in World Bank operations. The and livelihoods, and nearly 70% of carbon emissions come same type of picture emerges when looking at Africa as from land use degradation. Thus, improving long-term an entire continent: approximately 2% of all projects in land productivity, enhancing land and water management, the CDM pipeline are located in Africa, which contrasts as well as reducing the loss of vegetative cover, and defor- with the World Bank's carbon finance pipeline where estation and forest degradation, are all important priorities projects in Africa represent about 20% of all projects59. for Africa that can bring not just mitigation benefits, but also help address adaptation and development goals57. 57 Development and Climate Change: A Strategic Framework for the At the time of the Marrakesh Accords in 2001, many World Bank Group, 2008 expected that the so-called simplified modalities and pro- 58 At the time of drafting this report, over 900 SSC projects, represent- cedures for small-scale CDM (SSC) projects would lower ing 44% of all registered CDM projects, had been registered by the CDM Executive Board (http://cdm.unfccc.int). the CDM-related transaction costs and ensure such proj- 59 If shares are attributed according to project size, the projects in ects would not be at a disadvantage. Although the CDM Africa represent about 11% of the overall emission reductions expected 54 Experience on the Ground Carbon finance at the World Bank Addressing CDM barriers facing LDCs: lessons from the Community Development Carbon Fund (CDCF) The CDCF experience successfully demonstrates the viability of a regulatory approval has proven to be much more difficult than co-benefit approach to carbon finance by linking climate change anticipated. mitigation tangibly to the poverty reduction and the development agenda. The CDCF had ambitious geographic distribution objec- Three key lessons can be drawn from the CDCF experi- tives which are on track to be exceeded. The original objective ence: was to place at least 25% of the Fund's resources in the poorest Without significant reform in the CDM regulatory process, a ("priority") countries. As of March 2010, 52% of the projects (in large number of small-scale carbon finance projects in LDCs value) were located in priority countries. Out of 33 projects in its is unlikely to happen. Transaction costs and delays have to portfolio, the CDCF has 11 projects in LDCs (about 20% of the be dramatically cut to make small-scale projects viable. worldwide total) of which 2 are registered, and 9 projects in Sub- Managing the requirements of the CDM process, both for Saharan Africa (out of a world total of 61, excluding South Af- project validation and monitoring of emission reductions, rica). The Fund also gave priority to small-scale projects, a target requires substantial capacity building efforts and technical also on track to be achieved with 25 projects in that category. assistance support to project entities. However, this success is accompanied by significant chal- New CDM methodologies or approaches are needed for lenges in developing the carbon assets. For instance, only LDCs, taking into account their need for growth in energy 39% of CDCF projects are registered by the CDM EB as of services, given the state of significant suppressed energy March 2010. This illustrates that sourcing projects and gaining demand. A look at the various steps in a CDM project cycle sug- these registered projects are expected to generate only gests that the performance of LDC projects--even after 0.25% of all credits by 2012. they enter the CDM pipeline--unfortunately still lags Only 1 project in an LDC (a micro hydro project in behind that of CDM projects located in other parts of the Bhutan) has issued CERs for a total of 474 tCO2e, world. Longer delays for implementation of projects are representing 0.00012% of all CERs issued to date. common and key CDM milestones (i.e., registration and There are 38 projects under validation in LDCs (out issuance of CERs) tend to take longer to reach in LDCs,60 of a total of 2,712). These 38 LDC projects, added to which contributes to relatively higher transaction costs and the 15 registered projects and 2 submitted for registra- often loss of revenue for project entities61. The following sta- tion, would represent just over 1% of the total CDM. tistics (updated as of March 2010) illustrate the situation: These 55 projects, if all registered and performing as planned, are expected to generate less than 1% of all Only 15 (0.73%) of the CDM's registered projects CERs by 2012. are hosted by LDCs. Because they tend to be smaller, When looking at Africa as a whole, 8 projects have issued CERs, totaling 5.6 MtCO2e (or about 1.5% of all CERs issued to date). These CERs are issued from (according to PDDs) from projects in the World Bank pipeline. This reflects the typically smaller size of projects in Africa compared to the projects located in Egypt, Morocco, and South Africa. projects in more advanced economies, and in particular China. 60 It must be noted that these critical milestones have not yet been reached by the majority of projects in the CDM pipeline (UNEP RISØ). Figures on registration and issuance will evolve as more projects Key Insights currently in validation reach registration and move to issuing CERs. 61 The assessment of "loss of revenue" is related to the registration Throughout the World Bank's work in pursuing and devel- date, as CERs can only be generated once a project is registered by the CDM Executive Board. It is in this sense that there is a "loss of reve- oping CDM projects in LDCs, and particularly through nue" when the registration of a project gets delayed. the experience gained through the CDCF (see Box 7), it Experience on the Ground 55 YEARS OF EXPERIENCE IN CARBON FINANCE is possible to identify several factors that can help explain may not be readily available in LDCs. Changes are the challenges facing LDCs in terms of attracting CDM needed to reflect the realities on the ground in LDCs investments. Some of these factors, which are in addi- and so create a fairer playing field for them. tion to the typically smaller size of the economy, lower Availability and costs of CDM consultants and consumption of energy, and thus smaller size of carbon Designated Operational Entities. The development finance projects, are related to conditions inherent in the of PDDs is often done by consultants who are familiar country and affect their respective attractiveness to inves- with the language, procedures and rules of the CDM63. tors and CDM project developers: There are, however, few CDM consultants in Africa, thereby often increasing the cost associated with pro- Good governance and enabling environment. ducing PDDs. Few DOEs have staff located in Africa, Numerous studies62 have pointed to the importance of and travel within Africa can be time consuming and good governance and an enabling environment when costly, which can also contribute to increasing the evaluating a country's ability to attract new invest- time required for validations and verifications. More- ments. This is also relevant to carbon finance and the over, DOE pricing is typically not directly related to CDM. Seeking to attract more CDM projects may the size of a project, but rather to the perceived com- well involve governments examining their own poli- plexity (and risk) of a project. This often appears to be cies and enabling environment. greater for projects in LDCs where data are not always CDM capacity and awareness in host countries/ readily available, and business practices and documen- CDM procedures not adapted to LDC realities. tation often differ from that in more industrialized Factors such as the time required to obtain a CDM economies. letter of approval from the host country CDM DNA; There is a need to seek to enhance awareness and and the awareness and familiarity of government engage private sector participation through train- entities and private stakeholders with the CDM, ing to build up service providers in Africa that could are important considerations for investors and proj- stimulate the private sector's ability to access carbon ect developers. CDM demands a minimum level of finance. capacity within the private sector company or public entity to handle all its requirements. When existing The above factors pertain mostly to the situation in resources are already stretched or insufficient for the LDCs that differs from that in bigger CDM markets. In core business, it is often difficult to find a champion our view, some technical and procedural decisions (or to manage the CDM with its intricate processes and absence thereof ) in the CDM may have had a dispropor- requirements in a timely manner. Many line ministries tionate negative impact on the LDCs' ability to attract that could be instrumental in helping promote and CDM flows. Four are highlighted below: facilitate CDM projects are often unaware of the pos- sibilities offered by carbon finance. Extending carbon Onerous CDM procedures and requirements finance capacity development efforts beyond DNAs not adapted to LDC realities. Methodologies and and a few key experts within environment ministries documentation requirements (e.g., the data require- will be a key element to fostering greater CDM activ- ity in LDCs. It often takes longer to obtain data and documen- 62 See, for example the Doing Business website: http://www.doing- tation required for the validation and registration of business.org/. Unfortunately, the majority of the countries with the a CDM project in LDCs than in other parts of the lowest ranking are LDCs. 63 In many cases, it can be argued that the CDM, with its language, world. This is also often due to the nature of the data methodologies and processes, has become overly complicated and not and documentation requested by the CDM, which easily accessible to many potentially interested project entities. 56 Experience on the Ground Carbon finance at the World Bank ments and documents often requested to demonstrate large suppressed demand reflected in fossil fuel-based the additionality of a project, as well as monitor- off-grid electricity and significant imports from elec- ing requirements) are often geared toward the most tricity systems in neighboring countries, that are not advanced developing countries and do not work well reflected in the grid emission factors. Such improve- for smaller projects with less capacity, less data, and ments would lead to a more realistic (higher) emis- for less sophisticated project entities with less formal- sion baseline, providing a larger potential to reduce ized processes. It is clear that current requirements emissions. This could help stimulate interest in energy and procedures (and associated transaction costs) projects, not only on the supply side, but also on the are significant obstacles to CDM project activities in demand side (e.g., transfer and/or diffusion of energy- LDCs. It is essential to reflect circumstances on the efficient technologies and equipment). ground and work towards streamlining methodolo- Treatment of projects that replace non-renewable gies and expediting registration procedures in order biomass. The CDM EB made the conservative deci- to enhance the attractiveness of LDCs in the CDM. sion to not base the baseline on non-renewable bio- In context, it is worth noting the Community- mass66 (typically fuel wood) but rather on other fossil focused Micro-Scale Scheme being developed by the fuels (kerosene/LPG), because non-renewable bio- Gold Standard64 where eligible project activities are mass is considered ineligible for crediting under the deemed additional, without any further requirements Marrakesh Accords. This led to a drastic decrease in the to demonstrate additionality. This Gold Standard emission factor for these types of projects and resulted scheme is worth a close examination, as it may offer a in essentially cutting in half their emission reduction unique window of opportunity and a way forward for potential67, thereby jeopardizing their financial viabil- community-based micro-scale projects. Similarly, the ity. This decision affects in particular projects that World Bank also recommended in its April 2010 sub- introduce new renewable energy end-user technolo- mission to the EB, automatic additionality for small- gies, such as biogas stoves and solar cookers, to replace scale renewable energy and energy efficiency projects the use of non-renewable biomass for cooking. It has (see Annex 4). disproportionately affected Sub-Saharan Africa and Grid Emission Factors and inadequate reflection of reality of suppressed energy demand. Baselines often rely on historical experience. In the case of LDCs, emission baseline calculations do not take into 64 Gold Standard presentation on "Making Carbon Finance Work for the Poor--the Gold Standard Example", Africa Carbon Forum, Nai- account latent demand for energy that exists and are robi, March 5, 2010. thus under-estimated, diminishing the potential for 65 See, for example, presentation at COP 9 Side Event (Suppressed GHG reductions. Instead, they tend to assume the demand: extending CDM potential into least developed countries) by A. Michaelowa and Dang Hong Hanh on "Challenges in determina- continued supply of low/poor quality energy services tion of suppressed demand", Milan, December 3, 2003 (http://www. as these countries develop. The issue of suppressed southsouthnorth.org/) 66 At its 37th meeting in 2007, the CDM EB ruled that for the small- demand is not new and its recognition is reflected in scale methodology AMS.I.E. (Switch from Non-Renewable Biomass the 2001 Marrakesh Accords, which explicitly allow for Thermal Applications by the User), the emission factor for the for baselines to account for emissions "above current baseline would be that of the projected fossil fuel likely to be used by levels due to specific circumstances of host parties." similar consumers, such as kerosene or liquefied petroleum gas (LPG), and not the emission factor of non-renewable biomass which is signif- However, the debate continues on how to determine icantly greater. suppressed demand and therefore how to measure it65. 67 The World Bank made a submission (dated April 16, 2007) to the Addressing barriers to CDM projects in LDCs call for public input by the CDM Executive Board on proposals for methodologies for small-scale CDM project activities that propose should include developing more appropriate and prac- the switch from non-renewable biomass to renewable biomass (it can tical grid emission factors (EFs), to account for the be downloaded from: www.carbonfinance.org) Experience on the Ground 57 YEARS OF EXPERIENCE IN CARBON FINANCE projects in poor communities across LDCs where fuel energy security, environmental sustainability, and finan- wood, very often from non-renewable sources, tends cial savings. to be used. To date, the renewable energy sector, which is a key There may be some hope of revisiting this deci- focus for many countries' low carbon development, sion by the CDM EB with the recent recognition of has attracted the largest number of CDM projects REDD (Reduced Emissions from Deforestation and (see Figure 21). This is true for both the entire CDM Degradation) in the post-Kyoto context, which may pipeline and in the context of the set of already regis- stimulate a revision of the modalities and procedures tered projects. Waste management and industry are the related to the land use sector to enable the eligibility two other most "popular" sectors. However, the pic- of non-renewable biomass. ture changes when looking at the volume of emission Treatment of forestry projects and exclusion of reductions achieved by the CDM per sector. This is agriculture under the CDM. Forestry projects are due largely to differences among projects with respect penalized with "temporary" credits that are not rec- to (i) their size; (ii) the yearly emission reductions they ognized in some markets (e.g., the EU ETS), thereby can generate; and (iii) different GHGs global warming depressing demand and price for these credits. Agri- potential, i.e., the global warming effect of a GHG over culture and avoided deforestation, both with GHG a time horizon of 100 years in mass relation to carbon potential and extremely relevant for poor communi- dioxide. Indeed, the volume of CERs issued to date is ties throughout LDCs, are currently not eligible proj- largest for industrial gas projects that represent a rela- ect types under the CDM. tively small share of the total number of projects, but Given progress made in international negotiations have high GWPs leading to high volumes of emission on REDD and greater attention paid68 to the poten- reductions per project. These projects were also among tial of the agriculture sector as an important contribu- the fastest to be implemented and start requesting CER tor to climate change mitigation, the future may look issuance as a result of the financial significance of their brighter for these types of projects, to the potential CER revenue. This dominance is expected to dissipate benefit of LDCs. at the end of the commitment period, when other proj- ects move to requesting the issuance of their respective CERs. 4.3 Sector coverage: diverse with untapped The sector coverage of JI (Figure 22) differs from opportunities that of the CDM, with renewable energy occupying a smaller share of the total, though still significant. This 4.3.1 Overview may be due to power sector installations being covered under the EU ETS and thus limiting JI opportunities in The climate challenge demands that we act differently many countries (as discussed earlier). The shares of fugi- by moving towards the development and diffusion of tive emissions (e.g., from gas flaring reduction projects) GHG-friendly technologies and processes. There are is larger and is expected to deliver a large share of the JI's plenty of opportunities to increase efficiencies and to ERUs. lower the world's high-GHG intensity. For example, The technology composition of the World Bank port- existing technologies and best practices could reduce folio (CDM and JI combined) is more diversified, with energy consumption in industry and the power sector markedly larger shares of projects in the forestry sector by 20­30%, shrinking carbon footprints without sacri- ficing growth (WDR 2010). Many mitigation actions-- 68See for example, the agenda and presentations made at the March meaning changes to reduce emissions of greenhouse 3­5, 2010 Africa Carbon Forum in Kenya (http://africacarbonfo- gases--have significant co-benefits in public health, rum.com/2009/english/index.htm) 58 Experience on the Ground Carbon finance at the World Bank FIGURE 21 Technology distribution of CDM (until March 2010) ­ global CDM Power-Other: 1.2% EE Demand: 1% EE Demand: 1% EE Demand: 1% EE Demand: 2% Forestry: 1% Forestry: 0.1% Forestry: 0% Forestry: 0.6% Transport: 0.4% Transport: 0.1% Transport: 0.1% Transport: 0.3% 100% 4% 6% 10% 17% 23% 19% 15% 11% 2% 4% 4% 18% 10% 75% 50% 10% 60% 42% 42% 13% 4,968 2,062 0.4Gt 2.8 Gt 0% By total projects By projects registered By issued CERs By expected CERs issued (number) (number) (tCO2e) 2008-2012 (tCO2e)* Power -Renewables: Biomass energy, geothermal, hydro, solar, tidal, wind Waste management: Methane avoidance, landfill gas Power ­Other: EE supply, energy distribution, fossil fuel switch EE Demand side: EE household, EE service, fugitive emissions Industrial gas: HFC, N20, PFCs & SF6, CO2 capture Forestry: afforestration,agriculture & reforestation Industry: Cement, Coal bed / mine methane, EE industry, EE own generation Transport *2008­2012 CERs are not risk adjusted and represent full PDD volumes. As of March 2010 UNEP RISØ estimates ~1.036 Gt CO2e to be delivered from CDM FIGURE 22 Technology distribution of JI (until March 2010) ­ global JI Forestry: 0.3% Forestry: 0.0% Forestry: 0.1% Transport: 0..0% Transport: 0.0% Transport: 0.0% 100% 4% 13% 5% 26% 19% 4% 44% 17% 27% 50% 11% 21% 13% 26% 10% 27% 42% 8% 0% 288 5.4 Mt 0.3 Gt By total projects By issued CERs By expected CERs issued (number) (tCO2e) 2008­2012 (tCO2e)* Power -Renewables: Biomass energy, geothermal, hydro, solar, tidal, wind Waste management: Methane avoidance, landfill gas Power ­Other: EE supply, energy distribution, fossil fuel switch EE Demand side: EE household, EE service, fugitive emissions Industrial gas: HFC, N20, PFCs & SF6, CO2 capture Forestry: afforestration, agriculture & reforestation Industry: Cement, Coal bed / mine methane, EE industry, EE own generation Transport *2008­2012 CERs are not risk adjusted and represent full PDD volumes. As of March 2010 UNEP RISØ estimates ~0.3 Gt CO2e to be delivered from JI Experience on the Ground 59 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 23 Technology distribution of World Bank portfolio (by technology type) Transport: 3.3% EE Demand: 1% Transport: 0.4% 100% 6% 17% 13% 8% 19% 26% 50% 12% 39% 1% 7% 6% 26% 16% 211 45 Mt 0% By total projects By average tons per year (number) (tCO2e)* Power -Renewables: Biomass energy, geothermal, hydro, solar, tidal, wind Waste management: Methane avoidance, landfill gas Power ­Other: EE supply, energy distribution, fossil fuel switch EE Demand side: EE household, EE service, fugitive emissions Industrial gas: HFC, N20, PFCs & SF6, CO2 capture Forestry: afforestration, agriculture & reforestation Industry: Cement, Coal bed / mine methane, EE industry, EE own generation Transport *2008­2012 CERs are not risk adjusted and represent full PDD volumes. As of March 2010 UNEP RISØ estimates ~1.036 G + CO2e be delivered from CDM and in the demand-side energy efficiency sector, again attributed to dedicated efforts on projects that directly FIGURE 24 Global GHG emissions by sector (2005 data) benefit the poorest communities (see Figure 23). In terms of expected emission reductions, the industrial gases and Electricity & Heat 3% the industry sector projects are expected to generate the Manufacturing & Construction most. Transportation 13% 29% A look at the sectoral distribution of GHG emis- Other Fuel Combustion sions in developing countries (Figure 24) provides a Fugitive Emissions 14% perspective of the potential for emission reductions in Industrial Processes 4% these countries. But it must be recognized, once again, Agriculture 12% 4% that the CDM's inability to reach the full mitigation Land-Use Change 9% 12% & Forestry potential across sectors is related, at least in part, to the Waste demand for CERs (which is dependant on the ambition Source: CAIT, World Resources Institute 2005 data. of emission commitments). It is also very clear that many Includes land use change investments, especially large capital investments, require greater clarity and certainty of longer-term carbon finance revenue streams. Moreover, it may simply be that 60 Experience on the Ground Carbon finance at the World Bank all sectors are not equally well suited for a project-based starting point. Furthermore, in the absence of the CDM mechanism. For instance, in some sectors, and for some (or any regulation), there would be no incentive for their types of activities, other measures, such as regulation or elimination, making these the closest to "black-and- standards, may be equally or more effective in stimulat- white" cases of additionality. The majority (i.e., about ing GHG-reducing activities. There are also some sectors 75%) of CERs issued to date are for industrial gas proj- where methodologies may not be suitable or where the ects (see Figure 21). The World Bank, through Tranche design and implementation of projects is more complex, 1 of its Umbrella Carbon Facility (UCF), was one of the possibly requiring larger scale programmatic approaches. first market players to unlock this CDM sector by sign- In the case of forestry, it is clear that the current unfavor- ing 2 ERPAs for HFC-23 projects located in China70. able regulatory framework is affecting its potential under These large deals dramatically affect the technology com- the CDM (discussed below). Insights on key sectors, and position of the World Bank`s carbon finance portfolio as how the CDM was able, or not, to reach them is outlined shown in Figure 23. However, the CDM market is natu- below. rally dynamic and continues to search for the next level of "low-hanging fruit." This is reflected in the industrial gas sector's decrease in expected share of issued CERs by the Industrial gases end of 2012 as compared to their current share of issu- ance (see Figure 21). While at the outset, many expected the CDM to mainly target GHG reductions in sectors that contribute most to global emissions of GHGs (see Figure 24), the carbon Methane avoidance and waste gases price logically directed the CDM first to the projects with the lowest abatement costs. In market context, the Reduction in emission of methane (CH4) closely follows lowest abatement cost naturally translates into projects industrial gases in attractiveness for the carbon market. that result in high emission reduction with manageable In fact the CDM is helping countries find a more sus- cost, ease of management, a fast path to commissioning, tainable solution to their growing waste management and simpler methodological requirements. The "lowest- challenges. Sometimes referred to as the "methane kick", hanging fruit" turned out to be non-CO2 GHGs with given the higher GWP of methane (the landfill gas) com- high global warming potential, such as HFCs69 and N2O pared to CO2, the CDM provides a value to capturing (commonly called "industrial gases"). Apart from the landfill gas. The captured landfill gas, which would other- higher volume of emission reductions, these projects were wise be vented into the atmosphere, can instead be flared also in well-established sectors that had the financial and and transformed into CO2 (with much reduced GHG technical ability to undertake projects in a nascent car- impact on the atmosphere) or used for power generation. bon market and to work with the emerging CDM rules. The coal mining sector, waste gas recovery and use (for As the baseline is clear and the methodologies and addi- power generation or other useful energy needs) also have tionality fairly straightforward, and because it is simpler to develop a CDM project at single-point sources, elimi- nating `end-of-pipe' industrial gases allowed the CDM to generate early volumes consistent with the scale of 69 For example, the GWP of HFC-23, an unwanted by-product in the production of HCFC-22 is 11,700. demand, build market confidence, and lower the initial 70 These transactions were accompanied by the Chinese authorities' cost of CER supply. (See Box 8). establishment of the China CDM Fund, funded through levies on There have been critics of this early dominance of projects' CERs including a 65% levy of CER revenue from HFC-23 projects. Questions and answers are posted on the World Bank car- industrial gases. However, from a market point of view, bon finance website: http://wbcarbonfinance.org/docs/HFC23_q- eliminating industrial gases provided a cost-effective and-a_12-18-05.pdf Experience on the Ground 61 YEARS OF EXPERIENCE IN CARBON FINANCE The CDM and HFC-23 projects Some refer to the CDM's impact on HFC-23 projects as a sign selling refrigerant gases--by any measure a major distortion that the market signal works and ensures that limited capital of the market." to mitigate emissions gets the "biggest bang for the buck" (in terms of GHG reductions) wherever possible. Others see it as Others (e.g., MacWhinney 2007 and IETA) argued that profit an unfortunate waste of CDM resources. margins are not the issue. What is critical for the CDM is that projects lead to an additional benefit to the global environment. The bulk of HFC-23 generation comes as a by-product of the Without a value for the reduced emissions, which the CDM production of HCFC-221, which is used primarily as a refriger- brings, the reality is that facility owners have no incentive to ant and as a feedstock for manufacturing synthetic polymers. reduce HFC-23 emissions. Without the CDM, and given the lack By mitigating the HFC-23 waste stream under the CDM, plant of regulations in host countries, it is likely that these potent operators can gain significant revenues from the sale of CERs, gases would still be vented into the atmosphere. These types due to the high GWP of HFC-232. of end-of-pipe projects are seen as the closest to clear-cut ad- ditionality in the CDM. There are many critics of the early dominance of industrial gas- es, in particular HFC-23 (and N2O), in the CDM. Pointing out the The issue of perverse incentives, i.e., facility owners having a cost-effective nature of HFC-23 destruction and the high profit potential incentive to set-up an HCFC-22 facility with the main margins for HFC-23 reduction in the CDM market, critics argue purpose of destroying its HFC-23 by-product, is misguided as that this has been a wasteful use of the CDM, when it would new HFC-23 facilities are not eligible for CDM credits under the have been cheaper to simply give the factories the money to approved methodology. Schneider 2007 also concludes that install the equipment to destroy the gas. They also worried "despite the public criticism, it is unlikely that there are any about potential perverse incentives. Michael Wara, in his 2007 perverse incentives to increase HCFC-22 production under the article published in Nature, writes: "HFC 23 emitters can earn current rules of the CDM." almost twice as much from the CDM credits as they can from 1 HCFC-22 is an ozone-depleting substance (ODS) as well as a GHG with a GWP of 1,700 and it is controlled under the Montreal Protocol. HFC-23 is not an ODS, but a GHG and is controlled under the Kyoto Protocol. 2 HFC-23 has 11,700 times the Global Warming Potential of CO2, with a long lifetime of 260 years. benefited from the CDM incentive to stimulate produc- refinery gas or coal mine methane for power generation tive uses of otherwise released methane. In major car- and other useful energy or feedstock needs. In addition, bon-intensive manufacturing industries (iron and steel, a significant amount of methane can be recovered from cement, chemicals), the CDM incentive attracted the leaks during operation and storage, in particular in oil attention of plant managers and catalyzed the uptake of and gas upstream and transportation segments. Despite commercially proven technologies to capture waste heat the highly capital intensive nature of these industries, car- and waste gases and to increase efficiency. bon finance is creating an important additional incentive for investment in the difficult regulatory and market con- texts of developing countries. The scope of CDM proj- Energy extracting industries ects in these sectors could be significantly improved by enlarging the scope of methodologies to cover different Energy extracting industries also have provided significant activities and by adjusting methodologies' monitoring potential for the recovery of waste energy for productive provisions, relying on the established practical industrial use, such as the use of previously flared petroleum and processes for the monitoring. 62 Experience on the Ground Carbon finance at the World Bank Renewable energy infrastructure investment--are essentially locked out of the CDM. Moreover, the GHG impact of these projects CDM has played a very important role in stimulating depends on the behavior of users, which is typically very renewable energy (RE) projects. In fact, an examination difficult to assess, thus complicating the quantification of the global CDM pipeline of nearly 5,000 projects of GHG emissions. To reach this critical sector with the shows that the majority of projects (i.e., 60%) are renew- CDM, a new more practical approach to methodologies able energy projects, mainly hydro, wind and biomass and additionality will be required. projects. Large hydro and wind projects typically have a long construction period, affect large numbers of local stakeholders, and involve large investments, of which Energy efficiency CDM revenue is a very small component concerned with their additionality and sustainability. Nevertheless, Energy efficiency initiatives reduce GHG emissions these projects are typically easier from the carbon mar- through energy savings and, on the basis of a life-cycle cost ket perspective than dealing with small or micro scale, assessment, appear to provide low pay-back periods. This community-level, renewable energy projects involving situation often invites intensive questioning on the part higher transaction and development costs and usually of DOEs and the CDM EB. However, it is well-known not pursued out of purely commercial interest. The com- that, despite their inherent attractiveness, they are not plex CDM rules around public funding71 further ham- implemented in practice due to the range of documented per small, RE-based, rural development projects. Most barriers not captured in technology cost-curve analyses. of these projects require extensive grant financing and The CDM can help remove some of these barriers (e.g., capacity building support to be conceptualized and com- see Figueres and Philips, 2007; and IEA 2007). Typi- missioned, before they can even enter the CDM pipeline, cal demand-side energy efficiency initiatives generally but then they struggle to prove their additionality (due to involve a large number of micro, dispersed opportunities the existence of public funding). and multiple stakeholders requiring complex implemen- tation arrangements, which can now be encouraged using the CDM programmatic approach. These demand-side Transportation energy efficiency projects have many synergies with developing countries' development objectives. In fact, the The transport sector comprises nearly a quarter of global World Bank is pursuing several energy-efficient lighting GHG emissions today, and these emissions are expected projects in some of the poorest countries, e.g., Bangladesh, to increase exponentially over time with urbanization. Rwanda, and Senegal. Energy efficiency is also important To date, the CDM has not been able to make significant for the larger countries whose growth and development inroads into the transport sector, apart from its limited potential may be hampered by energy shortages and/or success in supporting technology shift types of projects costly energy imports. (e.g., commercial vehicle retrofits and low emission vehi- cles) that actually tend to result in rather small, short- term improvements. The current additionality approach 4.3.2 The special case of forestry makes it difficult to establish the additionality of projects that have large investments, and environmental and social Even though land use changes account for about 20% of benefits that are much greater than their GHG impact. global GHG, more than the entire global transportation The truly long-term transformative activities--mass tran- sit system development, transit-oriented development, 71Including rules to ensure that CDM does not divert official devel- modal shift incentive schemes, non-motorized transport opment assistance (ODA) funds. Experience on the Ground 63 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 25 Multiple benefits delivered by BioCF projects IRL by directly involving Fuel wood multiple stakeholders Timber IRL of surrounding communities by funding rural development activities Timber, non timber & agricultural products Ec Land tenure al o ci no So securitization m Non-timber ic Capacity building and products Climate Change institutional strengthening mitigation Timber, improved pastures & dairy products Biodiversity conservation Water sources protection and water quality improvement Erosion control and soil restoration Integrated land management Environmental IRL: Improved rural livelihoods sector (IPCC 200772), the land-use sector is vastly under- with 11 projects registered in 2009, compared to none in represented in the CDM, although better represented in 2008 or 2007 and one project registered in 2006. the World Bank portfolio, as a result of the BioCF. Project entities, DOEs and A/R-WG, have been learn- The history of the CDM afforestation and reforesta- ing together how to effectively apply the A/R CDM rules. tion (A/R)--the only two land-use activities currently For example, most (68%) World Bank BioCarbon Fund eligible under the CDM--started two years later (2003) (BioCF) projects73 entered the portfolio between 2004 than other sectors. These two years were devoted to defin- and 2005 when no methodology for GHG accounting ing rules and an extra year to the design and approval of existed. Some pioneer projects provided field based expe- the first A/R methodology. Five years have passed since rience for the development of 7 approved CDM method- then and important achievements have been made: 14 ologies. These projects also provided feedback from the approved CDM methodologies covering a wide range of field on the application of the CDM rules, which helped baselines and project scenarios are available, including six the CDM EB to develop procedures, guidance, clarifi- for small-scale projects and two large-scale consolidated cations, and tools to facilitate the application of meth- methodologies. The CDM A/R Working Group (report- ing to the CDM EB) published 14 tools/guidelines to facilitate methodology application, and some organiza- 72 Intergovernmental Panel on Climate Change, 2007. Climate change 2007: the physical science basis. Contribution of working group 1 to the tions have also published useful tools and guidebooks that fourth assessment report of the Intergovernmental Panel on Climate contribute to improving and spreading knowledge on for- Change. www.ipcc.ch/publications_and_data/publications_ipcc_ estry carbon. In addition, 15 DOEs are accredited for vali- fourth_assessment_report_wg1_report_the_physical_science_basis. htm dating A/R projects and 14 for verification. The number 73 The World Bank forestry projects are part of the BioCF portfolio, of projects in the global A/R pipeline is also accelerating, except for two projects that are part of the PCF. 64 Experience on the Ground Carbon finance at the World Bank odologies and rules. New projects could build on this Entities of multi-stakeholder projects have to create for- experience and introduce simplifications. estry capacities which usually include the introduction of Well-designed projects can significantly contribute to a culture of long-term land use planning. the sustainable development of impoverished rural areas Realizing the CDM's potential is impaired by CDM and these contributions can be done in different ways. technical challenges associated with demonstrating com- Projects have a wide range of benefits including greenhouse pliance with the CDM land-related rules, i.e., land eligi- gas reductions, soil conditioning, and erosion control. bility, legal land tenure, project boundaries, and control Figure 25 illustrates the range of sustainable development over the land. Demonstrating land eligibility is costly and benefits A/R projects can deliver. Some projects have been demands specialized knowledge and technology as well designed to deliver many of these benefits at once, while as specialized studies of land use patterns and/or ecology. others have focused on a smaller sub-set. The BioCF projects that have submitted their land eligi- A key feature of A/R-CDM is its potential for tackling bility assessment to validation scrutiny are mainly located mitigation as well as adaptation to climate change. Many on degraded lands. Challenges related to low capacities of the benefits delivered by BioCF A/R projects contrib- have delayed the assessment of these projects. The CDM ute to strengthening the natural and socio-economic cap- legal land tenure requirement is also an obstacle, as it is ital of rural people, thus improving their capacity to cope usually a time-consuming process that requires the sup- with adverse events and reducing their vulnerability. The port of national and local institutions. A/R activities regenerate severely degraded and remote Another technical challenge is the amount of infor- lands where special planting techniques may need to be mation and the level of detail required by a CDM A/R employed. The rural economy of impoverished commu- methodology. Despite substantial progress in developing nities is therefore stimulated with timber and other reve- simplified methodologies, this remains an issue, espe- nues. Adaptation to adverse conditions is also achieved by cially when using native species and accounting for emis- improving the soil condition and water retention capaci- sion leakage, as growth data for native species are scarce ties, and helping prevent soil erosion. In addition, A/R and may involve lengthy and costly evaluations. activities are promoting integrated land management, CDM A/R activities face particular financial and with a number of projects promoting alternative activities market challenges linked to the temporary nature75 of for- such as improved agriculture, intensive pasture manage- estry carbon credits under the CDM. According to this ment practices, agro forestry and fuel wood plantations. rule, the verification of sequestered carbon can only occur Another prominent feature of forestry carbon finance once every five years, complicating the viability of proj- is its potential to remove land tenure related barriers. ects as carbon finance payments are performance-based. Clear land tenure and carbon rights are requirements of Some projects, like those involving poor farmers cannot A/R-CDM. In four BioCF projects in Kenya, Madagas- wait for five years to compensate stakeholders for their car, Niger, and Ethiopia, communities have been granted land use change. land tenure rights through ERPA contracts and benefit- The other side of the problem with temporary cred- sharing systems. In addition, in other projects, communi- iting is the replacement liability placed on the buyers ties that are afforesting / reforesting State lands have been purchasing a forestry credit. Indeed, according to the pre- granted with usufructuary rights74 to the land, including vailing CDM rules, forestry credits need to be replaced tradable rights to carbon. with other temporary or permanent credits prior to their The A/R CDM is making a significant contribution expiration. In the current uncertainty surrounding the to improving forestry practices and forestry monitor- ing. Project developers have to systematically measure 74Rights that provide for the use of property that belongs to another. biomass increments and projects' emissions and ensure a 75The CDM temporary credits (tCERs) were put in place to address high quality of data collection, storage, and management. the non-permanence risk associated with forestry projects. Experience on the Ground 65 YEARS OF EXPERIENCE IN CARBON FINANCE post-2012 climate regime, acquiring a temporary credit supply side is good; developments in the regulated and plus a replacement credit is not an obviously attractive voluntary market frameworks have been positive, and, proposition compared to buying a permanent credit. building on the experience already gained, some countries The establishment of Programmes of Activities are scaling up the forestry CDM through new projects or (PoA) under the CDM has been a positive development PoAs. However, more positive market signals are neces- for CDM A/R, as they are more compatible with the sary to boost the demand for these credits. Such a boost dynamic of farmers' land use decisions. The BioCF is cur- could then lead to significant environmental, social, and rently validating the first forestry PoA. PoAs allow the economic benefits, particularly for rural communities. A flexibility to add lands whenever they are identified and study of BioCF lessons learned from A/R CDM is under are ready to be planted, as long as additionality and eligi- preparation; it aims to shed light on the challenges that bility criteria are met. Simplified A/R methodologies will project developers have encountered in achieving effec- be essential for a greater uptake of forestry PoAs. tive project preparation and implementation, and also on Although there have been challenges, the window for opportunities that the CDM has brought to the forestry forestry carbon credits has opened up. The outlook on the sector. 66 Experience on the Ground The Benefits of Carbon Finance Has the experience with the Kyoto mechanisms been easy? We would say "No." Are there improvements to FIGURE 26 Origin of capital financing in World Bank be made? "Of course." Has it been worth it? Yes, most CDM projects definitely, because we have seen the benefits. While the benefits of specific project activities and capacity build- ing have already been mentioned, this section describes in 13% more detail some of the key benefits of the carbon finance experience over the past decade and discusses how they 17% 49% could be further enhanced. 21% 5.1 An important catalyst of development finance Private Capital Carbon Finance One of the successes, and a key feature of carbon finance, Foreign Public Investment Local Public Investment is that it can both complement and leverage other finan- cial resources to unlock low carbon investment in host countries. Carbon finance revenues enhance the overall financial viability of climate friendly projects and, as per- lative value of approximately US$25.6 billion, benefiting formance-based payments, create positive incentives for some US$106 billion in underlying low carbon invest- good management and operational practices to sustain ment, or an average leverage ratio of 1 to 4.6.76 More emission reductions over time. Carbon finance revenues generally, it is estimated that projects that entered the can also leverage upfront capital for underlying invest- global CDM pipeline over 2002­09 represent an overall ments and provide incentives to overcome social inertia, climate-friendly investment of more than US$150 bil- low awareness, transaction costs, and financing of Pro- lion (two-thirds of which is in renewable energy).77 As grammes of Activities. Experience so far suggests that car- a comparison, sustainable energy investment in develop- bon finance, alone or in combination with other policy ing countries totaled approximately US$120 billion over and finance instruments, has made a difference in favor of climate action and catalyzed the shift of much larger amounts of (essentially private) financial and investment 76 Market data source: State and Trends of the Carbon Market 2010, flows to low carbon development (see Figure 26). The World Bank, Washington, DC; leveraging ratio compiled using data from State and Trends of the Carbon Market 2009. It is estimated that over 2002­09, forward contracts 77 UNEP RISØ CDM/JI Pipeline Analysis and Database, March 1st of about 2.2 billion CERs have been agreed for a cumu- 2010. 67 YEARS OF EXPERIENCE IN CARBON FINANCE 2002­09.78 In addition, projects that entered the JI pipe- downturn and its dampening effect on European emissions line over 2006­09 are estimated to have stimulated about and lower demand for CERs; (ii) the emergence of AAUs US$18 billion in underlying climate-friendly investment in the market, satisfying the appetite of several buyers for (predominantly in energy efficiency).79 more secure assets in large volumes; and (iii) the closing There is great variability in the ratio of the underlying window for new CDM projects as the end of the first upfront investment required for a CDM project activity commitment period approaches. For a complete market or a Programme of Activities to the net present value of update, please see State and Trends of the Carbon Market its expected future carbon revenues (see Figure 27). 2010 published by the World Bank in May 2010. It is not surprising that this ratio depends on project For a number of low carbon investments that have rela- type (which can be more or less capital-intensive) and the tively low upfront capital requirements and for which the size of carbon revenues. Carbon revenues, in turn, result net present value of carbon revenues represents a relatively from: (i) the volume of credits generated, which are highly large share of the investment, carbon finance can make a dependent on the GHG intensity of the baseline (from critical difference in facilitating their implementation and which emission reductions are calculated); (ii) the length operation. This is, for example, the case in solid waste man- of the purchasing period (in the ERPA), which tends to be agement (as discussed earlier), where carbon revenues can short given persisting post-2012 regulatory uncertainty; improve the internal rate of return (IRR) of investment and (iii) the price, influenced by the overall market trends by more than 50%, while their net present value compares and by the project performance risk (which so far has to the underlying investment. With such numbers, there reduced by two-thirds expectations of CERs from CDM exists tremendous potential for carbon finance to mobi- projects).80 Figure 28 shows the historical trend in CER lize capital for projects with immediate development and market prices. The drop in transaction volume experi- climate benefits. Additional resources of carbon finance enced in 2009 can largely be attributed to (i) the economic can improve the financial sustainability of solid waste management policy reforms and investment programs and scale up adoption of more sustainable practices. Car- bon finance can also provide enough incentives to over- FIGURE 27 Ratio of Investment to net present value of ERPA in the World Bank CDM portfolio 78 Source: Bloomberg New Energy Finance. Estimates of clean energy investments that benefit from CDM tend to be higher than actual sus- HFC 0.02 tainable energy investment in developing countries since many CDM projects are often neither operational, nor commissioned, nor even at EE Households 0.76 financial closure at the time of contracting. These operational mile- stones are expected to be achieved later. LFG 1.04 79 This estimate follows Seres and Haites' approach to quantify invest- ment behind CDM projects, i.e., by multiplying the amount of Other Waste Mg't 3.77 expected annual emission reductions from active projects in the pipe- line for a specific technology by the capital intensity of this technol- LULUCF 6.95 ogy. See: S. Seres and E. Haites (2008). Analysis of Technology Transfer in CDM projects. UNFCCC, Bonn. Technology-specific capital Wind 12.23 intensity estimates are calculated as the ratio of the sum of underlying upfront investment for all project activities or Programmes of Activ- BIomass energy 12.22 ities for a given technology to the sum of their expected annual emis- sion reductions, using data for projects with a signed ERPA within the Hydro 16.47 World Bank portfolio. 80 Potential CER supply by the end of 2012 stands at about 2.8 bil- lion (nominal PDD value for all active projects in the pipeline) while Source: The nominal value of teh ERPA is discounted at 10% per year, risk-adjusted deliveries by the same date are 1.0 billion CERs. Source: assuming all future payments occur in a period of five years. UNEP RISØ CDM/JI Pipeline Analysis and Database, March 1st 2010. 68 The Benefits of Carbon Finance Carbon finance at the World Bank FIGURE 28 Average price and volumes transacted in primary project-based Kyoto flexibility mechanisms 700 18 16 Annual Volumes of Project-based 600 Average price (US$ per tCO2e) 14 Transactions (Mt CO2e) 500 12 400 10 300 8 6 200 4 100 2 0 0 2002 2003 2004 2005 2006 2007 2008 2009 come social inertia, low awareness, and transaction costs tional, which is critical for sustaining emission reductions to accelerate the diffusion of more energy-efficient equip- over time. ment or renewable energy sources in rural areas (e.g., com- Still, the leveraging potential of carbon finance has pact fluorescent lamps, cooking stoves, or biodigesters). not yet been fully explored and must be further exploited In general, more capital-intensive technologies (like to mobilize, along with other instruments, both climate many investments in renewable energy for instance) are and development finance on a larger scale to support low very often limited by financing constraints81, with many carbon development. While some challenges to leverag- developing countries in particular having limited access ing greater climate financing are beyond the immediate to long-term and affordable capital. In such circum- scope of carbon finance (e.g., creating an enabling envi- stances, the impact of carbon finance is typically smaller ronment, providing appropriate economic and regula- (improvement of IRR by only a few percentage points). tory incentives, and strengthening the capacity of public, As a result, carbon finance alone, as an incremental financ- private and financial sectors), some are specific to the car- ing mechanism, cannot overcome, in the current envi- bon finance mechanisms. These challenges include: ronment, the powerful financing barrier to low carbon growth so often found in developing countries. However, Chronic uncertainties about future demand for this does not mean that carbon finance has no impact; it emission reductions (ERs). Uncertainties about the can make a positive contribution by enhancing the proj- future demand for ERs are limiting post-2012 carbon ect revenues, thus helping to lower the cost of borrowing. market activity and discouraging the development Carbon finance may not be the best tool for the testing of pre-commercial/high-risk/ capital-intensive new tech- 81 For a discussion on constraints to financing, see for example, Kos- nologies, but it can be a powerful tool in cases of relatively soy (2010). low-risk investments in proven climate-friendly tech- 82 The number of new projects entering the CDM pipeline has con- tinuously declined over the past year, and now stands at about 80 new nologies by making them more attractive and profitable, projects per month. The window of opportunity to develop new proj- and thus enhancing their chances (over carbon-intensive ects, have them registered by the CDM Executive Board, and generate alternatives) of being developed and remaining opera- CERs by the end of 2012 has started to close. The Benefits of Carbon Finance 69 YEARS OF EXPERIENCE IN CARBON FINANCE of new projects82. These uncertainties relate to the front-loading of carbon finance revenues to permit a allowed amount of credits that can be used to meet commercial loan for the project (see Box 9). compliance obligations, eligible mechanisms or stan- dards, and rules on eligible credits. This makes it also A number of actions can help maximize the transfor- extremely difficult to estimate the future price of emis- mational impact of carbon finance, notably by enhancing sion reductions and the amount of additional carbon long-term carbon finance revenues, leveraging carbon finance resources that could flow to projects. Except finance, and making it fit better into public and private for the European Union (EU) and New Zealand, sector investment decision-making. These include: adoption of a countrywide emission trading scheme (ETS)--which creates a demand for emission reduc- Policy and regulation. Two of the major challenges tions from covered installations--has been further to the expansion of the carbon market relate to lack of delayed in other Annex I countries (Australia, Japan, certainty and ambition, on both the demand for and and the USA). In addition, rules governing the use of the supply of emission reductions. Bringing longer- offsets under Phase III (2013­20) of the EU Emis- term clarity to the demand for and eligibility of carbon sions Trading Scheme (EU ETS)--so far the engine credits will allow the tenor of ERPAs to be extended of the carbon market worldwide--have not yet been as well as provide a long-term price signal to the mar- clarified, leaving question marks as to what type of ket. In addition, in order to increase the likelihood of emission credits will be eligible (e.g., countries of ori- achieving ambitious GHG reductions commensurate gin and technologies) and thereby making buyers even with meeting the ultimate objective of the UNFCCC more conservative. As more domestic initiatives may (i.e., the stabilization of GHG concentrations in the emerge, harmonizing offset rules would help to ensure atmosphere), cost-effectiveness is an important consid- a minimum compatibility and fungibility of ERs eration to which offsets from developing countries can across regimes and maximize the benefits of hopefully contribute. A long-term, predictable, and appropriate growing demand83. price signal can only be provided with signs of robust Complex and fast-changing rules, capacity bottle- demand, which will hopefully stimulate a vibrant necks, and regulatory inefficiencies. These issues market and offer developing countries a meaningful (discussed earlier) have resulted in year-long delays opportunity to support their low carbon development and instability, with financial implications for projects. priorities. Without these signs, the carbon market could Lack of upfront financing. Carbon finance does not unfortunately face serious risks of losing momentum. (fully) address the need for upfront financing of low In turn, building a substantial and credible supply carbon investment, as most often payment for cred- of offsets will require improving regulatory efficiency its occurs on delivery, once the project is operational. and effectiveness of the project-based mechanisms (as Some advance payments (for emission reductions to discussed earlier). be achieved later) have been seen in the market (up Capacity. Building an enabling environment for low to 10­25 % of the value of the carbon transaction)-- carbon investment and facilitating the expansion of including for several World Bank carbon finance domestic financial markets around carbon finance transactions; however, there have been few attempts opportunities would enhance carbon finance's reach. by financial institutions to monetize forward carbon Risk-management products specific to carbon revenue streams to provide (in part or in full) the finance. Risks and uncertainties can deter potential investment capital required, given the risks to underly- carbon asset buyers and investors in underlying low ing projects, often low familiarity with carbon finance, and post-2012 uncertainty. The Brazil Plantar project 83For more information on carbon market trends, please see Kossoy is an example of a pioneering transaction that enabled and Ambrosi 2010. 70 The Benefits of Carbon Finance Carbon finance at the World Bank Plantar project in Brazil: pioneering structured finance around carbon revenues The Plantar project consists of the substitution of coal in the credit risk mitigation also resulted in a reduction in the overall pig-iron industry, and was financed through a loan with a com- risk perception by the lender, which could provide attractive mercial bank (Rabobank). The nominal value of the ERPA con- loan terms to Plantar. tract between the World Bank (as trustee of the PCF) and the project sponsors (Plantar) was anticipated by the commercial Plantar structured finance arrangement lender to Plantar, who is both recipient of the loan and seller Cross border of the emission reductions. The financing was structured in a US Brazil way that the expected payment for the verified emission reduc- CF Host Country tions1 (in this case made by the PCF) would perfectly match Letter of Approval the loan's amortization schedule while the loan's repayment would be made directly by the Word Bank to Rabobank. The anticipated sources of revenue streams provided by emission ER payment ERs ERPA Permits, etc. $$$ reductions in the project, the absence of currency convertibility and transferability risks, and the intangibility of those emission Up-front finance reductions led the transaction to be rated by the lender as $$$ "credit-risk free". This eliminated the lender's obligation to ob- Rabobank Plantar tain any insurance. Therefore, the project became bankable, Financial Agreements and the loan became attractive to the lender. In addition, the 1 The Plantar project receives payment on the basis of verified emission reductions (VERs). The CDM regulatory risks (i.e., risks of converting ver- ified emission reductions to CDM-approved certified emission reductions) are thus borne by the PCF. This is an important risk-sharing feature of the ERPA. carbon projects, thereby dampening carbon finance ple benefits are maximizing effective use of resources, potential. These comprise, for instance, regulatory their leverage of public and private domestic invest- risks linked to project and program eligibility and pro- ments, and their impact on climate action. cedures, technology risks (the first of its kind), and a riskier business environment. There is a need to expand to the sellers the application of risk management tools 5.2 Greenhouse gas mitigation & sustainable (e.g., insurance), which so far have been largely avail- development able for the buyers' benefit (notably derivatives), and may help maximize the value of credits and enhance the The Kyoto Protocol's CDM Article (article 12) was impact of carbon finance on low carbon investment. groundbreaking in establishing a market-based mecha- Structure financing to turn carbon into finance. nism focused on project activities implemented in devel- Solutions need to be explored to frontload anticipated oping countries. With only the limited experience from carbon revenues into upfront finance, such as bonds the pilot phase on Activities Implemented Jointly (AIJ)84 or other structures to monetize future carbon receiv- ables, or piloting innovative use and combination of 84The 1992 Framework Convention on Climate Change provides instruments building on synergies, each addressing for Annex I Parties to implement policies and measures jointly with specific barriers, risks, or needs. To illustrate this, box other Parties. In order to build experience and "learn by doing," COP 10 showcases an innovative example from India, where 1 (Berlin, March/April, 1995) launched a pilot phase of activities implemented jointly, under which Annex I Parties may implement a combination of several dedicated environmental projects in other countries that reduce emissions of greenhouse gases sources of funding to support programs with multi- or enhance their removal through sinks. The Benefits of Carbon Finance 71 YEARS OF EXPERIENCE IN CARBON FINANCE Building on synergies between the Global Environment Facility, Montreal Protocol & carbon finance to scale-up climate action The India Chiller Energy Efficiency Project (CEEP) will improve new chiller technology), and carbon revenues (contributing to the energy efficiency of building chillers (a major source of a revolving fund to support replacement of additional chillers), power demand) and accelerate phasing out of ozone-depleting further complemented by public and private capital. substances by helping to overcome the limited availability of upfront resources necessary to replace and upgrade older This project illustrates how a limited upfront provision (less CFC-based chillers by more efficient non-CFC-using ones. than 10%) of highly concessional resources (mostly from GEF) can potentially mobilize a much larger amount of resources The objective of the CEEP is to replace a total of 370 chillers (total cost of replacement estimated at $90 million) to achieve (out of a total market size of about 1,200 chillers), over a pe- a greater transformational impact (targeting more than 25% of riod of 3 years, with an average incentive of 20%, leading to chillers), by building on synergies and maximizing the effective- an estimated (direct and indirect) 13 MtCO2e reduction in GHG ness of resources through increasing their leverage. A similar emissions over 20 years. It draws on an innovative combina- project operates in the Philippines, while Indonesia has also tion of the Global Environment Facility (GEF), Montreal Protocol expressed interest. resources (providing an upfront subsidy for early adopters of and virtually no infrastructure upon which to build, CO2e will be reduced by JI over the 5-year commitment the Kyoto Protocol, as noted earlier, established the period. As of March 2010, 391 million credits have been CDM with the dual objectives of (i) assisting developing issued by CDM and JI projects combined. countries (non-Annex I Parties) in achieving sustainable To appreciate the significance of the 1.2 Gigatons development; and (ii) assisting the industrialized coun- (Gt) CO2e expected to be reduced by the project-based tries (the Annex I countries) in achieving compliance mechanisms, it is useful to put this figure into perspec- with their emissions commitments through emission tive through a comparison with industrialized countries' reductions from CDM projects. emissions. For example, according to its Fifth National The Kyoto Protocol also stipulates that Annex I coun- Communications, the Netherlands is expected to emit tries shall meet their emission commitments while also approximately 1 Gt of CO2e during the Kyoto Proto- promoting sustainable development. col's first commitment period86 (see Figure 29). Another 85 RISØ estimated (in March 2010) the 2008­2012 CDM CER issu- Mitigating climate change ance by discounting the expected volumes indicated in the PDDs of proj- ects in the registered CDM pipeline. It takes the 2,836 million CERs from all projects in the CDM pipeline projected for 2012 and multiplies Data suggest that the mechanisms are on track to generate them with the 96.5% issuance success. The future CDM projects which emission reductions to assist Annex I countries in meet- are currently under validation are multiplied with the 18.3% chance of a negative DOE validation (or termination) and the 6.1% chance of being ing their emissions obligations under the Kyoto Proto- rejected by the EB. The total expected CERs in 2012 are then adjusted col. UNEP RISØ estimates that by December 31, 2012, to take into account time lags (to reach registration). The resulting total the CDM projects are expected to generate reductions expected (i.e., discounted) CERs to be issued by the end of 2012 is 1,036 Million CERs. See http://cdmpipeline.org/ of 1,036 MtCO2e (based on the discounted estimated 86 Note that these estimates do not fully capture the impact of the eco- emission reductions outlined in the PDDs, to reflect the nomic downturn and path to recovery. Projections do not include the use of sinks and flexibility mechanisms. 2008­2012 data are taken probability of lower emission reductions resulting from from multiplying the annual amount released in the Fifth National the scrutiny and delays in the CDM approval process)85. Communications by five to estimate the cumulative amount of emis- RISØ estimates that an additional 180 million tons of sions over 2008­2012. 72 The Benefits of Carbon Finance Carbon finance at the World Bank FIGURE 29 Contribution of CDM & JI towards meeting GHG commitments: comparison with selected countries' emissions87 Expected overall Expected total country emissions over the period ('08­'12) emission reductions from CDM and JI ('08­'12) Mt CO2e Approx. 3,000 Approx. 2,000 Approx. 1,000 The Netherlands Spain United Kingdom ­1,035 (CDM) ­180 (JI) basis of comparison is the targets that have been agreed I buyers are meeting a portion of their GHG emissions by the Parties that have ratified the Kyoto Protocol (i.e., obligations at less than 10 per ton, a cost lower than they excluding the U.S.), amounting to an overall reduction of would be able to achieve through either the purchase of about 4% below 1990 levels, representing an approximate tradable allowances (EUAs), and likely lower than what reduction of 2.6 Gt over the 5-year commitment period, could be achieved through internal investment decisions, assuming emissions stay stable over that period88. or through national policies and measures.90 By design, market-based instruments are meant to help achieve an environmental objective cost effectively. While it is not possible to assess this fully without com- Contributing to sustainable development paring with the abatement costs of other options, evi- dence suggests that the Kyoto mechanisms are achieving Under the 2001 Marrakesh Accords, it is the responsibil- their aim of cost effective mitigation of global greenhouse ity of the respective host country to determine whether gases. As shown in Figure 30, the primary CER (pCER) 89 prices have been lower than the EU allowance (EUA) price (used for compliance in the EU ETS). Of course, the 87 2008­2012 data taken from multiplying the annual GHG amount two commodities (i.e., pCERs and EUAs) are not fully released in the Fifth National Communications by five to estimate the comparable, as pCERs, which are issued ex-post--after cumulative amount of emissions over 2008­2012. 88 This is a simplified assumption, as in many countries, emissions the project has been registered, performed as planned have increased, thus also increasing the volume of emission reductions and CERs have been issued--involve greater risks (e.g., needed to meet their obligation. 89 A primary market transaction is a transaction between the original the project may not perform well) than the secure EUAs owner (or issuer) of the carbon asset and a buyer. A secondary market (which are allocated or auctioned ex-ante). Nonetheless, transaction is a transaction where the seller is not the original owner the CDM is thus working to assist in meeting the Kyoto (or issuer) of the carbon asset. 90 For instance, the Swiss Climate Cent Foundation reports that the Protocol emissions commitments at a lower cost. Indeed, cost of reducing CO2 through purchases of CDM credits is cheaper if the World Bank's experiences are assumed to be repre- than mitigation in Switzerland "by a factor of around 5". (http:/kima- sentative of others in the CDM & JI market, many Annex rappen.ch/en/foundation/) The Benefits of Carbon Finance 73 YEARS OF EXPERIENCE IN CARBON FINANCE FIGURE 30 Average monthly prices of CER, pCER & EUAs 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 4/08 5/08 6/08 7/08 8/08 9/08 10/08 11/08 12/08 1/09 2/09 3/09 4/09 5/09 6/09 7/09 8/09 9/09 10/09 11/09 12/09 ECX sCER Av. Future (up to '12) ECX EUA Av. Future (up to '13) IDEACarbon pCER Index Bluenext spot CER Source: State and Trends of the Carbon Markets, 2010 a given proposed CDM project will assist it in meet- in Box 6, and the Senegal Efficient Lighting in Rural ing its sustainable development objectives. Each project Areas Program91); submitted to the CDM Executive Board must first have Developing local natural resources (e.g., the recently obtained the approval of the respective host country's registered Félou run-of-river hydropower project CDM DNA. which will deliver clean power, 62 MW, to Mali, Mau- While there is no internationally agreed metric to ritania and Senegal); assess sustainable development benefits, it is the experi- Providing solutions for solid waste management, a ence of the World Bank that there are significant devel- problem for many developing countries with rapidly opmental co-benefits associated with CDM (as well as JI) increasing urbanization rates (e.g., the Alexandria projects, which should not be overlooked. Landfill project, see Box 11); It is undeniable that participation in the mechanisms Reducing both local air and water pollution, thus has raised overall awareness about low carbon solutions generating health benefits (e.g. the Thailand Sapthip and leveraged capital for climate-friendly projects in Wastewater Management project improving the local many host countries. The CDM has also provided oppor- air quality and human health. The closed anaerobic tunities to support basic development needs and broader socio-economic co-benefits such as: 91 The Senegalese program is part of the World Bank CDCF portfo- Improving energy access and energy services (e.g., lio. The program will distribute 1.5 million compact fluorescent light bulbs (CFL) in newly electrified rural communities. This is under- projects that contribute to rural electrification and taken in connection with a nationwide rural electrification plan that projects that enhance energy services such as the Ban- aims to increase electricity access in Senegal's rural areas from 16% to gladesh Solar Homes Systems project, highlighted 50% by 2012. 74 The Benefits of Carbon Finance Carbon finance at the World Bank Providing solutions for solid waste management treatment proposed also limits bad odor and possible health hazards caused by the methane that is released). The World Bank's Alexandria Landfill project includes two Generating employment (e.g. the Bangladesh Kiln municipal waste landfills in Alexandria, Egypt that are part of the global waste management system initiated by the Efficiency in brick-making project which is providing Alexandria Governorate. The comprehensive waste man- full-time employment and higher salaries, along with agement system was initiated in 2000 and is intended to safer working conditions) improve the quality of life for the city's 5 million residents. improving livelihoods (e.g., the Ethiopia Humbo The project's objective is to maximize the capture of landfill Assisted Natural Regeneration project, which is man- gas (LFG) from the two new landfill sites. In addition to re- aged by seven community cooperative societies) ducing the potential local impacts of odors and explosion or fire hazard associated with landfill gas, the project is Moreover, many CDM (as well as JI) projects have aimed at reducing the fugitive emissions of methane (CH4), a powerful greenhouse gas. The global waste management played an important role in contributing to technology system implemented for Alexandria, which is the first of transfer (e.g., in industrial projects) and, even more, to its kind in this region, makes numerous positive contribu- technology diffusion (e.g., in efficient lighting and bio- tions to sustainable development. Developmental benefits gas programs), which is critical to broadening the reach include the full spectrum of waste management activities of low carbon efforts. The CDM and JI projects have also from street cleaning to collection and treatment of all the household and commercial waste generated in the city. seen significant benefits at the grass-root level of building capacity and local empowerment of vulnerable groups. Different types of carbon finance projects, e.g., proj- ects of different technologies, different sizes and imple- mented in different circumstances, can all lead to positive sustainable development outcomes. It is also important to World Bank's CDCF's particular experience in ensuring recognize that there is not one single approach to con- that carbon finance projects support host countries' sus- tribute to host countries' sustainable development. The tainable development is highlighted in Box 12. The Benefits of Carbon Finance 75 YEARS OF EXPERIENCE IN CARBON FINANCE Community Development Carbon Fund The Community Development Carbon Fund (CDCF): outcomes can be categorized as: (i) improved local infra- assessment of community benefits and sustainable structure such as roads, health clinics, etc; (ii) improved development1 access to energy for heating and/or cooking; (iii) improved livelihood and employment opportunities; and (iv) improved The World Bank has gained significant experience in developing access to electricity and/or energy-efficient lighting. carbon mitigation projects in the poorest countries. The CDCF The level of community dialogue and participation in proj- was created in 2003 as a public private partnership aimed at ects with direct benefits tends to be high when they are em- extending the reach of the carbon market to poorer developing bedded in ongoing programs that are based on principles of countries, particularly the least developed countries (LDCs). community empowerment. In projects with indirect extrinsic The CDCF also intended to give preference to small-scale ac- benefits that require the preparation of an additional CBP, tivities that improve the quality of life of communities. It has a the participatory process tends to be stronger when the "learning-by-doing" objective of disseminating its practical ex- consultation process involves a range of key stakeholders perience. It has capital of $128.6 million. including local government administrations and is linked to broader local development priorities. A unique feature of the CDCF is its dual objective of achieving Most of the projects are targeted towards communities that emission reductions and simultaneously delivering measurable lack essential services such as electricity or basic health social, environmental, and economic benefits to local communi- care and have relatively low per capita incomes (typically ties. These benefits can be intrinsic to the project, when they less than $1,135 per year). However, there is a lot of het- are part and parcel of the project itself (e.g., village or neighbor- erogeneity and inequality within communities. In some CDCF hood electrification) or extrinsic. When there are limited intrinsic projects, such as the solar power project in Bangladesh and benefits or no identifiable benefits integral to the project, an the biogas project in Nepal, the poorest households are un- additional Community Benefits Plan (CBP) is put together (like able to access the technology as the upfront investment provision of computers for schools, or construction of health required is relatively high. clinics), and financed out of a premium in the emission reduc- Most projects demonstrate strong attention to operation tion unit price (through a "community development package"). and maintenance of investments, but the level of institution- While many CDCF projects are still in early stages of implemen- al sustainability varies considerably across the CDCF portfo- tation, key findings from the assessment of their community lio. Cost-effectiveness of CDCF projects also tends to vary benefits and sustainable development are as follows: and depends on the extent to which additional resources are The community benefits provided by CDCF projects often leveraged for the CBP. include a range of activities, but the key community benefit 1 Source: The Community Development Carbon Fund (CDCF): Assessment of Community Benefits and Sustainable Development (2009). http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/CDCF_paper_final_with_cover.pdf 76 The Benefits of Carbon Finance The Need to Scale-Up While the urgent need to scale-up mitigation efforts is 3. Industry-specific interventions, (e.g., reduction of gas widely accepted, the key question is: "How can scaling- flaring by the petroleum industry, led by public private up be achieved?" In a study commissioned by the World partnerships) Bank, Figueres et al. (2005) warned that "unless the 4. System-wide interventions (e.g., coordinated city-wide impact of the CDM can go beyond stand-alone project GHG mitigation activities across waste, transport, activities and be used to spur broad climate-friendly poli- and energy end-use sectors, led by municipalities92) cies and measures, the CDM will not promote the much- needed transformation in the energy trends of developing Programmes of Activities (PoAs) under the CDM is countries." Successful approaches are expected to include opening the door for programmatic approaches to GHG a combination of policy-based and technological inter- mitigation activities in developing countries, while Green ventions to be defined by country-specific circumstances Investment Schemes (GIS) may be an efficient means for and capacities. programmatic approaches in countries with emissions Strategically, aggregated programs could become obligations. good vehicles to scale-up system, subsector, or sector- wide mitigation efforts. Aggregation is widely practiced in investment-focused programs by financial institutions 6.1 Programmes of Activities in the form of credit lines, and by government agencies as sector-specific funds or budgetary allocations. Natural The concept of programmatic CDM was developed in aggregators can be mandated by law (e.g., public agen- response to calls for simplifying project preparation and cies), by stakeholders (e.g., industry associations), or by registration procedures (particularly for dispersed energy institutional goals (e.g., non-governmental organizations, efficiency micro activities) and expanding the scale of the private sector). CDM project activities. Many felt that the CDM was not The World Bank has been actively exploring various achieving its full potential and several concepts, such as scaling-up opportunities, such as: policy CDM and methodologies that use national stan- dards to create programs, were proposed. The roots of 1. Technology-specific interventions, (e.g., compact the PoAs under the CDM can be traced to a decision of fluorescent lamp (CFL) market transformation activi- the first session of the Conference of Parties/Meeting of ties and energy agency-led programs to help achieve Parties (COP/MOP 1), held in Montreal in November national geothermal development targets) 2005, stipulating that "local/regional/national policies or 2. GHG-specific interventions, (e.g., programs by rural development agencies to accelerate deployment of household biodigesters to capture and utilize methane 92See the World Bank's "City-Wide Approach to Carbon Finance" emissions from animal waste) 2010. 77 YEARS OF EXPERIENCE IN CARBON FINANCE Overview of Programmes of Activities (PoAs) under the CDM According to the CDM EB guidelines from July 20071, a CDM criteria defined in the PoA). A PoA can cover multiple countries, PoA is defined as a "voluntary coordinated action by a private if each country approves the programme. The PoA and the first or public entity which implements any voluntary or mandatory CPAs under a PoA are validated by the DOE and subsequent policy/measure or stated goal (i.e., incentive schemes and CPAs can be added to the registered PoA at any time, on the voluntary programmes), which leads to GHG emission reduc- basis of a DOE's desk review, with no additional registration tion..." fees. Emission reductions resulting from each CPA are verified and certified by the DOE. A PoA provides the organizational, financial, and methodologi- cal framework for the emission reductions to occur. The private or public entity that coordinates the PoA is referred to as a coordinating/managing entity. Broadly, four types of The emission reductions are attained at the level of "CDM pro- CPAs are possible: single measure in single location; multiple gramme activities" (CPAs). A PoA is expected to be a replica- measures in single location; single measure in multiple loca- tion of the same or similar discrete projects (as per eligibility tions; and multiple measures in multiple locations. 1 EB 32, Annex 38 and 39 standards cannot be considered as CDM project activi- procedures. CDM rules for PoAs have also been devel- ties, but project activities under a PoA can be registered oped using the "learning-by-doing" approach, but in this as a single CDM project activity." case a large part of the "learning" was through the par- It took some time after the December 2005 decision ticipatory process of inviting public inputs. It is still too to finalize definitions, procedures, and guidelines93 for early to identify factors that influence the chances of suc- PoAs (see Box 13), and although uncertainties and lack cess of a program, in terms of the cost-effective reduction of clarity remain, several project developers and stake- of emissions from numerous underlying project activi- holders, including the World Bank, are working to put ties. However, it is possible to identify key stakehold- the concept of PoAs into practice. ers that influence the program design and its successful From September 2008 to May 2009, 5 PoAs were sub- implementation. mitted for validation. From May 2009 to March 2010, 32 PoAs were submitted for validation, and the first two CDM Executive Board. The EB, as the regulator respon- PoAs were registered in July and December 2009, respec- sible for providing guidelines to develop PoAs and for tively: an efficient lighting program in Mexico, and an ensuring environmental integrity by reviewing PoA and animal waste management program in Brazil. The first CPA submissions, is also the key actor in engendering PoA in Africa, in Uganda (a PoA within the World Bank confidence in the PoA approach by responding to requests portfolio), was registered with corrections by the CDM and inputs from the stakeholders. In the context of PoAs, EB in April 2010 (see Box 14). the EB is also entering into a role that differs somewhat from its current approach for the "regular" CDM projects: once the EB approves the registration of a PoA, it becomes Challenges and opportunities an indirect regulator, where it is expected to observe the automatic registration of the underlying CPAs by the The first two years of the CDM PoA history (i.e., 2006­ 2008) were focused entirely on defining the concept of PoAs and establishing a workable set of guidelines and 93 See EB 32, Annex 38 and 39; and EB 47, Annex 29, 30, 31 and 32. 78 The Need to Scale Up Carbon finance at the World Bank The Uganda Municipal Composting Programme DOEs and may randomly review the registered CPAs. of Activities This shift has resulted in the creation of a "liability" clause (see Box 15) that holds a DOE responsible for CERs The World Bank Uganda Composting PoA is an innovative municipal composting programme based on the harness- generated from the so-called "erroneous inclusion" of an ing of carbon finance for addressing the significant environ- ineligible CPA being registered as part of a PoA. mental challenge associated with solid waste management. It initially covers 9 cities, with the possibility of expansion DOE. For PoAs, the DOEs have enhanced responsi- to at least another dozen municipalities within the coun- bilities and associated liability, as noted in Box 15. Most try. The PoA is coordinated and managed by the Uganda National Environment Management Authority. The project DOEs are uncomfortable with the vague definition of has significant sustainable development benefits, including "error" and the open-ended timeline for accounting for a positive health impact and a well-managed dump that can it. The liability, or the requirement to transfer all CERs be sustained by the revenues generated from the sale of issued to an "erroneously" included CPA, is triggered compost and emission reductions. only if a detailed review process, following a request by any one member of the EB or the host country DNA, finds the CPA to be ineligible. The EB finds this justified as the CPA only passes through one level of scrutiny-- that of the DOE--before being registered. DOEs seek to DNA. The DNA also has increased responsibility as mitigate this liability risk by entering into a risk-sharing PoA rules expect the DNA to randomly review CPAs in arrangement with the project entity, which can be virtu- their countries that are automatically registered by the ally impossible for most public sector entities. DOE, and inform the EB in case they identify any ineli- The CDM PoA "liability" clause The most significant--and most debated--implication of the But there is a lack of clarity on the definition of "erroneous." CDM PoA guidance and the largest barrier to PoA development The possibility of reviewing and recovering CERs from any (or to date has to do with the liability imposed on a DOE. As per all) previously registered CPA (essentially causing an open-end- PoA guidelines, documentation for the PoA and the first CPA is ed liability for DOEs); the process for detection of error; and validated by a DOE before review and registration of the PoA by limited recourse for a DOE to appeal regarding an alleged case the CDM EB. For subsequent CPAs, the DOE is solely responsi- of "erroneous inclusion" have together created a marked lack ble for scrutinizing the relevant documentation before uploading of interest among DOEs to undertake validation of CDM PoAs, it on the UNFCCC website for automatic registration. Removal due to the potential liability risks they would face (DOEs have of the additional scrutiny for each CPA by the host country, reported that their insurance would not cover such open-ended general stakeholders, the Secretariat, and the CDM Executive liability). Those DOEs accepting to undertake the validation of Board was intended to reduce costs, time lag, and efforts, and CDM PoAs, carefully evaluate and seek to mitigate their risks generally facilitate registration, as the underlying CPAs are ex- by only accepting validation contracts for the PoA and the first pected to fully adhere to the eligibility criteria of the PoA. CPA. DOEs that have been approached for validation of sub- sequent CPAs are unwilling to conduct a desk review-based However, as an additional check, to prevent erroneous inclu- validation, and insist on a full validation, with a site visit, costing sion of a CPA (and the associated risk of erroneous CERs), as much as validations for any regular stand-alone CDM project strict liability has been placed on the DOE: if a case of errone- activity, thus eroding the originally expected cost savings for ous inclusion is established, the DOE is required to transfer a the registration of PoAs and all underlying CPAs. quantity of CERs equal to the issued CERs for the incorrect CPA to the UNFCCC. The Need to Scale Up 79 YEARS OF EXPERIENCE IN CARBON FINANCE gible CPAs. Based on the DNA input, the EB can then Insights for scaling-up mitigation through undertake a full review of the CPAs and the PoA. The programmatic approaches DNA also authorizes the entity to coordinate or manage the program. Assessment of the appropriateness of the The programmatic approach has the potential to enable coordinating entity is emerging as a concern for many the scaling-up of mitigation efforts. This, of course, con- DNAs, as the PoA sets the framework that would impact tinues to depend on regulatory signals and the ability of the development of future project activities for the same the CDM EB and the DOEs to assess and ensure envi- technology. ronmental integrity without requiring excessive cost and effort. Simplification of methodological requirements Coordinating Entity. One of the biggest questions under and assessment of additionality would have the stron- the CDM programmatic approach is how to identify or gest impact on the ability of stakeholders to develop and create an entity or organization, called a Coordinating/ implement PoAs. Managing Entity (C/ME), to effectively manage the PoA. In early discussions, a PoA was perceived by many as In effect, a PoA can be considered the overarching primarily a tool for promoting CDM in less-developed framework for generating emission reductions. The suc- regions and for widely dispersed micro-scale activities cess of the framework depends on: and for end-use energy efficiency or renewable energy activities. This perception has revealed to be largely true, The PoA's legal, financial, and management design, as a majority of the PoAs developed in the past year focus including the integration of future CDM revenue on the distribution of cooking stoves, efficient light bulbs, streams in the PoA's financing mechanisms, such as biogas plants, and solar water heaters. Supply-side projects subsidies94; and, are few and far between, with only two large-scale hydro The administrative and technical capacity of the PoA PoAs and three PoAs in improving energy efficiency in operator (i.e., the C/ME). electricity distribution systems. It was expected that the transport sector would receive a significant boost from The all-encompassing requirements from the ideal the programmatic approach; however, complex meth- C/ME are rarely fulfilled by any single entity. Technical odologies, the involvement of multiple institutions, and institutions may lack the financial and legal capacity, and modest emission reduction volumes continue to limit the financial institutions, vice versa, may lack the technical development of PoAs in this sector. Forestry is another capacity. Interestingly, knowledge of the CDM processes sector that should lend itself well to this approach; how- is emerging (at least in the World Bank experience) as one ever, issues similar to the transport sector are currently of the key capacity constraints in a large proportion of the hindering further development. institutions. Fulfilling the CDM-specific requirements, As of March 24, 2010, 42 PoAs (Figure 31) have from baseline assessment to monitoring, is proving to been published on the UNFCCC website, out of which be a significant additional cost. This has led to the emer- 3 have already been registered and the remainder are in gence of new business models, in the context of CDM, the process of validation. Forty PoAs are based on small- that involve retainer-based or outsourced program sup- scale methodologies, with 12 having a rural community port functions and other such options to ensure effective focus, dominated by cooking stoves and biogas programs. operation of the program. However, it is still early in the testing phase, as only few of these programmes, thus far, are reported to have been able to finalize their design and secure the financing to 94The challenge remains how to fully integrate a future uncertain move forward. source of revenue stream into the financial design of a large pro- gramme that requires upfront expenditures (e.g., payment of subsidies Among all PoAs in the CDM pipeline, India leads for the purchase of energy-efficient equipment). with 7, followed by China with 6, Vietnam 4 and Ban- 80 The Need to Scale Up Carbon finance at the World Bank FIGURE 31 Distribution of CDM PoAs (by technology and region) ­ by number of projects 1 1 5 8 11 7 15 3 17 16 South Asia East Asia Latin Energy Efficiency Renewable Energy Waste Middle East Africa America Transport Forestry Source: UNFCCC CDM website (March 24, 2010). FIGURE 32 Distribution of PoAs by host country 8 7 6 5 4 3 2 1 0 Bangladesh Brazil China Egypt El Salvador Guatemala Honduras India Indonesia Mexico Nepal Nicaragua Philippines Republic ok Korea Senegal South Africa Thailand Tunisia Uganda Vietnam Yemen Source: UNFCCC website (March 24, 2010) gladesh, Indonesia and South Africa with 3 PoAs each. In (in Uganda), as well as the first PoAs in large-scale renew- total, 21 host countries are involved, of which 4 are LDCs able energy, supply-side energy efficiency, and in the (see Figure 32). The World Bank is helping develop 12 transport and forestry sectors. PoAs in 12 different countries across all regions. This PoAs, even within the same sector and using the same includes the first PoA developed and registered in Africa technology, are different as they are modified to suit coun- The Need to Scale Up 81 YEARS OF EXPERIENCE IN CARBON FINANCE try-specific circumstances, the capacity of the coordinat- simplified and related costs were lower, these entities ing entity, and the appropriate incentive mechanism. C/ could use more of the CER revenues to implement the MEs are utilizing the programmatic approach to achieve a PoA more broadly. Such rationalization and simplifica- myriad of objectives. There are private sector based PoAs tion would not only reduce the unnecessary upfront that are promoting advance sales by encouraging custom- financial burden on the PoAs, it would also reduce the ers to make new purchases or replacement purchases, with operating costs of CDM maintenance (e.g., the vali- CDM revenue off-setting the extra cost. These PoAs are dation costs for each subsequent CPA, which remain using CER revenue to promote EE and RE technologies high) and thus enhance the financial viability of a among urban and rural households that in a business-as- greater number of PoAs. usual scenario would have negligible incentive to adopt While it is too early to fully derive lessons from the these technologies. Government agencies are making use implementation of the CDM programmatic approach, of CDM financial incentives to encourage sub-national the approach definitely exhibits the potential to be an agencies to reduce emissions by implementing energy effective tool for scaling up GHG mitigation activities efficiency. and reducing CDM transaction costs. PoAs have gener- A key factor to ensure sustainability of PoAs is the ated interest from government and private sector entities ability of CER revenue to support and fund the opera- alike, as they provide the opportunity to achieve econo- tion of the programme itself. The PoA framework in mies of scale, reach a wider group of stakeholders in an many ways is a promotional framework that does not organized manner, and achieve emission reductions in generate ERs itself but (i) brings in project activities sectors and activities that require aggregation over time (i.e., the CPAs) that do so, (ii) supports them through and across widely dispersed populations. the CDM process, (iii) maintains CDM specific infor- The CDM regulatory system (i.e., the CDM EB and mation for each of the activities, and (iv) enables receipt its support structure) can effectively support and encour- of carbon credits. Such PoA activity is beyond the typi- age the PoA approach by considering alternative, but cal sales and marketing mandate of private companies streamlined approaches to ensure the high quality and and beyond the typical policy or program implemen- credibility of the validation and verification process, and, tation budgets of government agencies. A portion of therefore, the resulting emission reduction. Development CER revenue is used to support the activities unique to of POAs will provide significant sector-specific experi- CDM operations. In fact, it is reported95 that the share ence and best practices, which can be used to further of CER revenue typically retained by C/MEs to cover improve the programmatic approach. CDM PoA-specific costs, ranges from 2 to 30%. This Effective and efficient scaling-up through PoAs will share depends on a range of issues, from technology to need changes to the methodology approaches adopted location of CPAs to CDM methodological complexity thus far. Indeed mitigation efforts need to move from and often onerous requirements (such as the purchase measuring each ton of GHG emission reduction of a of monitoring equipment solely for CDM purposes, single project to estimating, with appropriate justifica- conducting adequate samplings, development and tion and confidence, the total GHG impact of a PoA. maintenance of databases). If CDM requirements were A simplified programmatic approach will encourage the involvement of a larger number of stakeholders and support the scaling-up of sector, sub-sector and system- 95For example, such information was reported at the Regional Work- wide emission reduction efforts. But if PoAs are to reach shop on Programme of Activities under the CDM organized by their potential and become a vehicle for scaling-up and the World Bank in partnership with the Thailand GHG Manage- possibly even a testing ground for broader, sector-based ment Organization held in Bangkok, Thailand in September 2009. (http://siteresources.worldbank.org/INTCARFINASS/Resources/ mitigation, then projects of larger size such as individual PoAworkshopBkkAgenda22Sep09final.pdf ) hydro schemes or mini co-generation schemes must also 82 The Need to Scale Up Carbon finance at the World Bank become eligible and become priorities--along with micro environmentally-related projects. The GIS is set up by the activities such as cooking stoves or solar home systems. seller countries, and operates as a domestic scheme within their climate policy framework, with operational details to be agreed on a bilateral basis between buyer and seller 6.2 Green Investment Schemes (GIS) nations. In practice, both AAU sellers and buyers have an Green Investment Schemes have emerged as potential incentive to ensure that AAU revenues are reinvested in vehicles for progammatic approaches in countries with environmentally beneficial activities, typically reducing emissions obligations: the countries with economies in GHG emissions. Relevant activity selection, monitoring, transition (also the typical JI host countries). reporting, verification and/or auditing instruments need The emissions commitments adopted under the to be built into GIS to ensure successful and credible Kyoto Protocol include recognition of the special circum- "greening." There is no universally accepted definition for stances of countries with economies in transition (EITs), "greening" as GIS are not internationally regulated. Both namely the sharp economic recession with the associated "soft" and "hard" greening terms have been used but are decrease in their GHG emissions that followed the fall meaningful only when a detailed definition is provided. of the Soviet bloc. These countries were thus allocated "Soft greening" is generally viewed as a GIS wherein Assigned Amounts for the duration of the Kyoto Proto- AAU revenues are allocated to environmental and/or cli- col's first commitment period amounting to more than mate-friendly "greening activities" that may not directly their emission levels at the time of the adoption of the result in GHG emission reductions relative to the vol- Kyoto Protocol in December 1997. The argument was ume of AAUs transacted (e.g., capacity building efforts, that the emission commitment level surplus would allow or development of climate change awareness programs). these countries' emissions to grow as their economies "Hard greening" usually refers to a GIS with "greening recovered. However, as their GHG emissions have not activities" that directly result in measurable emission risen as rapidly as anticipated, most transition economies reductions. have the possibility to sell--or possibly bank for subse- GIS offer an important benefit over JI, through stron- quent compliance needs96--their surplus AAUs. As such ger financial leverage and timing flexibility. Under GIS, headroom was created by economic collapse rather than all or part of the AAUs sold can be immediately trans- through climate change mitigation actions, some buy- ferred to the buyer and "greening" can occur later with ers, particularly Annex I governments, have been wary the progressive implementation of "greening" activities, of using AAUs (referred to sometimes as "hot air") for typically through a programmatic approach, in accor- Kyoto compliance due to political sensitivities and pos- dance with the bilateral agreement between buyer and sible reputational risks. Thus, a new approach, Green seller. Revenues from an AAU/GIS transaction can also Investment Schemes (GIS), was suggested by host coun- be received upfront and ahead of the investments, thus tries to provide AAU transactions linked with a positive providing the host country with greater possibility for environmental impact. For instance, Russia made a politi- leveraging and complementing carbon revenues with cal statement as early as 2000 (COP6), on its intention to invest revenues from the sale of AAUs into climate- friendly projects. 96 The possibility of banking depends on an international agreement being reached on a post-2012 climate regime based on AAUs. See Blyth and Baron (2003)97 described GIS as a way of Tuerk et al. (2010) for further discussion. promoting the environmental efficacy of transactions that 97 Blyth, William and Richard Baron, 2003, "Green Investment involve surplus assigned amount units (AAUs) from coun- Schemes: Options and Issues", IEA and OECD Information Paper prepared by the IEA Secretariat at the request of the Annex I Expert tries (...) with economies in transition. GIS involve the ear- Group on the United Nations Framework Convention on Climate marking of funds generated from the sale of AAUs for use in Change. The Need to Scale Up 83 YEARS OF EXPERIENCE IN CARBON FINANCE other financial resources. The "greening" investments, Largely thanks to GIS, the AAU has recently started programs, and project activities do not need to take place becoming a growing segment of the carbon market, with prior to 2012, providing more time to implement "green- several transactions completed (see Figure 33) in the past ing activities", possibly well beyond 2012. 2 years. Several buyers are increasingly seeking sizable and The World Bank has been developing GIS actively predictable volumes of Kyoto-compliant carbon assets at since 2003, initially in the form of technical assistance to attractive prices. In response, several host countries have several countries (e.g., Bulgaria, Latvia, and Ukraine). Its accomplished significant progress in developing GIS, assistance includes analytical assessment and recommen- with the extent of actual "greening" to be verified later dations on the possible design, regulatory framework, and once activities are implemented. In 2009 alone, the AAU financial and implementation structure, while highlight- market grew more than seven times to US$2 billion (1.5 ing the possible challenges and constraints of selected billion) with 155 MtCO2e transacted99, and the vast countries98. These efforts significantly contributed to the majority of these transactions reported as GIS. Look- design of potential and, as of now, partially implemented ing ahead, governments have announced their intent to GIS structures. The World Bank has also engaged in the sell about 1.8 billion AAUs through GIS (largely from development of actual AAU/GIS transactions, but has Ukraine and Poland), which is significantly greater than not yet concluded any at the time of writing. projected AAU demand100. Estimating future trends in The AAU transactions may play a critical role in a few the AAU market is complicated by uncertainties regard- Annex I countries' compliance with their Kyoto Proto- ing the rules for the bankability of AAUs from the first col emissions commitments (e.g., Japan and Spain). At Kyoto commitment period to a subsequent commitment the same time, the overall risk of negative impacts on the period, i.e., whether the surplus AAUs can be used for CDM and JI markets (i.e., by crowding out CDM and compliance in a still undefined post-2012 international JI) is significantly mitigated by the fact that the EU ETS climate change regime. does not allow the use of AAUs by private companies for Some of the key insights and lessons learned from the compliance. GIS experience to date can be summarized as follows: GIS imply a much larger role for host countries and require significant implementation capacity. FIGURE 33 AAU primary transactions up to Even more than for JI Track 1, the GIS experience to December 2009 by country (162.7 Mt) date shows that setting up legal frameworks, national 2.5 systems and institutions for GIS are a time- and 15.2 resource-intensive task. Governments must develop 11 rules to account for and manage these new national 47 assets and also develop "greening" programs and 18.5 oversee their implementation, including the relevant administrative, regulatory, and institutional frame- 68.5 98 See World Bank (2004), Options for designing Green Investment Schemes for Bulgaria; World Bank (2006), Options for designing Ukraine Czech Republic Latvia Green Investment Scheme under the Kyoto Protocol, World Bank Hungary Poland Slovakia (2007) Latvia GIS Options Study. 99 This includes one secondary transaction (15 MtCO2e) with Slova- Source: State & Trends of the Carbon Market 2010, The World Bank kia. For more discussion, please see the "State and Trend of the Carbon Market 2010," the World Bank. 100 Ibid. 84 The Need to Scale Up Carbon finance at the World Bank works. They must also pass relevant legislation. Fur- be challenging and time consuming, in particular in thermore, efficient and transparent implementation cases where the individual project activities targeted of GIS activities requires significant institutional and by the larger program may be quite small. It is there- operational capacities that may not be readily avail- fore important that application procedures (to gain able in host countries and need to be strengthened or access to GIS finance) be streamlined and that the newly created. For instance, operational and practical level of GIS support be sufficiently high to ensure an procedures, and documentation are still partly miss- attractive financial incentive to implement the desired ing. Development of these can be challenging: defini- energy efficiency projects, and thus secure the success tions, perceptions, and requirements for "greening" of the GIS. can vary within the host country and among the buy- Heterogeneity of "greening" definitions leads to ers. Appropriate and transparent treatment of the rev- difficulties in defining a price of a "greened" AAU. enues generated is also an important issue for the GIS Due to the specificity of individual transactions, there host countries to manage. is no publicly available comparable price information Timing flexibility of "greening" activities can com- of AAUs transacted under GIS. As a result, pricing plicate the legal structure of AAU purchase agree- of AAUs is challenging and opaque. Typically, AAUs ments. Purchase agreements may be complicated by transacted are perhaps better described as "AAUs to a combination of upfront payment and transfer of be greened." AAUs on the one hand, and a longer ex-post "green- GIS offer fertile ground to test programmatic/ ing period" on the other, especially as far as enforce- sector-wide approaches for GHG mitigation. GIS ment of "greening" activities is concerned. Despite allow flexible and novel approaches and procedures to these hurdles, there are strong incentives and active carbon finance. Successful GIS could provide fertile attempts to develop such agreements that would pro- learning grounds on the design and implementation vide a satisfactory level of comfort and responsibility- of mitigation activities grouped under a programmatic sharing to minimize any reputational risks, both for or sectoral approach. With the need to scale up GHG sellers and buyers of AAUs. mitigation, GIS experience could be relevant both for The success of GIS is contingent on careful con- the CDM and for other potential new market-based sideration of program design and disbursement instruments as well as for public funding mechanisms. arrangements to ensure efficient implementation However, replication of the GIS experience in any of "greening activities." Several of the proposed GIS other mechanism may require appropriate adjust- activities have consisted of energy efficiency programs ments to take into account the possible greater needs of significant scale and reach. However, successful for methodological rigor in contexts where there is no implementation and disbursement modalities may surplus AAU. The Need to Scale Up 85 Conclusion: An Experience worth Building On Carbon finance, which has its roots in the Kyoto Pro- although the full leverage potential of carbon finance has tocol's market-based mechanisms, is now a proven tool not yet been fully explored. to support GHG mitigation and sustainable develop- In addition to their contribution to meeting GHG ment. Over the past decade, the World Bank and many commitments cost-effectively, the Kyoto mechanisms others have gained practical experience with the Kyoto have generated other noteworthy benefits. There are many mechanisms. This experience demonstrates how carbon diverse examples of how the Kyoto mechanisms have con- finance revenues can enhance the overall financial via- tributed to sustainable development in host countries. bility of low carbon projects and, as performance-based They have also provided opportunities to support basic payments, can create positive incentives for good man- development needs and broader socio-economic co-ben- agement and operational practices to sustain emission efits, such as improving energy access and services (e.g., reductions over time. through efficient lighting and biogas projects); providing solutions for the solid waste management problems so often associated with the increased urbanization of devel- Impressive achievements oping countries; reducing local air and water pollution and generating health benefits (e.g., through wastewater The CDM has certainly exceeded expectations in terms management projects); generating employment (e.g., of the number of projects: there are just over 2,000 reg- through efficient brick making projects); and improv- istered CDM projects and more than 2,700 more proj- ing livelihoods (e.g., through reforestation projects). In ects undergoing validation. There are also almost 300 JI addition, CDM and JI have contributed to technology projects underway. It is expected that the overall emis- transfer, and even more to technology diffusion, which is sion reductions from CDM and JI will amount to more critical for scaling-up GHG mitigation. than 1 billion tons of CO2e during the Kyoto Protocol's Activities under the Kyoto mechanism have largely first commitment period. These mechanisms are thus on focused, at least initially, on the simplest projects to bring their way to making an important contribution to help- through the CDM system, those with lowest abatement ing industrialized countries meet their emissions obliga- cost and largest volume potential. Renewable energy tions under the Kyoto Protocol. Between 2002 and 2009, projects (e.g., hydro, wind, and biomass) are the most about 2.2 billion CERs have been transacted for approxi- popular types of projects in the CDM, followed by waste mately US$26 billion. management and industrial projects (e.g., cement, coal Carbon finance, either alone or in combination with bed/mine methane, and energy efficiency in industry). other policy and financial instruments, has made a differ- In terms of volume of emission reductions expected from ence in favor of climate action and has catalyzed the shift the CDM, the renewable energy and industry sectors are of much larger amounts of (essentially private) finan- joined in the top 3 by industrial gases (HFC-23, N2O, cial and investment flows to low carbon development, etc), because the few industrial gas projects generate such 87 YEARS OF EXPERIENCE IN CARBON FINANCE large volumes of CERs as a result of the much higher ment of more than 100 methodologies and the engage- GWP of these gases compared to CO2. Other impor- ment by so many stakeholders-from both developed and tant factors for attracting CDM activity are the capac- developing countries. It is indeed time to integrate the ity of project entities to carry out projects and the overall rich lessons and experience into reforms that will increase capacity of host countries. Thus far, CDM projects have the mechanisms' efficiency, enhance their effectiveness, indeed, overwhelmingly taken place in the largest and and enable them to reach their full mitigation and sus- most advanced developing countries, with the notable tainable development potential, while laying the ground dominance of China. China's success can be attributed for transitioning towards larger-scale mitigation that not only to a GHG intensive electric grid and a large will be necessary to meet the ultimate objective of the and growing economy, but also to the Chinese authori- UNFCCC cost-effectively. ties' capacity development and a CDM support structure The CDM may be a victim of its success in terms of that have combined to facilitating overall strong project the large number of projects that it has stimulated, but implementation capacity. the bottlenecks, the multiple checks translating into high Experience has shown that the key success features transaction costs and lost revenues risk choking the proj- of CDM/JI projects are similar to those of more typi- ect pipeline. The time needed to register a project has cal development projects: (i) a committed champion been increasing and now stands at 18 months, resulting in (within the company or government); (ii) strong proj- lost CERs valued at an estimated 800 million. The time ect design and planning from the start; (iii) solid poject required for processing requests for issuances is poised to financing; and (iv) the potential to meet objectives (in increase as more and more projects seek to obtain their this case, reduce GHG emissions). Inability to reach issued CERs by the end of 2012. The CDM validation financial closure has been the key reason for project ideas and verification costs for both small and large scale proj- not developing into CDM (or JI) projects, with upfront ects have been on the rise as well. financing barriers being significant for many projects. For It is essential to build on the impressive achievements, those projects that have secured financing, it is becom- capacity, and institutions. It is a well worthwhile task, as ing clear that the bulk of the work associated with CDM the CDM regulatory risks are hampering the viability of projects and programs actually takes place after registra- good projects, making the acquisition of financing even tion. In fact, successful project implementation and CER more difficult for the projects that are most dependant delivery--which is the key test for carbon finance--often on carbon finance. The regulatory risks are starting to take more time than originally anticipated and require erode the confidence and enthusiasm of stakeholders. sustained efforts. Successfully adhering to the relevant The international community, the CDM EB, and the methodologies and procedures defined in the monitor- UNFCCC secretariat are taking steps in that direction; ing plan is key. follow-through is vital. A more streamlined system, accompanied by train- ing and accountability of DOEs, as well as enhanced The CDM (and JI) face operational challenges communication and collaboration between DOEs and that need to be addressed the CDM EB, is possible and needed. The CDM should evolve towards trusting the validations and verifications, The environmental integrity of the CDM is critical to and enable the automatic registration and issuance of both the climate regime and to the carbon market. Devel- CERs to be automatic, but accompanied by a CER dis- oped through a "learning-by-doing" approach, the CDM count along with random spot checks. Such evolution and JI achievements must swiftly move to consolidate would bring some much needed oxygen to the CDM, as the rich learning from the practical experience brought well as lower regulatory and transaction costs, while also by thousands of projects and the development and assess- ensuring acceptable environmental integrity. 88 Conclusion: An Experience worth Building On Carbon finance at the World Bank Methodologies and additionality also need to be European Union, navigating the interplay between the examined, while the majority of projects used one of EU ETS and JI and avoiding double-counting have been the two most popular methodologies, too many other challenging. methodologies have limited applicability and too many In addition, while JI provides host countries with are overly complex and have onerous documentation and greater regulatory authority and responsibilities (com- monitoring requirements that do not always match reality. pared to the CDM), what has emerged is that JI proj- Perfect accuracy is often not possible or too costly. Many ects face additional host country regulatory risks. The JI methodologies have a high level of complexity and yet are experience to date shows that it takes time and resources still unable to pragmatically specify what is an acceptable to build national systems, institutions, and capacities, as level of uncertaint, exemplifying how "perfection can be governments must develop rules to account for and man- the enemy of the good." Simplified methodologies and age these new national assets, including domestic proce- pragmatic monitoring requirements are needed. This can dures and guidelines for project approval, and issuance be facilitated by moving to ambitious yet realistic base- and transfer of emission assets. line standardization wherever possible, along with clear and objective additionality, including pre-defined addi- tionality--accompanied by clear review provisions with Extending the reach of the Kyoto mechanisms to predictable triggers. Such changes are essential to ensure least developed countries the continued success of carbon finance as a meaningful tool to help tackle the climate change challenge over the Market-based instruments are designed to help meet coming decade. GHG objectives cost effectively. However, the resulting The next phase of the mechanisms, which will largely geographic distribution is striking with LDCs having depend on the level of ambition of GHG commitments largely been by-passed by the CDM thus far. Provided the adopted for the post-2012 period and the creation of rules are changed, the CDM could contribute to broader longer-term demand for GHG credits, will need to sustainable development in poor countries through miti- (i) increasingly focus on more difficult/complex types gation and sequestration activities that help address these of projects (e.g. end-use energy efficiency at the house- countries' challenges with energy poverty as well as with hold level), (ii) extend the reach of carbon finance to land management. new geographic areas, and (iii) exploit more effectively Good governance and an enabling environment are the synergies with host countries' efforts towards poverty pre-conditions for attracting CDM. In addition, there alleviation and low carbon development. are key areas to address: The streamlining and simplification of CDM proce- JI opportunities and challenges dures is an essential condition for extending the reach of the CDM to LDCs. Transaction costs and delays The experience with Joint Implementation has not mate- have to be dramatically cut to make small-scale proj- rialized as expected, as JI projects, which benefit from ects viable. the environmental safeguard provided by an overall emis- Managing the requirements of the CDM process, sions cap, are facing particular issues and challenges. JI both for project validation and monitoring of emis- suffered from a late start compared to the CDM, and has sion reductions, requires substantial capacity build- not been able to fully recuperate and exploit the greater ing efforts and technical assistance support to project flexibility (resulting from its implementation in countries entities. with emission caps) compared to the CDM. Moreover, New CDM methodologies or approaches are needed in the case of projects located in countries that joined the for LDCs, taking into account their state of significant Conclusion: An Experience worth Building On 89 YEARS OF EXPERIENCE IN CARBON FINANCE suppressed energy demand and their need for growth The importance of capacity building in energy services. Remedy "temporary" crediting in the afforestation / The Kyoto mechanisms, their institutions, and the capac- reforestation sector and expand the scope of forestry ity built throughout the world over the past ten years and agriculture activities eligible under the CDM. are without a doubt a remarkable accomplishment that Programmatic approaches (i.e., through Programmes needs to be sustained and built-upon. Host countries of Activities) could unlock some of the mitigation need to develop the necessary capacity and provide potential of the CDM in LDCs, but simplification the enabling environment for carbon finance to more and training is needed. effectively leverage climate-friendly investments. The evolution of the market-based mechanisms--whatever direction they take--will benefit from greater engage- Scaling-up ment from developing countries to ensure that they bet- ter integrate the practical realities of developing countries The urgent need for scaling-up mitigation efforts is and offer meaningful opportunities to support their low widely accepted. Successful approaches to scaling-up are carbon development priorities. The further contribution expected to include a combination of policy-based and of the mechanisms both in terms of GHG mitigation technological interventions to be defined by country- and its contribution to sustainable development will be specific circumstances and capacities. Strategically, aggre- enhanced if they can build on synergies with host country gated programs could become good vehicles to scale up policies and other financial instruments. system, subsector, or sector-wide mitigation efforts. Pro- grammes of Activities under the CDM and JI are open- ing the door for the use of programmatic approaches for Post-2012 policy clarity GHG mitigation activities in developing countries, but some clarifications of rules to adequately balance liability, Clarity on the post-2012 international climate change credibility and efficiency are needed to facilitate imple- regime, the longer-term demand for emission reductions, mentation. It is too early to draw lessons but it is becom- as well as on countries' plans to use market-based mecha- ing clear that the key factors of a PoA are its design and nisms to meet domestic GHG objectives, is urgently the coordinating entity's capacity. Moreover, scaling-up needed. Without clarity on these issues, the carbon mar- mitigation through programmatic approaches will need ket and carbon finance are losing momentum and face the to move from seeking to precisely measure every ton of serious risk that progress will come to a halt. Perhaps more GHG emission reduced (at each project site) to estimat- serious, is the real danger of not being able to sustain, and ing with proper justification and confidence the total even lose, the capacity developed over the past decade GHG impact of the PoA. Green Investment Schemes in so many countries, organizations, and companies in may be an efficient means for programmatic approaches terms of integrating GHG considerations into policy in countries with emissions obligations, by providing and investment decision-making processes, and sustain- transactional advantages through upfront financing for ing emission reductions over the long term. The failure programmatic activities combined with timing flexibly to sustain this capacity would exacerbate the challenge for their subsequent implementation. of mitigating climate change over the coming years. The international community must work together to ensure that we move forward, build on the rich experience of the mechanisms and make the necessary adjustments to con- front the climate and development challenges of the next decade and beyond. 90 Conclusion: An Experience worth Building On Postscript ­ Building on 10 years of experience: Where the World Bank Goes from Here This report has also been a way for the World Bank to cel- implementation and deliver the emission reductions they ebrate its first decade of involvement in carbon finance. are expected to generate. Looking back at the road traveled, it has been a fascinat- While the global community strives to put in place ing journey of discovery of how market mechanisms can an international climate regime post 2012, the World set in motion investments and behaviors that dramati- Bank will continue its work to expand the scope, scale cally change the way we look at development opportuni- and range of climate change mitigation activities in the ties in the World Bank's client countries. various sectors of its clients' developing economies. Fill- It has been a journey traveled together with carbon ing the climate finance gap will require that both the pub- fund participants, donors, host countries, the secretariat lic and the private sectors get engaged on a significantly of the UNFCCC, and a diverse group of entrepreneurs larger scale than heretofore. The private sector has indeed and investors in many different countries, inspired by the a key role in financing mitigation through carbon markets belief that there can be alternatives to business as usual and related instruments; official flows or international so that growth and poverty reduction can be achieved at funding will be an important complement to build capac- the same time as a more sustainable world is preserved ity, correct market imperfections, and target areas over- for generations to come. As the report documents, it has looked by the market. been at times a difficult journey but one that has been How the World Bank proposes to move forward mat- highly rewarding--and in which we have learned a lot. ters. Building on its experience serving as a market maker Today, the global community has a much better idea of (in the very early days), and a contributor to the global not only what works and does not work, but also what experiment that the first commitment period of the could be done to let market mechanisms reach their full Kyoto Protocol has provided, the World Bank recognizes potential to achieve climate change mitigation at the scale that the best chance for using carbon markets to achieve required to address effectively the global challenge our successful large-scale GHG mitigation in future will be a planet faces. partnership between all countries involved. Thus in addi- Strengthened by the rich experience amassed over the tion to continuing to "learn by doing", as is still required past decade and convinced of the need to continue its in many ways, a close partnership with all stakeholders support for mitigation actions, the World Bank proposes will help find better solutions that address the urgent to embark on its next ten years of carbon finance. There and critical challenges of climate change. Partnerships are is still a lot more to learn from the portfolio of projects also better suited to the evolution of capacity building we manage as we continue to help project entities to full and awareness among market participants, as well as the 91 YEARS OF EXPERIENCE IN CARBON FINANCE concept of "common but differentiated responsibilities" sion reductions through larger-scale, longer-term carbon embodied in the UNFCCC. Large-scale GHG emission finance investments through the use of Programmes of reductions will require not only the use and diffusion of Activities as well as other scaled-up approaches such as more advanced technologies, but will also entail innova- a proposed city-wide approach. For the first time, both tion and collaboration over a long period of time as stake- buyers and sellers of emission reductions will work jointly holders both create and transfer knowledge. to develop these new approaches, with the World Bank As a participant committed to making the carbon facilitating the partnership. The Facility is intended to be markets work, the World Bank has played various facili- a catalytic agent by experimenting with new ways of lever- tating roles, bringing together diverse stakeholders to aging private sector funds to invest in low-carbon devel- overcome hurdles. It proposes to continue this bridge- opment alternatives at large scale within host countries. building work whenever desirable by, for example: Building on the lessons learned about the importance of capacity building, the Facility includes a specifically Facilitating technical roundtable discussions on designed program preparation fund to provide techni- various topics, bringing together rule makers (e.g., cal assistance, as well as a more traditional carbon fund UNFCCC), those responsible for applying the rules to purchase carbon credits derived from GHG emission (DOEs), project or program entities, and other stake- reduction investments and client country activities. holders, with a view to sharing experience, learning Looking ahead, the World Bank plans to introduce a from one another and brainstorming future proce- dedicated facility to help build adequate capacity in devel- dures, processes and mechanisms; oping countries to make market instruments operational Providing a forum for host countries--through its for meeting their own mitigation objectives. Through a Host Country Committee--to advise the World proposed "partnership for market readiness", the World Bank on its carbon finance activities and share experi- Bank is prepared, in collaboration with other partners, to: ence on the ground; and (i) create a platform to enable policy makers from both Facilitating participation of developing country sell- developed and developing countries, practitioners, and ers and regulators in forums such as Carbon Expo to public and private entities, to share experience and infor- bring them in direct contact with "the market"; mation regarding elements of market readiness, learn from each other, explore and innovate together on new instru- Going beyond such informal initiatives, the Forest ments and approaches; (ii) provide grant financing to the Carbon Partnership Facility, established in 2008, is an participating countries in building "infrastructure" for encouraging example of pioneering work undertaken by market readiness; (iii) pilot, test and sequence new con- a strong partnership of more than 50 countries, dedicated cepts for market instruments, including identifying poten- to tackle the complex issue of REDD (Reducing emissions tial synergies between national market-based instruments from deforestation and forest degradation) and beyond at the design stage; (iv) create a body of knowledge that (REDD+) along with other REDD initiatives. Providing could be tapped for country-specific requirements; and countries with the means to prepare themselves for future (v) share lessons learned, including with the UNFCCC. large-scale incentive payments for REDD+ and in the pro- Last but not least, the World Bank's pioneering work cess, building not only knowledge, but also trust and confi- carried out through its BioCarbon Fund and Commu- dence among all stakeholders involved, has proven critical nity Development Carbon Fund are far from completed. to moving forward on this difficult REDD+ agenda. The BioCarbon Fund needs to be continued to extend The World Bank would like to emulate this positive the benefits of the carbon market to the rural, poorest experience on other fronts. areas of the world, with projects that conserve or seques- It is in the process of establishing the Carbon Part- ter GHGs in forests and agro-ecosystems, as well as strive nership Facility (CPF) to promote greenhouse gas emis- to change agricultural practices leading to soil improve- 92 Postscript ­ Building on 10 years of experience: Where the World Bank Goes from Here Carbon finance at the World Bank ments. Aware of the potential that such work has towards Market instruments should and can work for all coun- improving livelihoods and reducing poverty in its client tries at different stages of development. Making them countries, the World Bank seeks to build on the achieve- suitable to the variety of needs and country situations ments of and lessons learnt from the Community Devel- will require flexibility, innovation, imagination and above opment Carbon Fund and support the development ambition and perseverance. The World Bank is prepared needs of the least-developed countries in future. to play its part, for another ten years... Postscript ­ Building on 10 years of experience: Where the World Bank Goes from Here 93 YEARS OF EXPERIENCE IN CARBON FINANCE 94 Postscript ­ Building on 10 years of experience: Where the World Bank Goes from Here Annex 1 ­ World Bank Funds & Facilities Carbon Funds and Facilities at a Glance PCF CDCF BioCF At the close of calendar year 2009, the The Community Development Carbon Fund The BioCarbon Fund has signed 17 contracts Prototype Carbon Fund has 23 of 24 projects now has 33 emission reductions purchase involving afforestation and reforestation, generating emission reductions and eight of agreement with a value of $98 million. four of which have been registered under the the PCF's CDM projects have issued Certified Fifty-three percent of its portfolio is com- Kyoto Protocol's CDM mechanism, and the Emission Reductions. In early 2010, the PCF mitted to projects in the world's poorest remainder of which are in advanced stages successfully completed its first transfer of countries as defined by the World Bank of preparation. Fifteen of the projects have Kyoto assets from its projects in Annex I Group's International Development Associa- signed an emission reductions purchase agree- countries. tion or the United Nations' Least Developed ment. Tranche 2 consists of 8 afforestation/ Country designation. reforestation projects, which are expected to generate 3.02 million tons in carbon emission reductions. Fund Capital ($ million) 219.8 Fund Capital ($ million) 128.6# TRANCHE 1 Date Operational April 2000 Date Operational March 2003 Fund Capital ($ million) 53.8 Participants 22 Participants 25 Date Operational May 2004 Private % (by capital invested) 57.6 Private % (by capital invested) 45.1 Participants 14 Private % (by capital invested) 51 TRANCHE 2 Fund Capital ($ million) 36.6 Date Operational March 2007 Participants 7 Private % (by capital invested) 44 NCDMF NECF Italian Carbon Fund The Netherlands Clean Development The Netherlands European Carbon Facility With a capitalization of $155.6 million, the Mechanism Facility has a mature portfolio that (NECF) is co-managed with the International Italian Carbon Fund (ICF) has signed six includes the first project ever registered under Finance Corporation and supports carbon emission reductions purchase agreements the Kyoto Protocol's CDM mechanism. The market operations in Ukraine, Russia, and totaling $145.9 million and 26 million tons NCDMF portfolio includes a significant number Poland. of carbon dioxide. The portfolio includes of registered projects and others with signed projects operating under both the Kyoto emission reductions purchase agreements that Protocol's CDM and JI mechanisms. are in the process of being registered. Fund Capital ($ million) ** Fund Capital ($ million) ** Fund Capital ($ million) 155.6 Date Operational May 2002 Date Operational August 2004 Date Operational March 2004 Participants 1 Participants 1 Participants 7 Private % (by capital invested) 0 Private % (by capital invested) 0 Private % (by capital invested) 30.2 95 YEARS OF EXPERIENCE IN CARBON FINANCE Danish Carbon Fund Spanish Carbon Fund Umbrella Carbon Facility The Danish Carbon Fund (DCF) consists Divided into two tranches since 2008, the Consisting of five carbon fund administered of seven emission reductions purchase Spanish Carbon Fund (SCF) consists of by the World Bank and 11 members of the agreements with a total carbon reduction 14 signed emission reductions purchase private sector, the Umbrella Carbon Facility volume of 6.8 million tons of carbon dioxide agreements. With total commitments of (UCF) consists of 799.1 million, 75 percent equivalent. The fund has an additional 156.7 million, the fund has 71.2% of its of which comes from the private investment. 9 projects in pipeline equivalent to another capital pledged. Tranche 2, which has a In 2009 the facility delivered 19.2 million tons 35 million tons of carbon dioxide. Green Investment Scheme focus, signed its of carbon dioxide bringing the total amount first emission reduction agreements in 2008 of emissions purchased since inception up to purchasing 236,254 tons of carbon dioxide. 48.4 million tons of carbon dioxide. Fund Capital ( million) 90 TRANCHE 1 Fund Capital ( million) 799.1* Date Operational January 2005 Fund Capital ( million) 220 Date Operational August 2006 Participants 5 Date Operational March 2005 Participants 16 Private % (by capital invested) 78 Participants 13 Private % (by capital invested) 75 Private % (by capital invested) 22.7 TRANCHE 2 Fund Capital ( million) 70 Date Operational April 2008 Carbon Fund for Europe Forest Carbon Partnership Facility With total capitalization of 50 million, Operational since June 2008, the capital the Carbon Fund for Europe (CFE) signed a for the Forest Carbon partnership facility fifth emission reduction agreement in 2009 currently stands at 168.5 million. In 2009, bringing the total amount of emissions Guyana, Panama, and Indonesia became the purchased up to 3.4 million tons of carbon first three countries to submit Readiness dioxide emissions. The fund currently has an Preparation Proposals to the facility, which additional 1 million tons of carbon dioxide is the first step in allowing them to build emissions in its pipeline. capacity to tap into incentives under REDD. # Includes $ 5 million total participation of DCF * Includes 224.54 million total participation Fund Capital ( million) 50 Fund Capital ( million) 168.5 of Date Operational March 2007 Date Operational June 2008 PCF, NCDMF, ICF, DCF, and SCF Participants 5 Participants 51*** ** Not publicly available Private % (by capital invested) 20 Private % (by capital invested) 3 *** 14 financial contributors 37 REDD country participants 96 Annex 1 ­ World Bank Funds & Facilities Annex 2 ­ Key Elements of an Emission Reductions Purchase Agreement (ERPA) COMMERCIAL TERMS: Offset asset type (CERs/ERUs/VERs) Typically borne by Seller up to certain capped Contract volume amount Seniority/pari passu Taxes (if any) Annual/cumulative amounts (as specified in a Host country taxes: borne by Seller delivery schedule) Other taxes: borne by Buyer `Sweeping clause' (i.e. project over-performance CDM Share of Proceeds leads to acceleration of delivery schedule) CER ERPA: borne by Seller Unit price (fixed/variable) VER ERPA: borne by Buyer Call option for additional offset asset volumes & Risk allocation exercise price (fixed/variable/option premium) General principle: Risks to be borne by party best Conditions for sale & purchase obligations to become able to manage them effective CER/ERU ERPA: Seller bears political/project/ Payment project registration (determination)/methodol- CER/ERU ERPA: upon delivery ogy/Kyoto regulatory risk; Seller and Buyer share VER ERPA: upon verification price/force majeure risk Advance payment (if any) VER ERPA: Seller bears political/project risk; Certain percentage amount of contract value Buyer bears project registration (determination)/ Advance payment recovery risk mitigation tools methodology/Kyoto regulatory risk; Seller and (e.g., letter of credit, disbursement milestones etc.) Buyer share price/force majeure risk Transaction costs Costs related to project preparation/ implementation/supervision 97 Annex 3 ­ World Bank Social and Environmental Safeguard Policies The World Bank's environmental and social safeguard Indigenous peoples policies are a cornerstone of its support to sustainable International waterways poverty reduction. The objective of these policies is to Projects in disputed areas prevent and mitigate undue harm to people and their environment in the development process. These policies In addition, project information needs to be suitably provide guidelines for World Bank and borrower staffs disclosed both locally and internationally. The World in the identification, preparation, and implementation Bank also carries out stakeholder consultations and due of programs and projects. In projects where the carbon diligence to ensure that there are no reputational risks finance operation is a component of a World Bank invest- associated with project activities. ment operation such as an investment loan, the safeguards The compliance requirements are specific for each developed for the loan include the CF component. In line project depending on its project boundary, location, with the same requirements for other operations, even technology type, and the activities envisaged under the stand-alone projects taken up for consideration for the project. As soon as possible after a project is accepted Carbon Finance portfolio are reviewed for compliance for development, a task team is assigned to review it with these policies. This is in addition to the relevant host and determine which World Bank Group safeguard country approvals that are required under the Kyoto Pro- policies are triggered. This determination is developed tocol to confirm that a project will assist the host coun- through field reviews, and the required safeguard mea- try in meeting its sustainable development priorities. The sures and schedules for implementation are finalized rationales for the safeguard policies are to (i) contribute before the World Bank agrees to the signature of an to informed decision-making; (ii) build consensus on ERPA. Depending on the degree of complexity, proj- development alternatives; (iii) reduce unforeseen prob- ects are rated as C, B, or A, with progressively more lems and issues; (iv) prevent costly delays and stoppages; intense compliance regimes. (v) minimize or prevent disputes; (vi) sustain develop- At a minimum, all projects complete an environmental ment impact; and (vii) build public confidence. The assessment report (including an environmental manage- World Bank's safeguards policies cover: ment plan); other plans (such as an Indigenous Peoples Plan, a Resettlement Plan or other action or management Environmental assessment plans or material produced pursuant to safeguard poli- Natural habitats cies) are determined on a project-specific basis. These are Safety of dams disclosed in line with relevant World Bank Group Poli- Pest management cies & Procedures applicable to private sector projects Physical cultural resources both at the World Bank InfoShop (www.worldbank.org/ Forests infoshop/) and in a publicly accessible location in the host Involuntary resettlement country of the carbon finance project. 99 Annex 4 ­ Example of Simplified Modalities for Demonstrating Additionality The CDM Executive Board issued a call for pub- both the developing countries and the developed coun- lic inputs on simplified modalities for demonstrat- tries seeking cost-effective mitigation. ing additionality of small-scale renewable energy and The submission proposes a flow-chart based, yes/no energy efficiency project activities. The following assessment, that small-scale projects can use to prove example is drawn from the World Bank's submission automatic additionality. The suggested assessment is (April 12, 2010) responding to the call for inputs (it based on widely published documentation (e.g., UN can be found at http://wbcarbonfinance.org/Router. MDG reports, IFC Doing Business reports, WB's green cfm?Page=Methodology&mt=Papers) data book, and published national/regional/sectoral The World Bank's submission is structured to allow data) or country specific or sector specific national-level assessment of additionality for all small-scale category information available in the host country. The effort is (SSC) projects. To ensure the success of the CDM, to move away from project-specific assessment for this improved regional distribution of projects and reduction category of projects as it is practically impossible to in the timelines of project approval procedures, cost- find information on such small-scale projects, and the effective implementation of the simplified modalities for associated time and cost involved can easily outweigh all small-scale projects needs to be assured. This involves the financial incentive provided by the carbon revenue, close consideration and analysis of key issues related to which should be utilized for the project and not solely types of projects, technology, and region/country spe- towards CDM transaction costs. The flow chart outlined cific circumstances. As delays in the registration process is intended to simplify the procedures for the demon- translate into lost CERs, further simplification of existing stration of additionality for small-scale renewable energy modalities for additionality demonstration will benefit projects and programs. 101 YEARS OF EXPERIENCE IN CARBON FINANCE Demonstration of Additionality for Small Scale Renewable Energy Project activities with less than 5 MW* Is the project <=5MW Yes No Is the project off-grid supplying Use attachment A to households/communities? Annex B, if it is more than 5 MW and less Yes No than or equal to 15 MW ­ or use the guidance in the Project is additional Is project in LDC? methodology used. A Yes No Project is additional Is the project type/ technology supported by B the government (financial or technical?) Yes No Is the project located in Project is additional areas with (X economic indicator or Y type of C consumer, or Z share of poor communities?) Yes No Project is additional Use simple cost analysis or use Attachment A to Annex B D *The World Bank example uses the threshold specified in the CDM EB call for public inputs, but a higher threshold (i.e., 15 MW and 60 GWh) is recommended. Simple cost analysis has to prove that the type/tech- The check points on the flow chart are selected based nology of the project is costlier than the business as usual on the analysis of additionality criteria, which in turn are (BAU), say $/MW is higher than BAU, or demonstrate based on the analysis of registered small scale renewable that the benefits to costs ratio is less than BAU based on energy CDM projects and lessons learned from the WB's the total costs and benefits expressed in discounted pres- portfolio of projects. A project or program can be consid- ent values. This is without the need to follow regular ered automatically additional if it is: detailed investment analysis. 102 Annex 4 ­ Example of Simplified Modalities for Demonstrating Additionality Carbon finance at the World Bank 1. An off-grid project; irrespective of its location and envi- a. without any incentives from the government (C) ronment under which it has been implemented--This b. located in areas with (X economic indicator or is considering the fact that the size of the project is Y type of consumer, or Z share of poor communi- small and directly contributes to sustainable develop- ties) (D) ment (A) 2. An on-grid project and located in an LDC (B) The following table explains the rationale behind vari- 3. An on-grid project, located in countries other than ous checkpoints suggested in the above flow chart: LDCs, but TA B L E 8 Explanation of additionality check-point for energy efficiency projects Checkpoint Rationale Data Sources A. Is the project an Considering its small size and sustainable ˇ No further data are required. off-grid one? development priorities, any off-grid project with less than 5 MW capacities should be considered automatically additional irrespec- tive of its country of location. B. Is the on-grid Considering its size, and that sustainable ˇ No further data are required. project located in an development benefits and obvious barriers LDC? exist in LDC countries, any grid connected project with less than or equal to 5 MW should be considered automatically ad- ditional. This is also considering CMP.5 declaration on LDCs to push the additonality of REs. C. If the on-grid Projects of this scale highly depend on ˇ Any publicly available information on the government policies in project is not located incentives from the government mainly to the country in an LDC, there are reduce high upfront costs (considering their limited or no direct scale, location, choice of technology) and incentives from the hence any such project with limited or no government for the government support should be automati- promotion of project cally additional. type/technology. D. If the on-grid These types of projects help for the sustain- Last available published data on economic and welfare indicators project is located in able development of areas with economical- such as: countries other than ly poor population or areas that lack basic an LDC, in an area infrastructure to meet basic needs. Projects ˇ Millennium development goals, such as where the population that contribute essentially to the sustainable ˇ Target 1.1: Proportion of population below $1 per day is either poor and/or development of the area should be encour- ˇ Target 7.8: Proportion of population using an improved drink- lacks access to in- aged and considered additional. ing water source frastructure to meet ˇ Target 7.9: Proportion of population using an improved sani- their basic needs; tation facility (based on a specific ˇ Target 7.10 Proportion of urban population living in slums indicator) Others ˇ Economic and financial indicators such as the rate of electrification Note on indicators: The list of indicators is provided for discussion and illustration. It is proposed that all projects of this scale should be considered automatically additional till the relevant MDG goals are achieved or there is significant improvement in the other economic indicators in the division/ province/state/country in which the specified project is being implemented. Annex 4 ­ Example of Simplified Modalities for Demonstrating Additionality 103 YEARS OF EXPERIENCE IN CARBON FINANCE Illustrative examples being a subject of both international and national con- cern in the country. There are numerous projects across the world where the development dividend is larger as compared to the cli- mate mitigation benefit but which can provide the much C. Yeghegis Small-Scale Hydro Project needed performance-linked incentive for communities to pursue a low carbon path for development. Based on the This project involves installation of a turbine of 3.75 MW checkpoints A-D described in Table 8, here we provide (3,750 KW) at the small scale hydropower plant on the examples of projects that can be used to demonstrate the upper flow of the Yeghegis river with electricity supplied additionality (Source: UNFCCC website). to the national grid of Armenia. A first turbine at Yeghe- gis was installed and operational and not a part of the CDM project. The second turbine could not have been A. CDm Solar Cooker Project Aceh 1, Indonesia financed without the CDM project because this turbine will only operate during a wet season of approximately The project strives to transfer and spread the most two and a half months. The first turbine produces about advanced technologies of solar cookers and of heat retain- 25,000 MWh, while the second one will produce 7,296 ing containers (to finish cooking by unattended simmer- MWh. There is no government incentive program to sup- ing and to separate meal-time and cooking time). The port such project. transferred state of the art technology from Germany uses renewable resources for cooking meals, heating and sterilizing water, and preserving food. D. West Nile Electrification Project The project is the installation and operation of a 3.5 MW B. LUIGA Hydropower Project in Mufindi District, hydroelectric power plant, along with upgradation and Tanzania (under validation) extension of existing distribution networks in Paidha, Nebbi, and Arua municipalities in Uganda. It also con- LUIGA hydro power project is a 3 MW project located nects existing and new customers, who would otherwise in Mufindi district of Tanzania with a main objective operate small, privately-owned generation facilities. The of developing the rural energy sector in order to make overall objectives of the West Nile Electrification Project a significant contribution to bringing about rural trans- (WNEP) are to promote socio-economic development formation and poverty alleviation. Although the gov- in rural Uganda and to reduce energy-related CO2 emis- ernment considers electricity as an important source of sions causing global climate change. The project is being modern energy, less than 10% of the total population has implemented under the Energy for Rural Transformation access to electricity supply, with rural access being lower (ERT) program mainly to assist Uganda's rural energy than urban access. Estimates show that less than 2% of sector in contributing to rural transformation and pov- the population has access to electricity, despite this issue erty alleviation. 104 Annex 4 ­ Example of Simplified Modalities for Demonstrating Additionality Annex 5 ­ CDM Guidance on Government Policies (E-/E+ Policy Guidance) Annex 3 of the Executive Board's 16th meeting (October An E+ policy is national and/or sectoral policies or 2004) provides guidance on how to treat climate-friendly regulations that create policy driven market distortions policies in the baseline. The aim of this guidance is to pro- which give comparative advantages to more emissions- vide assurance that the CDM would not create perverse intensive technologies or fuels over less emissions-inten- incentives and would not penalize host countries that sive technologies or fuels. E+ national and/or sectoral have enacted climate-friendly policies. policies or regulations that have been implemented before According to this EB guidance, E- national and/ adoption of the Kyoto Protocol by the COP (decision or sectoral policies or regulations that have been imple- 1/CP.3, 11 December 1997) shall be taken into account mented since the adoption of the Marrakesh Accords when developing a baseline scenario. If "Type E+" national (November 2001) may not be taken into account in and/or sectoral policies were implemented after the adop- developing a baseline scenario (i.e., the baseline scenario tion of the Kyoto Protocol, the baseline scenario should should refer to a situation without the national and/ refer to a hypothetical situation without the national and/ or sectoral policies or regulations being in place)". An or sectoral policies or regulations being in place. E­policy is defined as "National and/or sectoral poli- The issue of E policy and additionality assessments cies or regulations that give positive comparative advan- by the EB is to be further elaborated. The Copenhagen tages to less emissions-intensive technologies over more December 2009 Decision 2/CMP.5 on Further guidance emissions-intensive technologies (e.g. public subsidies to to the CDM requests that the EB "... consolidate, clarify promote the diffusion of renewable energy or to finance and revise, as appropriate, its guidance on the treatment energy efficiency programs)." of national policies." 105 Annex 6 ­ Glossary Accredited Independent Entity (AIE): Accredited Assigned Amount Unit (AAU): Annex I Parties are independent entities (AIEs) are independent auditors issued AAUs up to the level of their assigned amount, that assess whether a potential project meets all the eligi- corresponding to the quantity of greenhouse gases they bility requirements of the JI (determination) and whether can release in accordance with the Kyoto Protocol (Art. the project has achieved greenhouse gas emission reduc- 3), during the first commitment period of that protocol tions (verification). (2008­12). One AAU represents the right to emit one metric ton of carbon dioxide equivalent. Additionality: A project activity is additional if anthro- pogenic GHG emissions are lower than those that would Baseline: The emission of greenhouse gases that would have occurred in the absence of the project activity. occur without the policy intervention or project activity under consideration. Afforestation: The process of establishing and growing forests on bare or cultivated land, which has not been for- Biomass Fuel: Combustible fuel composed of a biologi- ested in recent history. cal material, for example, wood or wood by-products, rice husks, or cow dung. Annex I (Parties): Include the industrialized countries that were members of the OECD in 1992, plus countries Carbon Asset: The potential of greenhouse gas emission with economies in transition. They currently include Aus- reductions that a project is able to generate and sell. tralia, Austria, Belarus, Belgium, Bulgaria, Canada, Croatia, Carbon Finance: Resources provided to activities gen- Czech Republic, Denmark, Estonia, European Union, Fin- erating (or expected to generate) greenhouse gas (or car- land, France, Germany, Greece, Hungary, Iceland, Ireland, bon) emission reductions through the transaction of such Italy, Japan, Latvia, Liechtenstein, Lithuania, Luxembourg, emission reductions. Monaco, the Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Russian Federation, Slovakia, Slove- Carbon Dioxide Equivalent (CO2e): The universal nia, Spain, Sweden, Switzerland, Turkey, Ukraine, United unit of measurement used to indicate the global warm- Kingdom of Great Britain and Northern Ireland, United ing potential of each of the six greenhouse gases regulated States of America. All but Turkey are listed in Annex B of under the Kyoto Protocol. Carbon dioxide--a naturally the Kyoto Protocol. occurring gas that is a byproduct of burning fossil fuels and biomass, land-use changes, and other industrial Annex B (Parties): The 39 industrialized countries processes--is the reference gas against which the other (including the European Union) listed in Annex B to the greenhouse gases are measured, using their global warm- Kyoto Protocol have committed to country-specific tar- ing potential. gets that collectively reduce their GHG emissions by at least 5.2% below 1990 levels on average over 2008­12. 107 YEARS OF EXPERIENCE IN CARBON FINANCE Certified Emission Reductions (CERs): A unit of the Kyoto Protocol to review and give national approval greenhouse gas emission reductions issued pursuant to to projects proposed under the Clean Development the Clean Development Mechanism of the Kyoto Proto- Mechanism. col, and measured in metric tons of carbon dioxide equiv- Designated Operational Entities (DOEs): Desig- alent. One CER represents a reduction in greenhouse gas nated operational entities are independent auditors that emissions of one metric ton of carbon dioxide equivalent. assess whether a potential project meets all the eligibility Clean Development Mechanism (CDM): The mecha- requirements of the CDM (validation) and whether the nism provided by Article 12 of the Kyoto Protocol, project has achieved greenhouse gas emission reductions designed to assist developing countries in achieving sus- (verification and certification). tainable development by allowing entities from Annex I Determination: Determination is the process of evalu- Parties to participate in low carbon projects and obtain ation by an independent entity accredited by the host CERs in return. country ( JI Track 1) or by the Joint Implementation CDM Executive Board: A 10-member panel elected at Supervisory Committee ( JI Track 2) of whether a project the Seventh Conference of the Parties, which supervises and the ensuing reductions of anthropogenic emissions the CDM. by sources or enhancements of anthropogenic removals by sinks meet all applicable requirements of Article 6 of Community Benefits: Community benefits are identifi- the Kyoto Protocol and the JI guidelines. able and quantifiable improvements in the quality of life of a local group of people who are identified by the trustee Emission Reductions (ERs): The measurable reduction and the project entity as in the vicinity of or affected by of release of greenhouse gases into the atmosphere from a a project. specified activity, and a specified period of time. Conference of Parties (COP): The supreme body of Emission Reductions Purchase Agreement (ERPA): the Convention. It currently meets once a year to review Agreement which governs the transaction of emission the Convention's progress. The word "conference" is not reductions. used here in the sense of "meeting" but rather of "associa- Emission Reduction Units (ERUs): A unit of emission tion," which explains the seemingly redundant expression reductions issued pursuant to Joint Implementation. One "fourth session of the Conference of the Parties." ERU represents a reduction of one metric ton of carbon Conference of the Parties serving as the Meeting of the dioxide equivalent. Parties (CMP): The Convention's supreme body is the European Union Allowances (EUAs): the allowances COP, which serves as the meeting of the Parties to the Kyoto Protocol. The sessions of the COP and the CMP are in use under the EU ETS. An EUA unit is equal to one held during the same period to reduce costs and improve metric ton of carbon dioxide equivalent. coordination between the Convention and the Protocol. European Union Emission Trading Scheme (EU ETS): The EU ETS was launched on January 1, 2005 Crediting Period: The crediting period is the duration of as a cornerstone of EU climate policy towards its Kyoto time during which a registered, determined or approved commitment and beyond. Through the EU ETS, Mem- project can generate emission reductions. For CDM ber States allocate part of the efforts towards their Kyoto projects, the crediting period can be of either seven years targets to private sector emission sources (mostly utili- (renewable twice) or of ten years (non-renewable). ties). Over 2008­12, emissions from mandated instal- Designated National Authority (DNA): An office, lations (about 40% of EU emissions) are capped on ministry, or other official entity appointed by a Party to average at 6% below 2005 levels. Participants can inter- 108 Annex 6 ­ Glossary Carbon finance at the World Bank nally reduce emissions, purchase EUAs or acquire CERs HFC-23 (triofluoromethane): Greenhouse gas that has and ERUs (within a 13.4% average limit of their alloca- 11,700 times the global warming potential of carbon tion over 2008­12). The EU ETS will continue beyond dioxide and is a by-product in the manufacturing process 2012, with further cuts in emissions (by 21% below of HCFC-22, used in air conditioning, refrigeration, and 2005 levels in 2020 or more, depending on progress in as a feedstock. reaching an ambitious international agreement on cli- mate change). Host Country: The country where an emission reduc- tion project is physically located. First Commitment Period: The five-year period, from 2008 to 2012, during which industrialized countries have Internal Rate of Return: The annual return that would committed to collectively reduce their greenhouse gas (or make the present value of future cash flows from an "carbon") emissions by an average of 5.2% compared with investment (including its residual market value) equal the 1990 emissions under the Kyoto Protocol. current market price of the investment. In other words, the discount rate at which an investment has zero net Flexible Mechanisms: Three procedures established present value. under the Kyoto Protocol to increase the flexibility and reduce the costs of making greenhouse gas emissions cuts; Joint Implementation (JI): Mechanism provided by they are the Clean Development Mechanism, Interna- Article 6 of the Kyoto Protocol, whereby entities from tional Emissions Trading, and Joint Implementation. Annex I Parties may participate in low carbon projects hosted in Annex I countries and obtain Emission Reduc- Green Investment Scheme (GIS): A GIS is a voluntary tion Units in return. mechanism through which proceeds from AAU trans- actions will contribute to contractually agreed environ- Kyoto Mechanisms (KMs): the three flexibility mecha- ment- and climate-friendly projects and programs both nisms that may be used by Annex I Parties to the Kyoto by 2012 and beyond. Protocol to fulfill their commitments. Those are the Joint Implementation ( JI, Art. 6), Clean Development Mecha- Greenhouse gases (GHGs): Both natural and anthro- nism (CDM, Art. 12) and International Emissions Trad- pogenic, greenhouse gases trap heat in the Earth's atmo- ing (Art. 17). sphere, causing the greenhouse effect. Water vapour (H2O), carbon dioxide (CO2), nitrous oxide (N2O), Kyoto Protocol: Adopted at the Third Conference of the methane (CH4) and ozone (O3) are the primary green- Parties to the United Nations Convention on Climate house gases. The emission of greenhouse gases through Change held in Kyoto, Japan in December 1997, the Kyoto human activities (such as fossil fuel combustion or Protocol commits industrialized country signatories to col- deforestation) and their accumulation in the atmo- lectively reduce their greenhouse gas emissions by at least sphere is responsible for an additional forcing, contrib- 5.2% below 1990 levels on average over 2008­12 while uting to climate change. The Kyoto Protocol regulates developing countries can take no regret actions and partici- six GHGs: carbon dioxide (CO2), methane (CH4), pate voluntarily in emissions trading through the CDM. and nitrous oxide (N20), as well as hydrofluorocarbons The Kyoto Protocol entered into force in February 2005. (HFCs), perfluorocarbons (PFCs), and sulfur hexafluo- Land Use, Land-Use Change and Forestry (LULUCF): ride (SF6). A greenhouse gas inventory sector that covers emissions Global Warming Potential (GWP): An index repre- and removal of greenhouse gases resulting from direct senting the combined effect of the differing times green- human-induced land use, land-use change and forestry house gases remain in the atmosphere and their relative activities. Expanding forests reduce atmospheric carbon effectiveness in absorbing outgoing infrared radiation. dioxide; deforestation releases additional carbon dioxide; Annex 6 ­ Glossary 109 YEARS OF EXPERIENCE IN CARBON FINANCE various agricultural activities may add to atmospheric lev- Sequestration: Sequestration refers to capture of carbon els of methane and nitrous oxide. dioxide in a manner that prevents it from being released into the atmosphere for a specified period of time. Monitoring Plan: A set of requirements for monitor- ing and verification of emission reductions achieved by Small-scale Projects: Projects that are compatible with a project. the definition of "Small-scale CDM Project Activities" set out in decision 17/CP.7 by the Conference of Parties Offsets: Offsets designate the emission reductions from to the UNFCCC. project-based activities that can be used to meet com- pliance--or corporate citizenship--objectives vis-ā-vis United Nations Framework Convention on Climate greenhouse gas mitigation. Change (UNFCCC): The international legal framework adopted in June 1992 at the Rio Earth Summit to address Primary transaction: A transaction between the original climate change. It commits the Parties to the UNFCCC owner (or issuer) of the carbon asset and a buyer. to stabilize human induced greenhouse gas emissions Project-Based Emission Reductions: Emission reduc- at levels that would prevent dangerous manmade inter- tions that occur from projects pursuant to JI or CDM ference with the climate system, following "common (as opposed to "emissions trading" or transfer of assigned but differentiated responsibilities" based on "respective amount units under Article 17 of the Kyoto Protocol). capabilities." Project Design Document (PDD): A central document Validation: Validation is the process of independent eval- of project-based mechanisms, the PDD notably describes uation of a project activity by a Designated Operational the project activity (including environmental impacts and Entity (DOE) against the requirements of the CDM. stakeholder consultations), the baseline methodology and The CDM requirements include the CDM modalities how the project is additional as well as the monitoring plan. and procedures and subsequent decisions by the CMP and documents released by the CDM Executive Board. Project Idea Note (PIN): A note prepared by a project proponent presenting briefly the project activity (e.g., sec- Verified Emission Reductions (VERs): A unit of green- tor, location, financials, estimated amount of ERs etc.). house gas emission reductions that has been verified by an independent auditor. Most often, VERs are traded on REDD plus: All activities that reduce emissions from the voluntary market. deforestation and forest degradation, and contribute to conservation, sustainable management of forests, and Verification: Verification is the review and ex post deter- enhancement of forest carbon stocks. mination by an independent third party of the monitored reductions in emissions generated by a registered CDM Reforestation: This process increases the capacity of the project, a determined JI project (or a project approved land to sequester carbon by replanting forest biomass in under another standard) during the verification period areas where forests have been previously harvested. Voluntary market: The voluntary market caters for the Registration: The formal acceptance by the CDM Execu- needs of those entities that voluntarily decide to reduce tive Board of a validated project as a CDM project activity. their carbon footprint using offsets. The regulatory vac- uum in some countries and the anticipation of imminent legislation on GHG emissions also motivates some pre- compliance activity. 110 Annex 6 ­ Glossary Annex 7 ­ Bibliography Baker & McKenzie, CDM Rulebook (www.cdmrule- through programmatic CDM", Report produced for book.org) the Energy Sector Management Assistance Program Baker & McKenzie, JI Rulebook (www.jirulebook.org) (ESMAP) and the World Bank Carbon Finance CDM website: www.cdm.unfccc.int Unit, ESMAP technical paper 120/07, www.carbon- Community Development Carbon Fund (CDCF), finance.org 2009, "Assessment of Community Benefits and Sus- Haites, Erik, 2004, "Estimating the Market Potential tainable Development". for the Clean Development Mechanism: Review Council of the European Union, 21 October 2009, "EU of Models and Lessons Learned", prepared for the position for the Copenhagen Climate Conference World Bank Carbon Finance Business PCFplus (7­18 December 2009)", Council conclusions, Research program, the International Energy Agency, 14790/09. and the International Emissions Trading Association. Ellis, Jane and Sami Kamel, May 2007 "Overcoming Bar- Intergovernmental Panel on Climate Change (IPCC), riers To Clean Development Mechanism Projects", 2007, Contribution of Working Group III to the document was prepared by the OECD and IEA Sec- Fourth Assessment Report of the IPCC, www.ipcc.ch retariats, and UNEP Risø Centre, in response to the International Energy Agency (IEA), 2008, World Energy Annex I Expert Group on the United Nations Frame- Outlook 2008, Paris. work Convention on Climate Change (UNFCCC) International Emissions Trading Association (IETA), European Environment Agency, 2009, "Greenhouse gas 2009 "State of the CDM 2009 Reforming for the emission trends and projections in Europe 2009", Present and Preparing for the Future" EEA Report No 9/2009 Kossoy, Alexandre, 2010, Managing Expectations", Trad- De Gouvello, Christophe, Felix Dayo and Massamba ing Carbon, 4(10), pp. 32­34 Thioye, 2008, "Low-carbon Energy Projects for Kossoy, Alexandre and Philippe Ambrosi, 2010, "State Development in Sub-Saharan Africa-Unveiling the and Trends of the Carbon Market", The World Bank. Potential, Addressing the Barriers", The World Bank. MacWhinney, Ross, 2007, "Reducing HFC-23: A Cru- Figueres, Christiana, with Margaree Consultants cial Component of the Battle against Global Warm- and Econergy International Corporation, 2005, ing", Evolution Markets, Executive Brief (http:// "Programmatic CDM Project Activities: Eligi- new.evomarkets.com/pdf_documents/HFC-23%20 bility, Methodological Requirement and Imple- Carbon%20Credits.pdf ) mentation", prepared for the World Bank Carbon McKinsey & Company, 2009, "Pathways to a low carbon Finance Unit (http://figueresonline.com/publications/ economy" ­ Version 2 of the Global Greenhouse Programmatic_CDM Gas Abatement Cost Curve (http://www.mckin- Figueres, Christiana and Michael Philips, 2007, "Scaling- sey.com/clientservice/ccsi/pathways_low_carbon_ up demand-side energy efficiency improvements economy.asp) 111 YEARS OF EXPERIENCE IN CARBON FINANCE Michaelowa, Axel, 2008 "Additionality testing--good UNFCCC, 1997, The Kyoto Protocol to the United Nations rules but sloppy practice?", presentation made at SB Convention on Climate Change (www.unfccc.int) 28 side event "Reforms are needed in the CDM" UNEP, 2004, "CDM Information and Guidebook", Sec- Bonn, June 9, 2008< ond Edition, The UNEP project CD4CDM Michaelwowal, Axel and Pallav Purohit, 2007, "Addi- UNEP RISØ, CDM/JI Pipeline Analysis and Database, tionality determination of Indian CDM projects", March 1st 2010 Climate Strategies. Wara, Michael, 2007, "Is the Global Carbon Market Moorcroft, Dave, Jasper Koch and Kija Kummer (Octo- Working?", Nature (vol 445, p.595­596) ber 2000), "The CDM: Exploring for Solutions Wara Michael and David Victor, April 2008, "A Realis- through Learning By Doing", World Business Coun- tic Policy on International Carbon Offsets"; PESD cil on Sustainable Development (WBCSD). Working Paper #74; Stanford University Mueller, Benito, March 2009, "Additionality in the World Bank Carbon Finance website: www.carbonfi- CDM," Oxford Institute for Energy Studies EV 44 nance.org OECD and IEA, 2000, Emission Baselines ­ Estimating World Bank Community Development Carbon Fund the Unknown, Paris. (CDCF), 2009, "Carbon Finance Guide for Local Rahman, Shaikh M., Ariel Dinar, and Donald F. Larson, Governments", Coordinated by Haddy, J Sey and 2010, "Will the Clean Development Mechanism written by M. Grieg-Gran (IIED), M. Chambwera Mobilize Anticipated levels of Mitigation?", Policy (IIED), B. Kantor (SouthSouthNorth); and Thais research working paper, The World Bank. Corral (SouthSouthNorth) Schneider, Lambert, November 2007, "Is the CDM ful- World Bank Group, 2008, "Lighting Africa Year 1: filling its environmental and sustainable develop- Progress and Plans", Annual Report (September 1, ment objectives? An evaluation of the CDM and 2008-August 31, 2008). options for improvement", Öko-Institut, Report pre- World Bank World Development Report 2010: Devel- pared for WWF opment and Climate Change, 2010. Seres, Stephen and Erik Haites (2008). Analysis of Tech- World Bank Group, Energy Sector Management Assis- nology Transfer in CDM projects. UNFCCC, Bonn. tance Program "Low Carbon Growth Country Strat- Tuerk, Andreas, Dorian Frieden, Maria Sharmina, egies Program-Mitigating Climate Change through Helmut Schreiber, Diana Urge-Vorsatz, 2010, "Green Development", 2009. Investment Schemes: First Experiences and Lessons World Bank Group, 2010, "A City-Wide Approach to Learned", Working Paper, Joanneum Research. Carbon Finance" A Carbon Partnership Facility UNFCCC, 2009, Annual report of the Executive Board of Innovation Series, The Carbon Finance Unit and the the Clean Development Mechanism to the Conference Urban Development Unit: www.carbonfinance.org of the Parties serving as the meeting of the Parties to the World Resources Institute, Climate Analysis Indicator Kyoto Protocol, FCCC/KP/CMP/2009/16 (http:// Tool (CAIT), http://cait.wri.org unfccc.int/resource/docs/2009/cmp5/eng/16.pdf ) 112 Annex 7 ­ Bibliography Annex 8 ­ Report's Methodology & Approach This work has been a collaborative and consultative pro- ity and Danish Carbon Fund. At each presentation, cess. The Prototype Carbon Fund encouraged the World participants' feedback and input were sought on both Bank to undertake this work in the winter of 2009. The the overall assessment and findings. The task team also work proposal was then discussed with the World Bank sought confirmation that the World Bank's experience supported Host Country Committee, formed of repre- and insights resonate with others involved in the CDM sentatives from developing countries CDM DNAs and and JI market. from JI national focal points in May 2009. The con- In early November 2009, the Task Team shared pre- cept was also discussed at the Prototype Carbon Fund's liminary findings and sought additional feedback more Annual Meeting in June 2009. broadly with the international climate change commu- The Task Team produced an initial concept note in nity on the margin of the Barcelona Climate Change July 2009. It was reviewed by four peer reviewers Mr. Talks, and through an official web-cast side event (chaired Hans-Georg Adam, Ms. Jane Ebinger, Ms. Christiana by World Bank Sustainable Development Network Vice Figueres and Mr. Johannes Heister. President Kathy Sierra). Following the concept note, the Task Team developed Based on the body of feedback received to that point, an internal and external survey to capture the experience the Task Team produced a brochure for release at COP15 of the World Bank's internal and external stakehold- in Copenhagen in December 2009. Entitled "10 Years of ers including World Bank staff, fund participants, and Experience in Carbon Finance: Insights from working members of the World Bank supported Host Country with carbon markets for development & global green- Committee. The surveys were conducted in July and house gas mitigation," the 20 page brochure covered August 2009 over an Internet platform. Follow-up inter- many of the highlights contained within this report. views were held in person or via-teleconference to clarify On the margins of the Copenhagen conference, the responses. Task Team circled back to share and discuss the prelimi- Throughout the summer and fall, the Task Team per- nary findings with members of the World Bank Host formed significant quantitative analysis on the World Country Committee at their meeting on December 12. Bank carbon funds' portfolios. The quantitative results Post Copenhagen, the Task Team focused on accumu- were followed up with internal discussions and cross lating the body of analysis, feedback, insights, and recom- checking between the Task Team and World Bank mendations and sought to document a coherent report. colleagues. A draft was later circulated to the peer reviewers and to In October 2009, the Task Team prepared initial a broader group of World Bank colleagues. The feedback findings for several of the World Bank Carbon Fund received was very valuable in helping the Task Team final- participant meetings. These included the Carbon Fund ize the report. for Europe, Community Carbon Development Fund, The final report is being released in Cologne at the the Netherlands Clean Development Mechanism Facil- May 26­28 Carbon Expo. 113 1818 H Street, NW Washington, DC 20433 www.carbonfinance.org helpdesk@carbonfinance.org