Clean Development Mechanism Overview and Concepts

1. National Workshop on Capacity Development for the Clean Development Mechanism 26-27 March 2003 Clean Development MechanismOverview and Concepts Bridget McIntosh Climate Change/Energy Specialist working with Cambodian Climate Change Project

2. Presentation Outline • CDM Context within the Kyoto Protocol • Overview of CDM • Eligible Projects • Basic Rules & Processes • Baselines • Sustainable Development • CDM Concepts - Developing Projects • What does the CDM mean for Cambodia? • Opportunities • Reality and Issues with CDM • Next Steps

3. CDM Context • The Kyoto Protocol commits industrialized countries to legally binding GHG reduction targets during the period 2008-2012 • Most countries have to reduce GHG emissions on ave 5% below their 1990 emission levels • results in a global target of ‘carbon’ reduction • These countries can choose to reduce emissions • ‘at home’ in their own country • in other countries • Reducing emissions in Developing Countries is eligible – known as CDM

4. Overview of CDM • CDM – Clean Development Mechanism • A mechanism by which Industrialised Nations can achieve part of their reduction obligations through projects that reduce or fix/sequester carbon in Developing Countries. • The Certified Emission Reductions (CERs) are a unit of carbon that is reduced or sequestered. • Industrialised Nations can submit their CERs to meet their target in 2008-2012. • there is a worldwide demand for projects and activities for ‘carbon’ reduction or fixation • Many of these projects will be in Developing Countries.

5. Developed Country Govt and companies want to reduce GHG emissions Invest in their own country Invest in a project in Developing Country Developing Country Many opportunities for projects that reduce emissions eg Forestry planting Renewable electricity Energy efficiency Clean transport Biomass energy Project Produces CERs CDM Concept $ Investment CERs

6. Purpose of CDM • to assist developing countries in achieving sustainable development • to assist developed countries in achieving compliance with part of their quantified emission reduction commitments.

7. Types of CDM Projects • Energy efficiency • End use improvements • Supply-side improvements • Renewable energy • Methane reduction eg landfill gas capture • Fuel switching • Agriculture (CH4 and N20) • Industrial processes • Sequestration/sinks – only afforestation and reforestation

8. CDM Project Examples

9. Summary of basic CDM Rules

10. Baseline Concepts • The baseline is a measure of emissions that would have occurred in absence of project • Used to estimate emission reductions for project – basis for CERs • On a project by project basis • Standard baselines for small scale projects • 15 MW renewable energy • 15GWh energy efficiency

11. Baseline Methodologies • 3 main accepted methodologies approved on the basis of:- • Status Quo - future emissions would been the same as current/historic emissions • Market Conditions - the technology used in the market is the baseline and market barriers prevent new technology being adopted • Best Available Technology - for markets where conditions are changing, historic emissions are less relevant – assume emissions for the technology that would have been installed

12. Baseline Examples

13. Basic Rules for CDM • Emission reductions from CDM project must be additional in developing country • Use of CERs can only supplement emission reduction at home in developed countries • CDM projects must:- • be approved by the host country • lead to sustainable development in host country • result in real, measurable and long-term benefits in terms of climate change • Money for CDM projects not divert Official Development Assistance (ODA) • Nuclear power projects are not eligible • Only afforestation and reforestation allowed

14. Small Scale CDM Projects • Simplified rules for small scale projects • Simplified baseline methodology, reduced validation and registration requirements; exemption from adaptation and admin fees • Examples include • Home Bigoas (cooking and lighting). Replace Kerosene • Efficient woodstoves • Mini-grid renewable energy

15. CDM Checklist Project approved by National Authority? - consistent with Sustainable Development - consistent with national + local development priorities; - no negative environment impact; - has local support Project validated, registered monitored, verified and certified? Project results in real, measurable + long-term emission reductions? Project started after 1 Jan 2000 + submitted by 31 Dec 2005? The project does not divert ODA. Project leads to transfer of new, environmentally efficient technologies or management practices? Are the emission reductions additional? CERs Certified Emission Reductions

16. Sustainable Development Criteria • Social Criteria • Improves quality of life • Alleviates poverty • Improves Equity • Economic Criteria • Provides financial returns to local entities • Results in new investments • Transfers new technology • Environmental Criteria • Reduces GHG and use of fossil fuels • Conserves local resources • Reduces pressure on local environments • Provides health and environmental benefits

17. How does CDM work in practice?

18. Developed Country Govt and companies must reduce GHG emissions Invest in their own country Invest in a project in Developing Country Developing Country Many opportunities for projects that reduce emissions eg Forestry planting Renewable electricity Energy efficiency Clean transport Biomass energy Project Produces CERs CDM Concept $ Investment CERs

19. PROJECT $9 million has emission reductions and eligible to produce CERs CDM Project Investment CERs $500,000 $ $ Project Investors/Financiers:- • International or Local Developers/Financiers • Cambodian Government • International Governments • Multilateral Agencies eg World Bank; ADB CDM Investors/Buyers:- • Multilateral CDM Funds eg PCF; CERUPT • Annex 1 Governments • Private Companies eg Shell • Non-Annex 1 Governments • Brokers/Traders

20. CDM Investment Structures • Full or partial equity in project • CER ownership becomes annex to the normal financing agreement • Usually investing for more than just CERs • Financial contribution • Usually upfront payment and takes ‘rights’ to CERs as they are produced • Normally not more than 10% project cost • Loan • Company provides loan at concessional rates in return for CERs eg payment of interest in CERs • CER Purchase Agreement • Company buys CERs as they are produced • Becomes additional income stream to project finance

21. CDM examples

22. Case Study • 3.65 MW micro hydro project Indonesia • Project offsetting diesel generation – 18,500t • $9.89m capital cost; $0.4m operating costs • Project executed by IBEKA a local institute • 16.5% IRR without CDM; 18.2% w CER @$5 • Investment plan:- • Up to 70% of project capital through long term loan from financial institution; rest through equity • CDM investor options:- • Long term CER purchase agreement • Equity (JV partner) + commitment to buy CERs • Soft loan against realisation of CERs

23. Any Country looking for CDM Project CDM Project Partner Long term CER purchase agreement Equity in project Soft loan upfront in return for CERs later Indonesia CDM Project 3.65MW hydro $9.89m capital cost $0.4m operating costs Project offsetting diesel emissions Likely 18,500 CERs basic CER value $92,500 looking for CDM Partner CDM Case Study $ Investment CERs

24. Choosing a Host Countrywhat do investors want? • Clear CDM Policy • Willingness for investment in CDM projects • Transparent and clear processes, • Quick and smooth government approval Time, effort and resources to complete deal • Secure investor climate • Political and economically stability What could occur that could affect investment? • Sound Techno-Economic potential Based on report conducted by Point Carbon www.pointcarbon.com

25. What does CDM mean for Cambodia?

26. Opportunities of CDM • CDM encourages developed countries to undertake GHG reduction projects in developing countries. • Increased investment flows • Attract capital for less carbon-intensive projects • Technology transfer • Assist in development priorities and sustainable development goals • Create new industries in environmentally sustainable technologies • Poverty alleviation through income and employment • Assist in improving current and future environment (including air quality

27. CDM in Cambodia • Governments, Project Developers and Brokers are seeking out CERs and emission reduction projects. • Emission reduction projects exist in Cambodia in many sectors:- • Transport – establish intercity/intra-city transport • Forestry – community forestry, replanting • Energy – • renewable energy (particularly in rural areas) • Installation of cleaner technology (cogeneration) • Energy usage – energy efficient technologies; building design • Waste management – capture of methane

28. Reality + Issues w CDM • CDM may tend towards large CDM Projects • High transaction costs with CDM projects PCF experience = $270,000 per project • transaction costs similar for small or large projects Solution - bundle small projects together eg association of community forestry; many small scale hydro projects • Larger developing countries more attractive • infrastructure & institution to deal w large projects • Larger market = ability to do many similar projects • Spreads the upfront cost in learning local conditions; securing suppliers, local management, financial, legal and contractual processes

29. CDM Transaction Costs Preparation and review of the Project Project completion • Upstream Due Diligence, carbon risk assessment and documentation: $ 40K 3 months Up to 21 years • Baseline : $20 K • Monitoring Plan: $20K Periodic verification & certification 2 months • Verification: $10-25 K • Supervision: $10-20K Validation process 1-3 years 2 months • Contract, Processing • and documentation: $30k 3 months Construction and start up Project Appraisal and Negotiation • Initial verification at start-up: $25K Total through Negotiations All expenses $265 K Based on presentation from Ken Newcombe, PCF Fund Manager COP 8 www.prototypecarbon.com

30. Reality + Issues w CDM (2) • CDM will be a competitive market • Restricted without the US • Limit on amount of CERs developed countries can use towards target (~20%) • larger projects with low risk and smooth approval/transaction procedures will be preferred • May limit opportunities in least developed countries

31. Reality + Issues w CDM (3) • Preparation of developing countries • poor co-ordination among Ministries • internal conflict over approvals Only 12 National Authorities registered • Capacity of developing countries • Weak knowledge of CDM at all levels policy-makers, businesses, finance + legal institutions, NGOs

32. Summary • CDM presents an opportunity for Cambodia • developing energy infrastructure; • forestry is significant activity • worldwide increased demand for projects that reduce emissions • win-win situation for both parties • Cambodia must be prepared • need an approval body + smooth and transparent approval process • need a ‘pipeline’ of projects for investors when they come investigating • Need to improve investor climate

33. Acronymns • CDM – Clean Development Mechanism • CER – Certified Emission Reductions • A standard unit of greenhouse reduction or sink • PCF – Prototype Carbon Fund • World Bank CER Fund • ODA – Official Development Assistance • Part of 0.07% govt aid • IRR – Internal Rate of Return • DNA – Designated National Authority • The national body who assess +/or approves CDM projects

34. Acronyms • Annex 1 countries • 36 industrialised countries and economies in transitions listed in Annex 1 of the convention who can invest in CDM projects. These countries have emission reduction obligations. • Non - Annex 1 countries • The countries who are not listed in Annex 1 of the Convention and who can host CDM projects