Carbon finance I Trading Carbon Credits I Role of the EBRD
The Kyoto Protocol
The Kyoto Protocol is an international treaty – in force since 2005 - to reduce greenhouse gas (GHG) emissions blamed for global warming. The Protocol provides the means to monetise the environmental benefits of reducing GHGs.
The Protocol and new European Union emissions rules have created a market in which companies and governments that reduce GHG gas levels can sell the ensuing emissions 'credits'. These are purchased by businesses and governments in developed countries that are close to exceeding their GHG emission quotas.
The EBRD region has much potential for using the Protocol to reduce GHG emissions and energy waste and costs. The region’s economies are highly energy inefficient: it takes twice as much energy to produce a unit of GDP in Hungary as it does in western Europe and 10 times as much in Russia and Ukraine.
Carbon finance
This is the term used for the carbon credits system that helps finance GHG reduction projects. There are two categories of countries involved in carbon credit trading and finance:
- Developing countries which do not have to meet any targets for GHG reductions. However they may develop such projects because they can sell the ensuing credits to countries that do have Kyoto targets. In the EBRD region these include Armenia, Azerbaijan, Georgia, Kyrgyz Republic, FYR Macedonia, Moldova, Turkmenistan and Uzbekistan. These countries are covered by the Protocol’s Clean Development Mechanism (CDM).
- Industrialised countries which include 13 of the EBRD’s countries of operation where the industrial base and other infrastructure are highly energy inefficient: Russia, Ukraine, Bulgaria, Czech Republic, Croatia, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. They are part of the Protocol's Joint Implementation (JI) mechanism.
Trading carbon credits
To implement the Kyoto Protocol, the EU and other countries have set up 'cap and trade' systems, under which companies are obliged to match their greenhouse gas emissions with equal volumes of emission allowances.
The Government allocates a number of allowances to each company. Any company that exceeds its emissions beyond its allocated allowances will either have to either buy allowances or pay penalties. A company that emits less than expected can sell its surplus allowances to those with shortfalls.
Companies or countries will buy these allowances as long as the price is lower than the cost of achieving emission reductions by themselves. Besides buying allowances, in the EU companies also have the opportunity to buy Carbon Credits from JI and CDM projects in order meet their compliance targets (see below).
Why demand for carbon credits is expected to grow
- Because of projected shortfalls and higher relative carbon abatement costs, it is anticipated that a number of OECD countries will need to purchase Carbon Credits to meet their Kyoto target by 2012. The higher relative emissions abatement costs in these countries mean that they will find it attractive to buy carbon credits generated elsewhere.
- Private companies in industrialised countries will increasingly be subject to 'cap and trade' mechanisms, such as the EU Emission Trading Scheme which started on 1st January 2005 (although this will initially cover only 50% of emissions). The EU scheme is separate from the Kyoto Protocol but the 'Linking Directive' of 2004 allows a European company to buy Kyoto Protocol Carbon Credits to comply with their obligations under the EU Emission Trading Scheme.
- Governments will also have to buy Carbon Credits because the 'cap and trade' mechanisms will initially only apply to a fraction of each state's economy and Governments are responsible under the Kyoto Protocol for meeting their country targets. OECD Governments and European companies subject to the EU Emission Trading Scheme will therefore be the main buyers of Carbon Credits.
Low-cost carbon credits available in the EBRD’s countries of operations
- The reference year used by the Kyoto Protocol for targets in emission reductions is 1990. Since then, emissions have dropped sharply in countries such as Russia and Ukraine, as a result of substantial real contraction of GDP.
- It is expected that the 13 countries of operation with Kyoto Protocol targets will remain below their agreed maximum greenhouse emissions. These countries will therefore be likely sellers of carbon credits.
- High carbon and energy intensities mean high potential for low-cost emissions reductions (low relative investment cost per tonne of GHGs avoided).
Role of the EBRD
The main role of the Bank in the field of carbon finance is to act as financier of emission reduction projects. However, in keeping with its principle of 'additionality' - supporting and complementing the private sector rather than competing with it - the Bank can play a number of additional roles:
Carbon Funds
The EBRD is well positioned to purchase, for the account of third parties, carbon credits from GHG emission reduction projects. The Bank's added value in this area stems from:
- The size and quality of emission and reduction projects. The Bank is the largest financier of private sector deals in the region, with preferred creditor status, a rigorous appraisal process, and integrity and 'good governance' requirements. It also has lengthy experience in energy efficiency and renewable energy projects.
- The importance of closely coordinating the project financing and carbon buying process
- Strong relationships with host country governments, and its ability to engage in policy dialogue to remove or alleviate obstacles to carbon trading and mitigate the 'political' risks inherent to the JI and CDM project cycles
- Its experience in managing funds from its shareholders for a variety of purposes (e.g. nuclear safety).
- Its ability to access donor funds to help develop and implement projects.
In October 2003, the EBRD established its first carbon fund, the Netherlands Emissions Reductions Co-operation Fund, with the Dutch Government. The fund buys Joint Implementation Carbon Credits from its 13 countries of operations eligible for this mechanism. Its first transaction was the PFS biomass conversion.
The Multilateral Carbon Credit Fund became operational in 2006. The fund will buy carbon credits from investments under the European Union scheme as well as the Protocol’s Joint Implementation and Clean Development Mechanism. It will also aim to facilitate the direct trading of carbon credits between some of its shareholders (so-called Green Investment Schemes).
Donor funding
The Bank can help Governments and companies in its region of operations overcome obstacles in emission trading by providing technical advice funded by donor governments. For example, as part of the Bank's Early Transition Countries Initiative for its poorest countries of operation, donors have approved funding to help in development of complex CDM projects.
Example of Policy Dialogue to advance the carbon market development is the option study carried out by Climate Focus for Kazakhstan. The report indicates options that can be explored by Kazakhstan to use the carbon market to leverage sustainable energy investments. The Donor for the study was Shareholders Special Fund.
Business opportunities for the private sector
EBRD's carbon finance activities create new business opportunities for the private sector in this emerging market:
- Selling carbon credits increases the feasibility of emission reduction projects, which helps to attract new private investors
- By being the buyer of carbon credits in a transaction, the EBRD can provide comfort to private sector buyers that would not otherwise consider these projects
- Outsourcing, to private firms expert in this area, the work of developing emission reduction projects covered by the Protocol. For example, this has been done for the three Carbon Managers working under the Multilateral Carbon Credit Fund.
