A PROJECT REPORT ON

ELEMENTS OF CARBON CREDIT TRADING

SUBMITTED BY

ASHUTOSH KARTIKEYA PANDYA

T.Y.B.M.S. [SEMESTER V]

DIV.: A

ROLL NO.: 034

ACADEMIC YEAR

2011 – 2012

UNDER THE GUIDANCE OF

PROF. GOVIND SOWANI

DATE OF SUBMISSION

15TH SEPTEMBER, 2011

SVKM’S NARSEE MONJEE COLLEGE OF COMMERCE AND

ECONOMICS

VILE PARLE (W), MUMBAI - 400 056

SUBMITTED TO

UNIVERSITY OF MUMBAI

DECLARATION

I, Mr. ASHUTOSH KARTIKEYA PANDYA, of SVKM’s Narsee Monjee College of

Commerce and Economics of TYBMS [Semester V] hereby declare that I have completed

my project, titled ‘ELEMENTS OF CARBON CREDIT TRADING’ in the Academic

Year 2011 – 2012. The information submitted herein is true and original to the best of my

knowledge.

________________________

ASHUTOSH KARTIKEYA PANDYA

CERTIFICATE

I, PROF. GOVIND SOWANI, hereby certify that Mr. ASHUTOSH KARTIKEYA

PANDYA of SVKM’s Narsee Monjee College of Commerce and Economics of TYBMS

[Semester V] has completed the project on ‘ELEMENTS OF CARBON CREDIT

TRADING’ in the academic year 2011 – 2012 under my guidance. The information

submitted herein is true and original to the best of my knowledge.

_________________________ _________________________

PROF. GOVIND SOWANI PROF. SUNIL B. MANTRI

Project Guide Principal

ACKNOWLEDGEMENT

The practicality of Bachelors of Management Studies program of University of Mumbai is

depicted in two of its aspects – first, the case studies and second, the project-work in the 5 th

semester. I’m grateful for both and the latter has especially helped me in respect of finely

carving my skills of presentation, writing and communication, while essentially and

substantially adding to my knowledge the topic that I’ve longed to research on. I feel that this

project is the beginning of my career as it has not only nurtured my skills to research, but has

also furthered my ability to prepare reports, which would be a vital part of my further

education.

For these reasons and many more I would like to thank the University of Mumbai for

providing the students of Bachelors of Management Studies with a prospect to experience

various facets of industry first hand.

I would like to extend my deepest gratitude to my college, Narsee Monjee College of

Commerce and Economics to whom I owe my education and all my respect. To the Principal,

Prof. Sunil Mantri, who has been an influencing leader for our institution, I acknowledge my

deepest thanks.

I would like to acknowledge my heartfelt appreciation to the coordinator of BMS, Prof.

Pankaj Natu and to the team of Prof. Richa Saxena, Prof. Conrad Coelho and Prof. Swaroopa

T, who have helped us with patience.

I owe this project to the guidance and blessing of Prof. Govind Sowani, my appreciation and

respect for whom I cannot put to words. Thank you, sir!

Prof. Ritesh Mehta and Prof. Anamika Banerjee have been most caring and have given me

their valuable time whenever I required it. I cannot thank them enough.

The state-of-the-art library at Narsee Monjee College of Commerce and Economics has been

the source of my literature survey and the staffs there has been the most kind and patient, my

sincere thanks to them.

Finally, I would like to thank all those people from the industry whom I’ve listed as my

references for their unconditional support, my friends for motivation, my family for all the

backing and support, especially my father whose anxiety is the key to all my hard-work.

Thank you one and all!

Dedicated to beloved Dadu - Dr. C. R. Pandya,

whose life of magnanimous philanthropy has

influenced all my paradigms.

Table of Contents:

Content Page numberExecutive Summary 1Methodology 3Background – Global Warming 4Carbon Credits:

The Genesis – Kyoto Protocol 6Defining Carbon Credits 10

India Welcomes Carbon Credits 13The Rise and Rise of Clean Development

Mechanism16

- Case: Cleaning it the Tata Way 34Joint Implementation - Joining Hands 39

-Case: Heating Up A Whole City In Ukraine

50

Emissions Trading 54-Case: The European Union Emission

Trading Scheme59

Pricing the Carbon Credits 64Buying Carbon Credits: A help to the Environment

69

As a Future 71Carbon Credits Versus Emission Taxes 76Accounting and Taxation Effects 79Criticism 82The Need to Environmentally Educate India – A Survey

83

Conclusions and Suggestions 85Bibliography 87Appendix 88

Index of Illustrations used:

Serial

Number

Sources Particulars Page number

0.1 IPCC Website Stimulated Temperature

Change with ECHAM5

3

2.1 None Types of Carbon Credit

Transactions

12

3.1 UNFCCC Website Estimated Aggregate

CER Generations by

Non-Annex Countries

14

4.1 None Explanation of CDM

Process

19

4.2 None Stages of CDM Process 20

4.3 None Risks associated with

CDM

32

5.1.1 UNFCCC Website Location of Tata Wind-

power plant

34

6.1 None Explanation of JI System 39

6.2 None Stages of JI Process 45

6.3 UNFCCC Website Percentages of different

JI Projects

48

6.1.1 UNFCCC Website Location of Donetsk,

Ukraine

50

6.1.2 UNFCCC Website Mini Don 51

6.1.3 UNFCCC Website Rex - 95 51

6.1.4 None Heating process in

Donetsk, Ukraine

51

7.1 None Emissions Trading

System

55

7.2 None Learning curve &

Average cost curve

55

8.1 Investopedia Demand Curve 64

8.2 Investopedia Supply Curve 64

8.3 Investopedia Price Equilibrium 65

9.1 Investopedia Carbon Credits Cycle 69

10.1 None Working of Carbon

Credits in futures market

72

11.1 Investopedia Negative Externality 76

Executive Summary:

In the year 1992, 165 countries signed at the United Nations’ Framework Convention on Climate Change at Rio de Janeiro. They listed a few most polluting countries under Annex1 and these promised to reduce their green house gas (GHG) emissions as much as 5.2% by 2008. But, the revolutionary event occurred in 1998 when the Kyoto-Protocol drafted by the UNFCCC for majorly defining a ceiling for the amount of GHG emissions.

Kyoto-Protocol discussed three methods of such ceiling, albeit contemporary but innovative, which were – Joint Implementation, Clean Development Mechanism and International Emission Trading, all of which were based on Assigned Amount Units (AAU) for each industry, which define the permissible emissions of GHGs, including carbon. Thus, Carbon Credits took shape as a part of the schemes announced in the aforementioned protocol.

Carbon Credit is thus “generic term to assign a value to a reduction or offset of greenhouse gas emissions, usually equivalent to one tonne of carbon dioxide equivalent (CO2-e).”

India, together with China has contributed a staggering $5 Billion to the global carbon trade of $30 Billion in the recent past. India is, today, a leading generator of Clean Development Mechanism Projects and Certified Emission Reduction contracts. This shows the huge potential of trading carbon in India. Importantly, the Multi-Commodity Exchange (MCX) of India has started trading in both, the CFIs and the CDM credits in the open market since 2008, giving the common man a chance of investment into emission reduction projects and thereby reducing their own carbon-foot-print.

The Tata Industries in India have proved to be the pioneers in the country in the field of Carbon Credit trading with three of its subsidiaries already participating actively in the trading on both domestic and international levels. Besides, companies like Godrej, Blue Star Energy, Bajaj Financial services, Reliance Energy Ltd., SAIL etc are vigorously involved in carbon trading. International trading has also become possible between companies as well as between exchanges due to commencement of trade of carbon credits in Chicago Climate Exchange, NASDAQ OMX Commodities, European Climate Exchange and four others.

These exchange markets, though roughly trading on the speculated prices of the credits, there are various factors like the price of crude oil and carbon in the market, the demand supply mismatch, the success of the CDM projects, coal and electricity prices, actual emission calculation and foreign exchange rate fluctuations, which with many more factors affect the market price of Carbon Credits. But, with the AAUs in place and with the price of the crude oil rising with its increasing demand and reducing supply, it is obvious that the prices of the credits in the exchanges are bound to rise in the future as more companies are going to have to increase their emission limitations by buying credits.

Considering the above, it is safe to say that there is a good chance to develop Carbon Credits as a future, option and investment for the common man. The surety of rise in the prices in the future gives a surety of returns. The recent hike in the petrol prices in India itself is the Indicator that the profits available, if invested for a long term, are huge.

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The concept of carbon credit has forced the businesses to consider the cost reducing carbon emission as an internal cost to the business and therefore mention it as a part of the current assets in their balance sheet. It thus creates a monetary value for the cost of polluting the air, but, at the same time, making it inevitable for businesses to purchase more emission allowances. It therefore helps create a clean environment by restructuring the finances of the company and their accounting as well as manufacturing patterns.

The Kyoto-Protocol has only mentioned Carbon Credits as an alternative to the Emission Taxes applied in the many countries. Although, it has stressed that such taxes are never hypothecated because they differ from government to government, while the carbon credits can only be created if there is implementation of emission-saving technology and thereby reducing the pollution. The units saved are thus the actual amount of credits that can be sold to other companies to augment their emission allowance.

Carbon Credits have made some allies and enemies alike. But, though facing strong criticism, they are a step towards the society which understands its responsibility towards the sustainable development and combating global warming. The future lies in evaluation and refinement of emission schemes while simultaneously focusing on the financial aspects of emissions, also place them as a cost to the organisation.

This report studies the various areas of the Carbon Credits and their trading with the help of case studies of various companies, a few of which have been aforementioned, involved in the same. The report also updates on the particulars, in justified exhaustion, regarding the various aspects mentioned in the summary. It is an effort to defend the various positive financial aspects of Carbon Credit Trading, especially in the India Inc. scenario.

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Methodology:

This project is exploratory in nature and aims at amassing adequate information about the topic at hand and substantiating the same with the help of primary research, which adds aspects of a descriptive research to it as well.

The various sources of information used for theoretical element of the project are mentioned in the bibliography. This marks the literature survey component.

Articles from various newspapers and magazines of repute have been used for the literature survey. As required, the URL has been mentioned for the same.

The primary research has been conducted in the form of case studies, whereby the application of the theory mentioned in the project in a practical scenario, with emphasis on Indian companies and state-of-affairs, has been used.

Wherever possible, the primary studies have been corroborated with opinions of aficionados in the field or the relevant personnel of the companies, as the circumstances have favoured. References to these have been duly mentioned.

Also, various annual reports of a gamut of companies have been used and properly cited for the convenience and adequacy.

A survey has been conducted to be acquainted with the public knowledge and opinion of and towards the subject. Stratified random sampling has been adopted as a sampling design for the purpose. The questionnaire draft has been included in the Appendix (000).

Thus, the aforementioned can be summed up to the following methods;1. Exploratory literature survey2. Case studies and analysis as a part of descriptive research3. Experience survey

Hypothesis:

“Carbon credits are environmentally and financially beneficial”

Limitations:

i. Due to the lack of knowledge in the field of “Carbon Credit Trading” in India, the project is limited in terms of interviews with experts. Wherever possible, emails where used in order to obtain information, however, this cannot replace the importance of one to one conversation.

ii. The experience survey conducted for the purpose of the project has a limited sample size and may not reflect the ideology of the population.

The various statistical calculations done on the results obtained from the experience survey is limited in scope due to the nature of the project topic, due to which two variables having any relationship could not be found, making the capacity of statistical analysis restricted.

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Background – Global Warming:

In the 1970s, the growing CO2 levels in the atmosphere became a major source of concern to the scientists who believed that the temperatures around the world were rising. This decade saw two major leaps towards the building of the Global Warming theory as we know it today – First, the 1972 World Conference of Human Environment in Stockholm, Sweden and second, the 1979 World Climate Conference, the first of its kind. This was followed by two more conferences in 1985 and 1987. In 1988, under the United Nations’ Environment Program, the Intergovernmental Panel on Climate Change (IPCC) was established. The IPCC today is the leading collaborative effort among nations to understand the climate changes and provide suggestions accordingly.

At the beginning of the new millennium, while the likes of George Bush have called Global Warming a hoax, Tony Blair, Barrack Obama and other prominent leaders have agreed over the past decade that the world is heating up and something needs to be done.

This global warming can be in brief defines as;

“The continuous rise in the temperature of the Earth’s atmosphere and the oceans”

The main reason for this rise in the temperatures is the Green House Gases (GHGs), including carbon dioxide, methane and nitrous oxide besides water vapour. These gases become instrumental in absorption of the ultra-violet radiation into the atmospheric cycle, thereby disturbing its balance. This phenomenon has been known to man in its quantitative form since 1896 when S. Arrhenius introduced it for the first time. These temperature rises are responsible for Global Climate Changes (GCCs), which include melting of glaciers and rise in the water levels. The IPCC model states a rise in temperature annually by +0.74% in the past century. In the last decade the rise was averaged at about +0.5% every year, with 2005 the warmest year and 2010 at +0.53%. Based on this the IPCC model provides the following estimates: (Fig: 0.1)

Some scientists have argued that the phenomenon of ‘Carbon Sequestration’, which means absorption of carbon into the natural life-cycle, is the method administered by earth to maintain the required amount of gases in the atmosphere, whereby the plants absorb the excess carbon dioxide from the atmosphere and this is then transferred through the roots into the soil, also known as ‘CO2 fertilisation’, thus, implying that global warming is non-existent.

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But, since the advent of industrial revolution, the industrial or the “developed” countries have been involved in at least 76% of the total GHG emissions, as mentioned by the Kyoto protocol. Developing countries like China and India continue to emit large amount of GHGs, but their per capita emissions is much lesser as compared to US, Australia, Belgium, Germany and UK, who have the highest per capita carbon emissions in that order.

Beside the GHGs, the industrial gases like CFCs, HFCs and PFCs are being instrumental in what the scientists have termed as the “Enhanced/Accentuated Greenhouse Effect”, which is known to not only increase the atmospheric temperature but also the core surface temperature on the Earth. The appalling scientific fact is that the GHGs are transparent to the radiation entering the earth’s atmosphere, but opaque to that which goes out. This thus leads to greater warming and causing acid rains due to heavy amount of nitrous oxide in the atmosphere, which has increased by 17% in past 150 years, an alarming increase!

In 1995, the IPCC predicted that due to the ‘influence of humans on global climate’, the sea levels were expected to rise between 15 to 90 centimetres and the temperature rise to increase between 1.4OC to 5.8OC by 2100, unless the emissions were reduced by 50% of the levels at that moment. The A1B scenario mentioned in the Figure: 0.1 shows the level of increase in the temperatures predicted by the model.

The model above predicts a thermal inertia, causing rise in sea-levels, expansions of subtropical deserts along with repercussion like heat-waves, droughts and heavy rainfall. This phenomenon is likely to strike in Arctic region rapidly and an increase in temperature by 4 °C is likely to exceed the limits of human adaptation and also has already started to exceed the limits of adaptation of the ecosystems.

The 2001 IPCC report states that the new and stronger evidence regarding the human activities in the last 50 years causing the warming has been observed. This puts a moral obligation on the human race to try and improve the environment or at least slow sown the rate at which the pollution is being created.

In the light of this realisation the UNFCCC has woken up and the 1992 Rio summit, the 1998 Kyoto Protocol and the recent G8 summits have proved that the importance and the repercussions have been understood. There is a need to avoid this anthropogenic catastrophe and therefore several schemes have been developed in aforementioned summits to avoid and restrain the emissions and pollutions. Carbon credits and its related terminologies is a brain-child of these efforts by the UNFCCC.

The first chapter of the following section will provide details of how the carbon credits and there their trading were developed since first introduced in the Kyoto Protocol.

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The Genesis - Kyoto Protocol:

The world woke up in the 1970s as the hippy-culture and the cold-war gradually phased out of the United States and the more serious subjects came to light. The wake-up call for stopping the anthropogenic pollution that affected our planet’s atmosphere was overdue when it came. The year was 1972. The venue was Stockholm in Sweden. And the hosts were the United Nations. The directions of the alarm were set by a few aficionados in the environment science in the Club of Rome in their publication – The Limit of Growth. The idea was simple – if no ceiling is placed on the continuously growing needs for the consumption of industrial fuel around the world, the coming century would undergo a scarcity of the same, leading to an economic crisis for the future generations. However, no element of the report discussed the effects on the environment. Degradation of the economy seemed to be the only concern.

Nevertheless, they did give a rise to Socrates’ favourite method of erudition – debates! And from these debates arose a graver concept – that of global warming. The World Climate Conference of 1979, ’85 and ’87, conducted by the World Meteorological Organisation, shouted out to the world that the phenomenon had been identified and the effects were quantified.

The initialisation of the involvement of nations around the world began when in 1988, United Nations joined hands with WMO to originate the first organisation that would study multiple subjects relating to the global climate change – IPCC or the Intergovernmental Panel on Climate Change. The main objective of this step was to facilitate the policy-makers with quantified data relating to climate change and there by justifying their actions. It studies the present atmospheric system on the planet, follows it up with the study of changes as compared to past record and finally the biological and anthropological response to these changes, thus systematically proving how the earth’s environment is on a detrimental ladder.

The importance of IPCC’s study came to light soon enough. It published in the year 1990, its First Assessment Report. The world was shocked – dumbstruck by the results. Over 12 million copies of the report were sold. The United Nations took immediate actions and the UNFCCC or the United Nations’ Framework Convention on Climate was formed. It was born in the year 1992, at Rio de Janeiro in Brazil, when the United Nations held one of the most discussed and contested meetings in the history – The United Nations Conference on Environment and Development or (UNCED), which had repercussions so strong that it if famously known as The Earth Summit.

It discussed, largely based on IPCC’s findings, that human interference on the planet’s environmental systems have been disastrous and that measures need to be taken to reduce these effects before the point-of-no-return is reached. It was here, that a total of 165 countries signed the agreement which stated that all participating countries will reduce their emissions in the environment by 5.2% as compared to the level mentioned by the IPCC’s Second Assessment Report in 1990, by the year 2008. But with the major polluter in the world – The United States – not signing the agreement, the scenario of climate change hoped to see little daylight.

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It was due to this reason that the United Nations met six years later in Kyoto, Japan. A protocol was established in order to achieve the 5.2% reduction, thus famously known as the Kyoto-Protocol. It set a “First Commitment Period”, from the year 2008 to 2012, in which to achieve the said reduction. The major objective of the protocol was to discuss and refine the policies which are to be followed by the countries that have signed the Earth Summit to reduce their emissions or at least bring them down to a “safe” level.

With this in mind, Kyoto Protocol segregates the signed-in countries into two wide groups – Annex - I Parties and the non-Annex countries. The obligations previously mentioned, were now only to be achieved by the countries listed in Annex – I. The other countries were given relief as their emissions were negligible as compared to the Annex – I countries, which include : (in alphabetical order) Australia, Austria, Belarus, Belgium, Bulgaria, Canada, Croatia, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Monaco, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Russian Federation, Slovakia, Slovenia, Spain, Sweden, Switzerland, Turkey, Ukraine, United Kingdom and United States of America.

These countries were included under the Annex-I, following the draft of the “Common but differentiated responsibility’ under the protocol, which agreed on the following three points;

1. The largest share in the emission of the greenhouse gases around the world comes from the developed nations.

2. The total emissions of the developing nations, per head, are still lower as compared to developed nations.

3. The emissions in the developing countries are bound to rise with the ever rising developmental requirements.

In order to facilitate the achievement of the said reduction, the protocol recommends three mechanisms, cumulatively known as the “Kyoto’s Flexible Mechanisms”. These mechanisms are based on the amounts of emission reduction and benefits to do the same. It provides financial and intrinsic awards for the emission reduction. These are quantified into AAUs or Assigned Amount Units, which are the accepted and standardised unit of amount of emissions considered under the protocol. National authorities have been set up under the protocol, in the participating countries, which verify the amount of the emissions and AAUs. Once these are certified, they become CERs or the Certified Emission Reductions. A ceiling is placed on the countries, beyond which they cannot emit pollutants.

The three methods that are mentioned in the protocol allow the participating countries to obtain these CERs:

1. Joint Implementation: This method is used jointly by two developed countries, whereby the investing country finds it cheaper to invest in the same technology in the host country, which would have cost it more if practiced indigenously. Against this investment the investing country receives CERs, helping them to increase their ceiling to emit.

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2. Clean Development Mechanisms or CDMs: Here, the Annex- I parties can invest in the non-Annex countries, or the non-Annex countries can themselves invest in the technology that has a proven and substantial reduction in pollution over the regular project. CERs are earned against this lesser polluting system and distributed among the host and investing nations, as the case may be and increasing the emission allowance.

3. Emissions Trading: This concept aims at creating Climate-Exchanges in the participating countries. These exchanges, like the stock and commodity exchanges, will allow for the spot trading of the Assigned Amount Units at a market price decided on the bases of the free market forces. Thus, the countries having a surplus of AAUs can sell them to the countries requiring them, thereby making them pay for the extra amount of pollutant emitted.

Kyoto Protocol thus provides with methods that help the developing countries to improve their technology and make it more environment-friendly. On the other hand it makes provisions for penalising the participants who can’t reduce their emissions or need to increase the permissible limit, in monetary terms. These CERs earned or sold/bought under the provisions of the Kyoto Protocol, jointly came to be known as ‘Carbon Credits’, i.e. CERs earned by saving carbon emissions.

Thus, the Kyoto Protocol gave birth to the term – “Carbon Credits”.

However, out of the Annex - I countries aforementioned, except for Australia, Iceland, New Zealand, Norway, Russian Federation and Ukraine, all the other countries have failed to achieve more than 95% of their allotted reduction quota. However, it is commendable that these remaining countries have at least fulfilled 92% of their targets.

The IPCC, in its Second Assessment Report, has mentioned the ‘Global Warming Potential (GWP)’ of all the countries, irrespective of their participation in and ratification to the Protocol. GWP is a relative measure of the total amount of heat a GHG (green house gas) traps into the earth’s atmosphere. It also compares the phenomenon as applicable to one GHG to the other and on basis of this comparison provides the rate of conversion for any carbon equivalent gas emission into the congruent carbon emission units. E.g.: If the GWP of Nitrous Oxide is 114 for next 12 years, it means that if the same amount of Carbon and Nitrous Oxide are released in the atmosphere over the next 12 years, then, Nitrous Oxide will trap 114 times more heat as compared to carbon.

This is an integral part of the Protocol, essentially, the Protocol thus provides for not only the emissions in terms of carbon and equivalents, but also defines conversion rates for the other GHGs into carbon equivalents, thereby, including them under the scope of the emission reduction program.

The aforementioned Annex-I countries have to submit to the UNFCCC, on an annual basis, a report on the inventories of the natural as well as anthropogenic GHGs emitted by the country. This has been termed as “Green House Gas Inventories” under the protocol, the tools for quantifying which have been mentioned under the ISO 14064 standards. For the purpose

8

of consolidating these reports and for the monitoring and controlling of the various projects under the protocol, each Annex-I country should also have a ‘Designated National Authority’. Although India is not an Annex-I nation, it still has a Designated National Authority under the Ministry of Environment and Forests. This authority also maintains the records of the total projects under the Joint Implementation and Clean Development Mechanism.

In the year 2001, a conference was held by UNFCCC at Marrakesh, Morocco, in order to lay down the rules to achieve the targets set under the Kyoto Protocol for The First Commitment Period, which was known as the Marrakesh Accords. The three mechanisms aforementioned were amended through Marrakesh Accords in to the Kyoto Protocol. Also, considering the financial requirements that may arise in order to enter such projects, the UNFCCC has established ‘The Adaptation Fund’, which, having functions similar to the International Monetary Fund (IMF), finances the developing countries to adapt to the harmful effects of the climate change. Fundamentally, it provides funds to adapt to the new, lesser polluting technology by enabling the developing countries to afford such technology.

The following chapters will discuss in detail the various methods to obtain CERs and various other aspects under the Kyoto Protocol.

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Defining Carbon Credits:

After having seen the background and the prelims of how carbon credits came into existence, let us now see the different opinions about the definition of a ‘Carbon Credit’;

“A certificate that allows an organisation or a nation to emit a certain level of pollutants and in turn allows them to trade the units of emission saved from the total allowance.”

-Encarta Encyclopaedia

This definition gives a raw idea of the existence of a certificate, implying that there is also a certification body. It also gives an idea of the capping or ceiling placed by the Kyoto Protocol and about rewarding result of trade allowance in the intrinsic value of the savings. It however, fails to mention the quantifiable amount of each credit and the underlying alternatives.

University of Minnesota Morris explains the term as;

“Carbon Credit is a financial instrument aimed at reducing green house gas emissions. One carbon credit represents the reduction of one tonne of carbon. Carbon credits are awarded to countries or groups that have reduced their greenhouse gases below their emission quota.”

This is a more acceptable definition which mentions the objective of the fact. Also, it mentions the existence of a quota, but it fails to mention the source of this quota. It also presents a carbon credit as an instrument, which implies that this is a commodity that changes hands like other transferrable instruments. Importantly, it mentions the quantity of reward under a single carbon credit, i.e. allowance to emit one tonne of carbon. Nevertheless, this definition is still incongruous to the whole concept. Let us look at another definition.

“Carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or carbon dioxide – equivalent (CO2).”

-Wikipedia

Though not considered by many as a reliable source, Wikipedia comes close to defining the term. It mentions the term as the either a certificate or a permit, thus, covering the scope of uncertainty due to differentiation of ideas. It also portrays it as ‘generic term’ which means that carbon credit is a term developed to depict a wider meaning and consolidate a wider view. It also quantifies the allowance. But it falls short, just like its predecessors on mentioning the protocol, the methodologies and transferability of the instrument.

“A carbon credit is an instrument which is used in the emission trading schemes, where one credit gives the owner a right to emit one tonne of CO2.”

-World Wildlife Fund

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This definition, for the first time, mentions the ‘emission trading schemes’ of the Kyoto Protocol. But, it does not make grade with the other aforementioned topic that are a necessity for the definition.

Investopedia provides an objective and roughly complete definition;

“Carbon credit is a permit that allows the holder to emit one tonne of carbon dioxide. Credits are awarded to countries or groups that have reduced their greenhouse gases below their emission quota. Carbon credits can be traded in the international market at their current market price.”

Let us try to consolidate all the above definition into one single definition that is objective and complete;

“A ‘Carbon Credit’ is a comprehensive term used to symbolize Certified Emission Reduction Purchase Agreements (CERPAs) or a permit which allows the bearer, nation or an organisation to emit one tonne of carbon dioxide or its equivalent gases, which is certified by a designated authority formed under the direction of Kyoto Protocol allowing the reduction of emissions by the flexible emission reduction schemes and acts an instrument to trade such allowances to other individuals, nations or organisations.”

‘Carbon Credit’ is mentioned as a generic term for a reason. The Kyoto Protocol itself does not mention the term. However, as a consolidation of the Certified Emission Reductions (CERs) mentioned in the protocol, as a result of the certification of amount of emission saved on the total allowance by the use of Clean Development Mechanism (CDM), Joint Implementation (JI) or Emissions Trading (ET), which are the three emission reduction “flexible mechanisms” amended under the Kyoto Protocol by the Marrakesh Accords, the different amounts of units saved started to be known as ‘Carbon Credits’.

The developing countries, which have been accepted under the protocol as lesser polluting as compared to develop countries, can invest in such technology that helps in reducing their emissions further. This investment may be funded by other developed or developing countries as well. This country, which hosts the project, will generate carbon credits, which it can sell to other countries or individual companies which need to increase their emission allowance, or to individuals who want to use these credits to reduce their carbon footprint or use it as a future market instrument to earn profits.

Carbon credits are essentially, the units of Emission Reduction Purchase Agreement which allows mitigation of emission to the party making the purchase. Purchase can be made in cash, credit or kind. Generally, if an investing country exists, the emission-saving technology is made available to the host country as a payment to for the carbon credits that it will generate in future. When the host country earns such credits, it automatically transfers them in the favour of the investing country. Thus, the transaction gets carried out in kind. Such transactions can broadly be classified as under:

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(Fig. 2.1)

Project – Originated Transactions are those in which a company undertaking an emission saving project by indicating that the project underway is lesser polluting than the orthodox methodology, offers the generated carbon credits to the other companies or individual buyers. These are thus, the CERs generated through the widely used CDM projects and the not so famous counterpart JI. The project-originated transactions thus need to generate a carbon credit before it can sell it. It therefore represents the cap-and-trade schemes and the emission unit saved thereof. CDM method, it should be noted, is single headedly the most used method in Indian Subcontinent.

Permit Originated Transactions on the other hand, involve transaction of the previously created CERs and Assigned Amount Units which are currently available as futures in the trading exchanges like the MCX (Multi-Commodity Exchange) in India, the CCX (Chicago Climate Exchange) in the USA and the EU ETS (European Union Emission Trading Scheme) in Europe. Though the credits are available in Indian subcontinent through MCX in form of CEFs and CERs, the trade through MCX and Permit-Originated means in general is negligible.

The generally accepted rate of exchange of carbon credits is decided by the EU ETS and is usually quoted in Pounds Sterling (£).

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India Welcomes Carbon Credits:

While the major pollution emitter in the world – USA, has refused to be a participant to the Kyoto Protocol, India, since 2002, India has ratified to the same. In the G8-Summit, India made its stand clear. PM, Dr. Manmohan Singh, mentioned in his speech that India and other developing countries emit much lesser pollutants than the developed countries. The protocol’s common but differentiated responsibility has been implied through this statement. It represents India’s ideology that though reducing emission has been undertaken in India on a large scale, there is an increasing need for the developed countries to reduce the emissions.

India, as a non-Annex party to the protocol, falls under the developing countries and therefore has the differentiated duty to reduce the emission by accepting new technology from the developed nations. It’ll benefit because it’ll not only receive new technology but also will generate carbon credits and reduce its carbon footprint. However, being listed under the non-annex countries, India cannot participate in the Joint Implementation programs.

When ratifying to the protocol in 2002, India agreed to develop Clean Development Mechanism projects within the country by accepting the project’s investments and technological aspects from the developed countries interested in such investment. However, most of the CDM projects today in India are majorly undertaken by the native companies themselves. The protocol does not specify whether the foreign entity is a compulsion for a CDM project to be accepted and registered by UNFCCC. Therefore, businesses in India today are looking to generate carbon credit with the use of CDM projects and later selling the carbon credits thus obtained, or using these to increase their own emission allowances.

Thus, project based transactions are the crux of the Indian carbon markets.

However, in the year 2008, the Multi-Commodity Exchange (MCX) of India has released the offer for short term carbon credits schemes. There are in the form of CERs and CFIs quoted on a regular basis like the other commodities in the market and are available for spot trading. These CERs and CEFs are, however, non-standard and have been newly quantified to suit the Indian investors. Similarly, the National Commodity and Derivatives Exchange (NCDEX), has also launched futures in Certified Emission Reductions.

Due to such undertakings, the policies in India have also been affected. The recent shocking news of the large scale deforestation in the states of Maharashtra and Gujarat are egregious. It such circumstances, the concept of carbon credit suits perfectly. Sustainable development has therefore become the fundamental and underlying principle of all the proposed development plans in India. The mandatory conversion of the state transport buses from petrol-guzzling machines into the eco-friendly CNG buses in Maharashtra and the same done in case of rickshaws and buses in Gujarat, displays how the policy framework has been affected.

In a similar endeavour, the government has announced that the subsidies on fuel for private vehicles will be removed in the near future. Doing this, the government is encouraging the use of public transport in an attempt to reduce the pollution, besides serving the purpose of reducing deficits and defaults.

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To give another instance, the Steel Authority of India Ltd. (SAIL), has identified 71 Clean Development Projects in their operations and has started the process of creating Project Design Documents, to be submitted to the UNFCCC for consideration. It expects to generate 1.6 million carbon credits per annum through implementation of such projects.

The power sector in India is the single largest contributor to the total reduction of emissions and thereby carbon credit creation, through the CDM projects. The estimates show that the sector has a potential to reduce more than 430 tonnes of CO2 equivalent emissions, while the total CER generation in India as compared to the world is 15% of the total CERs created by such projects world over:

Fig. 3.1

The National Designated Authority:

When the parties to The Kyoto Protocol assembled for their 7 th meet, the general consensus decided that all participating nations will be required to have a supervisory body to monitor, regulate and facilitate the CDM projects and Emissions Trading. In India, this role has been assumed by the Designated National Authority named – “National Clean Development Mechanism Authority” which falls under the Ministry of Environment and Forests. The Member-Secretary of the NCDMA is the person in charge to all the departments of the National Designated Authority.

The main functions of this authority in India are as follows:

1. To receive project documents for evaluation and consideration2. To provide guidelines to the interested parties on how to develop such projects3. Provide objective judgement on whether the project will lead to sustainable

development or not

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4. To decide whether the project is a national priority of otherwise 5. Provide guidelines for additional requirements with respect to the legal framework

and paper-work necessary in the country6. To check whether the proposed project has a positive edge over the rejected project,

which would have otherwise caused much pollution7. If two or more projects apply to the Authority foe receiving the investment from the

same source, the Authority has to decide, by thorough assessment, which project is more likely to succeed and give priority to such projects

8. To provide all information about the flexible mechanisms of the Protocol9. Create databases of the numbers, types and areas in which such projects are being

carried out in the country 10. To see that the value of CER in the open market is not undermined11. To carry out financial audits of the registered projects and make sure they are still

applicable and in accordance to the prescribed requirements by the protocol12. To co-ordinate with the UNFCCC and the entities applying for registration or

assessment13. Interact with the government to provide suggestion regarding the possible projects

and to provide estimates to them about the current scenario14. To concentrate on projects that offer immediate attention to improvement in the issue

of environmental degradation15. To provide the applicant with the estimate of the total carbon credit or CERs that will

be generated through the project that was considered for registration16. It should monitor and record from time to time the performance of the schemes

Majorly, India is involved in trading Carbon Credits in an open-market, where the stockholders have constantly tried to consolidate CERs from various Small and Medium Enterprises (SMEs), to sell them when the global market demands are high. As the First Commitment Period started in the year 2007, out of the first 550 that were registered with UNFCCC under the CDM projects, 179 projects were from India. This clearly obviates any doubt that there is a possibility of a multi-billion dollar industry in India arising out of the carbon credits.

The Delhi Metro Rail Corporation, by applying the principles of regenerative brakes in its rakes, has opened up an efficient source of income. Here, the energy is transferred from the regenerative brakes to the converter-inverter electricity generator, which is then transferred to the Over Head Electric Wires (OHE-W). This power thus generated is then used by the train-rakes operating on that same line, thereby saving a lot of fuel and energy. CERs worth INR 2.4 crores are generated by this project.

Thus, India has proved to be very ambitious and creative in using the protocol’s mechanisms to gain profits in short-term.

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The Rise and Rise of Clean Development Mechanism:

Kyoto protocol mentions the CER creation systems as “Flexible systems/mechanisms” for a reason. These reasons are two-fold:

1. It provides the Annex-I countries a technique to increase their emission permits and thereby meeting their obligation to reduce their emissions as required by the protocol

2. It provides the non-Annex countries, i.e. the developing countries, to obtain new and emission saving technology and thereby reducing their carbon foot-print

Although having such benefits, these mechanisms were stalwartly opposed by the developing countries in the trepidation that while such mechanisms will continue to force developing countries to reduce their emissions, it’ll provide additional ceiling to the developed nations, so that they might pollute more.

Nevertheless, with the Marrakesh Accords of 2001, the statutes for the implementation of these mechanisms were filed and such scepticisms have been successfully obviated and the continuation of the mechanisms is now a unanimous decision.

Perhaps the most widely used and discussed of these mechanisms is CDM or Clean Development Mechanism. The salient feature of this mechanism is that rather than concentrating on reducing the emissions of the most polluting developed countries, it focuses its attention on providing non-polluting technologies to the developing countries. These said technologies, however, are to be provided by the developed countries which enter into such a treaty, thus, making them indirectly pay for the pollution they create.

The rationale behind including developing countries in the mechanism is that it has its fiscal benefits. The Intergovernmental Panel on Climate Change, in its Second Assessment Report of 1996, provides the various reasons why such an act is justified. Firstly, the scope for being environmentally friendly is more in the developing countries than in the developed countries. Secondly, the legislations and legal framework regarding climate changes in developing countries are more lenient as compared to developed countries. Finally, the acquisition and implementation of such projects in the developing countries is considered to be cost effective in developing countries due to cheaper raw-material and manpower.

The UNFCCC, with this in mind, has devised CDM methodology to suit the more cost effective way of reducing the anthropogenic pollution on the planet. The report anticipated an enormous rise in the pollution levels in the developing countries from the IPCC’s climate change model. These predictions could be nullified if steps were taken now, when the developing countries were developing their infrastructure on a large scale. CDM is therefore designed to circumvent such a situation by providing the developing countries with technology that creates lesser pollution and making the developed countries pay for such technology and thus penalising them for their emissions.

CDM falls under the category “Project-based mechanisms”. The underlying idea is “production” of emission reduction, i.e. CERs. It aims at varying the production systems in

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order to make them environmentally-friendly. The total amount of emissions that are predicted to occur without the structural changes being carried out will be taken as a basis for calculation of the CERs that the project is able to generate. Therefore, the level of such predicted emissions without the proposed project are called “baseline emissions”. When the project is put to practice, the actual emissions by the project overall are aggregated and credited against the total baseline emissions and the balance is awarded to the company undertaking the project as CERs.

The concerns:

The CDM project has been criticised over and over for the following two implications that were strappingly apprehending the developing countries:

1. Addition: There are contradicting views among the participating nations about whether the actual amount of the emissions created and the baseline emissions can be justifiably quantified. Such additions can be both environmental and financial in nature. The companies involved in green-energy were automatically considered under such projects and CERs were issued, while the criteria for issuance allowed only providing CERs against noted reductions and not against the existent green projects. These concerns were given a boost by the WWF when an assessment report for more than 93 CDM projects was carried out by Schneider in the year 2007. The report stated that the additional credits “produced” by a majority of these projects were improbable and dubious.

2. The second major concern is if the cash rich developed countries should be permitted to enforce upon the developing country which is hosting the project, the project which it does not need or which is not a priority for the country’s development. This would mean that the project is essentially only being carried out by the developed country to purchase additional emission rights. The concern is accentuated further as the protocol requires that the hosting-developing country should report the sustainable development achieved by means of such a treaty with the developed country, which is fearsome because these developed countries have provided with valuable and much needed technology to the developing country.

In order to address these situations, the Kyoto Protocol has been now amended and now has a provision that only allows the developed countries to earn CERs if the project carried out in the host country has actually been supplemental to their sustainable development. Thus, it limits both excessive and malevolent use of CDM by such countries.

However, the use of CDM projects has increased many folds after it commenced in the year 2005. But, in the first few operation year, the parties to the protocol failed to provide monetary support to the Executive Board and due to this the commencement of the projects the world over was very unstable and rickety. Even so, when the “Adaptation Fund” was set up in order to provide finance to developing countries to in order to implement such projects, it provided a sense of security to the developing countries and CDM projects have been widely used since.

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The CDM Process:

In order to understand how CDM generates CERs, it is inevitable to understand the process to be undertaken and the terminologies involved, as prescribed under the protocol. The CDM projects, at some point in the project-cycle, involve 2 or more than 2 parties. These parties have been given various nomenclatures, which would prove instrumental in understanding the complete process. The parties are as under;

1. Project developers/operators: These are individuals or organisations which are allowed to make or develop CDM projects. These may be one of the following;

a. Government bodies/Municipalities/Foundationsb. NGOsc. Financial Companiesd. Private Companies

2. The Executive Board of CDM:This is an entity established in the Conference of Parties #7 which consists of 10 members representing various countries and elected by the representatives of both developed and developing countries. It is a supervisory board which has been assigned to see various COPs/MOPs and maintain the fidelity and has numerous functions like creating and approving the methods to calculate/formulate the baseline for the projects, providing accreditation to the parties/lapse them, maintain a registry for approved CDM projects, suggest amendments to the current statutes, review of the projects’ type, validate reports and issue CERs, monitoring and controlling the process of accreditation and validation and providing the information regarding the projects and the related official documentation for public use.

3. Host Government plus DNAs: The government of the country in which the project is to be administered is termed as the host government. This government, by the norms provided under the Marrakesh Accords, requires them to have a national authority looking over and approving of the CDM Projects. This national authority has been mentioned in the previous chapter.

4. Designated Operational Entities:The executive board of the CDM, provides accreditation to various independent bodies to monitor and control the CDM projects and involves itself in various stages of the whole procedure like validation of the activities as standard CDM activities, releasing the PDDs (Project Design Documents) to the masses and allow for them to give their opinion, also similarly taking opinions from the shareholders and to certify the creation of carbon credits and to measure, audit and validate the same. Although, such entities are statutorily allowed under the Marrakesh Accords, but they are not largely popular and this provision for DOEs is not generally exercised. Instead the DNAs, in common, exercise the same powers

5. Purchasers/Investors: Investors are the developed, Annex-I countries which have invested in the proposed CDM project for it to be carried out in the country of the host

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government. The CERs created by this project will be purchased by these developed countries and therefore, they’re interchangeably called ‘Purchasers’.

6. Other parties: The entities undertaking the CDM Project will have the obligation of taking the consent of the local authorities or publics, whom the project is likely to affect. Such entities, once the Project Design Document has been prepared, have to be invited to review them and provide suggestions. Unless these publics approve the project, the project cannot be continued. If the project is, however, approved, then the host has the obligation of making the documents available to the general masses for 30 days or more, as may be required and allow them to comment or provide opinion and guidance relating to the project.

Having understood the above nomenclatures, the following diagram will make the concept of CDM quite clear: (Fig.4.1)

Host Country

Back to host Sold to Investor

Technology &

Funds to host Investing

Country

- - Original Emission Levels By The Host Country

- Emission Levels after Implementing CDM

-- - Emissions Saved = CERs generated

- - Original Emission Levels in the Investing Country

- Additional Emission Level Obtained Due To Purchase of CERs

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The above diagram depicts a CDM project between two countries. The developed/investing country is at the bottom and the host/developing country is at the top. Once the project agreement is signed between the two countries, the investing country provides the environmentally friendly technology to the host country. Other required funds are also provided by the investing country.

Once the equipment is installed and the project is under way, the newly invested machinery starts to save emissions as compared to that before. Over a period of time, these reductions in emission are accumulated and then are verified and converted to CERs. These are then split into two parts. A part these CERs, the country may retain in its economy, while the other which it sells to the investing country, or may give it in lieu of the technology provided.

The above is merely a coarse design of how the CDM projects work. However, in order to fine-tune the understanding, the process of CDM, as mentioned in the protocol, need to be comprehended. This process is as follows;

(Fig. 4.2)

Key:

1. Red = Project Planning Phase2. Yellow = Execution Phase3. Green = Realisation Phase

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Any CDM project can be basically divided into 3 phases, i.e. Project Planning Phase, Project Execution Phase and Realisation Phase. Such a classification aides the understanding of the processes involved under them.

1. Project Planning Phase: This phase is perhaps, the longest phase in the CDM process and consists of the following steps;

a) Project Identification:This is the basic step for not only CDM but all types of projects. The stage is also called a “Conceptualisation” stage. Here, the basic idea of a new emission saving project or an idea to reduce the emissions in an existing project are drafted.This may be done by a developer/operator who suggests the CDM project. Such developer can be government, NGOs, companies, individuals etc. The major part that is involved in this step is that the operator should find out and provide sufficient proof that the project proposed is worthy of the CDM status. The developer must also find out whether the host country that it wishes to involve in the project will readily accept the project or not. If the project is not a priority sector in the host country, then the developer should not force the project on the host.In order to determine if the project is eligible to be called a CDM project, the following questions should be taken into consideration;i) Does the project fall under the types of CDM project allowed by the Kyoto

Protocol?ii) Is the potential technology always active in the host country?iii) Is the host country a party to the protocol? If so, is it willing to approve the

project?iv) Does the project lead to sustainable development in the host country?v) Does the project add to the emission reductions that would occur in its

absence?vi) What is the rough estimate of the total emissions that will be saved?vii) How many carbon credits do these emissions translate into? viii) Is the project funded by the general public? If so, how much of the funds are

collected from such publics?ix) Will there be any negative impacts on the environment due to the project?

The answers to the above questions will help the parties in deciding the various aspects of the project and to identify the objectives. Once the project outline has been laid out in the identification stage, the next stage is the Project Idea Note stage.

b) Project Idea Note:This is a voluntary stage in the CDM process and is not mandated by the protocol, albeit, most of the developers opt to undertake this step. This is because a PIN or project idea note, gives a rough idea to the host country/the public that funds the project, about how the project will be carried out and how the processes will be manipulated in order to make them environmentally friendly.

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This PIN is made as a response to the questions that have been listed under the Project Identification step. Once prepared, this document has to be sent to the carbon credit buyers and the host country. By undertaking this step, the developer not only increases his creditability but also indirectly promotes his idea to the expected host nation or government. On receiving this document, the host party scrutinizes it for errors, so that suggestions could be made to the developer in order to increase the scope of the whole project. It is thus used as a communication tool to provide the hosts information about the project.The scrutiny here is to check whether the norms laid down under the protocol have been extended into the project. However, this has been misunderstood as a mandatory stage and most of the PINs created are in a standard format and monotonous. Because the PIN is generated for interactive purposes, the feedback received from the host country will showcase the significance of certain types of projects in that particular country. It can thus be called, in theory, a cheap substitute to a large scale survey, while in practice it has become a systematic catalogue to lure the hosts into the project. A typical PIN will answer the following questions:i) What is the type and size of the project?ii) Where is the project to be located?iii) What amount of emissions will be reduced in comparison to the technology

currently undertaken?iv) What will be the operating life of the project?v) What is the price of each unit of CER generated expected to be?vi) Which of the parties are financing the project? How much is the contribution

in case of multiple funding?vii) What are the benefits of the project?

Since the PIN has become an integral part of the CDM process because of the aforementioned reasons, the UNFCCC has issued a template for a standard PIN. Though, it is still the discretion of the developer whether to use this template or not. The UNFCC has also made it clear that it is not a compulsion to answer all the questions on the template for it to be accepted as a PIN and this is because many projects are not involved in a number of fields for which certain questions have been designed to be asked in the template and are therefore not expected to answer them.

PIN, though scripted in a prescribed format, is only considered a rough draft of the project idea. The process of CDM expects exhaustive explanation to be presented to the concerned authorities, unlike the basic proposal put forward to the hosts. This is the reason why the next step becomes the base for the rest of the CDM process.

c) Project Design Document:A detailed version of a PIN can be called a PDD or Project Design Document. The process of development of such a document is very complex and therefore is generally outsourced by the developers to experts in the field. The document discusses each aspect of the project in great specification.

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It is important to note at this juncture that the PDD, unlike the PIN, is a mandatory document which has to be prepared by all the participating developers. PDD is the main document which is submitted to the National Designated Authorities for validation of the project and thereafter the same has to be presented to the Executive Board of CDM in order to register the project with the UNFCCC. Thus, without the development of the PDD, the CDM project shall not move forward. While being a document for registration and verification purposes, the PDD also serves as an offer to the masses to invest in the project, very much like the Annual Reports utilised by companies to attract potential investors. The Project Design Document has the following parts:1. Project description : Except for the questions answered in the PIN, the PDD

additionally requires the inclusion of the following details;i) What is the objective of the project?ii) Who are the various parties involved in the project?iii) What are the different technologies involved in the project? How will this

technology be transferred to the hosts? How will this transferred technology be instrumental in reduction of GHG emissions?

iv) Is the public funding being used only for the project and not for any diverted purpose?

v) What is the background of the project? Are there any major issues/barriers that might be faced?

vi) What is the schedule of the project?vii) And any other information that would be found necessary?

2. Setting up a baseline and carrying out assessment : The protocol requires reduction in the level of emissions as compared to the existing levels, or to that which would exist in the absence of the proposed project. A baseline is a hypothetical level of emission that would have occurred if the project was not administered. On the other hand, the PDD has to mention the amount of emission that the project will reduce so that the new level of emissions is below the baseline. Both these figures are together required in order to calculate the amount of CERs earned by the operators. For ease of such calculation, following steps are to be followed:

i) Selecting an approach for the baseline : This is the most significant step in the process of making the PDD. According to the Marrakesh Accords, the company may choose either, a) the greenhouse gas emissions as per the previous technology utilised, b) benchmark the existing technology with another technology which is emission reducing, to make an economic selection of the baseline, c) take the emission baseline as the same baseline taken up for a similar/same project, in terms of environmental, social, economic and technological parameters, or similar to the performance standard of the 20% of the companies, in which the developer falls.

ii) Baseline - Method adaptation and creation : Since the year 2005, a number of methodologies in various areas in which CDM projects have been developed, have evolved. Such technologies are approved and listed by the Executive

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Board and are available for common people on the UNFCCC site. The operators may refer to these previously approved methods in order to develop their own project. However, the EB has given the freedom to the developers to develop new methodologies, which are within the constraints of the above mentioned three criteria for the development of a baseline. Such new methodologies, nevertheless, have to be approved by the EB before they may be implemented.

iii) Ascertaining the boundaries of the project : The boundaries of the project become instrumental when the calculation of pollution emissions by the project is to be carried out. Any activity under the project which has a significant effect on the environment or whish makes a significant level of emission, should be considered while defining the boundaries of the project. But, the criteria here is that any such activity has to firstly be a significant part of the CDM project and secondly, these activities have to be those which will be constantly audited in order to find out the total emissions saved. Though a strict leash is put on the inclusions in the project boundary, the EB provides leniency in the projects in which capacity of such projects is based on other factors which may be emitting more than originally expected. The project developer is only expected to assess those parts that the project has in terms of the total GHG emissions. An easy way to decide on such activities is to decide whether the operator is undergoing a deliberate cost in conducting such activities. If, however, the project has some implied costs, they may be neglected from calculation of the project boundary.Thus, such factors affecting the project can be classified as, a) Geographical, which will decide the place related implied factors that the operator doesn’t control and, b) Activity level, which are upstream and downstream activities in the limits of the baseline of the project, the cost of which the operator doesn’t control. In short, the activities directly related to the project are to be included in the boundary. However, direct activities with negligible emissions or the indirect activities with considerable amount of emissions have to be considered. In the PDD, it is expected that the operator explains the same with the help of flowchart of activities, clearly demarcating the related and boundary activities from the others.

iv) Determining additional reductions over the boundaries : The concept of “business-as-usual” plays a significant role here. The additional reductions in emissions, termed as “Additionality”, can be explained as the reduction in emissions due to activities that would not have been carried out in the absence if the project. Additionality, thus, is a method to prove that the project is being active in reducing the emission levels and thus justifies the CDM status of the project. Simply put, it is an ‘additional’ activity by developer, which is unusual to general functioning, which reduces the GHG emissions.

v) Baseline Development : Once the ‘Additionality’ has been established, the next step is to consider the difference caused due to non-regular activities with use of a strict mathematical formula. This will result in a total amount of additions

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to reduction that can be used to develop a trustworthy baseline for the project at hand. The assumptions made regarding baselines are for the future and should therefore be focused. Factors such as the approach selected, local legislations, methodology being followed, assumptions and constraints of the project, availability of electricity and crude etc should be considered and quantified before considering the baseline structure. Once the baseline is set, the same has to be verified by the National Designated Authority and later sent to the EB. While the documents regarding the approval of baseline are with EB, concerned entities may communicate, within 30 days of submission by the developer, on whether or not the baseline is justified. If no objection is raised and the EB finds the baseline assumptions warranted, they may validate the same.

vi) Predicting the emissions from the project : For the purpose of record, the PDD is required to have the estimates of the GHG emissions through the project over the period of credit that will be allowed to the project. This prediction has to be similar to the baseline prediction, i.e. it has to be accurate and acceptable. The various aspects considered under the project boundary for the purpose of calculating the baseline can and should be utilised to make such predictions. The various indirect activities that are connected to the main project should also be considered, i.e. the contribution of such activities in the total emission cannot be neglected.

vii) Calculation of the leakage : Some of the activities relating to the project may be carried outside the location of the project. Such activities are therefore not sometimes considered for the calculation of the emissions by the project. The emissions that are generated by such outside activities are called leakages. Though the sources may be various and insignificant, but if these collectively form a significant amount of emissions, then the project boundary has to be revised. These leakages can be because of ‘Activity Shifting’ i.e. the same process done elsewhere and not the project site or ‘Outsourced Activities’ where the activity previously done by the project is shouldered to another entity based on contract terms. If such leakages are found, the UNFCCC does not stop the project, but, issues strict terms as to including them in the project boundary.

viii) Computing emission reductions : The total emission reductions are computed as the baseline emission minus the total emissions of the project and by adding or subtracting the leakages as and when needed. The calculations of GHGs other than carbon are to be done in terms of carbon equivalents for ease of calculation and comparison. The total monetary amount is generally quoted in Euros.

3. Crediting Period : This is the period over which the project is expected to generate carbon credits. This is different from the life cycle of the project, which may be equal or longer than the crediting period. The projects are given two options; a) Crediting period of 7 years with a possibility to renew the same twice, or b) A one-time crediting period of 10 years on a stretch. The baseline cannot be

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restructured during this phase and the CERs generated can only be claimed during this period. If they’re not claimed till the period ends, the same are lapsed. Once an option is decided, it can’t be changed and therefore it is a vital decision to make, based on the nature and performance of the business and also the future forecasts.

4. Monitoring Plan : This plan is the one that defines how the required information about the emissions will be collected from the project once it begins. This plan has to be put into force by a project developer/operator. It addresses concerns like the boundaries to be monitored, frequency, methodology, quality control techniques and their quantification, quantification of leakages, types of GHGs being monitored, backup system etc. The data thus provided, will be used to validate the CERs. Duties and responsibilities for such calculations have to be vested and then mentioned in the PDD.

5. Assessing Environmental Effect : If the project has significant impact on the air quality, noise pollution, chemical disposals, water pollution, soil erosion, biodiversity etc., then such projects are not considered CDM projects as they have environmental effects which are GHG based. If a plan exists to reduce or limit these, the PDD should have the information of the same. If the statute in the country of operation requires that the audit of the project be carried out by a legally acceptable entity, then such assessment has to be done and then documented into the PDD. The same has to be sent to the designated national authority to validate. The frequency at which such effect assessment will be carried out should be mentioned in the PDD.

6. Stakeholders’ Comments : In the final stage of PDD development, the stakeholders, i.e. the publics that would be affected by the project are to be consented about the project. A copy of the PDD or the rough draft or a short summary of the project is to be provided to the stakeholders. Later, their opinion is sought on how the project can be further improved. If international stakeholders are involved, then the PDD is made available on the web through the UNFCCC website and the stakeholder’s comments are received through the same resource. Also, two rounds can be conducted, i.e. one manual round and another web round, thereby covering all possible participants. NGOs are generally given this task as they have been providing a very objective feedback. If there are legal requirements for communication of such terms with public, the project developer should talk to the Designated National Authority to ensure that the statute in practice is similar or same as the rules of the CDM projects. If the legal restrictions are absent, the operator should create the same for themselves to be followed, in interest of the stakeholders.

d) Stakeholder participation: In this stage, meetings are held with the stockholders in order to get their opinion on the CDM project. They are invited to review the project in the first phase and provided with a copy of the PDD. Based on this the comments of these publics are sought in order to discover loopholes in the project. This step is largely covered under the last step of the PDD development system.

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e) Host country approval: Any host country is given a lenient and broad spectrum in accepting or rejecting a CDM project that has been proposed to it. The final authority of over the resources of a country is the government and therefore it becomes necessary that the hosting government is given a chance to accept or reject the proposal made in terms of the CDM project. Every country has an environment-friendly sustainable development plan. If the CDM project does not adhere to such plans, then it is the right and the responsibility of the ruling government of the host country to reject such a proposal. The Designated National Authority has to get the consent of the hosting company, the concerned government bodies, and then submit the agreement in written to the UNFCCC, the particulars of which have been defined in the Delhi Declarations and Marrakesh Accords. If the executive board is not satisfied with the documents submitted, it may ask the designated authority of the host country to submit specific documents, as may be prescribed. However, a rough draft of the same is available from the website of UNFCCC.The operator and the hosting party in the host country are responsible for submission of the necessary paperwork to the authorities which are prescribed by the UNFCCC. But before starting such a project, the operator has to make sure that there exists a designated authority in the host country that is recognised by the UNFCCC, find out if there are any statutes regarding CDM projects in the country or as may be issued by the designated authority and find out if the country is listed with the Kyoto Protocol as this would determine the risk that the host would carry. CDM projects may also be accepted by the host countries which are trying to fulfil the criteria to be ratified to the Kyoto Protocol. By doing so, the country exhibits a sustainable development plan, which may earn it a membership to the protocol.

f) Validation by Operational Authority: The completed PDD and host country’s approval of the same will clear the way for the paperwork to begin. This starts with the submission of the PDD and the acceptance in writing, to the National Designated Authority. The protocol has laid down several points to be covered by a project, for it to be a CDM project. This becomes a comparison tool for the Designated Authority. The validation is carried out by benchmarking, i.e. a standard is set up for achievement of a project to become a CDM and these standards are used for validation of the project. This is, in simple words, a step where the designated authority certifies that the various projections and predictions made in the project and the various other aspects that are mentioned in the PDD are all verifiable and are accurate. The Designated National Authority may also undertake test and audit in order to decide the aforementioned. The CDM projects that existed before the First Commitment Period started and those before the existence of the Marrakesh Accords are all eligible for registration and verification of their PDDs by the designated authorities and by the UNFCCC.

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The validation process is generally arranged by the operator. These costs are later recovered by the operator when the CDM project is underway and CERs begin to generate.The operator has to submit to the DA, a) the PDD and b) Affidavit by the government stating that the project is aimed towards the sustainable development plan of the host country and that it complies with all the connected laws. The list of DAs is available with the UNFCCC’s Executive Board. Only these listed DAs can validate the above mentioned documents. Consultation of experts in international arena is also one of the requirements to the protocol, as was decided in the Marrakesh Accords. This requires the DA in question to make these documents available to the experts around the world to view and comment on. Such participation helps in refinement of the project before it is validated. Once the DA is satisfied, the validation report is generated, containing particulars of the reasons for which the project has been validated as CDM. This same report is then submitted to the EB, which will make the PDD and validation report available on its website for 30 days to allow further comments from interested parties.

g) Registration: The request for registration to the EB has to be made through the DOE or the Designated Operational Entity. Once the PDD and the registration request are forwarded to the DA, the operator requests the DA to make a request to the DOE on its behalf. The DA accordingly sends the required documents to the DOE, who, after validating the documents, makes a formal proposal to the EB for registration of the project.The DOE retains a copy of the validation by the DA, in case any changes would be required in future. The EB takes a maximum of 8 weeks after the submission of the documents to finalise on the registration. However, there may be a delay if in the 30 day review period a substantial amount of revision is requested. Such registration is mandatory for any CDM project in order to be able to generate verified CERs.

2. Execution Phase: This phase, as the name suggests, deals with the implementation of the CDM project and its related activities.

a) Implementation and Monitoring: The implementation of the project may be started only once it is registered and the notification of the same is received from the EB. However, some projects may have already implemented a certain technology and then applied for the CDM status. For such projects, the CERs will be calculated retrospectively. Once the project is implemented, the process of CER generation begins. For this purpose, the operator who applied for the CDM status must constantly monitor the attributes mentioned under the project boundary and in order to note the changes in their emissions. Any additions or reductions in the capacity and the change thereby in the emissions must also be recorded. If, however, the project has a definite baseline for the commitment period of the CDM project, it is not required for them to monitor

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the changes in the baseline of the project, while the actual emissions have to be monitored still. As mentioned earlier, these baselines are generally fixed for at least 7 years and therefore the efforts on the operator’s side to monitor the baseline, are reduced, as the baseline is only to be reviewed after these 7 years. It is also required by the EB that a report may be generated on a regular basis. The frequency of the monitoring and the methods employed in the monitoring process are to be mentioned in the report sent to the EB. The Marrakesh Accords don’t require the operator to submit reports at fixed intervals, hence, implying that the monitoring activity may not be done at fixed intervals, but, the frequency of monitoring shall be strictly followed, as advised by the EB. Based on this monitoring, the CERs are calculated as the total GHG emissions saved as compared to the baseline emissions. The EB has therefore advised that for receiving an objective decision regarding the allocation of CERs, the intervals in the monitoring process may also be observed on discretion of the operator.

b) Verification: As mentioned above, the operator is responsible for monitoring the project and reporting the same to the EB. The reporting to the EB cannot be done directly and has to be routed through the same DOE that had previously validated the project. The DOE is requested by the operator to review its report of the monitoring of the CDM project and then verify that the particulars stated in the report are facts. By doing this, the DOE will indirectly verify that the project is actually generating the amount of carbon credits as had been foreseen in the PDD. Once the verification is done, a verification report is generated and sent to the EB through the DOE. Conducting this verification from time to time may become a costly affair for the project operator, however, it’ll enable them to receive the CERs; with every verification and thereby earn the proceeds by selling them off.

3. Realisation Phase: This is the final phase wherein the CERs generated by the CDM project are allocated to the operator.

1. Certification and issue of credits: Once the verification process is completed and the DOE has submitted the report to the EB, the EB in turn will request the same DOE to proceed with the certification phase. Here, the DOE certifies that according to the norms applicable under the Kyoto Protocol, Delhi Declarations and the Marrakesh Accords, the CDM project in question has been found complying with all the criteria relevant to the type of project. This certificate is then sent to the EB along with the reasons for certification and is then certified by the EB, if found in congruence. If any misrepresentations or misleading information is found by the EB while documents are being reviewed, punitive action, as prescribed by the EB, shall be taken against both, the operator and the EB.The certification reports contains a request to the EB to issue to the operator the amount of CERs as have been verified by the DOE and in compliance with the

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amounts mentioned in the PDD. On acceptance and approval of this certificate by the EB, the emission reductions of the CDM project will officially become Certified Emission Reductions, out of which, 2% are to be retained by the EB as a contribution to the Adaptation Fund, while the rest may be distributed between the Host and the operator in proportions as they may desire.These CERs are calculated using the following formula;

ERy = BEy - PEy - Ly, where, ER means the CERs, BE are the Baseline Emissions, PE are the actual Project Emissions and L stands for the total Leakages, all of which have been discussed above. Y stands for the particular year for which the calculations are being done.The CERs or Carbon Credits are thus “generated” under the Clean Development Mechanism of the Kyoto Protocol. Having understood the process of CDM, let us now look at the various types of CDM projects that exist in the current scenario and which have been accepted and registered by the EB.

The types of CDM Projects:

1. Energy efficiency projects: This includes -- Increasing building efficiency, i.e. the concept of green building. E.g.; Techno-polis

Building in Kolkata. - Increasing the commercial or industrial energy efficiency, i.e. modernisation and

renovation of the old plants.- Switching from more carbon intensive fuel to less carbon intensive fuel.- Also includes re-powering, upgrading instrumentation and control.

2. Transport: This includes -- Introduction of new technology to increase the fuel efficiency, e.g. the PUC being

installed for free all over India.- Changes in the vehicle or in the fuel type or both, e.g. Rickshaws in Bombay now run

on CNG.- Switching to lesser polluting transport modes, e.g. electric local trains in Bombay.- Reducing the frequency of transport activity.

3. Methane Recovery: This includes -- Animal waste methane recovery and utilisation, where an anaerobic digester is

installed and the generated methane are used to create electricity.- Coal and mining methane recovery, where the renegade methane in coal mine and

other mines is collected and utilised to generate power.- Capturing the biogas, under which the accumulated methane in landfills, is recovered,

collected and utilised.- Collection and usage of the methane generated from the industrial waste or from the

sewage.

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4. Industrial Process Changes: This includes -- Any change in any industrial process which results into the reduction of the emissions

of any GHG, will fall under this category.

5. Cogeneration: This includes – - The usage of the excess heat generated due to electricity generation, including exhaust

from gas turbines which is utilised for heating or other industrial purposes. E.g. Distilleries – Molasses

6. Agricultural Sector: This includes – - Improving energy efficiency by switching to lesser polluting water pumps or

alternatives to water pumps. E.g. Irrigation sets- Reducing the amount of methane in rice cultivation- To reduce the animal waste, or if inevitable, use the same for generation of bio mass

and thereby collection and utilisation of methane.- Any other type of activity which is adopted, which will reduce the emissions of any

GHG, as compared to the baseline.

7. Land use: This includes – - This category include aforestation and reforestation but does not include activities that

have reduced the need to deforest or if deforestation is avoided, as it is considered that such deforestation should be avoided even outside the scope of the Kyoto Protocol.

Benefits of Clean Development Mechanisms:

1. One of the major benefits of CDM is it enables the usage of newer and better technology, processes and techniques for the host countries.

2. The country receives more foreign investment in terms of both, funds and technological capital.

3. It provides opportunities to local companies to learn new and better techniques prevalent in their industry and thus improve their skills.

4. The priorities of any undertaking of the project can be met by the funds provided for CDM.

5. A more obvious advantage is that it allows the country’s sustainable development plans to be addressed with the use of cleaner technology.

6. The reduction of the GHGs is a major concern under the Kyoto Protocol and the practice of CDM allows for such reductions.

7. The mechanisms like CDM, through provision of many advantages for the business, allows the business to learn about environmental protection and helps it achieve its CSR objectives while also being responsible towards the environment.

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Limitations of Clean Development Mechanism:

1. There are no cheap alternatives available that can reduce emissions. Emission reduction alternatives are costlier as compared to the “Business-as-usual” machinery/technology.

2. Foreign investors may dominate the local companies if they are allowed to dictate terms of the project.

3. The investment in such projects could affect the growth of the country as the strategic plans for development do not consider the losses that may be raised due to such projects.

4. The operators may only limit their investments to the countries that have the industrial capacity to take up such projects. The result will be that the lesser industrialised countries may neither get an opportunity to reduce their emissions nor benefit from new technology.

5. The credits that will be given to the operator when the CERs are issued to the host for the emissions reduced. This will allow the developed countries to pollute more, meaning that the emission reduction only takes place in the host country and not in the developed country/operator.

6. If the hosts are forced to accept the new technology against freewill, there might be adverse impact on people’s mind regarding the efficiency of such technology.

Risks associated with CDM:

Fig: 4.3

1. Contractual Risk: This is the risk which is involved with the operating cycle of credit in the project. If the debts are not realised on time from the debtors, the project might not have enough cash flow to run the operations smoothly. It is therefore

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required that the risk of completion of contracts and the payment thereof are duly made by the debtors to the project.

2. Market Risk: The biggest drawback of the CDM system is also the biggest threat to it. The market in India to purchase carbon credits or any form of CERs is negligible, albeit the number of CDM projects from India as compared to the total number of CDM projects registered with the UNFCCC, form a large part of the latter. This is why the prices on a standard CER in the global market generates a risk for the Indian companies applying CDM as the prices as dictated by the EU ETS are generally volatile and are affected by elements of a free market.

3. Policy Risk: In a parliamentary democracy like India, the political conditions are always unstable and there is always a chance that the ruling party will not continue its tenure for the next elections. With the change in the ruling party, the policies and the attitude of the government towards the clean development and the allowances and clearances given to a CDM project would be affected. These may be positive or negative, but, there is a high probability that additional cost may have to be incurred due to such changes. This is the policy risk that a CDM project suffers.

4. Legal Risk: The recent example of the uproar led by Anna Hazare to amend the constitution with a new law against corruption has shown that the legal conditions in India are also unstable as the laws keep changing off and on. A CDM project, though governed by the guidelines of the Kyoto Protocol, has to abide with the legislations of the country which is hosting the project. Invariably, changes in the law of the land have a direct impact on the functioning of the project. Though there is also a probability that laws may also turn out to be in the favour of the CDM project.

5. Operational Risk: Operational risks are all those risks that are associated with the working of the project, i.e. if the project fails to perform as predicted or projected. It is not a congenital risk, but a risk that chronic due to certain contingencies that develop during the project life-cycle. The dysfunction of internal processes or people or systems may lead a CDM project to such risks.

6. Reputation Risk: The local shareholders/stakeholders, as seen in the CDM process, are a vital part of the CDM project. The hosts and operators need to maintain good relations with these natives in order to be able to operate smoothly in their area. However, with introduction of new technology and thereby lesser employment opportunities or due to the policy of the operators to avoid such stakeholders may be detrimental to the image of the project in the view of the public in general. Goodwill maintenance is therefore of prime importance which comes with the risk of loss of reputation or negative publicity.

The following case study will help in understanding the CDM process and the benefits and limitations of the same

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Case: Cleaning it the Tata way:

Ranging from chemicals, metals, cellular networks to automobile and power sectors, the Tata Group is India’s largest private corporate with a total of 114 companies and subsidiaries in over eight distinguished sectors of business. What stands out though is the magnitude of its philanthropy and benevolence which have been the face of Tata through the charitable trusts that have been functional throughout the country, giving back to the society. However, the Corporate Social Responsibility in Tata Group is a major concern and does not end with charity and donation alone.

The Tata Group has taken up 3 Clean Development Mechanism Projects all over India, thereby becoming the only private corporate in India to have more than 2 CDM projects. The latest inclusion was in ‘Khandke Wind Power Project’. This is a project developed in the Khandke village of the Ahmednagar district of Maharashtra. The project is designed to produce 50.4 MW of electricity.

(Fig 5.1.1)

The wind energy has been the most extensively used renewable source of energy in India ever since the Sixth Five Year Plan. There is a total capacity of approximately 45000 MW out of which only 13000 MW is being utilised at the moment. States like Rajasthan, Gujarat, Madhya Pradesh, Maharashtra, Karnataka, Tamil Nadu, Kerala, Andhra Pradesh and Orissa are leading Indian states in the Wind-Power generation. In Maharashtra alone, the potential of wind power is around 4600 MW spread over 28 different projects, as reported by the Ministry of Non-conventional Energy Sources.

Out of this 4600 MW capacity, the Tata Power Company Limited, which has set up two wind power projects, provides the state with 100.4 MW of energy. The project under study itself produces 50.4 MW with the use of 75 meter high windmills which have rotors of 53 m diameter. The liberal policy of the Maharashtra government, towards clean energy projects, has given Tata Power Company a chance to develop 2 out of its three CDM projects in Maharashtra.

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The CDM project was proposed to the hosts, i.e. the Tata Power Company Ltd, by the Enercon India Ltd, a subsidiary of the German company Enercon. Being the operator of the project, Enercon takes the responsibility of constructing, operating and maintaining the project. However, the funding of the project has been undertaken by the Swedish Energy Agency and by the Kingdom of Spain jointly through the Asia Pacific Carbon Fund.

Besides contributing to the deficit of electricity in the rural areas of Maharashtra, the project is expected to help in reduction of fossil fuel usage, reduce GHG emissions, avoid solid wastes, develop efficient electricity delivery system and help the state to stick to the sustainable development plan that is underway by avoiding unnecessary wastage of resources.

The project’s developments so far have been phenomenal. The total capacity of the project is 50.4 MW with capacity of each mill unit being 0.8 MW. There are a total of 63 windmills under the project which rotate at the Average Wind Speed (AWS) of the area, which is 5.44 meters per second. The infrastructure besides the windmills consists of the control room and transmission room on site, which allow immediate maintenance.

The project itself was started in the year 2007, but it was validated in the year 2006 by the Det Norske Veritas Certification AS (DNV). The DNV thereby becomes the DOE in this case. Enercon India, as mentioned above is the operator and therefore has the obligation of making the request to the Designated National Authority as well as the DOE. However, in this case, the request to the DNA has been made by the Tata Power Company (the hosts) on behalf of Enercon India, while the latter has made the registration request in to the DOE, i.e. to Det Norske Veritas Certification AS.

There are various factors that have been considered in order to formulate the baseline, which include – drainage, surface water, groundwater, climate and air quality, noise pollution, geology and soil and the pollution thereof, land usage, vegetation and impact on the same, existence and effect on flora and fauna and even socio-economic problems.

However, considering the above criteria, the project was given the standardised baseline ACM0002, which applies to the ‘Consolidated baseline methodology for grid-connected electricity generation from renewable resources’. This and similar baselines have been standardised based on the similar projects that have been developed in the past. It has given a pre-made framework to decide on the levels on emissions that would exist without the project. These were based on the Rapid Environment Impact Assessment carried out by the Care Sustainability.

Since the project is using renewable sources and thereby saving on use of traditional and polluting sources, the project is not likely to be the same as the baseline scenario and emission mitigation of CO2 equivalents is resulted. The emissions are therefore measurable and the reductions are additional to that which would occur in the absence of the project. The project is therefore eligible to receive CERs as it helps reduce use of fossil fuels to generate electricity.

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The plant load factor being 20% (as approved by the Electricity Board) the project approximately generates 88.301 GWh of energy. For the purpose of validation a third party report through Ravi Enteck Limited, Chennai, was also generated by the hosts. The turbines under the project are capable of generation of 1.352 kW per turbine, total 63 in number, which fall under the model number 48 of the Executive Board’s WEG models.

The crediting period of the project for consideration of CERs is 10 years while the operational life of the project is expected to be 20 years. Considering these factors the project has been allowed margin emission coefficient - 0.94022tCO2/MWh which is fixed ex-ante throughout the project’s operational life, as proposed by the Central Electricity Authority of India, while the built margin line is 0.7772tCO2/MWh. The aggregate of emissions of power industry in India was provided to the DNV by the CEA and this data was used to determine the baseline.

The investment analysis of the project is based on the expected return on equity at 23.6% while the weighted average cost of capital is taken at 13.99%. The benchmark proposed by IREDA as financial hurdle rate, has been taken at 12%. However the project has foregone this to be at a 12.30% of revenue, with the use of CDM technology. While without these CDM benefits, the percentage falls to 10.24%, which proves that the baseline of 12% returns is preferable and also that the project has a benefit of 2.06% points in revenue if CDM is followed, justifying its CDM status.

The above step to prove the CDM status becomes important especially in this case as the funding for the project is being undertaken by two foreign entities, i.e. Sweden Energy Agency and Kingdom of Spain through the Asia Pacific Carbon Fund.

The Additionality of the project having been established the ACM0002 standard provides the following formula in order to calculate the emissions reduced by the project, i.e. the CERs produced by the project;

ERy = BEy - PEy - Ly

Where,

ERy = Emission Reductions in the year ‘y’ (tCO2/year)

BEy = Baseline Emissions for the year ‘y’ (tCO2/year)

PEy = Project Emissions during the year ‘y’ (tCO2/year)

Ly = Leakage Emissions in the year ‘y’ (tCO2/year)

But, in this case, as the baseline is due to the displacement of grid electricity, it will be calculated as the product of Baseline Emissions Factor times the electricity supplied to the grid. Hence;

BEy = (EGy – EGbaseline) X EFy

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Where,

EGy = Electricity supplied to the Grid by the project

EGbaseline = Electricity supplied to the grid by modified facilities, taken zero here

EFy = CO2 emission factor for grid connected power generation in the year ‘y’

The ‘Western Grid’ of India, is taken here as the grid, for the purpose of calculations.

As the project is a wind-power project, the PEy is taken to be nil as the project does not emit any pollutants. Also, there are no possible leakages due to the type of project that is on hand, which makes the Ly nil too.

Hence, taking the Baseline emission factor (as aforementioned) as 0.94022tCO2/MWh, EGy

as 88.301 GWh, the Annual Emissions Reductions can be calculated as;

ERy = [0.94022tCO2/MWh] X [88.301 GWh]

= 83,022 tCO2e

As the project has opted for the 10 year crediting period, the following table will be applicable for the project to receive the CERs; (Table 5.1)

Year No. Project Emissions (tonnes of CO2e)

Baseline Emissions (tonnes of CO2e)

Leakage (tonnes of CO2e)

Emission Reductions (tonnes of CO2e)

1st 0 83,022 0 83,022

2nd 0 83,022 0 83,022

3rd 0 83,022 0 83,022

4th 0 83,022 0 83,022

5th 0 83,022 0 83,022

6th 0 83,022 0 83,022

7th 0 83,022 0 83,022

8th 0 83,022 0 83,022

9th 0 83,022 0 83,022

10th 0 83,022 0 83,022

Total (tonnes of CO2e)

0 830,220 0 830,220

Thus, the total value of CERs every year, for 10 year will be as follows;

Value of CERs = Number of CERs X Price per tonne of CO2e

= 830,220 X 13 € (according to the price at time of calculation)

= 10,792,860 X [66.14 (exchange rate of Euro at time of calculation)] X10

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= 7,138,397,600 INR

However, the responsibility of the operator and the host doesn’t end with this calculation. The next step, as we have seen in the CDM project cycle, is to monitor the project for changes.

For this purpose, again, the project uses the ACM0002 “Consolidated monitoring methodology for zero-emissions gird-connected electricity generation from renewable sources”. This requires monitoring of the following two aspects;

1. Electricity generation from power activity2. Operating margin emission factor and build margin emission factor of the grid, where

ex post determination of emission factor has been chosen.

The project however, uses a baseline methodology based on ex ante determination of emission factor, which makes the electricity supplied to the grid by the project the only aspect to be monitored.

The operators, Enercon India, have for this purpose employed a Quality Management System – Germanischer Lloyd, thereby ensuring proper monitoring of the project.

The local of the Khandke village have however, expressed their concerns on the aspects such as effect on rainfall, noise pollution, benefits to the locals, impact on cattle and other fauna, impact on yield of grains. But after having duly answered these questions, the operators were given a green signal by the village stakeholders and thereby the report could be sent for authentication to DNA and subsequently to the DOE.

It is important to note that there is no public funding in the CDM project and therefore the only stakeholders in the project are the residents of the corresponding villages in the gird in which the project supplies electricity. The above mentioned concerns were raised by the representatives of residents of these villages who were invited by the Tata Power Company to comment on the project, on behalf of the Enercon India.

The case of 50.4 of Tata Wind Farm can be summarised as follows;

Project Title 50.4 MW Tata Wind Farm - Maharashtra

Host Party India (Authorised Participant : The Tata Power Company Limited)

Operator Enercon India Ltd.

Other Parties Sweden Energy Agency and Kingdom of Spain

Methodologies used (standardised) ACM0002 Ver. 9

Emission Reductions by the project 83,022 metric tonnes of CO2e

Scale of Activity LARGE

Crediting Period 01 June 2010 to 31 May 2020

(Table 5.2)

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Joint Implementation - Joining Hands:

Out of the three “Flexible” mechanisms offered by the Kyoto Protocol, CDM is considered to be the generator of CERs, ET (Emissions Trading) is used to trade these CERs and quite different from these two, the Joint Implementation (JI) is considered to be the exchange of emission allowance in form of Emission Reduction Units (ERUs) and is perhaps the least popular method among the three proposed.

JI has been included in the Kyoto Protocol under the Article 6. This article defines what JI means in term of the Annex I countries that have already been mentioned in the context of CDM. However, unlike CDM, JI does not include a Non-Annex country. In the case of JI the host is always another Annex I country.

JI can therefore be defined as that mechanism under which an Annex I country can invest in a project to reduce emission/pollutants, in another Annex I country. The Protocol mentions this as a way reducing the emissions in another country instead of reducing the emission in the investing country itself. This is primarily done because it is believed that it is much cheaper to install emission reducing equipment and thereby reduce emissions in a few Annex I countries while it is much costlier in comparison in other Annex I countries.

Financial and Technological

Reduced emissions received by Country 1 Support

(Fig. 6.1)

The same emission reduction goals that have been mentioned in the CDM section also apply to JI. It is important to note here that, while CDM and JI are different tools provided by Kyoto Protocol, they’re both the mechanisms used to achieve the same objective, the same goal, i.e. to reduce the emissions by 5.2% by the year 2012 as compared to the levels in 1990. JI is thus a tool that helps countries reduce their emissions to meet the emission reduction targets allotted to them.

Joint Implementation, as the name suggests, is joint efforts by two Annex I countries to adopt an emission reductions project. It is a medium through which while one country reduces

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Advanced Country 2

Emissions Reduced Joint Project

A

Advanced Country 1

emissions by using efficient techniques, the other benefits by the emission reductions which are available to it to increase its emission permit in terms of AAUs (Assigned Amount Units). The mechanism therefore is a medium for these countries to meet the target set for them the Kyoto Protocol.

Eligibility Criteria for Countries:

The basic condition is that the country has to be ratified under the Kyoto Protocol. The secondary condition is that the country has to be listed under the Annex I of the Protocol and should comply with the following criteria:

1. It has to appoint an authority similar to the Designated National Authority under the CDM process. This authority is called Joint Implementation Focal Point or Designated Focal Point. It is responsible for the supervision, monitoring and approval of the concerned JI Project.

2. Apply to the project a set of ‘National Guidelines and Procedures’ for JI which should be in accordance to the nation’s legislations. These may be formed with the guidelines and drafts provided by the Joint Implementation Supervisory Committee and UNFCCC. These guidelines should cover areas such as the performance of the project, monitoring procedure for the same, verification of the reductions in emission, consideration of comments of stakeholders and other similar issues.

Joint Implementation, just like the CDM, is a system based on the “Assigned Amount Units” or AAUs. On the basis of these AAUs, following further conditions have to be fulfilled:

1. Its AAUs have been calculated according to the directives of the UNFCCC.2. It has a national body for:

a. Estimation and reduction of anthropogenic sources of GHGsb. To register and verify the JI project

3. It has presented to the required authorities, the documents relating to the national inventory in order to ratify itself to the ‘First Commitment Period’ and the eligibility of the same should verified.

4. It has justified the calculation of the AAUs by providing sufficient information on the reasons for additions to and subtractions from the AAUs assigned to it under the Kyoto Protocol.

By enforcing such requirements, the JI tries to protect the fidelity of the emission reductions transactions and acquisition of ERUs by such countries, which are resulted from a JI project.

Difference between Joint Implementation and Clean Development Mechanism:

Though these systems both result in carbon credit trading, there are certain differences in the working and outcomes of both. There are four main distinctions between Joint Implementation and Clean Development Mechanism. The following table will explain the same:

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Point of Distinction Joint Implementation Clean Development Mechanism

1. Parties involved It occurs between two Industrialised or developing countries listed under the Annex I of the protocol and have commitments to the Kyoto Protocol.

It occurs between a party with Kyoto Protocol commitment, i.e. a Developed or industrialised country listed in Annex I, with a developing or non-industrialised country not listed in the Annex for a commitment.

2. Type of emission reduction units

Under JI the parties have a captive environment under which the commitment has been made to reduce the emissions of an existing project up to a certain level and based on the AAUs of these countries, they’re allocated Emission Reduction Units (ERUs) which are tradable carbon credits under JI.

CDM applies to new projects that have adopted clean and non-polluting production techniques at the time of commencement itself. Based on the emissions reduced in terms of the ‘baseline’ formulated, they’re issued CERs or Certified Emission Reductions which are tradable carbon credits under CDM.

3. Flexibility in parameters

JI uses a baseline scenario based on which the project has to reduce the emissions to certain amount. The methodologies to be used, the definition of baseline scenario etc have the flexibility of discretion of the developer/operator.

CDM also uses a baseline scenario in order to reduce the emissions by considering ‘Additionality’ like in case of JI. However, the Executive Board has strict guidelines and norms regarding the methodologies and the definition and calculation of baseline scenario, making it comparatively lesser flexible.

4. Issuance of credits In the case of JI, there is not specific authority that issues the credits, but it is the host party that issues the ERUs to the investing party, based on the amount of emission actually reduced by this joint project.

In a CDM project, the EB, after rigorous assessment and verification by the DNA and DOE, issues the CERs, in amount which it might find the project eligible for and the hosts or the operator has no control on issuance process.

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(Table 6.1)

The JISC:

JISC stands for ‘Joint Implementation Supervisory Committee. It is a committee which can be compared to the Executive Board in the CDM mechanism. Its main function is supervision and control of the procedure of verification of the JI projects as well as the ERUs that are assigned under such projects.

JISC was formed in the year 2005, December, when the First Conference of Parties under the Kyoto Protocol took place for the discussion of JI and its prospects. JI being a highly flexible mechanism, the scope of this committee is superficial, albeit important;

1. The first such function is to review the project design if such request is made, or the situation is found to be relevant for a review or if a stakeholder comment desires the JISC to undertake a review.

2. The second is that it provides accreditation to the independent entities that will carry out a third-party review of the JI projects.

3. Another important function is to develop and review various standards and procedures as well as guidelines which are likely to improve the process of a JI project or make it more bona fide.

4. The last of the functions of JISC is to make an Annual Report on the developments in the JI and also to provide information about the activities carried out during the year to the Conference of Parties.

The Role of the UNFCCC Secretariat:

The guidelines that are provided by the protocol for JI request the UNFCCC secretariat to help the Joint Implementation Supervisory Committee by undertaking the following actions;

1. The first action is to help the JISC to conduct meetings, seminars, workshops, roundtables and other side events and outreach activities.

2. The protocol also requests the secretariat to provide sufficient and substantial help to the JISC in term of coordination and management to any work that is connected to Join Implementation.

3. The most important function is that it maintains an information system for JI which is the source for all JI related data and it also develops the software and programs required for such management. It is also responsible for maintenance of the JI website.

4. If the parties involved in the JI project require help in implementation, the secretariat helps them manage the process and the flow of the JI cycle and conducts completeness assessment of the projects if the need arises.

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5. It develops and maintains the strategies to communicate with the hosts, operators and the JISC.

6. It also communicates with the stakeholders of the projects in order to verify the stakeholders’ views on the project. It does this by interacting with the public in general and the media/press with any inquires or queries that they may have.

7. Lastly, it is the supervisor of fee collection from the parties in the JI, which it uses to clear the administrative expenses that it may incur while undertaking the above mentioned responsibilities.

Track 1 and Track 2 Projects:

The projects under the JI are further segregated into Track 1 and Track 2 projects. The following table will provide the distinction between the two types, thereby providing an understanding of the same;

Criteria Track 1 Track 2

Requirements for the host country

If all the eligibility criteria given by the Conference of Parties are fulfilled by a project design, the project design can be called a Track 1 project.

If the project design only partially fulfils the eligibility criteria given by the Conference of Parties, then such a project is called a track 2. This shows that JI system is very flexible.

Approval The project approval and the verification of the ERUs are carried out by the participating host and investing countries.

As all the criteria are not fulfilled by the project, the project approval and the approval of the ERUs will lie in the hands of the JISC

(Table 6.2)

Thus, the JI mechanism provides flexible systems for the projects to be implemented even though all the criteria for the eligibility are not fulfilled. It thereby becomes an important tool to motivate developed and industrialised country to reduce their emissions even though they might not want to incur additional costs by complying with all the conditions.

Methodologies:

The Joint Implementation further portrays its flexibility while allowing the project developers to select the methodology that they desire to follow in the project development process. This flexibility is the form of two options provided to these developers based on guidance documents that were adopted by the Conference of Parties. These are:

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1. The first of the options is to adopt a project specific method. In this case the project adopts a newly created methodology, especially for setting up the baseline, which is in accordance with the project guidelines adopted by the Conference of Parties. However, a combination of approved and new methodological tool developed may be used by the project.

2. The second option is to follow a multi-project emission factor. In exercising this option, the project developers will have to follow the methodologies, especially the method to set up the baseline on the basis of an approved CDM methodology. When using these CDM methodologies, duly credited by the Executive Board of CDM, shall have to be practised as is, i.e. all the clauses and descriptions under the methodologies have to be followed strictly without any deviation.

An example of such methodologies is the ACM0002 methodology used by the Tata Power Company in their Wind Power Project aforementioned in the case study.

Project Cycle:

The major part of the Joint Implementation Project Cycle are similar to the CDM Process, however, there are certain distinctions that need to be cleared, without repeating the explanation for the phases which are same as that in case of CDM and therefore obviating the repetition of such explanation.

The following steps are to be carried out by the operator and the host party;

1. The first step is to create a project design document (PDD). This step has been discussed in detail in the CDM process. However, instead of the DNA, the DOE and the EB verifying the PDD, the PDD in case of JI is verified by the JIFP and the JISC. It has to be proven and established that the JI project has ‘Additionality’ in terms of emission reductions, like in the case of CDM.

2. In the next step an Accredited Independent Entity (AIE) reviews the PDD in order to find out whether the estimates made in terms of the emission reduction that have been made in the project are trustworthy and accurate. It also reports whether the required processes for monitoring the activities of the project during the implementation phase have been properly mentioned in the PDD. The baseline formulation is same as in the case of a CDM project but it is however more flexible as mentioned in the methodology section above. After this, the host country gives its letter of approval and with this the PDD is published for comments of the stakeholders. After receiving the comments of the stake holders, the same have to be incorporated in the PDD and after such incorporation the PDD is again thrown open for public comments for 30 days.

3. If necessary or if requested, the next step would be a review by the Joint Implementation Supervisory Committee. This becomes a mandatory step in case the project type is ‘Track 2’. If no such review is conducted, the project acquires the

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status of JI project within 45 days of after the completion of the 30 days of allowance to public to comment on the PDD.

4. The AIE intervenes in the project from time to time, as found necessary, in order to assess and monitor the development of the project. This shall go on till the ‘First Commitment’ period gets over in 2012.

5. If there is a verification disregard by the AIE, the host country and the operator may finalise the results on the ERUs generated and transfer these ERUs to the investing operator on the basis of this verification report.

The following figure will make the JI process clear;

(Fig. 6.2)

Determination:

Determination is the stage at which the JI project that has been proposed by the parties is reviewed to find out if the project is in accordance to the norms and guidelines of JI. Such an assessment has to be carried out before the project can be commenced. Such verification is neither allowed to be carried out by the participating entities or by the JISC, but is outsourced to an independent 3rd party verifier. These can be of two types under JI as follows;

1. AIEs: Accredited Independent Entities or AIEs or the 3rd Party, is an independent company. They have important functions in relation to JI, the first is to review the project design in order to determine whether the project is according to the prescribed norms and guidelines, which is called determination and is carried out before the commencement of the project. The second function is to review whether the reductions in the GHG that the project emits, are actually achieved by the project. This step is called the ‘Verification’ phase. If there are no hindrances in the

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>Filing of PDD Forms >Approval from host country >Setting up Baseline >Publication of PDD for 30 days

verification, the ERUs created by the project could then be issued. AIEs, by undertaking the above activities ensure the environmental integrity of joint implementation. A company can only perform the above functions and become an AIE only if the Supervisory committee approves them. This accreditation shows the entity’s competence, impartiality, compliance with its organisation and operations, by completing all accreditation requirements.

2. DFPs: All the parties that are involved in a JI project are bound by the JISC to submit to it the information regarding its Designated Focal Point and the guidelines and statutes being followed in their respective countries for acceptance and approval of JI projects. Taking this into consideration, a Designated Focal Points have been given the powers to approve and verify the projects and also authorise legal entities to be able to participate in such a mechanism. This means the project operator has to first take the consent of DFP in order to be able to carry out the project. These DFPs involved in JI mechanisms, especially those connected with the party in the host country, are involved in the verification of the documents related to the JI project before the approval process begins. They also carry out monitoring of the GHG emissions to ensure that the standards are being met by the JI project and this step is carried out during the operational period of the project. The host party, before sending the project to the UNFCCC secretariat gets it verified and approved.

ERUs:

The emission credits generated by a JI project are called Emission Reduction Units or ERUs. These allotted units are permitted to be traded with the government of the concerned country or with private companies who are interested in such an investment. The underlying objective is immediate need to reduce the GHGs. The Kyoto Protocol only requires developed and industrial countries to fulfil the commitment to reduce the GHGs. Therefore, ERUs can only be traded between two industrial countries, while other countries, i.e. developing countries may trade in CERs.

The amount of ERUs that can be certified by the parties as claimed to be reduced by the project, should never exceed the total reductions that have actually been affected by the project. For this very reason, the verification process has been included in the JI project cycle. However, if the JI project is a Track 2 Project, then the verification of the actual emissions is done by a 3rd party AIE and DFP, unlike the Track 1 projects, where the operator and /or the host country may provide verification through proper documentation and corroboration. Additionally, the assessment of the AIE may be further reviewed and challenged by the JISC, if found necessary.

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Of benefactors and beneficiaries:

The proceeds from the sale of the ERUs provide an extra cash flow stream to both the parties involved in the JI project. The UNFCCC has stated that the revenue from such cash flows every year is around 20-40% of the total cost of investment in the project. Also, because the parties are trading in carbon related derivative, the inherent risk of commercial lending is obviated and this will help the project to increase its capacity to bank. The perspicuous benefit that will result from this is that the creditability of the project in banking circles will be boosted. The local investors’ funds can therefore be leveraged into eco-friendly projects.

The transfer of technology and know-how of international best practices is perhaps the most important benefit of exercising JI for the host country. This allows improvement in production, productivity and efficiency on one hand, while balancing the same with the reduction in GHG emissions. Though a long term benefit, such mitigations help in the country’s sustainable development plan.

Also, as both the parties involved in JI must be Annex I countries, they can avail JI mechanism in order to meet their emission reduction commitments under the Kyoto Protocol. Another aspect largely feared in implementation of JI was the lack of funding. Taking an initiative into this problem, the International Monetary Fund’s Carbon Funds have done a commendable task in financing the JI projects in both public and private sectors with focus on renewable energy and energy efficiency projects.

Active Countries:

By establishing their own Designated Focal Points, most of the countries involved in JI projects have increased the scope of their activities. Of these, Czech Republic, Russia and Ukraine have done an outstanding job in development of JI projects and are leading the other in terms of number of JI projects registered. In terms of purchase of the ERUs generated from such projects, Denmark, Netherlands and Austria are the major buyers. On the other hand, Romania, Bulgaria, Poland and Czech Republic are the leading ERU sellers.

Around 28% of the projects are energy efficiency and fuel switching projects while 13% are Biomass project, 12% are wind power projects while 10% are hydro power projects. Next in line are the Nitrous Oxide Projects, which account for 8% of the total. As mentioned earlier, Russia and Ukraine are making constant efforts in using JI to the fullest and therefore the JISC has predicted that the number of gas, power and oil projects is bound to increase in the coming years. The following graph represents the classification of JI Projects in various sectors. (Fig. 6.3)

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.

Most of the European Nations involved in JI are vigorously using this mechanism. The Following Table will show the number of projects being undertaken by each country;

Serial Number Host Country of the JI project

Number of Registered Projects with UNFCCC

Track 1 Track 2 Total

1 Czech Republic 85 0 85

2 Ukraine 39 16 55

3 Bulgaria 21 1 22

4 Germany 21 0 21

5 Russia 17 1 18

6 France 17 0 17

7 Poland 15 0 15

8 Romania 14 1 15

9 Estonia 12 0 12

10 Hungary 11 0 11

11 Lithuania 0 10 10

12 New Zealand 6 0 6

13 Spain 3 0 3

14 Finland 3 0 3

Total 264 29 293

Source: UNFCCC (Table 6.3) Information as on 1st May, 2011.

Concerns facing the existing JI mechanism:

The current 2-track system of JI has multiple loopholes. These are as follows;

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1. Due to differences in processes of different nations with regards to the Track 1 project, the work burden on policy makers of these nations’ increases and transaction cost and knowledge barriers are faced.

2. As the subsidisation of Track 1 projects has been carried out, the financing by JISC has become unsustainable.

3. The policies and procedures of the involved parties are not very transparent.4. Due to varied tracks and many processes, there is dispersion in the momentum of the

JI projects.5. Due to insufficient control of Track 2 projects, they may end up being huge and may

not be catering to the needs.

The following case study will make the concepts mentioned in this section of the report crystal clear.

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Case: Heating Up a Whole City in Ukraine:

Donetsk city of the district by the same name in Ukraine has a temperature range from -7oC to 19oC. The city therefore requires external heating for almost 183 days every year in order to maintain the average indoor temperature around the range of -1to 8oC. The municipal corporation of the area therefore has to use boilers in order to provide heating solutions to the households in the city. However the cost incurred and the pollutants emitted in order to cover approximately 948,412 residents and to an area spread over 358 square kilometres, both become very high.

(Fig. 6.1.1)

At the time when the city used the traditional boiler, the total emissions of the project were not more than 45,000 CO2 equivalent units, which would make the project a small scale project. This necessarily means that the annual emission reductions by the project will be less than equal to 60,000 tonnes of CO2-equivalent. As the project is trying to reduce the emission through efficient technology for heating solutions for the city, the project is therefore ‘Improvement of Energy Efficiency’ project.

The project is being handled jointly by the Municipal Commercial Enterprise of Donetsk city being the host party, along with VEMA SA of Switzerland being the investing and operating party. Both the parties are from countries listed under Annex I of the Kyoto Protocol, making them eligible for a Joint Implementation project such as this one.

The crediting period of the project is from the January 1, 2005 to December 31, 2012. This makes a total crediting period of 7 years. Though, the actual life span of the machinery involved is on an approximation between 20 to 30 years. Therefore on the request of the host and the operating parties, the crediting period may be extended as far as reasons for the use of the machinery over the above mentioned life cycle if justifiable.

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The following boilers are being utilised by the project in order to boost the efficiency which before the project lay between 70 to 94%. The increased efficiency will result in an increase in the lower boundary of the efficiency window, raising the bar to 90-93%;

1. KSV – 1502. NIISTU3. Viessmann4. REX – 95, 405. APK 2102 GN6. Mini-Don

(Fig. 6.1.2 – Mini-Don) (Fig. 6.1.3 – REX - 95)

The illustrations show the most widely used boilers under the project.

The project has taken the liberty provided by the JI mechanism in terms of forming its own baseline criteria which can be explained with the help of the following illustration;

Fuel Fuel

Heating & Hot Water Energy

Consumers of energy

(Fig. 6.1.4 – Baseline versus Project boundary scenario)

The boundary of consideration in the baseline scenario is taken as the GHG emissions in terms of the electricity generated by the power plant, the electricity consumed by the boiler, the and the further GHGs in terms of CO2 generated due to the heating of water in the boiler and its related processes.

There are some leakages in the system in terms of the CO2, CH4 and N2O which are generated by the project’s external activities. However, as there is sufficient reason that the

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Boiler Energy Power

Plant

Heating & Hot Water

Heat distributions main

amount of such emissions cannot be determined, such leakages, especially in terms of transportation and fuel production, have been excluded.

Though using a firsthand method for the baseline methodology, the project uses a pre-specified monitoring plan known as ‘Rehabilitation of Heat Supply Systems’ – AM0044. However, as the project is directly linked to weather effects, the project requires adjusting the baseline as may be required, subject to change in the environmental conditions.

The monitoring plan, in such circumstances, has been structured around the use and savings in the use of fuel. The difference between the baseline and project scenario will show the amount of fuel consumption, a saving on which will result in the generation of Emission Reduction Units.

The Carbon Emissions Factor or the CEF for the project is considered at the 2005 level, i.e. the level of CEF at the time when the project commenced. This value is taken at 0.896 tCO2e/MW*hour. Using this value, the CO2 conversion factor for the 1000 m3 of gas used as fuel in the standard process, can be calculated to 1893 tCO2. Also, the baseline consumption of the natural gas per year, as a fuel, in Nm3/year is valued at 67380.

Using the above mentioned parameters, the following formula can be used in order to calculate the total ERUs generated by the JI project;

ERU = Ʃ {E I, b – E I, r}

Where,

E I, b = Boiler house index for base year and

E I, r = Boiler house index for reporting year

Thus, the difference between the index of the baseline and the index of the year under consideration will give a rough estimate of the ERUs that can be generated by the project.

Based on this formula the baseline and project emissions can be used to calculate the estimated emission reduction units. The following table shows the amounts as estimated by the host party, i.e. the municipal commercial enterprise of Donetsk city;

Year Baseline Emissions (tCO2 Equivalent)

Project Emissions (tCO2 Equivalent)

ERUs (tCO2

Equivalent)

2005 131,464 98,240 33,224

2006 131,464 94,538 36,926

2007 131,464 91,849 39,615

2008 131,464 90,862 40,602

2009 131,464 89,890 41,574

2010 131,464 88,013 43,451

2011 131,464 83,201 48,263

2012 131,464 83,201 48,263

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2013 131,464 83,201 48,263

2014 131,464 83,201 48,263

2015 131,464 83,201 48,263

2016 131,464 83,201 48,263

2017 131,464 83,201 48,263

2018 131,464 83,201 48,263

2019 131,464 83,201 48,263

2020 131,464 83,201 48,263

2021 131,464 83,201 48,263

2022 131,464 83,201 48,263

2023 131,464 83,201 48,263

2024 131,464 83,201 48,263

Total (tCO2

equivalent)2,629,280 1,718,206 911,074

(Table 6.1.1)

Therefore, as seen in the above table, the Boiler house’s Baseline Index is equal to 2,629,280 tCO2 equivalent. Also, its Reported Index for emissions is 1,718,206 tCO2 equivalents. Therefore, substituting these values in the formula to find ERUs, we get;

ERU = Ʃ {E I, b – E I, r}

Therefore,

ERUs = 2,629,280 – 1,718,206

Hence, ERUs = 911,074 tCO2 equivalents

Unlike the prices of CERs that are decided based on the market prices in the EU ETS, the price per unit for the ERUs is decided by the host and the operating parties among themselves. However, before the final issue of these to the operating/investing party, the prices and the authentication of these ERUs has to be made.

In the case of Donetsk city’s endeavour, the verification of documents, the verification of the ERUs and the monitoring of the project (i.e. being the designated focal point of the project) are the three-fold functions that are carried out by the Bureau Veritas.

It can be safely said that the case portrays how the JI and CDM mechanisms are almost similar and parallel systems, except for the difference in the four major areas – parties involved, baseline formulation and related liberty, type of emission reduction credits and the price, approval and issue of these emission reduction credit, all of which can be contrasted with the help of this case and the case of Tata Power Wind Farm case.

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Emissions Trading:

The third and the most widely used and older than JI and CDM technique of carbon credit trading is emission trading. The CERs produced from the CDM projects or the ERUs generated from the JI project can be traded to the parties other than those involved in these projects along with the credits generated under the trading system.

The Basics:

The liberal policy of this mechanism allows trade of the excess credits that may have been retained by the parties and allows trade of emissions saved under a capping scheme as well. Under this, a cap/ceiling is laid on firms allowing them to emit a specified number of units of pollutants only. Against these they will hold carbon credits. If the firms produce lesser emissions than they are allotted, they can sell these extra credits to the firms/countries that need to increase their allotted amount of emission permits in order to meet the quota to be achieved by them.

The underlying concept of this method is that of pollution’s affects on the entities other than the ones creating the pollutants, are not the elements of market and its mechanism, i.e. the demand and supply. Such effects are called externalities. Pollution’s externality is dealt with by cap-and-trade emission trading techniques such as emissions trading.

Defining Emissions Trading

In their 2009 book – ‘Linking the Tradable Permit Systems: A Key Element of the Emerging International Climate Policy Architecture’, Judson Jaffe, Matthew Ranson and Robert Stavins define ‘Emissions Trading’ as, “A cap-and-trade system constrains the aggregate emissions of regulated sources by creating a limited number of tradable emission allowances, which emission sources must secure and surrender in number equal to their emissions.”

This definition necessarily sites that a surrender of the allocated permit has to be made in order for the trade to occur. This means that the while the party surrendering the permits will lose the allocated allowance to emit GHGs, the party receiving these would benefit by gaining the same rights and increase their allowance thereby. It thus becomes a transferable instrument with the difference that a price is paid to own this instrument by both the parties.

The Benefits

The main benefit of this technique is also the reason for its wider use, which is that the cost of meeting the Kyoto Protocol’s specified emission targets, in comparison to CDM and JI, become much cheaper. With each trade in the credit, the seller also loses the traded units from its Assigned Amount Units and thus has a lesser emission capacity. NGOs and Non-

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polluting manufacturing units are also eligible to purchase and sell such allowances, pushing its price higher in the market and allow the seller to reduce the tax payable. On the other hand, the buyer has to make payment in order to avail the benefits of the credits and therefore, the buyer is made to pay for the extra pollution that is generated by them.

Saved emissions

Allotted Cap

Actual Emissions

(Fig. 7.1)

The Economic Impacts

Economically speaking, emission trading is preferred over the taxing systems and the regulation systems. While taxing and regulatory systems focus on penalising the involved parties for non-compliance, emission trading focuses on rewarding for compliance and doing better than the set emission cap. Also, the regulatory board only has the obligation to set up a ceiling and how to achieve this set level is a liberty given to the manufacturer and polluters. This will allow the firms to choose the least costly method, allowing them to stick to their plans for profits and break evens while also complying with environmental standards set by the government. This will also boost the need to develop best industry practices in order to reduce the cost of such operations, which will further lead to development of better and efficient non-polluting technology. It thus becomes an example of learning curve whereby the technology is improved over a period of time and which will ultimately lessen the cost. The following graphs will show this phenomenon;

Y axis =Cost/ Average cost curve

Efficiency/ Learning curve

Better

Technology

0 Time taken ===> X – axis

(Fig. 7.2)

The above figure represents the fact that as the time passes and a better technology is developed; the average cost comes down at the point where the best practices in the industry are achieved. When this point where the average cost and the best practices in form of learning curve meet, the involved firm would not only be at a cost advantage but would also have the highest level of sustainable development, i.e. the least amount of polluting

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Country 1

Country 2

Emissions

saved

Money

Carbon Credits

emissions. Thus, the emission trading methods are beneficial for sustainable development as well as for achieving greater economies of scale.

The Emission Trading Paradox: The other side of the coin

Also known as the Green Paradox, it states that as the system for trading in the carbon becomes more efficient, with passage of time it acts as a green policy that is like an expropriation to the people who own fossil fuel extraction facilities and would compel them to extract more resources currently because of the future speculations, which will increase the amount of pollution in the current scenario.

Thus, Hans-Werner Sinn in this paradox has implied the importance of a regulated policy for emissions trading, in absence of which, the paradox will lead to more pollution rather than reducing it. Hans writes in his research paper – “Strategies to reduce the demand for the carbon credits simply depress the world price of the carbon and induce the environmental sinners to consume on what the Kyoto countries have economised on. Even worse, if the suppliers feel threatened by a gradual greening of the economic policies in Kyoto countries that would damage the future prices, they’ll extract their stocks more rapidly and hoard them, thus accelerating global warming.”

The Various Aspects of Emission Trading Systems

The emission trading system includes all the credits that are generated by CDM, JI or offset of credit approach, which can be traded in the same way in which the spot trading is done in stock markets. While the cap and trade systems of CDM and JI put a ceiling on the amount of emissions, there is no such emission cap in the case of credit approach, whereby the firm wanting to generate carbon credits, irrespective of whether in any of the mechanisms and whether or not from an Annex I country, may form a baseline and reduce the emissions as compared to these levels in order to receive the said credits.

From the scenario of world trade, the countries may choose either to apply the direct taxation method or apply the indirect taxation through emission trading. However, in both the cases, there will be a difference in the cost of all the involved countries as the cost per additional unit eliminated will be different for each country depending on many factors including condition of the economy, time value of money, statutes, market conditions, cost of infrastructure and it’s availability, which are the major ones.

The instruments of the above mentioned nature being circulated in the market can be categorised as follows;

1. Quantity instruments; which allow the quantity of carbon equivalents represented by the instrument to be constant, while the prices may vary. These face the wrath of

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market conditions and the prices are very unstable and volatile, similar to the shares/stocks in their respective markets.

2. Price instruments; where the price of the instrument is kept constant but the quantity represented by the instrument is allowed to vary according to the economic conditions that currently exist.

3. Safety Valve; where a blend of the quantity and price instruments is made in order to form an emission cap and permit trading system whereby the maximum price of the instrument is capped. Due to this ceiling on the instrument’s value, it is called a ‘safety valve’, which allows trade to occur without breaching the circuit of gains that are allowed in the exchange in which such instruments might be listed.

The main features of the cap and trade and credit schemes are as follows;

Type of Scheme Cap and Trade Credit

Cap on emissions Units of emissions that may be released during the credit period

Implementation of Cap Allowances up to cap:a) Free allocations to

participants and/orb) Sale of allowances

Baselines up to cap:a) Free allocation to

participants

Trading Mechanism Allowances are tradable Baseline is not tradable, credits are tradable

Offsetting Emissions Allowances covering total emissions

Credits covering emissions only in excess of baseline

(Table 7.1)

The General Agreement for Trade and Tariff mentions that border adjustments need to be made while trading in these credits. This means that the duty and responsibility to be accountable for the reduced emissions which the permits represent, is on the producer and the producing country. However, this has been strongly opposed by countries including India as the import duties on international markets due to such a policy amount to $50 at the minimum, giving an undue advantage to developed countries while the developing countries may have to suffer a substantial loss on import deals for carbon credits and permits.

The Markets

Just like DOW and SENSEX are market places for the trade of listed shares and stocks, there are markets for spot and future trading in carbon credits as well. These include, Chicago Climate Exchange, European Climate Exchange, European Union Emission Trading Scheme, NASDAQ OMQ Commodities Europe, Power-Next, Commodity Exchange Bratislava, European Energy Exchange, Multi-Commodity Exchange of India etc.

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These transfers, when undertaken, are to be certified by the UNFCCC and in case of European Union, they’re further to be certified by the EU ETS. The above mentioned market places provide spots, futures as well as options in carbon trading. This helps to regulate the liquidity of such markets. The prices of a credit are quoted in Euros as major transactions in credits are carried out through the EU ETS. The trade of other GHGs is also allowed, however this is only done by converting them into carbon equivalents using the GHG’s GWP, i.e. their Global Warming Potential.

With emissions management becoming one of the fastest growing segments in the capital markets, Barclays Capital has predicted that it’ll be the world’s largest market with carbon being the most traded commodity by 2020. These carbon markets therefore become increasingly more important.

The following case study of European Union Emission Trading Scheme will make clear the concepts of the market place and trading for carbon credits.

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Case: The European Union Emission Trading Scheme:

The underlying objective of setting up a common emission trading system for the European Union was to make available to the masses a liquid platform to trade the CERs, ERUs and other such permits. Doing this, it will enable the EU to achieve the various points laid down to it in the Kyoto Protocol. Through application of such a scheme, the EU saves more than € 3.1 billion which would otherwise have brought additional costs to the EU. This scheme was formed by the European Commission and approved by the EU members and the Parliament of Europe and was formed based on six principles which include –

A Cap & Trade System, focus on Carbon Dioxide emissions from industries, functioning in phases and reviews to be done from time to time, the AAUs and total allowances to industry may be reviewed on a regular basis, the fulfilment of the decided framework is very strict and the market is established for the European Union but is actually trading in credits generated from around the world through CDM and JI projects.

The Scope:

A large gamut of industries and GHGs are covered by the EU ETS. Though during the first of its functioning cycles from 2005 to 2007, the EU ETS has only traded in the CO2. However, 2007 onwards it has started trading in other GHGs by converting them into CO2 equivalents. The major credits trade was seen in the sectors like energy, power and heat generation, oil refineries, iron and steel, glass, cement, bricks and paper industries. The amount of pollution and the size of the firm decide whether they could be included in the ETS or not. It has over 11,000 units and 25 member states of the Union are registered with the ETS and responsible for 45% of the world’s total carbon credit trading.

The Common Trading Currency:

The only common trading option which forms the basis of the EU ETS is the ‘Emission Allowance’. As mentioned in the definition of carbon credits, every emission allowance within the ETS represents a right to emit 1 tonne of carbon or carbon equivalent. Every nation within the European Union has a national plan under which every unit that is registered under the ETS has a distinct amount of credits allocated to it and is permitted to emit only the corresponding amount of emissions which the credits represent. Because of this ceiling created by the ETS, the paucity of credits is created which helps the trading within the ETS to gain momentum. The registered units that create pollution below the assigned levels are permitted to sell the saved emission units through the ETS at a price which is quoted in Euros at that moment by the ETS. This price is decided by free market mechanism of demand and supply. On the other hand, those wanting to increase their emission allowance will buy these credits through ETS. But the condition here is that the unit should be operating with a carbon saving technology and in process of trying to reduce its emissions.

The credits can be bought at a discounted price, if offered or at the market price, whichever is lesser. Due to this factor, cost benefit can be achieved whilst trying to reduce emissions, thus encouraging the parties involved to improve their standards in emission reductions on a

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continuous basis. The credits are only issued to the units that are registered with the EU ETS. However, any other entities, including individuals, who want to purchase these credits, can do so through the open market of the ETS system but in spots and futures trading, but no credits are assigned to them for any emission reductions on their part.

Allocations:

The ETS has laid down a strict framework for the member of the European Union to follow. But, it also requires each member country to make and submit a NAP or National Allocation Plan which is a very unbiased and objective rulebook for each nation to be followed in reference to the ETS. Some of the major rules laid down by the ETS in its framework are;

- The NPA has to portray how much is the targeted and the actual levels of emissions of the units in the member country and the amount of emission credits that have been allocated to each of these units. Also, a justification for more or less credits being issued to a specified unit has to be given.

- Allocations of carbon credits to the units registered with the ETS must provide with corroborations of their emission reductions and such allocation should not be more than what is required by the unit or what the unit deserves according to its emission levels.

- If a nation or a registered unit intends to use their credits from JI or CDM projects and not trade them, these have to be corroborated with budgetary provisions.

The ETS has its own advisory and supervisory commission known as the European Commission, which appraises the NAPs and issues new norms if necessary and also certified these NAPs as well as the trades done under the ETS.

Strict Fulfilment:

Giving a centre-stage to the economic incentives, the ETS has provided with a rigorous framework that ensures total fulfilment by all member countries. Out of the total allowances allocated to each unit, every registered unit has to surrender the amount of allowances that corresponds the number of units of emissions that the unit has actually released during the year and these surrendered allowances are cancelled. If any registered unit has allowances remaining after such cancellations, then these can be traded with another unit. However, of the verified emissions are more than the allocated allowance, then the unit is liable to pay a fine of € 100/tonne of emission. Any unit purchasing the credits to cover the short comings of the year that follows is named in the ETS’s publication and is blacklisted. Along with this, there are also penalties for non-compliance with and infringement of any other norm that has been set by the EU ETS.

Scrutiny and Exposure:

It is important to understand that permits and allowances are not the same, though they are usually used interchangeably. Permits are decided amount of emissions that the unit requires for monitoring and exposing its project. Allowance on the other hand is simply the unit which can be traded in the ETS. The ETS trades in a total of six GHGs and every unit registered

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under the ETS has to obtain a permit from a designated authority in its country for the total emissions permitted to it in terms of all these six GHGs. Without the ability of the operator to monitor the project and provide with a quantitative report of the same at the end of every calendar year, the units are not allocated the carbon credits. Just like the CDM and JI projects have guidelines to be followed in terms of monitoring and reporting the projects to their respective authorities, the ETS too requires the registered units to follow a set of predetermined norms, which are common for all. These yearly report have to be published and made available to the public. If on verification the compliance of the unit is found to be faulty, the unit faces the risk of being denied the credits for that year.

Registration:

Just like the DMAT accounts in Indian share market scenario, there are no printed or physical allowances in the ETS system, but an electronic account is given to each registered unit, using which it can carry out the trading. The statutes regarding this system has been set up keeping in mind the standards provided by the UN, by the European Commission. These also include tracking of the credits with special attention to the credits from the CDM and JI projects, if they are being traded.

The system concerns itself with the transaction’s quantum and its ownership but is not concerned with the type of transaction. Just like SEBI tracks individual transfer log of each individual transaction in the share markets, there is a similar central authority with the European Union which monitors every transaction of carbon credits in the ETS. This allows an objective and transparent system to be established.

How they trade it...

The major drawback in the ETS system is that it does not specify the place of the trade or where, when and how such trade and the resulting transfer should take place. However, this can also be perceived as an added advantage to the traders as a high degree of liberation is available.

The parties involved in the trade are free to choose whether they wish to directly trade with each other or should they trade through market intermediaries who have been registered under the ETS, like exchanges, brokers, agents and other similar authorised entities. These authorised entities are therefore able to take the advantage of the ever expanding significant market.

The elements of market mechanism, i.e. the supply and demand for the credits, are used in order to decide the price of every unit. The volume traded in the ETS markets has constantly seen an upward trend. However, these are only in the ‘forward’ contracts. As the new contestants keep emerging the ETS, the demand for the credits is also rising. On the other hand, the parties who are already trading in the credits are gaining momentum and are getting used to the systems, which is a vital sign for the further development of the ‘spot’ trading in the ETS, which currently can be called an experimental avenue, with only a few individuals

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involving in such spot trades while majority of the spot trading is done by the firms and corporate involved in the ETS.

The following table shows the number of registered installations in the year 2011 and the total emission units allocated to that country of the EU within the limits of the ETS;

Country Installation Counts Allocated Allowances

Austria 225 32,545,335

Belgium 362 55,547,922

Bulgaria 144 35,500,215

Cyprus 13 4,815,090

Czech Republic 423 86,462,509

Denmark 407 23,908,956

Estonia 56 11,875,206

Finland 658 37,996,500

France 1124 130,192,153

Germany 1989 399,473,463

Greece 162 65,564,460

Hungary 270 23,261,437

Ireland 124 21,559,418

Italy 1197 194,912,987

Latvia 111 3,517,760

Lithuania 114 8,047,099

Luxemburg 15 2,488,229

Malta 2 2,168,005

Netherlands 443 88,831,673

Poland 938 206,077,118

Portugal 280 32,363,481

Romania 274 74,794,339

Slovak Republic 201 32,618,314

Slovenia 100 8,208,974

Spain 1139 149,659,031

Sweden 819 22,711,843

United Kingdom 1137 223,491,629

Total 12727 1,978,593,146

(Table 7.1.1) (Source: EU ETS website)

For those outside the European Union:

As far as entities outside the union are concerned, the ETS focuses on generating a stable response for the carbon credits created from the CDM and JI projects.

We already know that the JI and CDM allow developed countries to earn carbon credits in terms of CERs and ERUs under the Kyoto Protocol by investing in emissions saving

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technology in another country, developing or developed, as the case may be. CDM cover those nations which do not have any commitment to reduce their emissions under the Kyoto Protocol, while JI is only applicable to countries which have these commitments, i.e. these are developed countries requiring the reductions in their emissions under the ratified commitment it has made to the Kyoto Protocol.

Since the beginning of the Kyoto’s First Commitment Period, CERs and ERUs have been included under the ETS. The ETS is the first system in the world to recognise these units on a common scale, making 1 ERU = 1 CER = 1 EUA and allows all these three to be traded under the ETS scheme. The only exception to this is the credits that may be generated through projects related to nuclear facilities, land use and forestry activities. The credits created under such projects are not accepted under the ETS.

This status was given to the CERs and ERUs even before the commitment period of the protocol began, which portrays the fact that the scheme is ready to allow the ETS to emerge into the global markets. By doing this, it encourages extra overall investment in such projects, thereby helps the countries reduce their emissions in a more efficient manner and also helps developing countries to incorporate best technology and best practices in the industry into their units of production, thus moving a step closer to sustainable development.

The added benefit is actually also for the registered units under the union itself, as allowance of CERs and ERUs will give them more options to choose from while deciding how to reduce their emissions to meet the emission targets. Not only the registered units, but also the states of the EU are also willing to use this liberation in order to portray themselves as the countries that achieved the emission targets. Even before the first commitment period began, most of the EU countries had already registered a demand for over 500-600 million carbon credits, while an average project, whether JI or CDM, generates close to 500 thousand to 1 million carbon credits, which means that even before the projects could start, the potential demand of the credits was already very high.

Keeping this in mind, the European Investment Bank created a dedicated facility for such project worth € 500 million, so that the increasing demand for the credits could be met through implementation of more projects. Even Germany’s KfW also set up a similar fund. These are vital signs of a developing market for carbon and other GHGs.

The Partners’ link

The ETS openly trades with GHG trading systems in other countries. For instance, the MCX of India trades its CER and CFI units freely with the ETS and entities that are a part of the ETS. It is obvious that both the parties involved will recognise the units of carbon traded with each other, which will be a deciding factor in whether or not such markets could trade among each other and thereby expand themselves. The ETS has also been successful in including the countries like Norway and any states in the US in its trading system.

Pricing the Carbon Credits:

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The prices of carbon credits, just like any other tradable commodity, are decided by the elements of free market mechanisms, i.e. supply and demand, the basics of economic theory.

The ‘Law of Demand’ says that, given that all other factors are constant in the trading environment, as the price of a commodity rises in the market, the corresponding demand for the same will reduce.

(Fig. 8.1)

As can be seen in the diagram, as the price falls from P1 to P2, the demand rises from Q1 to Q2, which will result in a downward sloping curve. The relationship between price and demand is thus inverse, i.e. lesser the price, more the demand.

Conversely, the ‘Law of Supply’ states that, given the other factors are constant, with an increase in the price of a commodity, there is also a consequent rise in the supply of that commodity.

(Fig. 8.2)

Similar in understanding to the demand curve, in the supply curve, as the price increases from P1 to P2, the supply increase from Q1 to Q2, due to which the curve is upward sloping. It indicates that there is a direct relationship between the price of a commodity and its supply.

The economic price equilibrium, however, is achieved only when there is an intersection between demand and supply curves, i.e. the price at which and the quantity at which the demand exists, is the same as the price and quantity at which the supply of the commodity is being made. This is the optimum price at which the market can trade the commodity in question, whereby the conditions of the buyer as well the seller are satisfied.

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(Fig. 8.3)

In terms of linear equations, these can be laid down as follows;

Qd = I - (S*P)

Qs = I + (S*P)

Where,

Qd = Quantity Demanded

Qs = Quantity Supplied

I = Intercept of Qd or Qs as the case may be

S = Slope

The following example will make clear how the above formulae can be used to determine the prices of carbon credits:

The prices and quantities demanded and supplied for June and July 2009, as available from the website of Multi Commodity Exchange of India, are as follows;

1. Initial Price of CER in June 09 = INR 780.382. Initial Demand of CER in June 09 = 19,771 units3. Initial Supply of CER in June 09 = 739,640 units4. Changed Price of CER in July 09 = INR 847.895. Changed Demand of CER in July 09 = 14,293 units6. Changed Supply of CER in July 09 = 946,143 units

Using the above information, we compute the equation for Quantity Supplied as follows;

When, Supply = Qs

Then, linear equation to be used is Qs = SP + I

So, from the above information, Qs = 739640, P = 780.38

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Using these values, we get –> 739640 = 780.38S + I

Similarly, if Qs = 946143, P = 847.89

We get –> 946143 = 847.89S + I

So, I = 739640 – 780.38S

Substituting these values –>

946143 = 847.89S + 739640 – 780.38S

Hence, 206503 = 67.51S

So, S = 3058.85

Therefore, 739640 = (780.38 * 3058.85) + I

So, I = - 1647425.363

Hence, the equation for Quantity Supplied is -

Qs = 3058.85P - 1647425.363

Similarly, we also compute the equation for the Quantity demanded as follows;

When, Demand = Qd

Then, the linear equation to be used is Qd = SP + I

Therefore, when P = 780.38, Qd = 19771

Hence, 19771 = 780.38S + I

Similarly, P = 847.89, Qd = 14293

We get ->14293 = 847.89S + I

Rearranging, we get – 19771 – 780.38S = I

Substituting this value,

14293 = 847.89S + 19771 – 780.38S

-5478 = 67.51S

S = - 81.14

Also, 19771 = - 63320.0332 + I

Hence, I = 19771 + 63320.0332 = 83091.0332

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Therefore,

Qd = - 81.14P + 83091.0332

Now for equilibrium to occur the quantity demanded and supplied have to be equal. Hence,

Qd = Qs

- 81.14P + 83091.0332 = 3058.85P - 1647425.363

Hence, 1730516.39 = 2977.71P

Therefore, P = 581.156

Hence, demand and supply equilibrium will match at a price of INR 581.156, which will become the aggregate trading price.

In theory, we take all other factors as constant, which allows for easier calculation of the optimum quantities, however, there are various factors affecting the prices of carbon credits and it is inevitable to consider them in real-life scenario.

Factors affecting the prices of carbon credits:

1. The Break Even Point: If the party purchasing the credits is also the party that has the responsibility to reduce the greenhouse gas emissions, then such parties will be looking to increase their emission permit in the cheapest possible manner. For the very same reason, they will demand the carbon credits at a lower price and in no case will it demand the credits at a price that is higher than the cost which the party has to undergo in order to reduce the emissions to the required level.

2. Cost to the seller and feasibility of project: The costs that are involved in generating carbon credits are generally affected by the type and quantum of the CDM or JI project, the baseline emissions and the credit period of such project. In order to make profits, every seller will try to sell the carbon credits at a price which is higher than the unit cost of producing each one of them and so if the criteria for funding a JI or CDM project is the returns on sales of carbon credits, then the seller will want to try to reduce the cost of the project to the minimum possible level.

3. Elements of Market: The market factors as in the terms of payment as well as the trends in the market will directly affect the investment in carbon credits. Terms of payment will also consider the time of delivery, financing cost, transaction cost and the risk involved. The knowledge of the current market and the speculations about the future markets will also affect the purchases and sales.

4. Parties involved: Once the project is underway, the carbon credits are not issued right away, but after the first verification period. It is therefore important that there exists a long term relationship between the parties involved. The capabilities as well as the creditworthiness of both the parties will decide whether they want to enter into such a long term contract with each other or not.

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5. Cost of practice: There are some inherent costs in the processes of CDM and JI which cannot be avoided by the parties involved, e.g. cost of registration, cost of verification by AIEs or DOEs/DNAs, etc. These costs are mandatory in nature and so if the amount of these costs is huge, the parties may consider getting a higher return on the price in order to cover the cost.

6. Conditions applied in the contract: If the contract places a high degree of responsibility on the part of the supplier of the credits, the supplier will obviously look forward to cover the cost of such liabilities by raising the price. Similarly, if the liabilities are placed on the buyer of the credits, the buyer may demand a lower price.

7. The risk factor: If a high degree of risk exists on whether or not the project will be able to achieve the levels of emissions required to be reduced in order to get the sanctioned credits, then the buyer, due to such uncertainty will demand a better price from the seller. Inversely, if the certainty in the project is high, the seller may be in a position to bargain with the buyer. Also, as the projects under JI and CDM are long term, the risks of achievement and delivery of carbon credits is also risky. This will therefore affect the prices of carbon credits.

Buying Carbon Credits: A help to the Environment:

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The main objective of carbon credits of all types is to reduce the anthropogenic pollution which harms the environment. This, it achieves by the way of assigning a value in terms of money for polluting and emitting harmful pollutants. These emissions are thus additional cost to the internal activities of the business and therefore they are treated as current assets/liabilities which are considered to be as liquid as the raw materials, and therefore appear just above or below the same in a balance sheet, according to the accountant’s perception.

(Fig. 9.1)(Source – Investopedia)

This impact can be understood by the following example;

Suppose that XYZ ltd, which is a company in an Annex 1 country, owns a manufacturing unit which is creating 400,000 tonnes of GHG emissions annually. The country’s statute requires different industries to reduce emissions to a certain levels under the Kyoto Protocol agreement. Accordingly, the manufacturing unit is given a quota of 300,000 tonnes of GHG emissions.

In such a situation, it is the decision of the owners as to whether they want to reduce the pollution to 300,000 units or they want to purchase carbon credits from the market and increase their emission permit. For this, company will undertake a detailed cost analysis, whereby if it finds that the cost of altering or purchasing new technology is cheaper than purchasing carbon credits from the market, it will change its manufacturing process to reduce the emissions. Contrarily, if it finds that purchasing carbon credits is cheaper, it will not consider the change in technology. However, in both these options, the company will have to either bear the cost of new emission saving technology or face the expense of buying new credits. This way, the carbon credits, when applied, either force the company to reduce the pollution or make it pay for the extra pollution that it creates.

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On the other hand, there is also a mark left by the production processes of alternative sources of energy. E.g. a wind turbine only has initial set up cost and does not have costs related to generation of electricity or pollution created by the same as well as the transport. This would not allow issuance of a credit for a decided period of time.

There can be two possible scenarios;

1. There are companies which choose to go with the carbon offsetting, which is pretty much like outsourcing the responsibility to reduce the emissions to others. These companies will invest in a project in developing countries instead of its own. For instance, the company might choose to fund a biomass project in another developing country whereby the energy produced would be used in powering a power project which was previously using fossil fuels, which would reduce the emissions of that country. Nevertheless, the company still keeps polluting the environment, while it bears the cost of investing in a technology in the developing country in order to reduce the amount of GHG gases in that country which are equivalent to the extra emissions by the company in its country. Therefore, it pays for its inability to reduce its pollution levels.

2. There also exist other type companies which have already invested in the new emission reducing technology and due to which it has an increased capacity of emission allowances. These are the companies from which the companies which have a deficit in their allowance permit will buy carbon credits in order to increase their allowances. When such a sale happens, the sale of allowances will help in subsidising the cost of the new machinery purchased. However, the buyer as well as the seller will have to corroborate the fact that their levels of allowances were met clearly, by furnishing proper accounts, reports or statements as may be required or demanded.

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As a Future:

By definition, in finance, any standard contract between two parties to exchange specified assets of standard quantity and quality for a price agreed today, with delivery occurring on a specified future date. As we have seen in the earlier chapters, the prices of carbon credits, if traded in the emission trading schemes and carbon markets, have a quoted price, making them a futures contract.

However, until the credits generated from the CDM and JI projects enter such trading markets, the prices of these credits are decided by the project operators and hosts while the amount is decided by DNA, DOE or AIE, as may be applicable, which will make them simple derivatives. But as soon as they’re clubbed to be sold in the open markets, the demand and supply mechanism will decide the price, while the credits will be delivered as and when they are created through these projects, making them futures at that moment.

Carbon Credits being futures have some inherent benefits;

1. Efficacy is achieved in the detection of the price2. It provides with a hedging platform3. Another important benefit is that there is no risk of counter parties4. The reference price in aggregate is always available5. A ready market of large buyers and sellers is available to off-load6. As the prices will be listed, there will be transparency in pricing7. Trading carbon credits as futures will help in integrating the indigenous markets with

foreign market, thus enabling a global market place for exchange of credits

The utility of futures market for carbon credits is invaluable. This can be explained in the following two scenarios;

If due to speculation, there is anticipation in the market of shortage of supply in the future, this would mean that the future prices are expected to be high. Due to this belief, the traders tend to purchase and store carbon credits, which will increase the volume of spot trading in current scenario which will in turn reduce the current consumption. In such situations the government will motivate the increase in supply which will result in more information, more time for corrective actions and better prices to the seller and the ultimate buyer.

If however, there is anticipation in the market of surplus in supply in the future, then, naturally the future prices are expected to be low, therefore, the traders will have a current incentive to release the carbon credits which will affect the current spot trading negatively. This will result in an increase in the consumption and converse to the above situation, the government will try to promote the decrease in the supply, which will again stabilise the conditions to provide more information, time and better prices.

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Working of futures market for carbon credits:

The process of trading carbon credit futures can be understood with the example of the ECX – CFIs that are traded through the MCX (Multi Commodity Exchange of India);

1 4

2 5

3 6

(Fig. 10.1)

Key:

1. = Sell Order2. = Payment3. = Allowances Delivered4. = Buy Order5. = Payment6. = Allowances

Explanation to the above diagram:

The above case represents the example of CFIs, a copyrighted product of the ECX, in the MCX of India.

In the case, there are two parties that want to trade in the CFIs, the buyer and the seller, both having a registration with the ETS system. The seller places the selling order with his agent/broker, who is represented by the ‘Clearing Member A’ in the diagram. Similarly, the buyer also places a buying order with his clearing agent, ‘Clearing Member B’. These

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Seller with ETS

Registry account

Buyer with ETS

Registry account

Clearing Member

A

Clearing member

BMarket for ECX - CFIs

A’s A/C

B’s A/C

ECX Delivery System

ETS Registry 1

ETS Registry 2

ETS Registry 3

ETS Registry 4

clearing agents have an account registered with the ETS and other emission trading markets and when the respective orders are placed to them by their clients, they place the same order in the market using an electronic system which is similar to the “BOLT” in the Sensitive Index of India.

These orders remain in market till the prices of a corresponding buy or sell order are available, i.e. say if the buyer has placed an order to purchase the CFI at € 12.85, the order will be placed, but will not be executed unless there is another order placed by a seller to sell the CFIs at € 12.85. In the above case however, it is assumed that the buyer and the seller have transacted at the same desired price and in a finite number of units.

ECX Delivery system in the diagram represents the delivery of CFIs, i.e. the systems and mechanisms that cause reduction in the emissions, thereby creating credits, which the ECX converts into quantity applicable to CFIs. Therefore, the agent of the seller, when in receipt of the credits from the seller, will forward the same to the delivery system. These credits will remain with the delivery system till the order is executed in the exchange market. Once the order is carried out, the delivery system will deploy the credits to the agent of the buyer. It is important to not here that the market place, exchange and the delivery system only interact with agents, with the exception of the registration process of the clients of these. But some agents do carry out the registration process for their clients as well.

While the seller pays a brokerage fee to his agent, the agent on the buyer’s side will complete the transaction before receiving the payment. If the transaction remains incomplete, then the brokerage fees are not paid to the agent. ETS registry 1, 2, 3, 4, represent the other registered accounts with the ECX which will also pool their credits in the delivery system while come of them will also draw credits by making purchases.

The following example will make the concept of a future trade clearer;

Say, ABC Ltd and XYZ Ltd are two companies in India, each having a registered account with the MCX of India in order to trade in carbon credits through the agents PQR and MNO respectively. Their permitted ceiling is 150,000 tonnes of CO2 equivalent while their actual emissions are 200,000 tonnes of CO2 equivalent. Assume the price of each credit to be € 13. Assume also that the cost of reducing the carbon emissions for ABC Ltd is € 7, while that of XYZ Ltd is € 15.

It is elementary that the companies are falling short of the given target by 50,000 tonnes of CO2 equivalent, which they might reduce in their production process or they might purchase it from the market. These choices, as is obvious, will be made based on the increase in the cost of operations.

For company ABC Ltd, the cost per tonne of carbon equivalent reduced is € 7, which is cheaper that the market price of the credits, which stands at € 13. So, the company decides to reduce the emissions as the alternative is cheaper. Therefore, in order to reduce the required 50,000 tonnes of carbon equivalent, the company will undergo a cost of € 350,000. When the company will receive these credits, it will sell them through the clearing agent – PQR. When

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doing so, it will receive € 650,000 as the market price is assumed to be at € 13. Thus, it’ll make a profit of € 300,000.

Similarly, the company XYZ Ltd, for whom the cost of reductions of emissions per tonne of carbon equivalent is € 15, and therefore it, finds it cheaper to buy credits rather than reducing emissions. It’ll place an order through its agent MNO, who will place the order in the system. So, in order to cover the emissions of 50,000 units, the company will have to spend € 650,000. Now, as the market price is € 13, the credits available because of the sell orders placed by the other registered entities including ABC Ltd are available for XYZ Ltd to be purchased at the same price.

When there is availability of such credits at such a price, the order is executed and the credits will move from the seller to the delivery system, which will in turn deliver them to the buyer’s agent.

Such future contracts have been provided by the MCX of India, an example of which is as follows;

Contract Specifications of Carbon Credits – ECX- CFI Mini SM

Symbol CFI

Description CFIMMMYY

Contracts Available for Trading

December 08 Contract 1st Jan 2008 to 15th Dec of contract year

December 09 Contract 1st Jan 2008 to 15th Dec of contract year

December 10 Contract 1st Jan 2008 to 15th Dec of contract year

December 11 Contract 1st Jan 2008 to 15th Dec of contract year

December 12 Contract 1st Jan 2008 to 15th Dec of contract year

Trading

Trading period Mondays through Saturdays

Trading sessions Monday to Friday: 10:30 a.m. to 11:30 p.m.Saturday: 10:30 a.m. to 2:30 p.m.

Trading unit 200 tonnes of carbon credits

Quotation/Base value INR per ton

Maximum order size 10,000 tonnes

Tick Size 50 Paisa per ton

Daily Price limit 4%

Initial Margin 6%

Special Margin This margin, of percentage that is deemed fit, may be enforced for maximum 2 days, in case there is additional volatility.

Maximum allowable open position For individual clients: 500,000 tonnes

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For a member collectively for all clients: Not more than 25% of the market’s open position in a contract at any given point of time.

Delivery

Delivery units 200 tonnes of carbon credits

Quality Specification Each carbon credit is an entitlement to emit one ton of CO2 equivalent gases.

Delivery Option Both Options

Special Delivery Provision During the life of the futures contract, to the extent the parties having open position on the exchange enter into bilateral physical trade as per their futures obligation and intimate the exchange, their respective futures position will be offset by the exchange.

Final Settlement Price (DDR) Price of ECX-CFI prevailing on European Climate Exchange for relevant contract on the date of expiry of MCX contract converted into Indian Rupees.

(Table 10.1)(Source: MCX Website)

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Carbon Credits versus Carbon Taxes:

The need for carbon credits or carbon taxes is highlighted by the fact that there exists a negative externality in most of the products being produced today. The concept of negative externality states that the cost for such products to the society is much greater than what the consumers are paying for the product. In short, the person who makes the decision does not have to pay for that decision. Consumers tend to buy products that meet their marginal benefits at the marginal cost and since market externalities are not considered, these will result in inefficiencies in the market unless corrective measures are taken.

(Fig. 11.1)

Key:

P, P0, P1, P2 = Various Price Levels

Q, Q1, Q2 = Various Supplied Quantity Levels.

SMC = Social Marginal Cost

PMC = Personal Marginal Cost

SMB = Social Marginal Benefit

In unorganised sectors, such externalities are not accepted by the producers and are shouldered to the consumers. Due to this the company has a lower marginal cost, enabling it to produce and supply more than its capacity in absence of such conditions. Due to this the supply curve shifts to the right, and a little below the original curve, because the reduced marginal cost will allow dumping of products in the market at a lower price. This necessarily means that more of the product will be bought than is bought for an efficient equilibrium. Since too many products are sold and bought, the marginal cost is not equal to the marginal benefits, which gives rise to deadweight welfare loss.

In the above diagram, the red line between P0 and P1 shows the deadweight welfare loss, whereby, instead of selling the optimal quantity at Q2, the manufacturer is selling Q1 quantity of goods, which also causes the rightward shift of the supply curve, causing more externalities than necessary.

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This concept can be understood with the following example:

Say, A Ltd manufactures steel. The company, in its accounting books will only consider costs related to manufacturing like electricity, labour, raw material, work in progress etc. But, they’ll not consider the cost of polluting as a manufacturing cost as they are not directly affected by the cost. The people living in the vicinity, on the other hand, will bear a direct cost on account of this. Due to pollution, their costs of medical treatments, poorer quality of life and reduced ascetic want for better quality of air, add to their monthly expenditures and thereby the negative cost is borne by the people and not the manufacturers.

Carbon credits and carbon taxes are two tools used to levy a cost of these externalities on the manufacturers who do not, or are unable to reduce the pollutants emitted. They make the manufacturers pay for the negative cost that the people will bear and these will be used for public welfare. However, while the approach of one is to lucratively reduce the emissions, the approach of other is to tax the non-compliance. While carbon credits have been discussed in details, it is necessary at this juncture to discuss Carbon Taxes.

Carbon Taxes:

Carbon taxes are the rates of tax that are levied on each ton of carbon emitted into the atmosphere. These rates will vary according to the fuel being used in the manufacturing process. E.g. while coal will have high amount of taxation, oil will have a medium amount and natural gas will have lower or negligible taxation. This example clearly shows that the weight given to the taxation for a fuel is directly proportional to the amount of carbon content in that fuel, making the system of taxation a ‘carbon content’ based taxation.

However, when carbon credits were first accepted by Kyoto Protocol, they were accepted in the lieu of carbon tax as it was believed that because of lack of hypothecation of tax raising schemes, the government would allot the collected amount in the most desired area and not for the welfare of the people who face the negative externalities of the manufacturers as an additional cost. It is also argued that if carbon taxation is not accepted universally, the manufacturer, with the ability to do so, will shift his manufacturing unit from the country where he is being taxed to where he is being not.

Other disadvantages of the taxation include increased administration cost in order to collect the tax, lack of basis for estimation of tax and lack of consideration of social cost of tax as the manufacturer may dump the cost of tax on the buyer, a possibility of existence of low price elasticity and lastly increased fuel prices due to such taxation as the fuel manufacturers will bear the tax and later dump it on buyers to cover profit margins. The elasticity is a major concern as far as fuel is concerned as with about 10% of increase in the price of gasoline, the demand is noticed to reduce by 3% in short-run and about 7% in the long-run, which could mean a substantial loss for many oil producers.

There are inherent advantages to both the methods, however, and can be seen in the following table:

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Carbon Credits Carbon Taxes

The prices, as perceived by the buyer, may be fair or otherwise, helping them to control the cost of emission reductions.

They are easy to implement, are inexpensive and require lesser time for implementation.

There is an assurance that all investments in projects under the flexible mechanisms are being invested for genuine carbon reductions.

The risk of cheating the tax system is negligible as in comparison to the credits.

The target level of emissions can be brought down over the years as there is a monetary reward connected to it.

If credits are distributed in corresponding amounts of previous emission levels, then, the taxes will provide reduced incentives to the companies to delay any improvement that could be made.

It is a system based on ‘rewarding’ people based on the emissions they have reduced or the effort put in for such reductions.

The new companies are at a disadvantage with carbon credits as they cannot start receiving the credits immediately and will pollute more to that extent. Taxes will charge them for this flaw.

- The allotment of the collected funds becomes centrally controlled.

- Lastly, the value of carbon, instead of being decided by the market mechanisms and their fluctuations, will be decided by the government regulation and control.

(Table 11.1)

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Accounting and Taxation Effects:

Accounting:

We’ve already discussed that India is a major supplier of carbon credits in the trading market. The Indian companies involved in CDM projects have started realising carbon credits due on them while also making arrangements for them to be bought by a foreign country. Obviously, because this is a new venture in India, new and interesting aspects of financial accounting have been tangled by it. The various aspects involve: a) How to account the expenses of a CDM project, b) whether to account for the registered CERs, c) at what value and at which time these should be recorded and d) how to record the sale proceeds of the sold CERs. For these above mentioned points, it is important to note the following aspects:

1. It has been understood in previous chapters that the establishment of a CDM project is not a commercial transaction but is just a way to increase the profits of the business in an environmentally friendly way. It is not correct to undertake a CDM project on the basis of the amount of CERs that in can create, rather, while taking up the project, it has to be ensured that the project is financially stable and can survive in the long run. The financial benefits that arise from a CDM project include – reduction in energy bills, additional depreciation on machinery, reduced regulations and supervision etc. If these CERs are properly recognised and if there is a market for the same, there are additional revenues which will result for the company. There no specific accounting standards that have been set up for their recording. However, the cost of investment, depreciation and recurring costs as well as sales proceeds are well covered by the current accounting standards. It has been suggested that a separate section for accounting of CERs be made under the AS – 17.

2. The current accounting standards force us to accept CERs as goods. A ‘good’ has to be a tangible property OR an intangible one. They would only become a good if they have the attributes of the same in terms of 1) its utility, 2) should be capable of being bought and sold & 3) it should be capable of being transmitted, transferred, stored, possessed and delivered. It is therefore clear that carbon credits have to be treated as goods while considering the accounting aspects.

3. The Companies Act of 1956 43A(11), mentions that “Turnover” is an aggregate value of the realisation made from the sale, supply or distribution of goods or on account of services rendered, or both. Taking this into consideration, it is clear that the proceeds received from the sale of CERs cannot be included under turnover. However, because there is a sale and the company is earning profits because of such a sale, these proceeds are considered under other income. Schedule VI of Companies act requires that such abnormal income, i.e. income arising from sources other than the day to day business, should be recorded separately under “Non-operating” income. The logic being that these incomes do not result from the daily operations of the business. Though CERs may not be sold under exceptional circumstances, they’re sold on a non-recurring basis, which qualifies them under the non-operating income header.

4. A consideration of Paragraph number 11 of the Accounting Standards 9 will qualify the proceeds from the sale of CERs under financial accounts as recognised revenue.

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This is a self explanatory paragraph and has been reproduced below;I. 11. In a transaction involving sale of goods, performance should be regarded

as being achieved when the following conditions have been fulfilled:i. The seller of the goods has transferred to the buyer the property in the

goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods to a degree usually associated with ownership; and

ii. No significant uncertainty exists regarding the amount of consideration that will be derived from the sale of the goods.

5. The CERs that are held with the registry while the project is still operational and the redemption stage has not yet been reached, then, such carbon credits cannot be accepted as inventories and under Accounting Standard - 2, listing them under inventories is not allowed. On the other hand, these carbon credits meet the criteria to be called ‘Intangible Assets’ under Accounting Standard – 26. However, the paragraphs 19-23 lay down the specific requirements for intangible assets as follows:

I. It has to be probable that future economic benefits attributable to the asset will flow to the enterprise; and

II. The cost of the asset can be measured reliably.But, measuring the cost of each individual CER is not possible as these CERs are only the result of ‘Additionality’ created under the CDM project and so, although it may qualify as an intangible asset at best, it is not recognised as an accounting item due to the specific requirements of Accounting Standard – 26.

6. The Accounting Standard – 12, while defining ‘Government’ refers to – “government, government agencies and similar bodies, whether local, national or international”. In view of this explanation, some accountants have proposed that carbon credits can be accounted for as a government grant. But, there is a counter argument which says that there are no government bodies involved (as seen before), only designated authorities by the UNFCCC are involved. Also, there is a third argument that as soon as the credits are accounted for as a grant, the Accounting Standard – 9, which is related to the revenue recognition will become non-functional, which will further complicate the accounting of the same.

Taxation:

We’ve already seen that while the expenditure on trading of carbon credits can be included in the accounts, the self generated CDM carbon credits cannot be reflected on in the same. However, it has been suggested that the notes to accounts should include the bifurcation of self generated and traded units of carbon credits with the company.

As the CERs are capital assets, taxation of the same will be carried out under the header “Capital Gains”. A claim for concessional taxation can also be made in case these credits are being held for more than 36 months before they’re transferred. This provision will allow the

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companies to select the time frame in which they want to purchase and sell the credits. The benefits of this include balance in cash flow needs, interest factor and difference in rate of tax in long-term and short-term holdings can all be managed with ease.

For self-generated CERs, as the cost of acquisition is said to be nil, under section 55(2) of Income Tax Act, the sale consideration of the same will be taken into account while taxing it under the “Capital Gains” header according to the amount of period for which the credits are held.

Also, in India, if the CERs are sold to a foreign buyer for a property that the buyer holds overseas, though a sale of ‘goods’, will be taken as an exception and no Central Sales Tax will be applicable on such a transfer.

As of now, there is an on-going debate in the ICAI about the accounting and taxation of the carbon credits and they’re expected to unveil new standards for the recording of these details by the end of 2011. Views of the taxation authorities in India would also be an interesting dimension, as originally the credits are given for reduction of pollutants and the rate of tax which will be applicable to them if taxed under capital gains would decide whether the company will find it cost effective to generate or purchase the credits on a long or short term basis. Accounting and taxation standards for credits, may thus decide the fate of this system of pollution reduction in Indian subcontinent.

Criticism:

Carbon credits, thus far, have been discussed only in the limelight of fairness and advantages. However, there are few aspects on the other side of the coin as well. The three major

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allegations that critics have put on this emission reduction scheme of Kyoto Protocol are as follows;

Allegation # 1: Carbon Credits = Permits to Pollute

There is a theory whereby the critics have alleged that in countries like India, where taxation of carbon emission is negligible (INR 50/metric tonne of carbon equivalent emitted) and where there is no cap and trade system enforcement, unless the companies voluntarily take up reduction of their emissions, there is no way the government can force them to do so. On the other hand, there being an open market trade for CERs available in indexes like MCX and NCDEX, the companies and individuals who buy these credits feel that they’re reducing pollution, but actually they’re only getting the permit to pollute to the amount which has been saved by someone else. This means that the net effluents in the environment are not going to reduce as the pollution of one person is done by another, but done, nevertheless.

Allegation # 2: Support to projects that would have happened anyways

It has been discussed in the earlier chapters that the ‘Additionality’ in a project is based on the emission reduction in comparison to a baseline. There is an argument in this regards which states that a baseline can only be formed if the project actually existed in its more polluting state and later decides to change its processes to reduce the amount of emissions but, the present policy allows for the new projects to estimate a hypothetical baseline scenario that could have been in case a more polluting technology was adopted and based on which the credits are later awarded. This is seen in the latest example of Reliance Power Ltd, whereby the company acquired credits for a super-critical power project, stating its baseline to be the amount of pollution that which a thermal power plant normally generates. Thus, the company had never polluted using the orthodox thermal plant technology, however, they used it as a baseline in their super-critical project to gain more credits.

Allegation # 3: Permanency is inexistent

The final criticism is that the projects related to generation of carbon credits have a specified crediting period and have a specified life-cycle. Due to this reason, there are no provisions and accountability for the pollution that is created by the project after its registered life as a CDM or JI project. For instance, if the reforestation project in one area is being awarded carbon credits, there is no guarantee that the trees in the other areas or for that matter, the same trees in future will not be cut down. This means that carbon credits become a source of temporary income for people who seem to be doing a project that is reducing the pollutants, but the system does not consider whether the project will have benefits to the environment in the future.

The Need to Environmentally Educate India – A Survey:

Carbon credits, though a relatively new concept for the Indian industry, has been in practice in India since its very inception. Albeit, the knowledge of the field is strictly limited to the

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industry and individuals remain in dark about the working and the process. The government in India has done little to promote the concept for achieving its sustainable development goal. India does not fall under the Annex I of the Kyoto Protocol and is therefore not obligated to reduce its emissions. However, that does not mean that the country should keep polluting and not become socially and environmentally more responsible than it is right now.

Keeping this is mind a survey was conducted to find out how much people in India know about the concept and its various aspects. The sample size of a 100 people has been taken for the purpose of ease of analysis. A copy of the questionnaire used for the purpose has been attached as Appendix 000. The following were the findings of the survey;

94% of the people who answered the survey were between the ages 18 and 45 years, their particulars were found to be as follow;

- While 84% of the people agreed that global warming exists, 8% negated the same.

- 81% people believe that if global warming exists, it is because of anthropogenic reasons and on the other hand 13% people couldn’t decide if humans were responsible for the phenomenon.

- Interestingly, only 56% of the candidates believed that developed countries contribute majorly to the total climatic pollution, which is a well known fact and therefore shows India’s illiteracy in terms of pollution. 26% people chose the play-safe option of “Can’t say” which further shows passiveness in minds of Indians regarding pollutants. What is worthy of note here is that 85% of the people who believed that developed countries pollute more, were students, showing that there is an increasing awareness about the field.

- The following table will show the percentage of candidates who knew or knew not about the listed organisations which are vital to the topic of carbon credits;

- 34% of the people knew what carbon credits are, but the appalling truth is that out of these 34% people, 83% were professionals, managers or teachers/professors. This shows that the current generation needs to educate itself regarding the concept of carbon credits.

- While only 36% of people knew what IPCC was, only 17% knew about UNFCCC and a disturbing 10% knew about the Rio Summit of 1992. Interestingly, 96% of the people who knew about these subjects had an average income ranging from INR 300,000 to 800,000 per annum. This shows that the upper middle class in India, who is most affected by the aspects of pollution, knows more about pollution and its related subject than the others. Similarly, only 26% of the candidates knew about the Kyoto Protocol and 28% claimed that they had a superficial knowledge.

- 61% of the candidates said that if they had a manufacturing plant they would like to reduce the pollutant that they emitted into the environment. Similarly, an astounding 80% of the candidates wanted to reduce their own carbon footprints. However, out of these only 23% knew what carbon credit were, only 8% knew about the Kyoto Protocol and only 6% knew what the UNFCCC was. It is impossible for these people to use carbon credits to reduce their pollutant unless they’re educated for the same.

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- Adding to the above figures is the fact that the main Kyoto Mechanism used in India, i.e. Clean Development Mechanism, was known to only 15% of the candidates, all of whom were either professionals, self-employed or professors. 86% of the people who knew about CDM were in the income group of INR 800,000 to 1,200,000. This suggests that the intricacies of the carbon credits as a subject are known to people with higher income and higher education.

- 45% of the people who knew about carbon credits also knew that it is being traded in the international markets. But, only 24% of these people knew about the European Union Emission Trading Scheme and only 30% knew that MCX and NCDEX provide futures and spot trading in carbon credits.

- Also, out of the people who knew of the existence of carbon trading in MCX and MCDEX, around 50% people were ready to invest in carbon credits, though the survey informed them that the rise in the price of the credits was a phenomenon with high probability. This means that only 8 people out of 100 are ready to invest n carbon credits. But, when they were informed that India was one of the leading generators of carbon credits and that the future market for carbon are going to be dearer than now, the number changed to 12 people out of 100, which is an increase of 50% over the number of people who would have invested even without the same information.

- Coming to the more positive, 66% people said that they would accept pollution reducing technology even if they had to surrender the resulting benefits to the investor. This clearly shows that the people in India are ready to accept the concept of CDM, but there is a vital need for education because out of these 66% people, only 23% knew about carbon credits and only 18% knew what Clean Development Mechanism is.

- Although around 87% people were ready to invest from 1,000 to 25,000 INR annually for reducing the pollution, 26% of these didn’t know about carbon credits and 14% about CDM. But out of the people who were ready to spend from 5,000 to 10,000 INR for reducing the pollution every year, 98% fell under the income group of INR 300,000 to 800,000.

Thus, the above survey shows that the people in India are enthusiastic about being able to reduce the pollution; however, they are not aware about the most efficient means of doing the same that the world has provided. It is absolutely necessary to educate them about the same.

Conclusions and Suggestions:

Conclusions:

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In India, though the country being the second largest generator of the CERs, the majority of the common public is unaware about the Kyoto Protocol mechanisms and how the credits are generated.

Corporate houses like Reliance and Tata have successfully started implementing CDM projects in India, which shows that India is progressing with sustainability.

The government in India is inactive in promoting pollution free or pollution reducing technology as well as carbon credits and their benefits. It should therefore be the responsibility of the people who know of the subject, to educate those who do not and thus help in reducing the pollution.

Financial and accounting standards for carbon credits in India are very lenient and weak. There is an immediate need to provide the standards for the same.

The Annual Budget of India has no allocations towards the adoption of cleaner technology.

Though the MCX and NCDEX are providing tradable futures and spots for carbon trading, the volume of trade in the last 3 months has been nil in MCX and only 36 transactions in the NCDEX, which shows the level of knowledge about the topic among the investors in these indices.

Looking at the international scenario, the EU ETS has been the standalone example of a healthy trading in carbon credits.

Though USA has not ratified to the Kyoto Protocol, there are individualised and state-wise voluntary organisations like the Chicago Climate Exchange that deal in carbon credits.

China is the leading producer of carbon credits in terms of CERs however it is also the leading polluter in the world. This in itself shows the need for strict implementation of carbon credits and Kyoto Mechanisms.

India has recently introduced a carbon tax of INR 50 per metric ton of carbon dioxide equivalent released into the atmosphere. This marks the initialisation of the processes that would support carbon credits and the related system in India.

There are various flaws in the CDM and JI mechanisms offered by Kyoto and these need to be addressed at the earliest in order to stop illegitimate use of the systems.

The phenomenon of ‘Additionality’ which is the vital to the creation of carbon credits is being neglected and the UNFCCC needs to take a tough stance in this regard.

Indian carbon credit market is expected to grow to a stunning $10 billion by 2015. Thus, the scope for carbon trading in India has no bounds, however the issues mentioned

above need to be considered. Addressing these issues are the following suggestions;

Suggestions:

The UNFCCC must at the earliest consider the exclusion of activities like the avoidance of deforestation or aforestation that is destroyed in future, from the list of activities that

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are considered under the baseline methodologies to have the ability to reduce pollutions. In India, the government needs to set up a standalone ministry for reduction of pollution

and allow it to undertake all the activities under the Kyoto Protocol. This will allow the proper governance of these activities.

The indices that provide the products in carbon trading in India need to popularise them by the way of publications and advertisements. There is a restriction on such advertisements being published and these restrictions should be removed at once.

Though various indices in India are allowing carbon trading, learning from the European Union, India should set up its own Emission Trading Scheme. The government has already proposed this scheme, however, there are numerous bureaucratic delays holding it back. It should be brought into implementation at once.

Individuals in India, though having the option of purchasing the credits from the open market rarely do so. Mostly the transactions occur between companies and individuals, thinking that the credits are only meant to increase the emission allowance, fail to see the benefits of the same as a spot or future trading instrument. The government and the NGOs, if concerned about this situation, should educate the people about this as much as possible.

Green Economics and Green Finance are two fields that are quickly growing into a multibillion dollar market. But, there is no curriculum in India providing education in these said fields. It is therefore a necessity that such a curriculum is brought into practice at once.

Carbon credits, as seen in the Accounting and Taxation section, are only recorded in the books of accounts as expenditures when traded and when the tax is paid on them under capital gains header. The need here is to incorporate the credits into the balance sheet of a company along with the other assets, so that the companies start considering credits and the pollution created by their manufacturing processes with financial importance. This step will also lead to companies being more conscious about how much they pollute, as it will have a direct impact on their balance sheet figures.

While trading, the market prices of the carbon credits are taken into consideration. However, when listed as an intangible asset as previously suggested under the Accounting and Taxation section, they are recorded at the cost price. If there is a loss on sale of these credits, it will be considered as a non-operating loss. But by allowing this, a large window is left open for companies to show non-operating losses and thus reduce profits that could be taxed. It is therefore required that separate depreciation norms for credits be provided so that a limit can be set over the amount of loss that the company may show in the books due to the fall in price. On the other hand, a margin needs to be set up so that the holder of the credits may not sell them if the price falls below a certain percentage of the acquisition cost. This will protect companies from huge losses and speculations, while allowing government to regulate the wrong doings in term of use of the credits to show substantial losses.

Bibliography:

Websites:

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1. UNFCCC Website - www.unfccc.int2. Carbon Funds - www.carbonfunds.org3. Carbon Credits India - www.carboncreditworld.net4. Carbon Credits in India

-www.goodnewsindia.com/index.php/Supplement/article/320/5. Labnol - http://www.labnol.org/india/knowledge/carbon-credits-wealth-creator-for-

eco-friendly-indian-companies/233/6. Wikipedia - www.wikipedia.org7. Carbon Finance Online - www.onlinecarbonfinance.com8. MCX - www.mcxindia.com9. Tata Power - www.tatapower.com10. World Bank - web.worldbank.org

Books & PDFs:

1. 50.4 MW Tata Wind Farm Project - PDF file 2. REHABILITATION OF THE DISTRICT HEATING SYSTEM IN DONETSK

CITY - PDF file3. CDM and Carbon Trading in India - Article by Jitendra Kumar Singh4. CDM : A User's guide - PDF file5. Carbon Credits in MCX - PDF file6. Understanding Carbon Credits - Gurbat Singh

People:

1. Ms. Anita Khuller - CONGEN India - Delhi - congenindia@gmail.com

Appendix 000: Copy of Questionnaire for Experience Survey:

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