FAO 2005 Seminar, O. Cacho 1 Transaction Costs of Carbon Sink Projects Oscar Cacho School of...

FAO 2005 Seminar, O. Cacho 1

Transaction Costs of Carbon Sink Projects

www.une.edu.au/febl/Econ/carbon/

Oscar CachoSchool of Economics

University of New EnglandAUSTRALIA


Outline

• Background• Overview of abatement and transaction costs• Reducing transaction costs• A model to analyze the effect of project design • The measurement problem• Conclusions


Background

Clean Development Mechanism (CDM) allows Kyoto signatories to reduce greenhouse gas emissions in developing countries (Article 12).

CDM projects can operate in the energy sector (reduced emissions) or in the land-use change and forestry (LUCF) sector (sinks).

Afforestation and reforestation projects are eligible within the LUCF sector.


Project design

Validation

project developer

National approval host government

Stakeholder comments

Submit Project Design Document

Registration

project developer

CDM executive board

Verification and certification

CER issuance

operational entity

operational entity

CDM executive board

Submitting and approving CDM proposals


Abatement Costsopportunity cost of land-use change (SP).

Transaction Costscost of participating in the CER market (CT).

SA

CT

QA

PA

Q (CERs)

P ($)

SP

D

QP

PP


Buyer

Seller

0

5

10

15

20

0 5 10 15 20 25 30

100

120

140

160

180

200

0 5 10 15 20 25 30

a

b

c

Bu

yer

cost

($/

Mg)

Em

issi

on o

ffse

ts (

Mg/

ha)

Carbon price ($/Mg CO2)

TC

C1

Seller pays TC

0

5

10

15

20

0 5 10 15 20 25 30

100

120

140

160

180

200

0 5 10 15 20 25 30

a

b

c

TC

C1

C2

Carbon price ($/Mg CO2)

Buyer pays TC


0

10

20

30

40

50

60

70

80

90

1 4 7 10

13

16

19

22

25

0

10

20

30

40

50

60

70

80

90

1 4 7 10

13

16

19

22

25

0

10

20

30

40

50

60

70

80

90

1 4 7 10

13

16

19

22

25

0

10

20

30

40

50

60

70

80

90

1 4 7 10

13

16

19

22

25

0

10

20

30

40

50

60

70

80

90

1 4 7 10

13

16

19

22

25

0

10

20

30

40

50

60

70

80

90

1 3 5 7 9 11

13

15

17

19

21

23

25

0

10

20

30

40

50

60

70

80

90

1 4 7 10

13

16

19

22

25

0

10

20

30

40

50

60

70

80

90

1 4 7 10

13

16

19

22

25

0

10

20

30

40

50

60

70

80

90

1 4 7 10

13

16

19

22

25

years

carb

on

sto

ck (

Mg

/ha)

initial soil carbonlow medium high

Managing C stocks Gliricidia in Jambi, Indonesiafirew

ood harvest high

medium

low


Biomass C in Indonesian systemsRubber

0

10

20

30

40

50

60

70

80

90

Year

Cinnamon

0

10

20

30

40

50

60

70

80

90

Year

Damar

0

10

20

30

40

50

60

70

80

90

Year

Oil Palm

0

10

20

30

40

50

60

70

80

90

Year


Rubber Cinnamon Damar Oil

Palm

NPV ($/ha) -96.35 114.99 -36.46 -91.10

Average C stock (Mg/ha) 21.18 11.35 51.34 13.31 Opportunity cost ($/ha) 132.35 -78.99 72.46 127.10

($/Mg C) 6.25 - 6.96 1.41 9.55

Abatement Costs

Modeling results for Sumatra, Indonesia(degraded land)


• search

• negotiation

• approval

• administration

• monitoring

• enforcement

• insurance

Transaction costs• find site and group of landholders; • survey alternative land uses;• gather biophysical, social and economic

information about the site; • establish relationships with the locals.

• generating and disseminating information;

• allowing simplified baselines for smallholder projects.

Reduce by:


• search

• negotiation

• approval

• administration

• monitoring

• enforcement

• insurance

Transaction costs

• agree on required land uses; • assign responsibilities to parties; • agree on monitoring and payment

schedule.

• working through farmer groups and local NGOs.

Reduce by:


• search

• negotiation

• approval

• administration

• monitoring

• enforcement

• insurance

Transaction costs

• cost of delays after submission of Project Design Document;

• cost of project validation.

• CDM Executive Board simplifying validation process.

Reduce by:


• search

• negotiation

• approval

• administration

• monitoring

• enforcement

• insurance

Transaction costs

• keeping records of project participants;• administering payments and dealing with

problems and disagreements; • may require establishment of a local

project office.

• will decrease as countries and market participants gain experience;

• appropriate IT infrastructure is important.


• search

• negotiation

• approval

• administration

• monitoring

• enforcement

• insurance

Transaction costs

• measuring C sequestration actually achieved;

• certification and verification by Designated operational Entity (DOE).

• sampling C stocks at longer intervals;• using remote-sensing technology;• involving landholders in sampling C

stocks.

Reduce by:


• search

• negotiation

• approval

• administration

• monitoring

• enforcement

• insurance

Transaction costs

• ensuring compliance with the terms of the project;

• may include litigation.

• providing smallholders with credible prospects and sufficient incentives to prevent abandonment of the project;

• involving farmer groups and promoting monitoring within the community.

Reduce by:


• search

• negotiation

• approval

• administration

• monitoring

• enforcement

• insurance

Transaction costs

• no formal insurance for sink projects is available yet.

• deducting a risk premium from the price paid for C sequestration;

• diversification of project portfolio (spatial arrangement and project types);

• keeping a buffer of C stocks that is not converted to CERs.

Reduce by:


Reducing transaction costs

• Generate and disseminate information (LUCF systems, baselines).

• Bundle projects.

• Teach smallholders to measure carbon.

• Encourage community self-regulation.

• Bundle payments for other environmental services.

• Promote secure land tenure.


Sampling Intensity and CERs

0

20

40

60

80

100

0 10 20 30

Sample plots (n)

CE

Rs

(Mg

ha-1

)CV=0.4

CV=0.8


Synergies

Data from Murdiyarso et al.for Indonesia

0.0

0.2

0.4

0.6

0.8

1.0

0 50 100 150 200 250

C stock (Mg/ha)

Bio

div

ersi

ty (

pla

nt

rich

nes

s in

dex

)*

* relative to natural forest


Model of contractual arrangements

LATG CCCC

Transaction margin

Governance costs

Based on Dorward (2001)

= Revenue – Governance Costs

CT transaction costs

CA associated transformation costs (= 0)

CL cost of loss due to transaction failure

• For buyer: if seller defaults, the cost of buying C offsets elsewhere (market price of CERs) + transaction costs already incurred.

• For seller: if buyer defaults, the cost of converting back to preferred land use + establishment and learning costs already incurred.


The seller’s problem

Contractual form

Go

vern

ance

co

sts

and

ret

urn

s

free market vertical

acceptable to seller

RG(s)

CG(s)


The buyer’s problem

Contractual form

Go

vern

ance

co

sts

and

ret

urn

s


acceptable to buyer

CG(b)

RG(b)


Feasible solutions

Contractual form

Go

vern

ance

co

sts

and

ret

urn

s


acceptable to both

CG(b)

RG(b)

RG(s)

CG(s)

based on Dorward (2001)


Contractual forms

(A) Free Market

(B) Individual Farmer Contract

(C) Community Contract

(D) Vertical Integration

private entity establishes individual contracts with farmers to undertake certain land-use practices.

NGO establishes a program through farmer groups (farmer-group leaders play a critical role).

farmers and C brokers trade in free (local) market, brokers then sell C offsets in international market.

firm purchases land, establishes commercial plantations and sells C offsets in the international market (provides employment).


• Seller (farmers): • Buyer (NGO / government / private entity):

Agents

Sell C offsets at farm price PF

Buys C offsets from sellers at PF and sells them in the CER market at net price PB = PCER – CB

PF price obtained by seller per Mg C

PB net price obtained by buyer per Mg C

PCER price of C in the CER market ($/Mg)

CB brokerage costs per Mg C sold in CER market



mijk

BB mijkgmikjkxB,,,

,,,,,)(

k = contractual arrangements (1,…,K)

i = market conditions (1,…,I)

m = environmental conditions (1,…,M)

j = agent behaviour (comply, default)

buyer’s expected utility

proportion of C offsets under contractual arrangement k

profit to buyerprobability (to buyer)

of seller behaviour j



mijk

BB mijkgmikjkxB,,,

,,,,,)(

),,(),,,(),,(),( ijkCijkCikPiPgg LTFBBB





cost of failure

transaction costs

farm price

net C market price



mijk

SS mijkgmikjkxS,,,

,,,,,)(





seller’s expected utility

proportion of C offsets under contractual arrangement k

profit to sellerprobability (to seller)

of buyer behaviour j



mijk

SS mijkgmikjkxS,,,

,,,,,)(

),,(),,,(),,(),,( ijkCijkCmiOikPgg LTSFSS





cost of failure

transaction costs

opportunity cost

farm price


The measurement problem

B , S probability of agent behaviour

(CT)B,S transaction costs (for buyer and seller)

(CL)B,S losses due to transaction failure (for buyer and seller)

OS opportunity cost of land-use change to seller

PB price of C to buyer

Max:

for each contractual arrangement (k), agent behaviour (j), market condition (i) and environmental condition (m), estimate:

SwwBUFPx

)1(,

Optimizing contract design


Conclusions

• Transaction costs are largely related to obtaining and processing information.

• Designing efficient projects requires a good understanding of the abatement costs and transaction costs involved.

• Next step: flesh out model to allow consistent measurement and to help reduce transaction costs.

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