This article was downloaded by: [University of Leeds] On: 30 April 2013, At: 01:38 Publisher: Taylor & Francis Informa Ltd Registered in England and Wales Registered Number: 1072954 Registered office: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK Climate Policy Publication details, including instructions for authors and subscription information: http://www.tandfonline.com/loi/tcpo20 The investment climate for climate investment: Joint Implementation in transition countries Samuel Fankhauser a & Lucia Lavric a a European Bank for Reconstruction and Development, One Exchange Square, London, EC2A 2JN, UK Published online: 15 Jun 2011. To cite this article: Samuel Fankhauser & Lucia Lavric (2003): The investment climate for climate investment: Joint Implementation in transition countries, Climate Policy, 3:4, 417-434 To link to this article: http://dx.doi.org/10.1016/S1469-3062(03)00050-0 PLEASE SCROLL DOWN FOR ARTICLE Full terms and conditions of use: http://www.tandfonline.com/page/terms-and-conditions This article may be used for research, teaching, and private study purposes. Any substantial or systematic reproduction, redistribution, reselling, loan, sub- licensing, systematic supply, or distribution in any form to anyone is expressly forbidden. The publisher does not give any warranty express or implied or make any representation that the contents will be complete or accurate or up to date. The accuracy of any instructions, formulae, and drug doses should be independently verified with primary sources. The publisher shall not be liable for any loss, actions, claims, proceedings, demand, or costs or damages whatsoever or howsoever caused arising directly or indirectly in connection with or arising out of the use of this material.
Transcript
This article was downloaded by: [University of Leeds]On: 30 April 2013, At: 01:38Publisher: Taylor & FrancisInforma Ltd Registered in England and Wales Registered Number: 1072954 Registered office: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK
Climate PolicyPublication details, including instructions for authors and subscription information:http://www.tandfonline.com/loi/tcpo20
The investment climate for climate investment: Joint Implementation in transitioncountriesSamuel Fankhauser a & Lucia Lavric aa European Bank for Reconstruction and Development, One Exchange Square, London, EC2A 2JN, UKPublished online: 15 Jun 2011.
To cite this article: Samuel Fankhauser & Lucia Lavric (2003): The investment climate for climate investment: Joint Implementation in transition countries, Climate Policy, 3:4,417-434
To link to this article: http://dx.doi.org/10.1016/S1469-3062(03)00050-0
PLEASE SCROLL DOWN FOR ARTICLE
Full terms and conditions of use: http://www.tandfonline.com/page/terms-and-conditions
This article may be used for research, teaching, and private study purposes. Any substantial or systematic reproduction, redistribution, reselling, loan, sub-licensing, systematic supply, or distribution in any form to anyone is expressly forbidden.
The publisher does not give any warranty express or implied or make any representation that the contents will be complete or accurate or up to date. Theaccuracy of any instructions, formulae, and drug doses should be independently verified with primary sources. The publisher shall not be liable for any loss,actions, claims, proceedings, demand, or costs or damages whatsoever or howsoever caused arising directly or indirectly in connection with or arising out ofthe use of this material.
The investment climate for climate investment:Joint Implementation in transition countries
Samuel Fankhauser∗, Lucia LavricEuropean Bank for Reconstruction and Development, One Exchange Square, London EC2A 2JN, UK
Received 17 December 2002; received in revised form 26 March 2003; accepted 14 May 2003
Abstract
Transition countries are expected to become important players in the emerging market for greenhouse gas emissionreductions, as they can cut emissions at a relatively low cost. However, the attractiveness of the region as a supplierof emission reductions will not only depend on its cost advantage. It will also depend on the business climate offeredto carbon investors—factors like a well-functioning legal and regulatory system, economic and political stabilityand the capacity to process emission reduction projects efficiently. This paper looks at the carbon investment climatein the transition countries eligible for Joint Implementation (JI)—Russia, Ukraine, Croatia and the EU accessioncountries. It concludes that JI investors will face a clear trade-off between the scope for cheap JI on the one hand,and the quality of the business environment and JI institutions on the other. The countries with the highest potentialfor cheap emission reductions also tend to be the countries with the most difficult business climate and the leastinstitutional capacity for JI. The most attractive JI locations may be median countries with a reasonable JI potentialand an acceptable business climate, such as Bulgaria, Romania and the Slovak Republic.
Keywords: Joint Implementation; Transition countries; Business environment; Institutional capacity
1. Introduction
The transition countries of Central and Eastern Europe and the former Soviet Union are expectedto play a key role in the international effort to combat climate change. Unlike Western countries, theyhave some “headroom” in their Kyoto targets because of the slump in output and emissions duringtransition. Given the prevailing inefficiencies in large parts of their energy and industrial sectors, tran-sition countries should also have scope to reduce emissions further at relatively little cost (see, forexample,Victor et al., 2001; Chandler, 2000). This is particularly true for the 13 transition countriesbelonging to Annex I, which are expected to dominate the market for emission reductions under Joint
∗ Corresponding author. Tel.:+44-207-338-6088; fax:+44-207-338-6110.E-mail address: [email protected] (S. Fankhauser).
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Implementation (JI) and international emissions trading (IET): Bulgaria, Croatia, the Czech Repub-lic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, the Slovak Republic, Slovenia andUkraine.
Energy–economy models show that the use of the Kyoto mechanisms could reduce the total cost ofcompliance by perhaps as much as 50%.1 They also show that, if implemented fully, the mechanismscould result in an annual volume of emission reduction trades of maybe US$ 10 billion by 2010 (Joshua,2002; Halsnaes, 2002). About half of this volume could involve transition countries.
However, most of the models on which these forecasts are based use the standard economic assumptionof perfect markets. They ignore that the functioning of markets is contingent on certain requirements,such as effective institutions and the prevalence of the rule of law. The importance of good institutionshas been recognised both in the context of transition from central planning to a market economy (see, forexample,EBRD, 1999) and in the creation of environmental markets (see, for example,Parkinson et al.,2001; Petsonk et al., 1998; Tietenberg et al., 1998).
At present, the institutional and regulatory underpinnings for an effective carbon market are still de-ficient. Emission reduction-specific know-how is scarce, monitoring and verification capacity is lackingand there is considerable regulatory uncertainty, both at the international and the national level, where thetranslation of the Kyoto rules into national legislation has barely started. There is a shortage of whatYohe(2001)calls “mitigative capacity”. In many countries, these deficiencies are mirrored by similar short-comings with respect to market-supporting institutions in general, and arguably they are most pronouncedin the countries which have the highest potential for cheap greenhouse gas abatement—transition anddeveloping countries.
This paper investigates the investment climate for emission reduction projects in the Annex I countriesof Central and Eastern Europe, that is, in those transition countries that qualify for JI.2 The paper seeksto identify the places offering the best combination of mitigation potential and institutional development,based on the following three elements, which we consider to be the key determinants of the investmentclimate for JI transactions:
• The scope for cheap emission reductions, that is, the marginal abatement costs of a country.• The institutional capacity of a host country to process JI deals, including prior experience gained
through Activities Implemented Jointly (AIJ).• The general business environment, including factors such as political and economic stability, progress
in privatisation, liberalisation and structural reforms; the quality of the legal system, and the prevalenceof corruption.
The paper deals with each of these issues in turn, and for each of them provides an indicative rankingof country performance. These rankings should be seen as suggestive only, and they only concern oneparticular point in time in what is a fast evolving process. Nevertheless, they may provide an indicationof the attractiveness of transition countries in the carbon market, and the extent to which problems in thebusiness environment may lead to a redirection of carbon investments away from the countries with thehighest mitigation potential toward jurisdictions where abatement costs may be higher, but the investmentclimate is more attractive.
1 See, for example, the papers inThe Energy Journal, Kyoto Special Issue, 1999.2 Similar questions have also been raised byPoint Carbon/Vertis (2003), DREE (2002)andEvans et al. (2000).
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2. Scope for low cost JI
The scope for generating cheap emission reductions is easily the most studied aspect of the JI investmentclimate. There are umpteen studies of the emission reduction potential and greenhouse gas mitigationcosts in different countries, regions and sectors. The academic literature on mitigation costs dates backover two decades and has repeatedly been reviewed, for example, by the Intergovernmental Panel onClimate Change (most recently inIPCC, 2001). Nevertheless, there are no systematic, consistent andcomprehensive cross-sectional mitigation cost data for transition countries. Most studies at the countrylevel use different assumptions and modelling techniques and are therefore difficult to compare.
2.1. The absolute emission reduction potential
To develop an understanding of the likely emission reduction potential in the 13 JI countries in transition,we consider two different but related indicators, carbon intensity and energy intensity.
Carbon intensity is defined as the amount of carbon a country emits per unit of energy consumed. Wecan interpret carbon intensity as a rough measure of the potential for fuel switching, that is for achievingemission reductions by replacing high carbon fuels (such as coal) with cleaner forms of energy (such asrenewables). Carbon intensity is, however, an imperfect indicator of the fuel switching potential because itneglects other important factors such as the availability of substitute fuels, their cost, the age of generatingunits and the structure of demand. Nonetheless, the indicator is positively correlated to a country’s fuelswitching potential, and negatively to its abatement costs.
Similarly, energy intensity can be seen as an indicator of an economy’s potential to improve energyefficiency. Defined as the ratio of energy use per GDP, energy intensity is again an imperfect indicator ofa country’s energy conservation potential. This is because it neglects exogenous factors like settlementpatterns, comparative advantages, climate and the availability of cheap indigenous energy resources,which may explain differences in energy consumption. A country like Russia, for example, with its coldclimate and dispersed population, will always use extra energy for transport and heating, even if theeconomy is efficiently run. Nevertheless, the high energy intensity of transition countries is often used asevidence of their inefficient use of energy resources.
Scheme 1shows the carbon and energy intensity of the JI countries in transition. The best performingcountries are Croatia, Hungary and Slovenia, with energy intensities within 30% of the EU average. Inthe worst performing countries, Russia and Ukraine, the ratio is three to four times higher if GDP iscorrected for purchasing power parity (Scheme 1), and more than 10 times higher if it is not (Cornillieand Fankhauser, 2002). In terms of carbon intensity, the leading countries are those that rely heavily onhydro or nuclear energy, and their carbon intensities compare to those of EU countries. In contrast, thecoal-based energy systems of the Czech Republic, Poland and Romania lag behind both the EU and othertransition countries. In Bulgaria, a high share of nuclear energy is offset by a similarly high share ofcoal-based electricity, while Estonia’s carbon intensity is probably a reflection of its heavy reliance onoil-shale.
2.2. Stringency of the baseline
Emission reductions are measured against a baseline, that is, a scenario of what would happen in theabsence of a JI project. It is likely that some of the emission reduction potential implicit in highcurrent
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Scheme 1. Energy and carbon intensity (1998).Note: The energy efficiency potential is calculated as energy intensity (energy useover purchasing power parity corrected GDP) relative to the European Union average (EU= 100). The fuel switching potentialis calculated as carbon intensity (greenhouse gas emissions over energy use) relative to the EU average (EU= 100). The totalsfor Romania and Ukraine lie outside the graphed area in one of the two categories. The Ukrainian energy efficiency score is 440and the Romanian fuel switching score is 206.Source: World Development Indicators and UNFCCC.
carbon and energy intensities will be realised as part of this baseline and therefore not available for JI.Most countries have active energy efficiency and renewable energy programmes. They are also movingahead with the restructuring and technological modernisation of their industrial base. For more accurateinformation about the JI potential of a country we need to understand these baseline activities.
Particularly relevant in this respect are the requirements imposed on transition countries by EU ac-cession. Eight of the 13 JI countries in transition are expected to join the European Union by 2004 andanother two (Bulgaria and Romania) around 2007–2008. Croatia is expected to apply for membershipshortly, which will leave Russia and Ukraine as the only two countries not formally seeking EU member-ship. Several of the directives, which EU accession candidates have to adopt have implications on theirgreenhouse gas emissions. These include, among others, the Integrated Pollution Prevention and ControlDirective (IPPC), the Landfill Directive, the Large Combustion Plants Directive and various energy effi-ciency directives (seeEuropean Commission, 2001). Perhaps most importantly, accession countries willalso become part of the EU Emission Trading System (ETS), which is to be introduced in 2005.
Although transition periods have been granted for some of the directives, practically all of them will bein force before the start of JI trading in 2008. However, the interpretation and enforcement of the new rulesmay differ, which makes the extent of baseline emission reductions uncertain. This is particularly the casefor the IPPC, which stipulates the use of Best Available Technology (BAT) in large power plants and anumber of industrial sectors—a concept that is relatively vague and open to interpretation. The impact of
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the EU ETS is similarly uncertain until countries have decided on the allocation of allowances, althoughit is clear that the scheme will reduce the scope for JI in favour of emission reductions under ETS.
In most cases, EU accession implies more stringent baselines and, hence, a lower JI potential. There isone important exception, however, which has to do with the decommissioning of unsafe nuclear powerplants in Bulgaria, Lithuania and the Slovak Republic, to which the three countries have committedthemselves. The likely replacement capacity is thermal power and as a result baseline carbon emissionswill go up, compared to the status quo. The same may be true for Russia and Ukraine, which also stillrun a number of Soviet-style reactors, but international pressure for their closure is lower.
2.3. Summary indicator
To be able to make comparisons, the fuel switching, energy efficiency and baseline data need to beaggregated into a single indicator. In the absence of consistent abatement cost data, we put forwardexpected carbon emissions per GDP in 2010 as a rough measure of the JI potential. The indicatorcombines the fuel switching and energy efficiency potential since carbon emissions per GDP (C/Y) equalsthe product of carbon intensity (C/E) and energy intensity (E/Y). In addition, by looking at forecasts for2010, we incorporate baseline policies to the extent that forecasters anticipate their adoption over the next7 years.
The emissions data used inTable 1are primarily based on the countries national communications tothe UNFCCC, complemented by market forecasts such asEcosecurities (2002). Where several forecastsare available, a median scenario was used. GDP data are based on the EBRD’s internal macroeconomicforecasts. As with all long-term predictions, emission and GDP forecasts for 2010 vary greatly dependingon the underlying assumptions. However, for the present purpose the relative ranking of countries is moreimportant than absolute values, and this tends to be relatively robust across all scenarios.
Table 1also shows an indicative ranking of countries in terms of their potential for low cost JI. Ukraine,Bulgaria, Russia and Romania are identified as the countries with probably the highest scope for cheap
Table 1Indicator of JI scope and production cost
Country Carbon emissions per GDP,2010 (tC/million US$)
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emission reductions. In the case of Bulgaria, this partly reflects the need to phase out nuclear energy inthe baseline, but also its high emissions in the non-nuclear sector. Slovenia, Croatia and Hungary are thecountries with the lowest JI potential, according to this indicative measure.
3. JI capacity and experience
For the Kyoto mechanisms to work smoothly, host and sponsor countries alike will need to developinstitutional capacity for the review, approval and registration of emission reduction projects. Foreigninvestors, already wary of the onerous administrative procedures they face in many transition countries,will look for host countries where JI policies have been clarified and effective, transparent procedures forthe processing of proposals established.
3.1. JI policy and responsibilities
The procedures imposed by Kyoto to ensure the transparency and credibility of the mechanisms are setout in the Marrakesh Accords. In the case of JI, the accords provide for two tracks for the administrationof projects, depending on the institutional capacity of the host country. Of these, the more streamlinedtrack one is clearly more attractive to JI investors, but it seems unlikely that any of the JI countries intransition will qualify for track one in the short and medium term. Most of them are still in the process ofdeveloping their JI policy, have not yet clarified the government internal responsibilities for JI, and employonly a handful of staff with JI experience. The initial concern for JI investors will be about progress onthese fundamental issues. Particularly needed is a clarification of JI policy and responsibilities withingovernments. Sponsors in early JI projects have often been frustrated by the uncertain mandate of theircounterparts and a lack of clarity in the government’s position.Table 2summarises current JI policies,responsibilities and staff capacity.
3.2. Prior experience and technical assistance
The speed with which institutional capacity can be built depends not least on the amount of techni-cal assistance provided by donors. Organisations like the Global Environment Facility have for yearssupported the development of emission inventories and the drafting of national communications to theUNFCCC, and in these areas substantial capacity has been built. JI-specific assistance has been morerecent and coverage is more patchy. One of the first programmes was the National Strategy Studies pro-gram of the World Bank, which commissioned JI studies in the Czech Republic, Russia and the SlovakRepublic, among other countries. Other agencies have also stepped up their efforts, for example, throughthe Baltic Sea Region Energy Co-operation (BASREC). However, many programmes have apparentlysuffered from high turnover among newly trained staff and ill-defined or shifting responsibilities for JI,which make it difficult to target the right agencies.
Equally important is the amount of experience, which countries have gained through pilot projects. Mostof this experience has come from the AIJ pilot phase, during which 74 AIJ projects have been completedin transition countries for an emission reduction volume of close to 70 million tonnes of CO2-equivalent.Table 3provides a summary of AIJ activities, which suggests that while the largest deals were signedin Russia, the three Baltic states may have gained the most experience given the large number of deals
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Table 2JI responsibilities and capacity in 2002
Country JI policy Nationalregistry
Provisionalprocedures
DedicatedJI office
JI staff Institutions involved
Bulgaria Yes No Yes Yes 1.5 Ministry of Environment and WaterCroatia Draft No No No 5 Ministry of Environment (MZOPU),
Ministry of Economy (MG)Czech Republic na Under
preparationYes Yes na Ministry of Environment
Estonia Draft No No No 1 Ministry of Environment,Environmental Management:Technology department
Hungary Draft Underpreparation
Underpreparation
Na 2 Ministry of Environment,Atmosphere Protection: EnergyOffice
Latvia Draft No Beingdrafted
No 5(in 2003)
Ministry of EnvironmentalProtection and RegionalDevelopment, Ministry of Finance
Lithuania Underdiscussion
No No No 1 Ministry of Environment:Environmental Quality department
Poland na No Yes Yes na National Fund for EnvironmentalProtection and Water Management
Romania Draft No Yes Yes 4 Ministry of Environment, Ministryof Industry and Trade, Ministry ofAgriculture
Russia No No No Beingreformed
2 Ministry of Economic Developmentand Trade, Ministry of Energy,Roshydromet
Slovak Republic Yes No Yes No 2 Ministry of EnvironmentSlovenia Proposal Proposal No No 7 Proposal to nominate working groupUkraine No No No No 0 Ministry of Ecology and Natural
Resources
Source: Survey of environment ministries and various JI organisations in the region. Information on the Czech Republic andPoland comes fromNondek et al. (2001)andSobolewski and Karaczun (2002), respectively. See alsoMissfeldt and Villavicenco(2002)andOECD/IEA/IETA (2002).
they have processed. However, the experience gained from AIJ was mostly confined to baseline analysisand served to raise awareness among host authorities.3 Experience with the commercial, economic andfinancial assessment of a transaction was limited because under AIJ no actual emission reduction creditswere awarded.
3.3. Summary score
To summarise the organisational arrangements and experience of the JI countries in transition wehave developed an indicator of JI capacity that takes into account the various factors relevant to the
3 For a review of AIJ in transition countries, see for exampleBaumert and Petkova (2000), SEVEn/JIN (1997)andUNFCCC(2002).
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Note: For a number of projects the reporting has been incomplete. These are not included in the table.Source: UNFCCC.
effective handling of JI projects. The indicator is modelled on the EBRD transition assessments (see, forexample,EBRD, 2002) and uses the same scale. A score of 1 signifies basic JI capacity, while a scoreof 4+ describes countries with a sound record of processing JI transactions under track one. Evidently,this is a state that no country will achieve for some time, but it constitutes the ultimate objective. Likethe other EBRD transition indicators, the JI capacity indicator can only provide an ordinal measure ofrelative progress. It is based to a considerable extent on value judgement.
With these caveats in mind, we can look at the results inTable 4. The most advanced countries of theregion are Hungary and the Czech Republic, which have comparatively efficient public sectors, followedby Poland and the Slovak Republic. Bulgaria is relatively well placed despite its lack of AIJ experience,because it has already adopted a JI policy and provisional procedures. Romania and the Baltic states havebenefited from substantial technical assistance and pilot activities, but have not yet clarified their policiesand procedures. Croatia and Slovenia have paid little attention to JI and fare correspondingly badly, asdoes Ukraine, where deeper concerns about public sector performance also extend to JI.
4. The business environment
Like all foreign investment, the location of JI projects will be influenced by differences in the businessenvironment. The literature on the determinants of foreign direct investment (FDI) in transition countriesalludes to the importance of a sound business environment, in addition to such factors as the level ofprivatisation, the size of the local economy, political and economic ties between investor and host countryand host country risk (see, for example,Bevan and Estrin, 2000; Bevan et al., 2000; Holland and Pain,1998). In the case of JI, an additional factor may be the state of the energy sector, as most projects willbe energy related.
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Table 4Indicator of JI capacity (2002)
Country JI capacity indicator JI capacity, ranking
Note: The assessment based onTables 2 and 3and the sources given there. It uses the following classification system: (1) Initialnational communication, proposals for policies and institutional structures, little training and experience. (2) Regular nationalcommunications, provisional authorities appointed, procedures and responsibilities unclear, some training and experience. (3)Regular national communications, Kyoto ratified, JI policy adopted, provisional authorities appointed, national registry andinventory in place, procedures and responsibilities cleared, good capacity and prior experience. (4) Kyoto ratified, good inventory,registry established, designated authority, national system under preparation, supplementary information being provided, oncourse for track two, several JI projects hosted, but no transfer of emission reductions yet. (4+) Eligible for track one, severalJI projects hosted and emission reduction units successfully transferred.
4.1. The general business environment
A good business climate is difficult to define and has many dimensions. They include the quality ofinstitutions, government policies and the legal and regulatory framework. A sound business environmentalso requires political and economic stability, a level playing field between market participants, and a taxsystem, which is universally applied but not unduly distortionary. It depends on the integrity of public andprivate agents, and the absence of crime and corruption. Effective infrastructure and a well-functioningfinancial sector are other important considerations.
A survey that provides a good insight into the investment climate in transition countries is the BusinessEnvironment and Enterprise Performance Survey (BEEPS). Jointly commissioned by the World Bankand the EBRD, the BEEPS was first undertaken in 1999 in 20 transition countries, covering over 3000enterprises. A second survey of around 6000 firms in 26 countries, including the 13 JI countries intransition, was undertaken in 2002.Scheme 2shows the results of the two surveys.4 It distinguishes sevendimensions of the investment climate, and rates performance on a scale from 1 (no obstacles to businessoperation and growth) to 4 (major obstacles). A fuller circle inScheme 2thus signifies a more challengingbusiness environment. This scheme suggests that the quality of infrastructure and crime levels are theleast concern of enterprises, with access to finance and taxation topping the list of complaints. Overall,
4 SeeEBRD (2002)for more detailed results of the 2002 BEEPS. The 1999 results are discussed inEBRD (1999)andHellmanet al. (2000).
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the investment climate appears to be best in Slovenia, Hungary, Estonia and the Czech Republic andworst, by some distance, in Romania and Ukraine.
4.2. The state of the energy sector
Transition countries have made varying degrees of progress in reforming their energy sectors. His-torically, energy was provided through vertically integrated, state-owned utilities, but increasingly the
Scheme 2. Qualitative assessment of the investment climate in 2002.Note: Ratings reflect enterprise perceptions. A larger surfacearea indicates a more problematic business environment.Source: EBRD (2002).
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Scheme 2. (Continued ).
sector is unbundled into separate generation, transmission and distribution companies. Regulatoryagencies are created and the private sector is invited to acquire or manage the newly corporatisedutilities.
JI investors can be expected to prefer energy sectors where reform is well advanced, where transparentand predictable regulation provides comfort to investors and where the institutional framework welcomesprivate sector participation. The EBRD assesses developments in the power sector in its ‘Annual TransitionReport’ and the latest ratings are reproduced inTable 5.
A key problem which has long plagued the energy sectors of transition countries is the low level ofenergy tariffs and insufficient collection rates. Although progress in these areas is reflected in the EBRD’selectricity transition indicator, tariff and collection data are listed separately inTable 5, as they directlyaffect the scope for JI investment. The commercial attraction of energy efficiency measures is severelyundermined by low energy prices, even in the presence of additional JI revenues. Equally, investments incleaner and more efficient generation capacity will be unattractive unless capital costs can be recoupedthrough adequate sales revenues.
Table 5shows that Hungary, the Slovak Republic, Bulgaria and Ukraine have advanced furthest inpower sector reform. However, in Ukraine, and to a lesser extent Bulgaria, the financial viability of JIprojects is likely to be affected by low energy tariffs and poor collection rates. Low effective tariffs (thatis, tariffs corrected for collection rates) are also a problem in Romania and in Russia, where sector reformhas started only recently.
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Table 5The state of the power sector in 2002
Country Industrial tariffs (US cents/kWh) Cash collection rate (%) EBRD power sector transition indicator
Bulgaria 3.9 85 3+Croatia 6.7 100 3Czech Republic 4.3 na 3Estonia 4.1 97 3Hungary 5.7 90 4Latvia 5.2 100 3Lithuania 3.8 91 3Poland 4.5 97 3Romania 4.8 62 3Russia 1.6 97 2+Slovak Republic 4.2 100 4Slovenia 7.0 99 3Ukraine 2.2 78 3+Note: For comparison, the long-run marginal cost of Western power systems is around US cents 8 kWh−1. The EBRD transitionindicators are based on the following rating: (1) The power sector operates as a monolithic government department. Thereis political interference in the running of the industry, with few commercial freedoms. Prices are below costs, with externaland implicit subsidy and cross-subsidy. (2) The power company is distanced from the government, but there is still politicalinterference. Some subsidies/cross-subsidies and soft budget constraints. Monolithic structure, with no separation of differentparts of the business. Minimal or no private sector involvement. (3) A law has been passed providing for full-scale restructuringof the industry, including vertical unbundling and setting-up of a regulator. Some tariff reform and improvements in revenuecollection and some private sector involvement. (4) Separation of the industry into generation, transmission and distributionis taking place. A regulator has been set up. Rules for cost-reflective tariff-setting have been formulated and implemented.Arrangements for network access are developed. Substantial private sector involvement. (4+) Full vertical separation intogeneration, transmission and distribution. Independent regulator has full power to set cost-reflective effective tariffs. Large-scaleprivate sector involvement. Arrangements for network access and full competition in generation.Source: EBRD (2002).
4.3. Summary score and ranking
Combining the many facets of a good investment climate into a single indicator is not straightforward.One way to approach the problem is to reverse the causality in the “determinants of FDI” literature. Ifcurrent FDI flows are determined by differences in the investment climate, data on FDI per capita canserve as an indicator of relative investor satisfaction with the investment climate in different countries.The argument is that investors reveal their preferences by directing capital to those countries where thebusiness environment is most to their liking.
Table 6provides data on FDI per capita over the period 1997–2001. It shows total FDI rather thanenergy related FDI, because that data set is more complete. However, available data show that total FDIis a reasonable proxy for energy sector FDI. Total FDI also has the advantage of being a broader measureand being more closely linked with the general state of the investment climate in a country.
The FDI indicator is complemented by two other measures of the business environment. The firstis the growth competitiveness index compiled by the World Economic Forum (WEF, 2003) and thesecond the aggregate score of the EBRD’s transition indicators, which measure progress in privatisation,liberalisation, enterprise performance and financial sector reform (EBRD, 2002). The three indicatorspaint a surprisingly consistent picture and the ordinal ranking in the business environment they imply is
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Table 6Indicators of the general investment climate (2002)
Country FDI per capita (5-year average, US$) WEF (global ranking) EBRD Investment climate ranking
Note: The WEF index shows the ranking of countries in their global competitiveness table. For comparison, the US is ranked first,France 30th and Italy 39th. The EBRD transition indicators range from 1 (no progress) to 4+ (fully functioning market economy).The table shows the aggregate score over all reform dimensions. The ranking in the final column reflects the unweighted averageover the three previous indicators.Source: EBRD andWEF (2003).
also shown inTable 6. It suggests that the most conducive business environment can be found in Estonia,Hungary and the Czech Republic while Romania, Russia and Ukraine create the most severe problemsfor foreign investors.
5. Synthesis: the trade-offs
Table 7reproduces the indicative rankings developed for the three key aspects of the JI investmentclimate: the scope for low cost JI, the host country’s capacity to process JI, and its general business
Table 7Summary ranking—scope for JI, JI capacity and business environment
Rank Scope for JI JI capacity Business environment
1 Ukraine Czech Republic Estonia2 Bulgaria Hungary Hungary3 Russia Slovak Republic Czech Republic4 Romania Poland Slovak Republic5 Poland Romania Lithuania6 Lithuania Estonia Slovenia7 Czech Republic Bulgaria Poland8 Estonia Latvia Latvia9 Slovak Republic Lithuania Croatia
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Scheme 3. Country rankings—JI capacity and business environment.Source: own calculations.
Scheme 4. Country rankings—scope for JI and business environment.Source: own calculations.
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Scheme 5. Country rankings—Scope for JI and JI capacity.Source: own calculations.
environment. The Table shows that JI investors will face real trade-offs. No country scores well in allthree dimensions, and none consistently lags behind.
Generally, there is a good correspondence between JI capacity and the business climate. The countrieswith the most conducive business environment also tend to be furthest ahead in the development of JIinstitutions.Scheme 3shows this link graphically.
However, there is a clear negative relationship between the scope for JI and the general businessenvironment (Scheme 4). This makes intuitive sense, as the countries with the worst investment climatewill have attracted the lowest amount of investment to increase resource efficiency and upgrade theircapital stock—actions that generally lead to a reduction in greenhouse gas emissions.
The relationship between JI capacity and the scope for JI is u-shaped, reflecting two counteractingtrends (Scheme 5). At one end of the spectrum, the countries with a limited JI potential have, quiterationally, refrained from building expensive JI capacity, as they do not expect to participate much inthe market. At the other end of the spectrum, the countries with a good JI potential would have everyinterest in developing JI capacity and take advantage of this new opportunity. However, these are alsothe countries with the most difficult business climate, and it appears that the institutional and politicalconstraints, which slow down improvements in the business environment also hold back the developmentof JI capacity.
6. Conclusion
In this paper, we have looked at the factors that may determine the location of Joint Implementationinvestments in transition countries. We argue that JI investors will be concerned not only about the cost
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of emission reductions, which has been the main focus of the literature, but also the capacity of countriesto process JI transactions and the business environment they offer to foreign investors. We find that JIinvestors will face a clear trade-off between these dimensions, in particular between the scope for cheapJI on the one hand, and the quality of JI institutions and the business environment on the other.
Greenhouse gas mitigation models often treat transition countries as a homogeneous region. However,the 13 JI countries in transition are clearly not all tarred with the same brush. Currently, we can distinguishfive groups of countries:
• Croatia andSlovenia have a relatively conducive business environment, but few other features thatwould make them attractive for JI. The scope for low cost emission reduction appears to be limitedand, probably because they recognise this, the authorities have made few attempts so far to build up JIcapacity.
• Russia andUkraine are long-term prospects. They have a tremendous JI potential, but their businessenvironment is notoriously difficult and they have been slow in developing JI capacity. JI investorsmay shy away from these countries until the situation improves, or unless they can obtain risk coveragefrom institutions like the EBRD.
• Latvia, Lithuania andPoland can be characterised as median countries, which currently stand out asneither particularly attractive nor particularly unattractive for JI. Latvia has participated in one of the firstJI projects in the region but its potential will probably be limited. Given its size, Poland, in contrast, maydevelop into an attractive JI country over the medium term. Lithuania’s long-term potential dependsnot least on the future of the Ignalina nuclear power station, which currently provides most of thecountry’s electricity.
• The Czech Republic, Estonia andHungary are perhaps the most successful reformers of the regionand in the short-term they have much to offer for JI investors. They have the least risky businessenvironment and most of them are well advanced in developing JI capacity. However, their JI potentialmay be limited. Hungary already scores low on JI potential and the scope for JI in the Czech Republicand Estonia may be constrained by emission growth in these relatively small economies. All threecountries may in due course turn from carbon sellers into buyers.
• Bulgaria, Romania and theSlovak Republic probably have the best short to medium term prospectsfor JI. They have a good JI potential and are in the process of building the necessary institutionalcapacity. In the case of Romania, this could be enough to offset concerns about the difficult investmentclimate. Concerns about the Bulgarian and Slovakian business climate have receded since the electionof reform-minded governments, and although problems remain they have become more attractive toforeign investors.
The classification is roughly in line with the results of a similar recent exercise byPoint Carbon/Vertis(2003), except perhaps with respect to Poland which Point Carbon/Vertis saw as more attractive. Whilethis gives some comfort as to the validity of our results, we have to recognise, first, that assessments likethis necessarily entail a fair amount of value judgement and, second, that the rankings can change swiftlyin this fast evolving field. To remain up-to-date the exercise would have to be repeated periodically, whichwould also allow to track developments and identify trends. The methodology proposed here is well suitedfor that purpose as it relies primarily on information that is regularly updated and publicly available, suchas official emission forecasts (reported in national communications), the BEEPS, WEF information andthe transition indicators of the EBRD. Only the assessment of JI capacity required the gathering of someprimary data, but the survey on which it was based is fairly simple.
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Of course, the JI countries in transition will not only, and perhaps not even primarily, compete for Kyotobusiness among themselves. Investors will look for emission reduction opportunities in all countries thatare parties to the Kyoto Protocol. In fact, other regions such as Latin America have been noticeably quickerin developing a portfolio of emission reduction projects. However, this may be a temporary phenomenonthat can be explained by the faster regulatory progress under the CDM, the earlier start of crediting,and initial uncertainty about the impact of the EU ETS. Once these issues are overcome, JI activity intransition countries can be expected to rise sharply. While much remains to be done to build up JI capacityand reduce barriers to foreign investment, transition countries remain one of the brightest prospects inthe emerging emission reduction market.
Acknowledgements
In writing this paper, we have benefited from the comments and expertise of Anne Arquit Niederberger,Alan Bevan, Robert Casamento, Jaquelin Ligot, Ray Purdy, Nathalie Roth, Peter Sanfey, Paul Soffe andthree anonymous referees. The views expressed in this paper are our own and not necessarily those of theEBRD.
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