The Kyoto Protocol and Overview of the Clean Development Mechanism

Mini workshop - NBSSI

December 2005

Solomon K. Quansah, KITE

Aim of mini workshop

• To help establish GHG emission reduction projects that are consistent with national sustainable development goals, particularly projects in the energy sector.

• Develop national capabilities so that persons in developing countries are capable of analyzing the technical and financial merits of projects and negotiating possible finance agreements with Annex I countries and investors.

The Kyoto Protocol

The Kyoto Protocol is an agreement made under the United Nations Framework Convention on Climate Change (UNFCCC).

Countries that ratify this protocol commit to reduce their emissions of carbon dioxide and five other greenhouse gases, or engage in emissions trading if they maintain or increase emissions of these gases.

The Kyoto Protocol now covers more than 160 countries globally and over 55% of global greenhouse gas (GHG) emissions.

Clean Development MechanismThe Clean Development Mechanism (CDM) is an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment (so-called Annex 1 countries) to invest in emission reducing projects in developing countries as an alternative to what is generally considered more costly emission reductions in their own countries.

In theory, the CDM allows for a drastic reduction of costs for the industrialised countries, while achieving the same amount of emission reductions as without the CDM. In practise, however the emission reductions may be less with CDM than without it and may lead to unsustainable practices.

The CDM is supervised by the CDM Executive Board (CDM EB) and is under the guidance of the Conference of the Parties (COP/MOP) of the United Nations Framework Convention on Climate Change (UNFCCC).

• UNFCCC secretariat/ “CDM Team”• COP/MOP• Executive board• Panels and working groups• Validators/Verifiers• Project Participants• Project facilitators• Brokers/Consultants• CER buyers

CDM Institutions

http://cdm.unfccc.int/Reference/Documents/cdmmp/English/mpeng.pdf

• Definitions• Role of the COP/MOP• Executive Board• Accreditation & Designation of Operational Entities• Designated Operational entities• Participation requirements • Validation and registration• Monitoring• Verification and certification• Issuance of CERs

Modalities and Procedures

CDM key points

• A CDM project activity is mostly a part of a larger project

• CDM is available for emissions mitigation projects and certain sequestration projects

• CDM is market based• CDM is project based• CDM outputs are Certified Emissions Reductions (CER)

= 1 tonne CO2 equivalent• CERs give annex 1 countries possibility to emit one

tonne of CO2 = globally neutral

SustainableDevelopment

outputs

Baseline StudyIn Project

Design

EIA

Feasibility study

ValidatorAE > DOE

Public stakeholders

BuyersBrokers/

Investors/funds

DesignatedNationalAuthority

Full ProjectDesign

Document

ExecutiveBoard

IMPLEMENTATION MONITORING

CDM Project Cycle

Project appraisal

Process of project identification and design• Concept – Project Identification Note (PIN)• Pre-feasibility screening• Feasibility (technical, financial, legal etc.)• Project Design Document (PDD) is required to

register a CDM project• www.cdmguide.org

Refer to www.cdmguide.org

Project appraisal

Elements of the project appraisal (SSN)• CDM assists Annex 1 countries in meeting their

emissions reduction targets in return for income for credits derived from projects that contribute to sustainable development

….so sustainable development

Project appraisal

• CDM Requirements– Has the country ratified the Kyoto Protocol?– Does the country have a functioning DNA?– Does the project contribute to SD? - more – Does the project result in GHG reductions?– Are the emissions reductions real and measurable?– Is the project additional?– Does the project result in a diversion of ODA?– Is the project mitigation or A/R sinks?– No nuclear!

• Feasibility– Does the technology work?– Is there capacity to install, operate, and maintain the technologies?– Does the finance work?– What are barriers (financial, technical, capacity, institutional, normative etc.)?– Any other risks?

Project appraisal

• A/R? An A/R CDM project activity is an aforestation or reforestation measure, operation or action that aims at achieving net anthropogenic GHG removals by sinks.

• “Aforestation” is the direct human-induced conversion of land that has not been forested for a period of at least 50 years to forested land through planting, seeding and/or the human-induced promotion of natural seed sources.

• “Reforestation” is the direct human-induced conversion of non-forested land to forested land through planting, seeding and/or the human-induced promotion of natural seed sources, on land that was forested but that has been converted to non-forested land. For the first commitment period, reforestation activities will be limited to reforestation occurring on those lands that did not contain forest on 31 December 1989.

Project appraisal

Sustainable Development • What does the Ghana DNA say?• Gold Standard projects?

Project appraisal

Local/regional/global environment• Water quality and quantity• Air quality (emissions other than GHGs)• Other pollutants: ( toxicity, radioactivity, POPs, stratospheric ozone layer depleting gases)• Soil condition (quality and quantity)• Biodiversity (species and habitat conservation)Sub totalSocial sustainability and development• Employment (including job quality, fulfilment of labour standards)• Livelihood of the poor (including poverty alleviation, distributional equity, and access to essential

services)• Access to energy services• Human and institutional capacity (including empowerment, education, involvement, gender)Sub totalEconomic and technological development• Employment (numbers) • Balance of payments (sustainability)• Technological self reliance (including project replicability, hard currency liability, skills

development, institutional capacity, technology transfer)TOTAL

Does the project result in GHG emissions?• What would happen without the project

activity (baseline scenario)?• What would happen in the project activity

(project scenario)?

Project appraisal

Project appraisal

First step appraisal tool – does the project activity reduce emissions? The first step would be to consider a simple baseline for the project. The simplest place to begin is to consider the boundary for your project and to decide what is happening now in your project boundary (plant or area of activity) or rather what is the status quo. (In the case where the project introduces a service new to the area, the technology that would normally have been used and its emissions constitute the baseline.) The emissions from this status quo are considered as an initial estimation of baseline emissions (please note: this is a lesson you will be asked to unlearn later). The next step would be to estimate the emissions from your candidate project activity. Are the emissions of the project activity lower than the baseline emissions for the same level of activity? If the answer is yes, then your project does reduce emissions of GHGs.

Project appraisal

Real and measurable“The process of prediction and subsequent monitoring

and refining applies to the emissions from the project activity…

it follows that the parameters that are required to calculate the actual emissions reductions, can be monitored and accurately measured over time.

The difference between the baseline emissions and the emissions from the project activity will, of course, amount to the measured reductions in greenhouse gases as a result of the project.”

Reference from toolkit.

Simple discounted cash flow analysis: Project Base Case Discounted cash flow analysis

Years 0 1 2 3… 10… 21

Capital costs Planning and feasibility Technology

Training and commissioning

Sub-total

Operating costs Energy and water Labour Maintenance

Decommissioning

Sub-total

Income

Sale of product

Other income

Sub-total

Total

Internal Rate of Return Net Present Value Nominal Payback Period

Project appraisal

Project appraisal

Is the project additional?• What would have happened in the absence of the

project activity?• Additionality test: Standard tool may be applied• Investment analysis (IRR/NPV/Payback of base-case

i.e. without emissions reductions) is this conservatively below the investment threshold?

• Barrier tests (are there technical, normative, investment, other barriers)

Project appraisal

Tools for Users: Additionality decision tree .

Is the project in response to/ compliance with policy/ national/ provincial/ state/ regional/ local and/ or corporate legislation/ policy/ targets?

Is the project profitable under current market conditions this will depend on the project owners’ credit profile and the type of investor?

Are there other barriers to the project or its technology being implemented despite the project showing a viable rate of return?

Pro

ject is n

ot li

kely

to b

e a

dditio

nal

Project likely to be additional

No

Yes

Yes

No

No

Yes

Project appraisal

Tools for Users:

An Eligibility Checklist Is your project nuclear? NO - Is your project LULUCF? YES - ? [ reading on page ] Is your country a non-Annex 1 country? YES - [

Appendix] Has your country ratified the KP? YES - [

www.UNFCCC.int] Does your project contribute to your country’s sustainable

development? YES - [ Module 16] Does your country have a DNA in place? YES - [

www.unfccc.int] Does your project impact the environment negatively and

if so, will it comply with your country’s EIA requirements? YES - [ Module ?]

Will your project reduce/avoid GHGs? YES - [Modules ? and ?]

Will this reduction/avoidance be real and measurable? YES - [ditto]

Will this reduction/avoidance be additional to the BAU scenario? YES - [ditto]

Will your project divert ODA? NO -

Project appraisal

Technological Feasibility• Does the technology work?• Is the technology mature?• Is the technology new to the region?• Will the technology work in the region?• Is there capacity to install, operate, and

maintain the technologies?

Financial Feasibility:• Does the finance work?• Is the rate of return/Net Present Value/Payback

period sufficient to interest the investor?

Project appraisal

Barrier Assessment:• What are the barriers (financial, technical,

capacity, institutional, normative etc.)?• Do these barriers imply changes in interest of

investors?• Technology issues:

– is the project greenfield or retrofit? – Is the technology new to the region or is there

existing experience/track record in the region?

Project appraisal

Risk Assessment:– Risks?– Projects and CDM projects in particular are all

about risk and risk mitigation….– Go to Presentation on Risks

Project appraisal

Elements of the CDM project

Elements of the CDM project

Project size• Small-scale and “regular”• Size determines project design requirements

and parameters• See separate presentation on small scale

project activities…

Elements of the CDM project Project boundary• Definition: “The project boundary shall encompass all …emissions …

of (GHG) under the control of the project participants that are significant and reasonably attributable to the CDM project activity.”

• What’s inside and outside the project boundary?• What emissions are directly as a result of the project?• What emissions can be considered as “leakage”?• Which leakage must be included and which can be excluded?• Definitions: http://cdm.unfccc.int/Reference/Documents/Pdd

Glossary/ English/pddgloss

Elements of the CDM project

New and existing baseline methods:• Small-scale projects are dealt with top-down –

baselines are already set.• “regular” size projects can make use of existing

baseline methodologies.• If the baseline has not already been approved

new baseline methodologies can be proposed - follow guidelines at: cdm.unfccc.int

Sustainable Development and the DNA approval

SD and the DNA approval

The essential elements:• Approve that project activities contribute to

host country SD• Cede CERs to project participants• Voluntary: promote country projects, locate

sources of funding etc.

SD and the DNA approval

Project concept identification and description: • Introduction

SD and the DNA approval

Project concept:• Project Name, owner and beneficiaries• Project Objective and Background on the identified

proposed activity • Proposed Project Activities • Proposed Project Outputs • Background information on the institutional

arrangements • Eligibility Criteria: Please give information to illustrate

that the project is eligible (see above)• Cost of project.

PINsPIN TemplateRefer to Toolkit Module 19 for general advice in CDM Toolkit at

www.cdmguide.org

CDM Toolkit Module Ref

Notes

Section One: Project description and underlying project feasibility

Classify your project type (according to Schedule A in Module 10

10

Which greenhouse gases does your project reduce? (CO2 / CH4 / N2O / HFCs / PCFs / SF6)

10

Give a brief description of your project (approx 10 lines), including the objective of the project, its proposed activities, the technologies to be employed, the technologies replaced and project location (country, region and town).

10

Provide details of the project developer, including: organisational category, experience, function(s) in project, contact person

10 This item is of more relevance to external investors, or for a large organisation with fairly autonomous subsidiaries or divisions.

Describe how the project fits into the objectives of the developer organisation. Include any details required in internal project motivation applications.

10 This item is more likely to be relevant to internal decision makers.

Does the project have the necessary permits, licenses, rezoning applications for the plant, site or technology?

11,13,16

PINs

Section Two: Technology

Describe the technology to be used in the project, together with the technology this will replace (business as usual)

11

Provide examples of the ability of the technology to perform in similar circumstances (a case history)

11

Section Three: Greenhouse gas reduction and baseline

Describe your project baseline (5 lines) 14

What is the expected crediting lifetime of the CDM activity? Does this differ from the underlying project’s duration?

14

Describe your projects boundary, including a diagram where possible.

14

Give an estimate of your project’s anticipated GHG reductions expressed in tCO2e per year of project duration. Include a summary of relevant calculations.

14

Is your project likely to be small scale or regular? If regular is there an approved methodology for your project? If small scale, does your project involve any unusual interpretations of the rules and procedures?

14

PINs

PINsSection Four: CDM Requirements

Confirm that the host country has ratified/acceded to the Kyoto Protocol

16, 12

Does your project have an Annex 1 partner from a country that has ratified the Kyoto Protocol?

16, 12 Note that this is not necessarily a pre-requisite, but some investors may prioritise this.

Has the host country established a DNA with rules and procedures for approval? If not, give an indication of when is this likely to be operational.

16, 12

If your project financing structure includes ODA, describe your argument for Financial Additionality

15

Describe (15 lines) your main arguments for the project’s additionality, referring to barrier evaluation (technical, financial, institutional, capacity etc)

10, 13, 14

PINsSection Five: Financing

What are the expected IRRs of both the project base case and CDM project?

12

Attach Cash flow schedules (or other appropriate financial analysis).

12 You can use the cash flow analysis tools developed in Module 12. Include both base case and CDM project analyses.

Describe the anticipated finance structure giving details of financing sources, such as the amount anticipated from CER revenues.

12

List both secured and required financing partners together with the amount and type of finance (e.g. CER purchasers, equity, debt, bridging finance)

12

Give an indicative required-price of the CERs.

12

PINs

Section Six: Contribution to Sustainable Development

Describe the sustainable development impacts of your project (10 lines).

16

Is your project in compliance with the host country’s requirements for sustainable development? (If the host country has not yet established these requirements, use Gold Standard requirements as a proxy.)

16

Section Seven: Project partners

Describe the anticipated architecture of your project (5 lines).

18

List each of your project partners providing: organisation category; contact person; credentials (experience in the case of a technology partner, and financial standing in the case of a financial partner); their interest or main activities in the project

18

PINs

PINs

Section Eight: Implementation

What is the anticipated commissioning date of your project?

12, 14, 15

What are the major barriers and risks facing your project at this point?

11, 12, 13, 14, 15, 16, 17, 18

You may want to exclude this item for release to an external investor

List any capacity resource needs identified, and where these are to be sourced (internally or externally)

11, 12 You may want to exclude this item for release to an external investor