Archive for finance

Project-based carbon offsetting is like a lottery with no prizes

Posted in Climate Change with tags , , , , , , , , , on December 7, 2009 by Dan

At Carbon Retirement, we have just published a short piece of research into the efficiency of carbon offsetting through the Clean Development Mechanism, covered today by the BBC. It shows that for every £1 spent on CERs by voluntary buyers, 28p goes to the project’s capital expenditure and maintenance costs.

The chart below, from the report, summarises the costs per CER, with the grey chunks representing project expenditure. Project costs total £3.78 per CER, or 28% of the price paid by the final buyer.

Costs in the CDM market, per CER

Costs in the CDM market, per CER

This isn’t a study of profitability for any of these actors and the costs at each stage might be reasonable. The big chunk taken by the pCER buyer in our model, for example, may be a fair reflection of the risk it holds that the project will not deliver CERs.

However, the research shows that the efficiency of the overall system is very poor. While some transactional costs are inevitable and you could never expect 100% of your money to go to project funding, 28% seems far too low. Imagine if a development charity told you that 72% of your donation went to middlemen and admin fees!

Co-incidentally, 28% is also the proportion of UK national lottery revenue that goes to charity. So, buying carbon offsets to mitigate climate change is like buying lottery tickets to give money to charity. With carbon offsetting, you don’t even win a prize!

EUAs are a natural hedge against equities

Posted in Carbon markets with tags , , , , , on September 29, 2008 by Dan

The particular situation that the European carbon market is in makes EUAs a natural hedge against equities.

While credit restrictions could reduce consumption and therefore emissions, a greater factor in EUA demand is the reduced availability of finance for emission reduction projects, both within and outside of Europe.

Most analysts seem to be saying that the CDM pipeline is facing restrictions as projects find it difficult to find funding – and even that Phase 2 compliance buyers will not be able to fill their quota of CERs (collectively, EU ETS participants can use UN-regulated offsets, called CERs, to cover up to 13.4% of their emissions). This will make higher internal reductions necessary, exerting upward pressure on EUAs.

Within Europe, a higher cost of capital makes clean technology more expensive, so a higher carbon price will be necessary to make the business case for the same capital investment.

While tighter credit tends to send stock downwards, it will tend to send EUAs up.

Yvo de Boer’s climate bonds – how are they different to normal government bonds?

Posted in Carbon markets with tags , , , , , , on May 27, 2008 by Dan

Yvo de Boer, the head of the UNFCCC, told the FT yesterday about his idea for ‘climate bonds’.

Such bonds would involve a developing country government setting a national target on emissions or energy, for example a goal of producing a certain amount of renewable energy by 2020. It could count on receiving carbon credits equivalent to this renewable energy under a successor to the Kyoto protocol, which would enable the finance ministry to issue “climate bonds”. These would raise money from investors based on the promise that they would receive returns from the sale of the resulting carbon credits.

This is not possible under the Kyoto protocol because the system for awarding carbon credits requires would-be investors to put their money into emission-cutting projects, often small-scale and carrying big investment risks.

I can see that the formal Kyoto mechanisms don’t include provisions for up-front finance for emission reduction projects – the CDM requires projects to have reached a fairly advanced level of maturity before it awards credits. But if there are people out there who are prepared to take on the risk associated with CDM projects, couldn’t the market already deliver debt instruments like de Boer’s climate bonds?

Mr de Boer believes government-sponsored climate bonds would reduce the investment risk, because governments could act as a guarantor, and encourage much greater investment in carbon reduction in the developing world.

If the government takes on the risk of the CDM project, surely the coupon would be the same as one of that government’s normal bonds. How would that be different to a government raising debt money and deciding to spend it on national CDM projects?

Innovative finance can overcome consumers’ reluctance to invest in home efficiency

Posted in Consumer footprints with tags , , , on April 3, 2008 by Dan

Research published yesterday by the National House-Building Council (pdf) showed that house buyers are not very interested in energy efficiency, even though it will save them money in the long run. They’re more interested in a nice kitchen.

Something similar emerged from the UK version of the McKinsey curve of marginal abatement costs (see p14 of this pdf). Lots of the measures below the line (i.e. those that save money as well as reducing emissions) are to do with building efficiency – condensing boilers, wall insulation etc. – and are not happening even though they make economic sense.

Two possible explanations: (i) consumers are too short-sighted to understand the benefits of improving their homes, or (ii) their discount rate is sufficiently high to prevent them from investing. They prefer to spend the money on kitchens or holidays that they can have now.

There must be opportunities for energy suppliers to make deals with home owners. You get a new boiler for free and pay a premium on your bills until it is paid off (the better efficiency means that the total bill is not higher). The premium would be designed so that the supplier could profit on its capital outlay.

Geeky point about global warming potentials

Posted in Other with tags , , , , on January 7, 2008 by Dan

Greenhouse gases have global warming potentials that are described in terms of carbon dioxide equivalents. Methane, for example, has a warming potential of 25. This means that, over a 100 year period, one tonne of methane will warm the earth 25 times more than one tonne of carbon dioxide. Some less common gases have very high warming potentials. Sulphur hexafluoride, for example, has a warming potential of 22,800.

A central part of these factors is the length of time that the gases remain in the atmosphere. Methane, for example, remains in the atmosphere for around 12 years, while carbon dioxide remains in the atmosphere for longer – between 50 and 200 years. If warming potentials are assessed over a 20 year period, methane is 72 (not 25) times more potent than carbon dioxide. Gases with a short life look better when assessed over a long period.

Policy calculations use a time horizon of 100 years.

This is important because the timing of emissions matters. Reducing global warming now is more important than reducing it in the future. The warming potentials, however, assume that all warming caused over the 100 years following release of the gas is of equal value.

A sensible solution might be to use the atmospheric life of each gas as the time horizon, and discount the warming to reflect our preference for reducing warming closer to the present. This discount rate would also be used in the carbon capital calculations recommended in an earlier post.

For warming potentials and atmospheric lifetimes, see p212 of the IPCC’s Climate Change 2007 – The Physical Science Basis (pdf).

A suggestion for a cap and trade scheme that maximises clean development

Posted in Carbon markets with tags , , , , on November 16, 2007 by Dan

Cap and trade systems that allow participants to submit offsets are designed to allocate resources to the cheapest projects that reduce emissions, across the whole world. Take a look at McKinsey’s marginal costs of reducing greenhouse gas emissions by different methods. If a coal power station’s only option to achieve its cap is retrofitting the plant with clean technology, at a cost per ton of CO2-eqivalent abated of around $30, the plant can instead pay for wind farms to be built at around $15 per ton and pocket the difference.

This sounds like an economically sensible outcome, but it does have some flaws. The following is an idea for a cap-and-trade system that maximises the environmental benefit rather than minimising the cost, and also forces more competitiveness into the offset generation industry (without getting into the debate of whether offsets work or not).

(If you are familiar with the EU ETS, for credit read EUA and for offset read CER.)

  1. A cap is set and credits are distributed to participants accordingly.
  2. The fine per ton of emissions that a participant is responsible for but cannot cover with credits is set higher than you would reasonably expect the price of carbon to go in the trading round. The fine is the ceiling for the price of emissions. So far, so good – just like the European scheme. But:
  3. Participants may only present credits at the end of the round – they are not allowed to present any offsets.
  4. Certified offsets may be converted into credits at any time in the trading round according to the ratio (credit price / offset price) * a multiplier, where the multiplier is close to 100%. For example, if credits cost EUR20, offsets cost EUR10 and the multiplier is 80%, participants can convert 1.6 offsets into 1 credit.
  5. Converted credits are tradable but are marked. Participants may only present a certain proportion of marked credits among their overall portfolio at the end of the round.

This system still pushes capital to most efficient place, but has two further benefits. Firstly, it means that where the collective participants do not view it as economical to reduce emissions directly, they must purchase a larger volume of offsets than they do under a scheme where offsets and credits have equal weighting, and therefore finance more clean development. Secondly, it decouples the cost of credits and offsets in the system, allowing the cost of offsets to fall to a more competitive level. In Balance suspects that CER generation can be unreasonably profitable because the CER price is largely driven by the higher EUA price.