African Carbon Credits – An Unexploited Commodity
by Storm Steenkamp, Senior Associate, and Sean Buchanan, Projects Director, EcoMetrix Africa
In 2010 the global carbon market was valued at approximately $142bn. This represents a slight decrease in value on the previous year ($143.7bn, 2009) and a reverse in the trend after five years of consecutive, robust growth. The global carbon market comprises both compliance markets and voluntary markets but the large majority of transactions occur within the compliance markets with the voluntary markets accounting for only 0.3% of total global carbon market volumes.
The CDM market represents an opportunity for the developing continent to engage in the carbon market by implementing project activities which reduce carbon emissions.
Within the compliance markets the European Union Emissions Trading Scheme (EU ETS) accounts for 84% of the global carbon market and therefore the major trends within the global market are dominated by the rules and regulations promulgated by the European Commission (EC) with respect to the EU ETS. Certified Emission Reductions (CERs) generated by CDM projects in developing countries, more commonly referred to as ‘carbon credits’, can be used for compliance purposes within the EU ETS and together with the EU ETS allowances, secondary CDM transactions comprise 97% of the current global carbon market. This article examines the state and trends of both the EU ETS and CDM market in detail before taking a brief look at other international compliance schemes and the voluntary market.
Of most interest, from an African perspective, is the CDM market as this represents an opportunity for the developing continent to engage in the carbon market by implementing project activities which reduce carbon emissions from the ‘business as usual’ or baseline scenario. These projects, upon registration with the UNFCCC, are compensated for their efforts (and adoption of higher cost technology) by developed countries in the form of carbon credit revenue and technology transfer.
The EU ETS and the CDM
Over the past year there have been a number of significant market developments within the EU ETS compliance framework. The first of these is the decision by the EC that CERs derived from the abatement of HFC and adipic acid (N2O) emissions will no longer be eligible for offsetting purposes within the EU ETS after 2012. Given the fact that HFC and adipic acid CERs account for approximately 407 million of the 607 million total emission reductions to date, it is no surprise that this is having a substantial impact on trading within the EU ETS market. The trend is now to surrender these credits early and rather take a long position on EUAs (emission allowances issued to EU facilities regulated by the scheme), saving them for use in phase III when the HFC and adipic acid N2O credits are no longer eligible. This can be seen by the increase to an estimated 89 million of credits surrendered in 2010 versus 81 million credits in 2009 (2008:81 million). It has also created an eligibility price spread which ranges between EUR 1 and EUR 10.
The second notable decision was that CERs from any project registered after 2012 in non-LDCs (Least Developed Countries) would not be eligible for compliance purposes within the EU ETS. Looking at the state of LDC participation within the CDM market, this is a move that will have major impacts for the CDM mechanism. There are currently only 20 CDM projects registered in LDCs and these have generated a mere 16,000 CERs which is only 0.003% of the 605 million credits issued to date. Compare this to, for example, China which alone contributes 42% of the overall number of registered CDM projects and generates 62% of the CERs from CDM and one can see that LDC participation in the CDM is insignificant.
The price of carbon theoretically affects long-term emission trends by influencing investment decisions.
The decision to exclude non-LDC credits has had two primary consequences. Firstly there has been a marked rush to register projects in non-LDCs before the end of 2012, with a record 720 projects registered in 2010 and a further increase expected for 2011. And secondly, the focus for post-2012 CDM project developers has now shifted to Africa where 33 countries are classified as LDCs compared to Asia’s nine LDCs and the Americas one LDC. There is no doubt that LDCs in Africa will attract the next wave of investment in CDM project development, but given the lack of institutional capacity within many of these states, as well as their infrastructure and governance issues, the question remains whether they will fully be able to translate these investment opportunities into sustainable CDM projects that can reliably issue credits year on year.
Given the current situation with regards to CDM investment in LDCs and the difficulty associated with realising projects within these states, one has to wonder if this decision will present a supply and demand discontinuity within the CDM market? Not necessarily. The demand for CERs will be somewhat dampened with the third restriction that has been imposed on the EU ETS – that no more than 50% of emissions may be offset with CERs in phase III – but more importantly, both the primary and secondary CDM market remain a buyers’ market. This can be seen in the current Emission Reduction Purchase Agreement (ERPA) trends where purchases are conditional upon EU ETS eligibility and the agreement for CER sales persist at variable prices. This variable pricing is a buyers’ preference, with observed market prices between 60% - 80% of market value, while sellers would rather secure a fixed price and thus be protected from any further price decreases. This outlook is an exact reversal of the previous trend where sellers were inclined to favour variable pricing on the expectation that prices would increase. As such, this reversal represents that the downside risk is now viewed as much greater than in previous years.