Climate Change Opportunities Clean energy in Central and Eastern Europe The Kyoto Protocol’s flexible market mechanisms (Joint Implementation (JI) and International Emissions Trading (IET), for the countries of Central and Eastern Europe (CEE)) provide nations with the option of trading emission reductions between countries, and entities within them. Jl is an attractive means to raise capital and to generate additional income for renewable energy, energy effi- ciency, CHP and fuel switching projects. At present at least 60 Jl pro- jects are at various stages of development in the Central and Eastern European Countries (CEECs). ait , ESD, UK gives an overview of the current situation and opportunities in the region.

Central and Eastern Europe (CEE)’ repre- reduce the region’s high per capita fossil

sents a significant opportunity in the devel- fuel consumption. The value of energy

opment of ‘clean energy’ projects including resources has rapidly become apparent in

renewable energy, energy efficiency, and the 13 years since the end of centralised

combined heat and power (CHP). The planning. Investment in the energy sector

region is well endowed with renewable is booming, with large scale restructuring

energy resources and there is considerable and privatisation taking place in every

scope for energy efficiency measures to country.

Energy Related CO2 emissions from Eastern Europe & Ukraine

Resluctions ; necessaly to ; meet Kyoto /

Targets j I I / I

Base year 2010 Target BAU Projection forzQ10

The economies of Central and Eastern

Europe (CEE) have experienced large scale

restructuring in the transition period fol-

lowing almost 50 years of centralised plan-

ning. One of the outcomes of the transition

has been the decline in the industria1 sec-

tors. This recession has greatly influenced

the volumes of greenhouse gas (GHG)

emissions from the region. Figure 1 demon-

strates the impact the economic situation

has had on emissions from energy con-

sumption. The business as usual (BAU)

projection for 20 10 describes the volume of

emissions expected under current circum-

stances with no significant changes in

behaviour. The BAU projection suggests

that the countries of Central and Eastern

Europe will exceed the emission reduction

targets for 2010 agreed under the Kyoto

protocol.

Sellers Joint Implementation represents a signifi-

cant opportunity for CEE developments in

the field of renewable energy and energy

efficiency. The historically high fossil fuel

use, particularly coal, and the rapid decline

50 September/October 2002 REF www.re-focus.net

FEATURE - CLIMATE CHANCE OPPORTUNITIES __

and then restructuring of the region’s

economies, means that almost all countries

have decreased GHG emissions far below

the targets agreed upon under the United

Nations Framework Convention on

Climate Change (UNFCCC) in Kyoto,

December 1997. During the so-called

Kyoto ‘Commitment Period’ of 2008 to

2012, almost all will have sufficient emis-

sion reduction units (the unit of measure

under the Kyoto Protocol for these coun-

tries) to sell to other industrialised coun-

tries, such as the European Union (EU).

Each CEE government has the option to

retain the emission reduction from the base

year (generally 1930), or to sell part of their

emission reductions in excess of their targets

to other countries which have a higher cost

of reducing emissions. All ten of the

CEECs have signed the Kyoto Protocol and

half of them have ratified the Protocol. The

remaining 5 are expected to do so shortly

after the Earth Summit held in

Johannesburg in September 2002.

Buyers The EU has a combined emission reduc-

tion target of 8%, with many countries

voluntarily taking on tougher targets, e.g.

UK 12.5%, and Germany and Denmark

21%. While rhe US has not ratified the

Kyoto Protocol a number of American

states have adopted voluntary, and, in

some cases mandatory, GHG emission

reduction targets. The more industrialised

countries, such as those in the EU, have

high emission reduction relative to almost

all CEECs and to almost all developing

countries. Estimates for the costs of abat-

ing one tonne of carbon dioxide equivalent

(COze) in the EU range between

Euro40/tonne of CO,e and Euro200/

tonne per CO,e. These costs are high as

legislation on energy efficiency, environ-

mental performance and industrial best

practice are already well advanced in the

EU, and most countries in the EU have

been investing in industrial and insticu-

tional energy efficiency and demand side

management measures since the oil price

crises of the 1970s.

Joint Implementation allows entities

(e.g., private companies) to invest in pro-

jects in other industrialised countries

which generate emission savings which are

likely to exceed their target in exchange for

emission reduction units. The emission

reduction units may then be counted

towards the purchasers host nation’s emis-

sion reduction target. Investments in

emission abatement measures in CEECs

Existing Situation

\ (Coal fired)

Paper Market

Figure 2: The existing energy situation at the woodprocessingplant.

are frequently cheaper than in western

economies, allowing the emission reduc-

tions to be achieved in the most economi-

cally efficient way. Many of the projects

with which ESD has been involved in

CEECs have found that the contribution

of between US $ 3 and 5 per tonne of

C02e abated has been sufficient to increase

the viability of the investments. This is

clearly a more rational option for Western

Entities than investing in the capital inten-

sive abatement measures in their country

of residence.

JI qualification Projects should meet a number of criteria

to qualify under the JI mechanism. The

project must:

l Be located in an Annex 1 Country2

l Be environmentally additional

A question of additionality The primary condition of qualification as a

JI project is that it should demonstrate that

it will result in emission reductions addi-

tional to what would otherwise have

occurred without the project. In the case of

renewable energy and energy efficiency the

case for environmental additionality is often

easy to make. In the run up to the

Conference of Parties (COP) meeting in

Marrakech, November 200 1, considerable

discussion surrounded other issues of addi-

tionality, such as so-called financial and

investment additionality. Furthermore, the

parties agreed that for the next year (i.e.

2002) that two ‘tracks’ could be utilised for

Joint Implementation projects. In one case,

the host government must undertake to

measure national emissions in a sufficiently

rigorous fashion to satisfy both the UNFC-

CC Secretariat and the investor country

government that the project proposed

would result in emissions savings without

extensive baseline, validation and monitor-

ing (Track 1).

The other track, which is currently being

applied by most Annex 1 governments,

requires more baseline and validation

rigour, similar to those conditions agreed

for approval of CDM projects. In this case,

there must be some demonstration that the

revenues from the sale of emission reduc-

tions would make the project viable. It

should be noted, however, that these are not

hard and fast rules, and they will certainly

change in the next COP in New Delhi in

October 2002.

The case for projects additionality is

reviewed by independent third party valida-

tors. These play the role of independent

judges to assess whether or not the project

satisfies the additionality requirement(s).

The validtor judges whether or not the pro-

ject baseline and monitoring plan demon-

strate the project will, indeed, generate the

emission reduction unia claimed by the

project sponsors.

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m FEATURE - CLIMATE CHANGE OPPORTUNITIES

Proposed ect Proi co2

(reduced)

Wood processing plant

Figure 3: The energ;y supply at the woodprocessingplant fallowing the investment.

The projects A variety of technologies are suitable for JI,

most notably renewable energy. Two exam-

ples are provided here to illustrate how key

elements of the JI process work.

Project example 1 - Wind farm development. The wind farm project fails to achieve the

financial rate of return necessary to satisfy

an investor, based upon current electricity

prices, required approvals for the project,

and so on. In particular, the power pur-

chase price offered by the national grid does

not yield a sufficient financial internal rate

of return to satisfy the investor. However,

the project will generate substantial green-

house gas free electricity into a national grid

that is dominated by coal fired electricity

plants. It, therefore, satisfies the environ-

mental additionality criteria under Kyoto as

every unit of electricity generated by the

wind farm displaces a unit generated by fos-

sil fuels on the national grid. That is, the

investment will generate CO, emission

reductions, and therefore, the project

should easily be validated and qualify as a JI

project, thereby able to sell emission reduc-

tions to earn credits that, when added to the

rest of the project’s revenues, generates a rate

of rerurn that satisfies the investor. The

baseline methodology uses a financial analy-

sis to calculate the financial internal rate

of return of the project to demonstrate

that it is environmentally beneficial and

additional, and that without the credits

from the reductions, the project would

probably not go forward.

Project example 2 - Retrofitting a Combined Heat and Power plant A wood processing plant’s heat and electrici-

ty demand is met on site by a coal fired com-

bined heat and power (CHP) plant. The

wood company generates considerable wood

waste, which, on the one hand, poses an

environmental hazard (generating methane,

polluting the waster table, etc.), while serv-

ing as a non-utilised source of energy for the

factory, on the other. The proposed project

will replace the existing coal fired plant with

fluidised bed technology which allows the

boiler to burn both coal and biomass, thus

using all the wood waste (thereby reducing

methane emissions) and displacing a signifi-

cant amount of coal, thereby reducing

greenhouse gases associated with burning

that coal. Moreover, because the plant gener-

ates electricity, much of which is sold to the

national grid, the wood waste used to gener-

ate electricity displaces fossil fuels on the

grid, thereby reducing the country’s overall

GHG emissions. The existing situation is

illustrated in Figure 2. An on site coal fired

CHP unit produces heat and electricity

which feeds a wood processing plant. The

project generates GHG emission savings of

both CO,e and CH, both at the plant and

on the national grid (Figure 3).

A least cost analysis is used to set the pro-

ject baseline in order to determine whether

or not the investment is environmentally

additional, and, if so, what emission reduc-

tions should be available for sale from this JI

investment into the market place. The most

financially viable option for this plant is to

continue to generate their electricity and

heat using the coal fired CHI? However,

with the revenues from the sale of the emis-

sion reductions, the investment in co-firing

with wood waste makes the project more

attractive to the investor. The emission

reduction revenues are high enough to

ensure this co-firing investment will be

made under JI, and promotes the deploy-

ment of green technology.

ESD has assisted with the development of

carbon financing with a number of projects

in CEE, of which these are but two exam-

ples. The carbon (shorthand for greenhouse

gas) element of these projects represents

substantial contributions to the projects,

usually on average, around 10% of the total

investment cost, and, in the case of the

methane reduction projects, well over 40%

of the investment costs. The additional

contribution frequently provides sufficient

revenue to counterbalance the perceived risk

of investment in CEECs and in renewable

energy technologies.

JI looks attractive, so why isn’t more happening? All energy project developments have to pass

through the conventional project cycle

(Figure 4). Project developers have expertise

in the mitigation of risks and hurdles which

are integral to the development of projects.

Elements of conventional risks such as polit-

ical and financial risks are perceived by

many to be greater when developing projects

in the CEECs, but a variety of risk appraisal

methods exist to satisfy investors, and there

are a number of ways of mitigating those

risks (e.g., concessionary financing, export

credits, export credit guarantees, etc.).

However, assessing the risk of a JI project

is new, and little experience exists to give

investors the level of comfort they require

to proceed with a new technology in an

emerging economy. Given the fact that the

entire Kyoto process is still developing, and

that modalities and rules are still being set,

there are uncertainties to JI that lead most

investors to hold back. The lack of famil-

iarity of many host and investor govern-

ments on eligibility of projects, even the

desirability of using carbon financing to

promote clean energy, is another factor that

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FEATURE - CLIMATE CHANGE OPPORTUNITIES

concerns investors. The process of gaining

the types of approvals and support neces-

sary from governments for a JI project can

be arduous.

The JI mechanism is presently in its

infancy and all parties (host and recipient

governments, purchasers and sellers) are

learning from their experiences. The life

cycles of project based emission reductions

vary greatly and are largely dependent on

the purchaser and the host nation’s govern-

ment. The fundamental process is com-

mon amongst all JI projects. Investors are

used to dealing with the risks associated

with conventional or normal projects. But,

at this early stage of market development

ESD has found that the transaction phase

associated with going from the convention-

al project design, to gaining approval of the

project as an eligible JI project, with a

signed contract for the emission reductions

takes up to 18 months. This transaction

generates a substantial resource burden for

any project developer, and these costs and

delays must be reduced significantly before

large numbers of investors will begin seeing

Joint I m pl ementation as an attractive

mechanism for supporting renewable ener-

gy and adding meaningful incomes to their

investments.

Transaction costs related to the develop-

ment of a JI project are shown in Figure 5.

ESD has found that a good working rela-

tionship with the host and recipient nation’s

governments can greatly reduce the transac-

tion cost risk. The ‘learning by doing’

aspects of JI can be genuinely beneficial

where trust and experience are present.

Half of the CEEC’s have now ratified the

Kyoto Protocol and an increasing number

have first hand experience of the develop-

ment of JI projects. This familiarity eases

the process, accelerates it, and thus reduces

the risk. However some of the CEECs are

still in the process of the formulation of

national JI strategies, which can have the

opposite effect.

The baseline is the basis upon which the

emission reductions will be measured

throughout project lifetime. It is a scenario

which describes what would have occurred

in the absence of the project. Baseline

development requires thorough under-

standing of the specific energy sector

including the political, regulatory, econom-

ic and environmental conditions and the

ability to develop robust scenarios and fore-

casts. Once all relevant parties have agreed

the baseline an emission reduction calcula-

tion can be measured against it.

The baseline process varies between pur-

chases. With some purchasers such as the

>

PMCl ldentiflcation 3D Implemmntation Operation

Figure 4: The conventional project development q&e

Normal Project

Transaction Costs Government eligibility criteria Government and investors capacity

Better Defined Transaction Costs *Baseline development *Monitoring plan *Validation *Verification

Figure 5: JI related transaction costs.

Dutch Governments Emission Reduction

Procurement Tender the baseline, once

agreed is fixed for the lifetime of the project.

With other purchasers such as the World

Bank’s Prototype Carbon Fund the baseline

is agreed subject to a number of conditions

which are defined in the monitoring plan.

The conditions include events which trigger

the revision of the baseline. These may

include changes in the regulatory regime,

energy and environment related, significant

changes within the boundary of the base-

line, and project specific factors, such as

interconnectivity with other energy net-

works. The fixed baseline provides a degree

of security, but has no scope for the baseline

to be influenced positively or negatively by

future events.

ESD considers the dominant factors nec-

essary for the successful development of an

Emission Production Purchase Agreement

under JI are:

l A good project, emission reduction

income can make a financially marginal

project viable, but it can not make a

poor project good

l Host and recipient Government

approval and support

l Passing the UNFCCC additionality test

l Developing a robust baseline and

monitoring plan which not only satis-

fies an independent validator, but

optimises the projects emission reduc-

tion asset

l Identification of a suitable carbon pur-

chaser for the project

Conclusions l CEEC’s demonstrate enormous poten-

tial for renewable energy, fuel switching

and energy efficiency projects.

l There are an abundance of energy

projects which fit the JI criteria.

l There are fewer quality projects which

have the potential to secure emission

reduction purchase agreements.

l The JI process is evolving rapidly and

works.

l JI offers substantial financial benefits to

suitable projects

l JI can currently pose a burden for

project developers

l Intermediaries with Climate Change

expertise can increase the chances of a

project successfully securing emission

reduction related income and reduce

developers risk by harnessing a their

experience

Contact: Matthew Clayton, Field

Manager International, Energy for

Sustainable Development, Overmoor,

Neston, Corsham, SN13 9TZ, United

Kingdom. Tel: +44 1225 816819; Fax: +44

7787 523143; matthew@esd.co.uk;

www.esd.co.uk

Footnotes 1 Poland, Estonia, Lithuania, Latvia,

Czech Republic, Siovakia, Hungary,

Romania, Bulgaria and Slovenia.

2 http://unfccc.int/resource/kpstats.pdf

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