Results, Discussion and Conclusion of the Dissertation

What are the Risks to Carbon Credit Projects Post 2012 Kyoto Protocol?
by Dean Skivington

The focus of the research is to explore the current project risks and use the known data and risk management tools, as well as use deterministic and stochastic approaches, in scenario-based concepts.

The research questions are: 1. What are the current risks for carbon credit projects under the Kyoto Protocol? 2. How are these known risks being managed? 3. What risks are to be expected for the post 2012 regime? 4. How can these predicted risks be managed?

After a brief introduction to the topic, a comprehensive literature review on available books and articles on the topic was written (not included in this paper), which looked firstly at the Kyoto Protocol, the carbon credit, market, the risks of the carbon market and explores risk management procedures. It also discusses the Kyoto Protocol post 2012 and gives an outlook of the situation in the future. After the literature review the methodology states the research method, design and process (not included in this paper). The third part of the dissertation and first part to be included in this paper is a summary and comparison of the results of the primary research. The analysis of the results includes the suggestion of three scenarios for three different periods of time. A worst-case scenario, an ideal situation and a realistic situation are explained for three periods: up to the end of 2012, 2013-2015 and 2016-2020. The second part of this paper looks back at the literature review and at the fieldwork and discusses similarities and differences. The last part of this paper is the overall conclusion of the research project, which incorporates recommendations for the industry as well as further research.
Comment [IE1]: Between what and what?

Results
Review of the Questionnaires
A research was conducted to understand the Kyoto Protocol, the carbon markets and the role and risks faced by the carbon projects in current markets and post 2012 scenario, when the first phase of the Kyoto Protocol comes to a closure. Seven professionals involved in the carbon markets were requested to share their views via a questionnaire. The respondents were:

Juned Khan, Royal Climate Care, Royal International Federation and other boards Chris Charge, Biogas Technology Ltd Fergal Mee, Carbon Action Phil Smith, Hoshin Richard Selby, Global Carbon Ukraine Anonymous Walter Gama Barboza, B & G Empreendimentos/B & B Ambiental

The questionnaires are annexed at the end of the document for reference. The following sections briefly review their comments:

Comment [IE2]: The completed questionnaire

How has the Kyoto Protocol changed the situation of climate change? Kyoto Protocol has changed the situation of climate change by creating environmental awareness, establishing a carbon credit market, supporting infrastructure development in implementing projects and in bringing more finance to developing economies. Out of seven respondents, three mentioned the creation of awareness about the environment as Kyotos largest impact on climate change. Three respondents also mentioned that Kyoto Protocol has impacted the climate change by creating carbon markets/carbon credits. A few respondents mentioned more than one way in which Kyoto Protocol has changed the climate change situation.

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What impact did the Kyoto Protocol have on the carbon market? All the respondents believe that the Kyoto Protocol has had a direct impact on the development of the carbon markets, with two pointing out that Kyoto Protocol has been instrumental in developing carbon as a marketable commodity.

Some quotations from the respondents are: The carbon market could not exist without Kyoto. To a large extent Kyoto is the carbon market. Without Kyoto Protocol there would be no carbon market. Kyoto Protocol is the originating point of carbon markets.

Has Kyoto Protocol been successful? On being asked if the Kyoto Protocol had been successful, only two respondents out of seven gave a definitive yes, while the rest could not give a definitive answer and mentioned sectors where the Kyoto Protocol has been successful and other areas where it has not performed. Three respondents mentioned that the Kyoto Protocol has been successful in creating awareness, while the reasons for its failure were given as ripe with corruption and projects have limited impact.

Has Kyoto Protocol been successful?

2 No definitive answer Yes 5

Figure 6: Result Success of the Kyoto Protocol

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How do you see the future of Kyoto Protocol post 2012? The views on the future of the Kyoto Protocol post 2012 seem divided, with only three respondents giving a definitive yes. One respondent answered with a definitive nothing, meaning no future, while another saw only a limited future for the Kyoto Protocol post 2012. The remaining two respondents believed that the future of the Kyoto Protocol will largely depend on the future developments and the new mechanism that is developed post 2015. The current financial crisis in Europe is seen as the reason behind the death of Kyoto Protocol, as nobody is going to take the lead. Post 2012 the Kyoto Protocol may exist in the form of a carbon market, which is seen to be from Kyoto. Even if Kyoto Protocol is not renewed as an international treaty, the market will see a rise in bilateral and multilateral trades in carbon credits.
Comment [IE3]: To what question?

Future of Kyoto Protocol Post 2012

1 3 2 1 Yes No To be seen Limited Future

Figure 7: Result Future of the Kyoto Protocol

What alternatives are there to the Kyoto Protocol? As an alternative to Kyoto Protocol, three respondents clearly suggested that bilateral arrangements like carbon trading agreements and Clean Development Mechanism (CDM) loan schemes may be developed. The bilateral arrangements, which may be United Nations (UN)-brokered, would replace the global platform. It is suggested that in absence of an international binding protocol: A voluntary market may emerge which gives incentives to buyers
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The private sector infrastructure will be replaced by non-governmental organisations (NGOs) Bilateral agreements may be developed New derivative schemes from Kyoto Protocol, like Nationally Appropriate Mitigation Actions, CDM loan schemes that focus on sustainable development of poor countries, could be created

Emission taxes could be introduced

Comment [IE4]: Your wording implies that th is an explanation of Nationally Appropriate Mitiga tion Actions: is this correct? The abbreviation has been removed because it is not subsequently use

What are the known risks for carbon credit projects? The respondents pointed out the following as the known risks for the carbon credit projects:

Activities not supported by the policies National levels of governance Regulatory hurdles Lack of robustness of any Measurement, Reporting and Verification (MRV) system Fraudulent projects Seen as free money Favouring wrong projects Credibility of carbon accounting practices Market failure due to over supply Price of carbon credits Risks associated with verifications and the approval process
Comment [IE5]: What is?

These can largely be grouped as follows: Fraud risks: This can occur in fraudulent projects, fraud accounting practices and the fact that the free money has attracted many non-deserving projects and politicians. Regulatory risks: These risks are process-related and include the risks in verification and approval process, and the dependence of a project on the national regulations and governance system of country where the project is being implemented
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Market risks: These include risks associated with market failure due to oversupply, too much price fluctuation, and very low carbon prices. What mechanisms are in place to control existing risks? The lack of effective risk control mechanisms is visible in the fact that three respondents clearly mentioned that they were not aware of any mechanisms that are in place to monitor and control the existing risks. Three respondents believe that the systems set up by the UN, such as their programs, standard methodologies, approval mechanisms, monitoring systems and permissions for accredited entities, actually function as risks, monitors and controllers. The remaining one respondent mentioned the use of due diligence tools for monitoring and controlling the existing risks while finalising the Emission Reduction Purchase Agreement.

Mechanisms to Monitor and Control the existing Risks Not Aware 1 3 3 UN programs and initiatives Other Tools

Figure 8: Result Mechanisms to Monitor and Control Risk

What are the predicted risks for carbon credit projects post 2012? The risk of market collapse in the near future was seen as the biggest risk factor predicted for the carbon projects, with four respondents discussing its collapse, partly ascribed to low Carbon Emission Reduction (CER) prices, in their answers. The other predicted risks for the carbon credit projects, as mentioned by the respondents, are as follows:

Financial companies that fail to meet their environmental goals Still existing market for fossil fuels
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Risk of fraud Low carbon prices Delay, performance and compliance risk

Predicted risks for carbon credit projects post 2012

Failure to meet goals

1 14% 1 14%

1 14%

Low CER prices/ Market collapse

Fraud 4 58% Delay, performance and compliance risks

Comment [IE6]: This figure is very small: can you make it larger so it can be read more easily?

Figure 9: Results Predicted Risks for Projects Post 2012

What mechanisms are in place to protect carbon projects post 2012? Respondents were divided on the mechanisms in place to protect carbon projects and their stakeholders post 2012, with three respondents being optimistic that the new improved mechanisms developed for the second commitment period will have mechanisms in place to protect carbon projects and their stakeholders post 2012, while two respondents say that they do not see any safety mechanisms in place (especially for new projects, as the existing ones still have some time left to run), and one respondent saying that the mechanisms are not effective anyway.

Other mechanisms that are in pace to safeguard carbon projects post 2012 are the credibility of projects, the existence of voluntary markets, and own mechanisms. What are the incentives to take on the carbon credit projects? The incentives to take on the carbon credit projects that have been listed by the research respondents are as follows:
Comment [IE7]: What do you mean?

Economic (including tax incentives, project financing, a revenue source) Corporate Social Responsibility (CSR) benefits for companies
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Energy savings/environmental Minimal benefits Regulated market Technological

Comment [IE8]: Environmental what?

Comment [IE9]: Technological what?

Out of these, economic benefits (including tax incentives, project financing, and a revenue source) and CSR benefits for a company are seen as the largest set of benefits: each of these were mentioned by five respondents out of seven. The second biggest benefit is that of energy savings and the related environmental benefits, mentioned by three respondents out of seven.

Economic (including tax incentives, project financing, a revenue source) CSR

Incentives to take on carbon credit projects Energy 6% 6% 6% 19% 31%

Technological Savings/Environmen tal

32%

Regulated market

Minimal Benefits

Comment [IE10]: Again, can you make the figure larger?

Figure 10: Results Incentives to Take On Projects

Is it worth taking up carbon credit projects? The respondents were divided in their opinion on whether it is worth taking on the risks of a carbon credit incentive project, with two agreeing, two disagreeing and the remaining three saying that the answer depends on the project conditions (national and international political considerations, quantities of carbon generating potential and broader economic development).

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Is it worth taking on risks of a carbon credit incentive project?

2 3

Yes No Depends

Figure 11: Results Risk versus Rewards

How do you see the future of carbon credit projects? Only three respondents out of seven said they were optimistic about the future of carbon credit projects in general. While three did not answer the question directly and said that the future of these projects is dependent on many variables such as the economic crisis in European Union (EU) and future policies, one respondent said they say that there was no future for carbon credit projects under the current system.

As a way forward for the carbon industry, the following are possible:

Creating an improved industry that is flexible enough to undergo transformations every six months Increasing the participation of institutional investors rather than small scale carbon outfits Developing a private international voluntary market Diversifying the plan Internationalising the disparate Measurement, Reporting and Verifications Developing carbon market by identifying sellers and buyers Utilising available and upcoming market based mechanisms

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Future of carbon credit projects in general 1 14%

3 43%

Optimistic Depands No future

3 43%

Figure 12: Results Future of Carbon Credit Projects

What is the way forward? There was no overwhelming common ground in the way forward suggested by the respondents; however, the tone seems to suggest that the best way forward will be to utilise the already established mechanisms and modify them to make them more flexible in adapting to global changes, including institutional investors and developing systems to prevent fraud and corruption (maybe through privatisation). What other agreements exist? The role of other agreements such as Durban 2015 and Europe 2020 is still largely seen as ambiguous. Only two respondents out of seven expressed optimism about these agreements, and with a word of caution that these agreements are largely aspirational and somewhat diluted in their focus. The remaining respondents were vary of their role as they believed that the importance of these agreements will largely depend on whether emerging economies like India and China agree to curb their emissions.
Comment [IE11]: This is not clear.

The Way Forward: Three Scenarios

Based on the desk research conducted and the primary research through questionnaires, three scenarios can be developed: the worst case, best case and the most realistic case. Since the current condition with the global climate change regime is so unstable, these three scenarios can be applied to three different time periods in an
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attempt to better understand the three possible scenarios. These different time periods are until the end of 2012, 2013-15 and 2016-20.

Table 3: Three Scenario Timeline

Period up to the End of 2012 The current carbon market is very unstable and it is possible that three different scenarios emerge by end of 2012, depending on the circumstances. The major influencing factors being the EU collapse, the current economic crisis and the unwillingness to major emerging economies like India and China to sign the treaty.
Comment [IE12]: Is this a reference to the euro?

In the worst case scenario, it is possible that the whole carbon market will collapse. As the future of the carbon projects is currently so unstable, investors are reluctant to invest in the market. As pointed out by one of the questionnaire respondents, even with the existence of their own companys risk assessment mechanisms, the investors are reluctant to invest in any new carbon projects. Under this scenario, in accordance with the current trends, the price of the CERs and Voluntary Emissions Reductions (VER) continues to drop, ultimately making it economically worthless for investors to invest in a carbon project. The numbers of fraudulent projects may increase (or stay as high as it is now, especially in Russia), further reducing the credibility of the carbon investments and the related portfolios.

The volatile political and economic scene will divert the attention of nations from that of climate change to maintaining their Gross Domestic Product (GDP). The voluntary sector will also see a drop, along with the compliance sector, resulting in the complete breakdown of the carbon sector. In the absence of compliance and VER, coun-

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tries continue to pollute (or at least do not decrease their pollution levels substantially), resulting in further environmental degradation.

In the best case scenario, the political and economic instability will not impact the climate change efforts. Countries continue to invest in infrastructure development to reduce consumption of fossil fuels (like closing down coal power plants etc.) along with other more holistic efforts. As a result, the carbon projects will see a natural progression from 2012 to the next period of a renewed Kyoto Protocol. The new projects attract investors, just as the existing projects will continue to receive funding. In the most realistic scenario, the investors will wait and watch. The existing carbon projects will not be affected; however, the new projects might not attract investors. The current trend of decrease in carbon prices will continue, with an increase in the volumes of carbon credits generated. The 803 registered CDM projects (2007), generating 168 MCERs per annum, are expected to add up to 1,070 MCERs up to end of 2012.

Figure 13: CDM Pipeline (November 2010) Source: CGES (2010) 2013-2015 This phase will be the most unstable phase, as a new international agreement with legal force to reduce Green House Gas (GHG) emissions will be finalised by 2015, to come into force
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after 2020.

In the worst case scenario, the governments of different countries will fail to agree on any formal agreement in setting targets to reduce GHG emissions. The top polluters, including India and China, will not agree to bind themselves to the target reductions. As no nation will agree to lead, there will be complete breakdown of the existing climate change discussions. The existing European economic crisis and the near failure of the first phase of Kyoto Protocol in achieving actual emission reductions are seen as the major factors here.

The carbon prices will continue to drop in this phase, due to an oversupply of credits generated from projects started before 2012.

The risks to the existing projects, for example the existing market for fossil fuels, the risk of fraud, low carbon prices, and delay, performance and compliance risk, would not have been mitigated. This increase in risks in absence of substantial risk assessment and management mechanisms will defer investments in new carbon projects. Various insurance products, like Energy Savings Insurance (ESI), Credit Delivery Insurance (CDI) etc., and the establishment of various funds to support GHG mitigation projects in dealing with their associated risks, such as the post-2012 Carbon Credit Fund, the Internation Finance Corporation (IFC) post-2012 Carbon Facility and the World Bank Carbon Finance Unit (CFU), will not prove to be very effective as they may be too little to save the market, resulting in the loss of credibility of the carbon market.

In an ideal scenario, 2013-2015 will see the global national governments come together and sign a binding treaty by 2015. This treaty will be formally applicable from 2020 and will bind all countries, including industrialised countries and the emerging economies like India and China, in agreeing to reduce their emission levels or pay a fine for not doing so. Even though the agreement will formally come into force from 2020, it will stabilise the carbon market, encouraging investors to invest in carbon projects. The carbon markets will continue to develop with carbon value on an increase.

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The projects will see proper risk assessment and management systems/mechanisms in place, like well designed insurance products, funds aimed to cover various projects risks, and the standards/policies developed to protect projects from already known risks like fraud, corruption in system, standardisation of systems to reduce delay and performance related risks and importantly deciding the role of national governments in these projects. In an ideal situation, the investment finance to establish and implement carbon projects will not be seen as free money, and the investments will actually support sustainable development in the region.

A voluntary carbon market will also develop parallel to the compliance market. With a healthy competition between compliance and voluntary carbon market, the carbon prices will increase, attracting more and varied investors.

Figure 14: Growth of Compliance and Voluntary Carbon Markets Source: SKM (2012)

Comment [IE13]: Will it be possible to read t print here, once the dissertation is printed?

In the most realistic scenario, it is understood that the nation members may not come to an agreement and an international global treaty may not be signed. However, this global platform will be replaced by bilateral and multilateral trades (which could be UN-brokered or not), as pointed out by respondents optimistic about the
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future of Kyoto Protocol, and the carbon markets will still exist. In the absence of an international binding force, voluntary carbon markets will arise and CERs will be replaced by VERs.

The voluntary market will see further development, with investments coming in from corporations, and other entities looking to make themselves carbon-neutral. Now that corporations globally have realised the importance and benefits of a robust CSR policy, corporations will push the carbon market through VERs. The current recession and EU breakdown will not be impact this as this scenario will be pushed by private sector and NGOs.

The 803 registered CDM projects (2007) are generating 168 MCERs per annum, and are expected to add up to 1,070 MCERs to 2012. Most of these projects will continue to generate CERs even after 2012, the exact quantity depending on the crediting period of the projects.

2016-2020 In the worst case scenario, this phase will see a further breaking down of carbon projects and the carbon market will cease to exist. The existing projects will not be renewed and new projects will not find investors, cutting down investment in developing countries.

In an ideal situation, this time period will see the member countries reaching a consensus that all the major carbon emitters, along with the developed countries, bind themselves to reduce and regulate carbon emissions. This will see the carbon markets stabilise, as the CDM projects are implemented globally. The risks faced by the carbon credit projects will be reduced considerably, such that, under an integrated international market, trading will become more transparent.

The new international agreement which will be designed to overcome the shortcomings of the existing Kyoto Protocol will be more inclusive (in terms of sectors), and be flexible such that it can be modified according to the fast-changing political and economic circumstances globally, as pointed out by respondents optimistic about the furture of Kyoto Protocol. Based on Rio 2020, the new agreement will be holistic in its approach and will tackle poverty reduction and economic growth, climate and clean
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energy, food security and sustainable agriculture, water, healthy seas and oceans, biodiversity, healthy forests and ecosystem services. The existing Kyoto Protocol is often criticised for the fact that it is based on a flawed concept, such that it instead of actually reducing emissions, it allows industrialised countries to evade the responsibility by buying the credits from the developing countries. It is expected that in its new form, the climate change treaty that will come in force after 2020 will learn from this and will devise measures to counter these issues.
Comment [IE14]: Can you be more precise?

In another possibility, if the countries do come together to sign a treaty, and the new version of Kyoto Protocol is similar to the existing system, then the CDM will remain the most influential tool, with a support role from other flexible mechanisms like the Joint Implementation (JI) and International Emissions Trading (IET).

In the most realistic situation, the 2016-2020 period will still face political instability; however, the bilateral and multilateral carbon agreements will come into play. Even as the countries keep the discussions on climate change and the need to curb GHG emissions alive, it is expected that a formally binding treaty will not be signed and agreed by all parties (including China and India).

The EU will continue its emission trading until at least 2020, as it has already introduced policy and has regulatory measures in place; the developing countries will be impacted as they will receive limited investments for their carbon projects from developed countries. In the absence of a single market, the regional carbon trading markets will become stronger and each will have its own set of eligibility criteria and carbon prices. Under these conditions, it will be a buyers market as the sellers will need to look for the best price offers. The carbon credit projects will face greater risks under this scenario.

Comment [IE15]: Can you expand this point?

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Figure 15: Potential Growth in Carbon Market in $ Trillion Source: Forbes (2010)

Discussion
The Kyoto Protocol has beyond a doubt impacted the situation regarding climate change. The actions of the Kyoto Protocol has, arguably, reduced GHG emissions, encouraged its members to develop policies supporting energy efficiency, and promoted the development of renewable sources of energy, along with sustainable forms of agriculture. The literature also supports the contention that the Kyoto Protocol has encouraged technological advancements through the exchange and transfer of low-carbon technologies to developing countries. Its largest contribution to managing climate change has been its mechanisms, like CDM and JI, and setting up and mobilising environmental monitoring and verification systems.

The Kyoto Protocol has attempted to tackle global warming by reducing GHG emissions. To achieve this, a mechanism of carbon trading has been established whereby the member nations can exchange carbon credits. A nation that is emitting GHG in excess of its allowable limit can buy carbon credits. Each unit of tradable credit (CER) is equivalent to one ton of Carbon Dioxide Equivalent (CO2-eq) reduced in

Comment [IE16]: See note above on the defi tion of this abbreviation.

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comparison to the established baseline. The Kyoto Protocol has developed the carbon market through its mechanisms of CDM and JI, amongst others. It has had a direct impact on the carbon markets. In fact, according to this survey, the carbon market would not have existed without the Kyoto Protocol.

When the questionnaire respondents were asked about their opinion on the impact of the Kyoto Protocol on climate change, the two strongest impacts mentioned were the generation of environmental awareness and the establishment of the carbon credit market. The other impacts of the Kyoto Protocol, according to the survey, were its support for the development of infrastructure in developing countries for project implementation, and in attracting more finance into the developing economies. In fact, Kyotos role in actually reducing the GHG emissions was questioned by one of the questionnaire respondents.

Comment [IE17]: Can you expand on this poi

The success of Kyoto Protocol is very debatable. The results from the survey were largely negative, with only two out of seven respondents answering a clear yes. The only area where the Kyoto Protocol is believed to have been successful is in creating awareness regarding climate change issues. Existing literature on this largely agrees with this finding of the survey, as the Kyoto Protocol is seen to be successful in being the first step and providing the platform for future climate change regimes. The emission targets set up by the Kyoto are anyway not adequate to meet todays climate change challenges. To deal with the current levels of emissions, reductions of up to 85 percent by industrialised countries by 2050 are required: the Kyoto Protocol currently demands a reduction of just 5 percent. So, the Kyoto Protocol was, from the beginning, not designed effectively to have any actual impact. It has received criticism from the beginning for setting its GHG reduction targets significantly too low. It is suggested that as the first commitment period of the Kyoto Protocol comes to an end, a new treaty should be devised (for implementation post 2020) that includes the following three conditions:
Comment [IE18]: To what question?

The participation from all polluting members, globally A substantive enough emissions cut to have an impact on the current climate condition Enforcement effective enough to deter any non-compliance
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The carbon credit projects have many associated risks, which can be largely grouped into fraud risks, regulatory risks and the market risks (derived from our survey). However, the Kyoto Protocol has set up various mechanisms to control and assess risks to make the whole process of carbon trading effective. Risk management mechanisms: the way forward According to the finance theory, the carbon markets contain both systematic risks (risks affecting the entire market) and unsystematic risks (risks specific to a particular project or entity). Systematic risks such as the impact of the recent financial crisis and the macro regulatory framework are extremely important and must be addressed at an appropriate level. Development of more sophisticated risk management processes, tools and products is important because these will, over time, attract a broader range of investors and greater capital flows to help fight climate change.
Comment [IE19]: Why are you including this long quotation here? How is it worked into the argument?

It is possible to take the risk management forward by adopting various measures, which are listed below:

Additionally aspects Insurance products Project implementation risks

Carbon funds

Risk Management Mechanisms

Green fund

Uncertainty about the post2012 regime Figure 16: Risk Management Mechanisms
Regulatory uncertainty

Comment [IE20]: Uncertainty about the post 2012 seems incomplete.

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Insurance products Based on the findings from the questionnaire, the risk management mechanisms currently in place include systems set up by the UN, such as their programmes, standard methodologies, approval mechanisms, monitoring systems, and permissions for accredited entities, and due diligence tools.
Comment [IE21]: Used by whom?

None of the respondents mention insurance products and specialised funds introduced in the market to counter the risks for carbon projects, both current and post 2012. These are considered in the literature review. Leading insurance companies have responded to the risks in the market by offering specific products:

RNK Capital LLC and Swiss Re have jointly implemented a carbon offset insurance product for managing Kyoto Protocol-related risk in carbon credit transactions. The policy provides coverage from failure to deliver the agreed number of emission rights, risks related to delays in registration and certificate issuance of CDM projects.

The Kyoto multi-risk policy offered by Munich Re is designed to cover losses that occur if the investor has to deliver the credits in to a secondary market or is forced to comply with reduction requirements due to the non-deliverance of the carbon credits.

Carbon Credit Delivery Insurance by AIG Inc covers technological, political or credit risks. AIG is also developing carbon credit insurance endorsements, renewable energy certificate insurance, and forest carbon sequestration insurance.

Carbon funds Carbon funds are a significant feature of the carbon market, especially CERs and ERUs, and can serve as a tool for risk management. A carbon fund is a vehicle to pool investments in the carbon market and their structure and role vary. Some focus exclusively on purchasing CERs and/or Emission Reduction Units (ERUs) for compliance use by their investors. Others purchase allowances and credits and hope to resell them at a higher price. More recent funds take equity stakes in emission reduction projects and provide both financial returns and credits to their investors.

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To lower the uncertainty associated with period after 2012, when Kyoto Protocol creases to be in effect, various carbon funds have been developed to support carbon credit projects.

The funds are as follows:

The Post-2012 Carbon Credit Fund, established in 2008, has EUR 125 million available to invest in carbon credits projects that were expected to be produced from 2013 to 2020, from GHG-reducing projects, either directly financed by the IFC or by local banks financed by IFC.

The IFC Post-2012 Carbon Facility offers financial products to help mitigate risks in the carbon market by absorbing the risks associated with long-term projects and credit risks in the emerging markets. The facility provides advisory services and upfront loans to projects earning income from sales of carbon credits.

World Bank Carbon Finance Unit facilitates the financial reward through carbon credits for the reduction of GHG emissions by emitters in developing countries.

Figure 17: Growth Graph of Carbon Funds and Facilities at the World Bank Source: World Bank (2012/1)
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Figure 18: World Bank Carbon Finance Projects Worldwide Source: World Bank (2012/2)

These carbon funds propel much needed finance into the carbon credit projects and in a way helps in the risk management.
Comment [IE22]: Can you be more specific here?

Uncertainty about the post-2012 regime There is a lot of uncertainty in the market; this which is leading to a decline in the carbon market. The value of emission reductions after 2012 is uncertain, so projects with longer payback periods become progressively less attractive, reducing the flow of new projects.
Comment [IE23]: carbon trading?

The world community can take the risk management forward by bringing in strong environmental legislation which will restore the confidence of the public and lead nations to invest in carbon projects. Regulatory uncertainty Another potential mechanism for managing risks is managing regulatory uncertainty. With over 68 developing countries participating in the CDM, managing the implementation capacity of each of them becomes very difficult, especially for the buyer. Each
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host country has a different risk profile, infrastructure to support CDM projects, rules and regulations on CDM project developments covering taxation, CER ownership rights, floor pricing, grid feed-in tariffs, government funding and interpretation of sustainable development. Mechanisms are required to stabilise this regulatory risk by establishing a clear and efficient process for host country approval.

Comment [IE24]: Can you give a page numbe

China is an excellent example, as the supplier of over 53% of global CERs. In the last three years it has invested in provincial and county level CDM centres, focused on capacity-building and given strong guidance on tax and floor pricing regulations. CDM project monitoring, methodology and implementation risks A CDM faces different risks at different stages of its development. Implementing a CDM project requires technical skills and an experienced team. The project team should have a financially robust project, along with the knowledge of the generation and delivery of CERs, and the cycle that ultimately leads to the issuance of carbon credits, etc. This can be very demanding, as the project owner is usually kept busy with the core business.

A project undergoes a very rigorous process of validation, registration, verification and investigation before the CERs are made available to the buyers in the carbon markets. The following illustration shows the steps involved. Each of these steps has underlying risks associated with them.

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Comment [IE25]: Will the words in the figure be legible once the dissertation is printed?

Figure 19: The CDM Project Cycle Source: CO2 Focus (2012)

The monitoring risks faced by the CDM projects were brought forward in the response received for the questionnaires. Even a registered project is required to undergo verification and be subject to on-going and regular performance checks against the monitoring plan. A project that issues CERs one year will not necessarily, left to its own devices, issue CERs the next year; and post registration there are very real technical risks that need to be tackled in project operations to ensure consistent CER issuance. The monitoring systems must work in accordance with the monitoring plan and if they do not, then a project can encounter further delays due to a need to submit for a revision or to change the monitoring system itself. Risks related to aspects of additionality The concept of additionality was not discussed by any of the respondents, either as a drawback/risk to the projects or even as the risk management mechanism. However, the literature review brings forward the need to reconsider this aspect in the new protocol. The concept of additionalitycreates confusion within industries about the seemingly arbitrary judgments of how similar projects in different countries or even geographic locations are judged under different rules. As such, the goal of the CDM with respect to additionality may warrant reconsideration. Future iterations of CDM
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Comment [IE26]: Page number?

and developments of Executive Board regulations would do well to reconsider their goals for additionality and their mechanisms for achieving it.
Comment [IE27]: Who are you quoting?

The demonstration of additionality is an important feature for maintaining the integrity of a CDM project. The concept of additionality, initially introduced in Article 12.5(c) of the Kyoto Protocol and paragraph 43 of the modalities and procedures for the CDM, refers to the question whether the proposed project activity would lead to a reduction of anthropogenic emissions of GHGs by sources below those that would have occurred in the absence of the registered CDM project activity.

To be able to maintain a consistent approach for demonstrating the additionality aspect, the board approved the tool for the demonstration and assessment of additionality (the additionality tool) and the combined tool to identify the baseline scenario and demonstrate additionality (the combined tool). Both these tools follow a generic approach of including an assessment of consistency with laws and regulations, an investment analysis, a barrier test, and a common practice test. The additionality aspect should be seriously considered in the decision to proceed with the project (prior consideration). Although not mandatory, additionality has been a very important consideration in selecting CDM projects.
Comment [IE29]: Why is this?

Comment [IE28]: What is this a reference to? this the CDM Executive Board mentioned below?

The carbon credit project may face an additionality risk, post 2012, depending on the decision of the new protocol on the eligibility criteria for a project, especially the criteria of additionality for the avoided deforestation projects. As a way forward, the additionality factor needs strengthening. In fact this has already been addressed. The CDM Executive Board (the Board) has been requested (the request was made during the Conference of Parties (COP) serving as the meeting of the parties to the Kyoto Protocol, at its seventh session in Durban, South Africa) to continue ensuring environmental integrity when developing and revising baseline and monitoring methodologies and methodological tools, in particular by considering possible ways of improving the current approach to the assessment of additionality, in order to provide clarity to encourage project activities in the private sector and the public sector. In response to this request, the board included the project Improvements in the demonstration of additionality (project 164) in its 2012 CDM management plan (CDM-MAP). The CDM-MAP further specifies that the secretariat
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Comment [IE30]: Who are you quoting?

should prepare a concept note on possible improvements in the demonstration of additionality.

United Nations Framework Convention on Climate Change (UNFCC) suggests that innovative approaches to demonstrate additionality could be developed and adopted, highlighting the need for objective and simplified approaches to demonstrate additionality, while acknowledging the difficulties in identifying appropriate innovative approaches. UNFCCC makes the following suggestions and recommends to prioritise work on both the improvement of the existing approaches and the development of new approaches in parallel:

Introduce performance benchmarks in methodologies Positive and negative lists of certain renewable energy technologies may be implemented in ACM0002, the Application of Combination of Large Scale Methodology
Comment [IE31]: What does this refer to?

Positive lists of certain project types for Least Developed Countries (LDCs)

Green Climate Fund The Green Climate Fund created at the UNFCCC meeting in Durban will go a long way toward reducing ever-increasing emissions in developing countries by broadly distributing investment risks and encouraging an increased flow of private capital into the fight against climate change.

The Green Climate Fund will help spread the investment risks more broadly. The fund, as committed to in Durban, will have enough money to invest in different parts of the world, in different technologies, and in different business models, and it will be able to build different tools to meet the specific needs of each investment. With a very diverse portfolio, the fund will be more effective in managing risks than individual countries.

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Conclusion and Recommendations

Conclusion
The world is now facing ever-increasing pressures on limited resources for energy and food requirements. It is undeniable that our past and current actions have led to climate change, and the need is for policies and actions that promote holistic and sustainable development. The UN Conference on Human Environment (UNFCHE) in Stockholm, in 1972, was the first global platform that discussed the issues relating to the environment and the need for the global community to come together for assertive action towards saving the Earth. After many conferences and accords, the Kyoto Protocol was established in 1997 and enforced in 2005. The Kyoto Protocol set out to reduce the GHG emissions by 5% across the developed world in comparison to 1990 baseline; it completes its first commitment period in 2012. Its achievements and success has been debated on many platforms, mostly suggesting that although the Kyoto Protocol has not been able to reduce the actual amount of GHG emissions, it has brought discussion of climate change to an international platform. The Kyoto Protocol has generated awareness of the changing climate and the potentially damaging impact it can have on human existence. During a short survey, which was conducted as part of this paper, it was suggested that the biggest success of the Kyoto Protocol has been in awareness-generation and in establishing the carbon markets.

As the first commitment period of the Kyoto Protocol comes to an end, there is uncertainty in the carbon markets. The carbon projects are exposed to many risks, in both the pre-2012 period and post it. Fraud, regulatory and the market related risks were brought forward during the survey. With all these risks that the current and the future carbon projects face, the risk assessment and management become very important. Most of the survey respondents were pessimistic about the existing risk management systems, as most of them were not aware of that such mechanisms existed. However, in response to the needs for this kind of risk assessment, the UNFCCC has indeed established regulations and standardisations. Other existing risk management mechanisms are carbon funds, for example the Post-2012 Carbon Credit Fund, the IFC Post-2012 Carbon Facility, the World Bank Carbon Finance Unit and various insurance products such as the Kyoto multi-risk policy, and the Carbon Credit Delivery Insurance amongst many others.

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As the first commitment period of Kyoto Protocol comes to an end, two scenarios are possible from post 2012. In the first most likely scenario, the nations will likely not be able to come together and agree on a single internationally accepted binding treaty. This will lead to the collapse of the compliance carbon market; however, it is expected that the bilateral and multilateral exchanges will replace the international treaty, keeping the voluntary carbon market alive. In the absence of an international binding force, voluntary carbon markets will rise and CERs will be replaced by VERs. The voluntary market will see further development, with investments coming in from corporations, and other entities looking to make themselves carbon-neutral. The current political instability in the EU and the economic downturn will not impact the carbon markets as much. The EU will continue its emission trading until at least 2020, as it already has introduced policy and regulatory measures in place. In the absence of a single market, the regional carbon trading markets will become stronger and each will have its own set of eligibility criteria and carbon prices. Under these conditions, it will be a buyers market as the sellers will need to look for the best price offers. The carbon credit projects will face greater risks under this scenario.
Comment [IE32]: Here you are giving two scenarios, but you have discussed three above.

In the other scenario, member countries will reach a consensus that all the major carbon emitters along with the developed countries bind themselves to reduce and regulate carbon emissions. The carbon markets will stabilise, as the CDM projects are implemented globally. The risks faced by the carbon credit projects will be reduced considerably, such that under an integrated international market, trading will be more transparent. The treaty for the second commitment period will learn from the mistakes of the first treaty. It will be more flexible to the changing environment, more inclusive, as it will include more sectors under its banner, and most importantly the new treaty will be holistic in its approach. Based on Rio 2020, the new agreement will tackle poverty reduction and economic growth, climate and clean energy, food security and sustainable agriculture, water, healthy seas and oceans, biodiversity, healthy forests and ecosystem services. The treaty will be finalised by 2015 with another five years for the member countries to ratify it.

The carbon credit projects may face an additionality risk, post 2012, depending on the decision of the new protocol on the eligibility criteria for a project. The CDM Ex Dean Skivington 28

ecutive Board has realised that the additionality factor needs strengthening and, in response to the request made by Conference of the Parties, it has prepared a concept note dealing with the concept of additionality more transparently. As a way forward, no overwhelming commonalities have been observed; however, the tone seems to suggest that the best way forward will be to use the already established mechanism. The current systems need to be made more transparent to avoid fraud and corruption. Based on the response received in the survey, it is estimated that the member countries will most likely not be able to come to a consensus, and post 2012 will see growth of voluntary carbon market and bilateral carbon exchanges. As these will be more independent than a global treaty, these arrangements will respond to the need of risk management more by modifying Project Monitoring, Methodology and Implementation Risks, and will also be able to deal with the risks due to regulatory uncertainty better. Through bilateral arrangements, the buyers will be better able to assess the country risk profile along with the implementation capacity. This was proving to be very difficult when there were over 68 members participating in the Kyoto Protocols CDM mechanism.

Recommendations
Based on the results of this dissertation, various recommendations should be made.

As this research has revealed, no best practice risk management procedures and risk management guidelines are in place. It is suggested that fundamental guidelines on how to tackle the risk that stakeholders of carbon projects are facing are developed. Especially for the period of Durban 2020, there needs to be strict and comprehensive risk management guidelines, for example set by the UNFCCC, national governments and the financial institutes that fund the projects. The UN or a similar institution could control these guidelines. This will guarantee that all projects are assessed in the same way and individual project risks are reduced.

Following on from there, a global carbon market should be established. There needs to be a flat price for carbon credits which never falls below a certain point. A suggested minimum figure could be $50 per ton. This would prevent the risk of project failure and secure a truly sustainable carbon market. The prices would be based on

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the current pricing model apart from a mechanism that each market introduces a minimum carbon value as suggested in Durban. Carbon capital would be traded like bonds, currency etc.

To ensure the future of a self sufficient global carbon market there needs to be a decision made on either government green grants or the carbon market. To ensure the future of the carbon market, any future grants for green projects should be replaced with loans, which could then be paid back with funds generated from the carbon credits. The government could replace its green grant systems by being involved as a guarantor in the projects, giving the banks confidence in the projects.
Comment [IE33]: By whom?

This year the UK government launched that it is mandatory for the FTSE (Financial Times Stock Exchange) 350 to report their carbon emissions for each year. This is a prime opportunity for the UK to take hold and develop a model that can be rolled out across the entire UK market, and possibly scaled down and could be adopted worldwide. This could be achieved within ten years. Each company reports a baseline of their carbon emissions depending on size, operation and type of company and are then given a yearly carbon allowance for the future based on this baseline. For example, company A might have a baseline of 1000 tons per year. In year two, its emission rate increases to 1100 tons per year; the company has to buy 100 tons by law. Company B might have an allowance of 1500 tons per year but only uses 1200 tons. In that case company B can sell 300 tons to the government or to an international platform which acts an intermediary and sells the credits to companies who have exceeded their baseline. The same concept is applied to whole countries. The trading profits could be used to help tackle poverty, recovery after natural disasters etc.

This research will help clarify the carbon industry and especially the current and post 2012 risks of carbon credit projects. In terms of further research it is recommended to look into Durban Platform and Rio +20, how to move forward and how to plan for it. Further it would be interesting to involve a wider panel of experts in a larger scale projects, interviewing experts from around the world to establish a better understanding of the situation and to back the study up with quantitative data.
Comment [ds34]:

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