The emerging market in carbon dioxide credits offers opportunities to energy investors. These finance initiatives are the result of a government mandated double bill – the JI and CDM programme – to reduce greenhouse gas emissions.

Erik Saat,, The Netherlands

Under the Kyoto Protocol, countries which have agreed to cap their greenhouse gas (GHG) emissions can purchase carbon dioxide (CO2) credits in countries other than their own. The Netherlands is one of the parties that has committed itself to a six per cent reduction of greenhouse gases within the country boundaries with respect to the year 1990. This comes down to 200 million t of CO2. The reduction must be realized between 2008 and 2012, the so-called First Commitment Period under Kyoto. Although the Protocol has not been signed into a binding agreement, with the possible signing of Russia, it will come into force.

Wind energy will be more profitable with the sale of carbon credits
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Carbon dioxide is by far the biggest greenhouse gas by volume. CO2 credits are sought in developing and central and eastern European (CEE) countries. In general, in these countries low CO2 energy facilities should offer the biggest reduction against the lowest costs. This would be more cost effective than locating such facilities in the western world. The creation of the carbon credit is governed by strict rules, which are enforced by a United Nations agency. The Netherlands aims to purchase approximately 100 m t of CO2 in the next few years.

Some of the parties to the Protocol, such as The Netherlands, are anticipating its execution. Accordingly, The Netherlands is reducing its domestic CO2 emissions, but is also trying to purchase emission reductions through the Joint Implementation (JI) and Clean Development Mechanism (CDM). These two programmes are facilitated by the Kyoto Protocol as a flexible tool for participants to import CO2 reductions that are established in other participating countries. The CDM facilitates CO2 emission reduction transfer from projects in developing countries to other countries under the Kyoto Protocol. The JI does the same for countries in CEE. Generally the approach is that the costs per tonne of carbon dioxide reduction will be lower in developing countries and CEE countries, than in the western world. The Netherlands is helping this market to evolve rapidly.

Kyoto procedure

The JI and CDM work with baselines to assure the quantity and quality of the CO2 reduction. The concept of the baseline procedure is presented in the figure above.

The baseline represents the situation without the project. For example, in the energy sector the baseline could be the average output of CO2/kWh of the country mix of energy generators.

Countries with renewable energy will become more attractive to exploit carbon credits
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The difference between the baseline and the CO2 emissions of the project represents the reduction. The baseline is subsequently fixed for the contract period, i.e. until 2012. In addition, the projects’ emissions must be monitored as the reductions are being produced, in order to obtain the exact amount of reductions. The method to establish a baseline as well as the monitoring report, that will be delivered every year, will be validated and certified by companies that have a mandate from the United Nations. With the official validation report from a validation company, the reductions can then be certificated under the Kyoto Protocol. Only then, can they be traded under the Kyoto Protocol to other countries. The contracts the Dutch established with suppliers of CO2 reduction, are based upon preliminary statements by validation companies.

CO2 reduction

The Netherlands is one of the first large scale buyers in the CO2 reduction market that is governed by the JI and CDM mechanism. By taking early action the country hopes to gain from low prices. The government decided to buy 100 million t, half of the total reduction for the first commitment period, of CO2 emission reductions through the JI and CDM mechanism. The team has been active in purchasing these emissions reductions since the year 2000. The team is a part of Senter Internationaal, which is an agency of the Dutch Ministry of Economic Affairs.

The CO2 reduction is purchased through the mechanism of public tendering. Any company from any participating country in the Kyoto Protocol may apply to sell emissions to the Dutch government. Within six to eight months the tender process results in contract awarding for those projects selected. The projects are assessed on the feasibility of the long term delivery of the product. The Netherlands takes a low risk approach in this purchasing strategy.

A calculation of emission reductions under the Kyoto Protocol
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Since 2000, has contracted the delivery of 10 million t of CO2 reduction under the Kyoto Protocol from projects in CEE. The average contract price that was offered in the tender applications, was approximately E5/t. The projects are located in Romania, Poland, Czech Republic, Slovakia and Hungary. They utilize wind energy, biomass energy, hydropower and landfill gas to reduce CO2 emissions in their countries. An example of a carbon credit contract is the contract with AES Borsod in Hungary. This contract was closed in December 2002.

In this project, AES wants to convert two pulverized coal boilers into bubbling fluidized bed (BFB) boilers. With this operation AES is able to burn biomass instead of coal. The new facility will be operational from January 2004. With this, AES is able to reduce the emissions of CO2 by more than 700 000 t from the year 2004. AES offered to sell the emission reduction to the Netherlands for a price of E4.4/t.

In addition to the activities in CEE, is active in the developing countries. Recently, the Dutch government announced the results of the first tender for CDM countries, called CERUPT. The Dutch government has committed to contract the CO2 reduction delivery from 18 CDM projects from all over the world. Together these contracts represent the purchase of more than 16.5 million t of CO2 reduction. The average price is slightly above E4.5/t. In this tender 78 applications were received, offering 80 million t of CO2reduction. A great part of this reduction did not meet the high quality technical and financial criteria set for the CERUPT tender. Ultimately, 18 projects from central and south America, India, southeast Asia and China have been offered a contract. Within the portfolio, geothermal and hydro technology, offer more than half of the total amount of the CERs. Wind technology and biomass offer 13 and 9 per cent, respectively. Landfill capture and fuel switching form the additional technologies. Generally the carbon credits contract covers five to ten per cent of the initial investment. Thus, a carbon financing contract does represent a significant revenue stream to CO2 low energy operations.

All the projects fulfil the requirements of the Kyoto Protocol. Now, the Kyoto Protocol has to formalize the registration of these emission reductions. From a commercial point of view, the projects were chosen for their low risk profile. Most of the projects have multiple financing and product delivery contracts. The obligation to deliver energy reduces the risk for the delivery of CO2 emission reductions.

The reductions that are contracted, will be fully compliant with the Kyoto Protocol. The reductions are accompanied by a validation report. Therefore these reductions represent low risk. In addition, the commercial risk of producing the reductions is related to the commercial obligation of the supplier to produce energy for their customers.

From the results it can be concluded that it is possible to buy low risk, low priced emission reductions through the JI and CDM mechanism. After all, the domestic costs for CO2 reduction in The Netherlands, is identified between E30–50/t. The price paid is significantly lower.

Sector approach

For most countries under the Kyoto Protocol, the energy and chemical sector account for 80 or more per cent of all CO2 emissions. The biggest source of CO2emissions is also the biggest potential for reductions. The energy and chemical sectors should be able to offer the best opportunities in volume for large scale CO2 reduction. Many different technologies have a certain potential to reduce CO2 emissions. These technologies range from renewable technologies such as wind, hydro and biomass; to fuel switching to lower carbon content fuels; efficiency operations and landfill gas capture technologies. The actual reduction depends on the baseline as well as the technology used. When renewables are used for producing energy, the baseline determines the reduction potential. In the case of fuel switching or energy efficiency, the reduction greatly depends on the technology itself. In general, the possible carbon financing gives these technologies a competitive advantage over polluting technologies. The creation of the additional commodity of the carbon credit tends to shift revenues towards cleaner technologies.

In general, the ownership of CO2 emission reductions is in the hands of the operator and owner of the energy facility. However, one should realize that the technology, apart from the baseline, is the single source that makes CO2 emission reduction possible. When the financial advantage becomes big enough, operators in the energy sector will start to favour low CO2 equipment for new investments. In countries where renewable sources are available for electricity and heat production, these sources will become more attractive to exploit with carbon credits.

In countries where energy efficiency operations and fuel switching operations are possible investments in terms of energy savings, they also will become more attractive because of additional carbon reduction sales.

Technology suppliers should be aware of the significance of low CO2 emitting equipment now and in the future. It is just a matter of time before investors start to incorporate possible carbon reduction sales into their investment scheme.

The experience from the team shows that certain technologies are capable of adding a significant revenue stream to energy operations in certain countries. In countries where hydro and wind resources are available, they could be exploited more economically. Carbon credits sales show that the technologies have the potential to deliver between five and ten per cent of the total investment sum for a typical kind of new facility. Biomass, energy efficiency and fuel switching technologies seem to offer between ten and 20 per cent of their initial investment sum from the long-term carbon finance contract.

Trade within the EU

The most recent topic under the Kyoto Protocol that is being explored by the governments that have signed in the European Union (EU), is the European trading system. Within this proposed cap and trade mechanism, that is supposed to become operational from 2007, several large CO2 emitters within the industry will be given the option of trading of emission quotas with others within the EU.

With CEE countries about to access the EU, this implies an extension of the trading system with relatively cheap sources of reduction. These sources of reduction mainly involve existing power generation facilities in CEE that are capable of reducing millions of tons of carbon dioxide at lower prices than possible in the current EU countries.

In addition, during the early 1990s, the CEE countries underwent a severe recession forcing many factories to close. The emission levels of several CEE countries were almost halved in those years. This means that many CEE countries have 50 – 100 per cent more emission rights than they actually use. This is called ‘hot air’.

The EU most probably does not want this hot air in its trading system since it would inflate the amount of reduction too much. In the current proposal of the EU, ‘hot air’ is excluded from the future trading system.

It is likely that ‘hot air’ will be traded under the Kyoto Protocol to other countries, that want the money invested in green funds.

The new EU-wide trading system would overlap the JI mechanism, that also has its focus on CEE. The differences will be many, but nothing is clear yet, since the rules for emission trading are not there yet. The EU is currently working on a so-called ‘linking directive’.

This means that, at this point in time, only the JI mechanism can be fully exploited by the parties to the Kyoto Protocol, i.e. the governments that have signed. Therefore, current investments in the energy sector can clearly benefit from carbon financing under the JI mechanism. Investments from 2007 will most probably find their way to the EU-wide emissions cap and trade market to get additional funds.

How this will work is just speculation now. But what is clear, is that the JI mechanism would then become a mechanism that will be commercially attractive to use in countries that fall within the CEE, but outside the EU, such as Russia.

Hydropower will generate an additional revenue stream with the sale of carbon credits
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The number of projects with carbon credits sales is too low to calculate any standard revenues or typical additions to the internal rate of return.

However, with the establishment of more standardized baselines and a more liquid emissions trading market i.e. with more buyers and sellers, one will be able to estimate the additional revenue from carbon credits within a certain energy operation more significantly.


The market for the trade in CO2 emission reductions under the JI and CDM mechanism of the Kyoto Protocol is rapidly developing.’s activities show that within the energy sector in CEE and in the developing countries, huge CO2 reductions are possible.

Prices per tonne are significantly lower compared with domestic costs. The combination of the country baseline and a low CO2 technology offers opportunities for investors in the energy sector to generate an additional revenue stream. The energy sector should develop new strategies on how to benefit from this global initiative.

Companies can anticipate their future reduction commitments by exploring the JI and CDM mechanism. The emissions from JI and CDM will be tradable in the EU wide trading system. Prices for reductions under JI and CDM are much lower than the anticipated fines under the EU trading scheme.

Finally in the corporate headquarters, the energy sector should develop new strategies on how to gain from this global initiative to reduce CO2 emissions worldwide. An initiative that will be here to stay.