Opportunity NOx

Russia’s decision to ratify the Kyoto Protocol on Climate Change ensured that the treaty would come into effect but what does it mean to Russia itself and will the opportunities to achieve emissions reductions in the country be taken?

Eric Saat & Lennard de Klerk, Global Carbon, The Netherlands

With the ratification of the Kyoto Protocol, Russia has ensured accession to the World Trade Organization next year. Now everybody is looking to see whether Russia will become an important player in the emerging Kyoto market and can benefit from the Kyoto Protocol. The potential for the reduction of greenhouse gases, the most important of which are carbon dioxide (CO2) and methane (CH4,) in Russia is enormous.

The Kyoto Protocol sets a cap on greenhouse gas (GHG) emissions that each industrialized country is allowed to emit in the period 2008-2012. The base year of the Kyoto Protocol is 1990 and Russia negotiated a reduction target of zero per cent. After the collapse of the Soviet Union in 1991, the emissions of GHGs went down considerably and as a consequence Russia is expected to be below the Kyoto cap of 500 – 700 million tonnes of CO2e per annum in the period 2008-2012.

Figure 1. Reduction of GHG emissions in 2008-2012 due to JI project implementation creates ground for stabilization of GHG emission in further periods
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For Russia, like many other Central and Eastern European countries, meeting the Kyoto obligations will not be any problem. On the contrary, the trading mechanisms of the Kyoto Protocol create opportunities to modernize its industrial infrastructure and further reduce the emission of greenhouse gases.

Under the rules of Kyoto, the Russian state is entitled to sell the headroom to Western governments that are in deficit. However, currently there is a political ban on buying this ‘hot air’ as the reductions of emissions since 1991 were not caused by any energy saving policy. Furthermore, were the EU, Canada or Japan to purchase all the ‘hot air’, there would be hardly any incentive to reduce emissions at home, undermining the environmental integrity of the Kyoto Protocol.

Joint implementation

Most of the attention is now focussed on project-based emissions trading, better known as the joint implementation (JI) mechanism. Under a JI project a concrete investment should be made that leads to additional reductions of the emissions of greenhouse gases. CO2 is the most common greenhouse gas, but also CH4, Nitrous Oxide (N2O) and three other rare gases are considered to contribute to the greenhouse effect. These emissions can be reduced directly at an existing installation, for example using alternative fuels in a cement factory, or can be reduced indirectly e.g. through the construction of a wind farm. In an indirect JI project, electricity is produced for the grid, thereby reducing power generation from fossil fuel fired power plants.

Several categories of project qualify under JI including:

  • Fuel switching (e.g. coal to natural gas);
  • Energy efficiency measures;
  • Biomass;
  • Capturing methane at landfills or waste water treatment facilities;
  • Wind power;
  • Hydro power;
  • Afforestation and reforestation

The first three project types in particular have the biggest potential in the Russian Federation. The Russian Ministry of Economy expects that in the period 2008-2012 approximately 200-300 million tonnes of CO2e will be traded through JI and other project based mechanisms.

Additionality demanded

The Kyoto Protocol sets several requirements for a JI project. First of all the project should be additional. This means in effect that the investment should not be business-as-usual and is not commonly implemented in the market it is operating in. Countries of the former Soviet Union (FSU) often find it difficult to obtain the financial means to undertake projects and the additional revenue arising from a JI project makes it easier to attract financing. Hence proving additionality is in most cases not a problem unless the project has already been constructed. Other ways of proving additionality is the application of new or innovative technology in the project.

Secondly, a baseline should be constructed that indicates the emissions levels arising in a particular case, were the project not to have been implemented. This so-called baseline study should describe the hypothetical ‘no-project’ situation from the start of the project until 2012. An independent Validator that has been accredited by the United Nations Framework Convention on Climate Change (UNFCCC) should approve this baseline study. After project implementation, the actual emissions should be monitored on an annual basis so that the reductions can be determined. Based on this report, a project owner can claim the emission reductions and transfer them to the buyer.

In recent years, some very good JI projects have been developed in the energy and industry sector in Russia. One of the most prominent projects is a fuel switch at the Amursk cogeneration plant in the far east of Russia, owned and operated by the state monopoly RAO UES. By switching from coal to natural gas, considerable emission reductions will be achieved – up to 1.5 million tonnes CO2e for the first commitment period. Against current market prices for future delivery contracts for JI credits, the carbon revenue of this project is almost equivalent to the investment costs. The prospective buyer is Denmark through the Danish Environmental agency.

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Another good JI example is a 55 MW thermal biomass boiler plant at a particle board and fibre board factory in Kostoma owned by the Swiss Kronoholding. The project will reduce an estimated 1.7 million tonnes for the period 2008-2012. The prospective buyer is the Dutch government through its purchasing programme ERUPT.

On the seller side, more and more funds are being created to invest in JI projects or purchase the resulting emissions reduction credits. Governments and international institutions have been the most active buyers to date. The World Bank is the dominating market player with several multi-country and national funds. The Prototype Carbon Fund is the best known. The Netherlands has established funds at the European Bank for Reconstruction and Development, while the International Finance Corporation has been one of the biggest buyers through its tender-based ERUPT programme which has contracted for the delivery of more than 15 million tonnes of CO2e since 2001.

Market growing

With the start of the European Emissions Trading Scheme (ETS) in January 2005, more and more private buyers such as energy and industrial companies and intermediaries are expected to enter this market. These companies will have liabilities under the ETS in the coming years. When they compare prices of EU allowances and their own marginal reduction costs, against prices for JI credits, the latter will offer an interesting hedge product. The JI credits can be imported into the EU system thanks to the EU linking directive. The price difference between JI credits, currently around €5-6 ($6-7) and EU allowances (€10-17) will also attract private intermediaries such as banks and hedge funds.

Different structures of JI deals can be observed. Most buyers have up until now only bought the future emission reduction based on future delivery contracts directly from the owner of the project. The price and the volume of emission reductions to be generated and transferred were fixed during the negotiations phase. Lately, hardware suppliers have also stepped in, offering emission reductions from equipment they have installed with their clients. Many private funds are now considering investing directly in the projects themselves, instead of just purchasing the resultant emission reductions.

Missing framework

The emerging carbon market is growing quickly and becomes more and more creative in finding ways to close the gap between buyers and sellers. The biggest challenge for Russia at the moment is setting up an institutional framework necessary to endorse and approve JI projects that want to export JI carbon credits to buyers. According to the Kyoto Protocol, each JI project should be approved by the ‘Focal Point’ of the selling country. This Focal Point would maintain a national JI log, submit data to the UNFCCC, guarantee offsets transactions and issue and transfer Emissions Reductions Units (ERU). In Russia, this Focal Point does not yet exist although the government is working on establishing such an institution. Even more important will be an established approval procedure and the application of transparent criteria. This is the big challenge for Russia if it is to open up its potential to buyers becoming more and more eager for JI credits. In other countries such as Bulgaria several JI projects have been approved since 2002. Currently the Bulgarian government applies a very transparent and quick procedure to award projects with JI credits. As the approval comes at the ‘end of the pipe’ developing a JI project in Bulgaria has low risks.

A number of benefits could flow to Russia through the implementation of JI projects, not least of which would be a reduction of GHG emissions under conditions of economic growth and a macroeconomical cost saving. Extra ecological, social and economical benefits can come from JI projects implemented with public financial support, such as the promotion of environmental activity and innovation. Russia could also meet its obligations on stabilization of GHG emission beyond the bound of the first commitment period.

Russia is potentially a large supplier of emission reductions, but not the only one. Large developing countries like China, India and Brazil are also able to supply emission reductions in a similar way and could present competition to Russia. The ministry responsible, Russia’s Ministry of Economy, insists that the JI approval procedure will be up and running in September 2005. If it achieves this, Russia opens up a huge opportunity for both itself and foreign investors to benefit from the Kyoto Protocol.

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