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          05/2003 - issue 5
               page 3

CDM as financing source for projects in SEA

by D. M�st, W. Fichtner, O. Rentz
Institute for Industrial Production (IIP), University of Karlsruhe, Germany


Humanity has greatly affected our ecosystem, including causing climate change and harming both plants and animals. Moreover, the continued involvement of non-environmental work methods will continue to harm people, at you can read more about this. Introducing restrictive emission ceilings at enterprise level as well as implementing an international emission trading system in which enterprises receive tradable emission permits for the basket of six greenhouse gases (GHG) as determined in the Kyoto Protocol would have a considerable impact on the production planning of business firms, especially in energy intensive sectors (electricity and heat production, iron and steel, refining, etc.). With the Clean Development Mechanism (CDM) of the Kyoto Protocol, new investment possibilities arise for European investors in Non-Annex 1 countries like those in Southeast Asia (SEA). Within this article, the CDM as a financing source for projects in SEA will be discussed. The article starts presenting expected prices per tonne CO2, which have been ascertained by various research institutes and consultant companies. Due to the fact that CDM projects will only be realised if their production costs plus their transaction costs are lower than these prices, some estimations on transaction costs are given. Finally, risks arising from CDM projects will be shown and examples and types of other financing sources will be presented.

Financial viability of CDM projects

By means of the market-based Kyoto Mechanisms Joint Implementation (JI), Clean Development Mechanism (CDM) and International Emissions Trading (IET), it will be possible to trade emissions permits globally. Demand will be driven by the emission reduction commitments of industrialized countries and countries with economies in transition, the group of so-called Annex 1 countries. This emerging global market will offer challenging opportunities to a wide variety of different players in industry and business.

While for environmental taxes, the price is fixed through the states, for flexible instruments within the Kyoto Protocol the price will be achieved through the certificate market and hence will be economically optimal. Market participants can decide whether they buy certificates or implement reduction measures by themselves. Measures with negative CO2 avoidance costs, so called no regret-actions, are economically profitable and should be chosen (see Figure 2.1).


Figure 2.1 Profitability of projects depending on certificate price


Measures with negative CO2 avoidance costs, so called no regret-actions, are economic and should be made in each case (see Figure 2.1).



Price per tonne CO2 (USD)




[Kainuma et al. 2000]



[Sijm et al. 2000]



[Ellerman et al. 1999]



[McKibbin et al. 1999]



[Capros 1999]



[Kurosawa et al. 1999]



[Mensbrugghe 1998]



[Enzensberger 2003]



[Manne & Richels 1999]



[Springer 2000]



[Criqui & Viguier 2000]



[Nordhaus & Boyer 1999]



[B�hringer 2000]

Table 2.1: Permit Prices in Emission Trading

Transaction costs

As early as 1937 Coase defined transaction costs to be the costs that arise from initiating and completing transactions. In the context of the Kyoto Mechanisms, transaction costs are caused by the administrative process and thus depend on the institutional framework. In principle, transaction costs of CDM projects can be differentiated into transaction costs arising from undertaking projects in developing countries and transaction costs arising from undertaking a project under the CDM framework. Furthermore, transaction costs accrue at different stages in the process of a transaction or project cycle (see Table 2.2).


Transaction Cost Components


Project based (JI,CDM): Pre-implementation

Search costs

Costs incurred by investors and hosts as they seek out partners for mutually advantageous projects

Negotiation costs

Includes those costs incurred in the preparation of the project design document that also documents assignment and scheduling of benefits over the project time period. It also includes public consultation with key stakeholders

Baseline determination costs

Development of a baseline (consultancy)

Approval costs

Costs of authorization from host country

Validation costs

Review and revision of project design document by operational entity

Review costs

Costs of reviewing a validation document

Registration costs

Registration by UNFCCC Executive Board / JI Supervisory Committee

Project based (JI,CDM): Implementation

Monitoring costs

Costs to collect data

Verification costs

Cost to hire an operational entity and to report to the UNFCCC Executive Board /Supervisory Committee

Review costs

Costs of reviewing a verification

Certification costs

Issuance of Certified Emission Reductions (CERs for CDM) and Emission Reduction Units (ERUs for JI) by UNFCCC Executive Board /Supervisory Committee

Enforcement costs

Includes costs of administrative and legal measures incurred in the event of departure from the agreed transaction


Transfer costs

Brokerage costs

Registration costs

Costs to hold an account in national registry

Table 2.2: Transaction cost components
Source: Michaelowa 2003

In the following, we will focus on transaction costs arising from undertaking a project under the CDM framework, because the emerging structure of the CDM envisages a series of formalities and institutional hurdles that a project has to overcome in order to be officially regarded as a CDM initiative and be credited with Certified Emissions Reductions (CERs). This set of institutional requirements or stages, known as the CDM �project cycle�, is designed to ensure the environmental integrity of the CDM and a degree of comparability between CDM initiatives. These stages include the preparation of a project design document, gaining host country approval, validation of the design document by an independent third party or operational entity (OE), registration of the project with the CDM Executive Board and, following project implementation, the verification and certification of the claimed emissions reductions.

Transaction costs could have a significant impact on whether CERs add to the viability of a project. Undertaking a project under CDM framework will only be viable if the costs of transacting the CERs are substantially lower than the revenue they will generate. In Table 2.3 transaction costs for a typical electricity generation projects are shown.


CDM Emission Reduction (CER)

Project Cycle

Estimate of Cost (USD)

A) Up-front (pre-operational) costs

1. CER Feasibility Assessment

12,000 - 20,000

2. Monitoring & Verification Plan

5,000 - 20,000

3. Registration


4. Validation

10,000 -15,000

5. Legal Work

20,000 � 25,000

Total Up-front Costs:

57,000 � 90,000

B) Operational Phase Costs:

1. Sale of CERs:

Success fee in region of 5-10% of CER value. Higher for a small project than a large project.

2. Risk Mitigation

1-3% of CER value yearly. Mitigation against loss of incremental ER value as a consequence of project risk.

3. Monitoring and Verification

USD 3,000 - 15,000 per year.

Table 2.3: Estimates of transaction costs
Source: Harmelink 2001



When considering the financial viability of a project, lenders and investors are particularly interested in assessing the cash flows over the first few years of operation. This is the most critical period when attempting to attract finance. The impact of the first 5 years CER transaction costs in relation to the revenues over that period is shown in Table 2.4. Even if the operational transaction costs (Table 2.3 section B- Operational Phase Costs and Table 2.4) will only be of relevance if the project is considered viable based on pre-operational costs, they are also shown in Table 2.4. Project developers generally expect up-front costs to be no more than 5-7%. Having in mind that search costs (for seeking out possible investors for the selected CDM project) are not included in the calculation, they have to be added to the general up front cost. In the example shown in Table 2.4, the up front costs in percent of the emission reduction value are much higher (11,9-17,8%) than 5-7%. Therefore, this project would probably not be tenable under CDM aspects, especially as search costs would augment this figure. If the project would achieve a CO2 reduction of about 80.000 tons, the up front costs in percent of the emission reduction value would come down to 5-7%. So, this example demonstrates a first pre-calculation for projects in SEA, whether they should start efforts to get CDM as financing source by comparing transaction costs with the value of emission reductions.

It is also possible to determine the minimum amount of CERs that have to be generated, so that this project is viable in regard to the up front costs. In addition, the estimated certificate price can be varied. However, it should be noted that the above analysis does not take into account other potential costs (administration charge, �) as well as risks in relation to CDM.





Emission Reductions (tCO2)



Value of Emission Reductions (Price 4 USD/tCO2)



Present Value of CERs (Discount rate 6%)




Up Front costs



Up Front costs as a % of emission reduction value



Operational costs

Monitoring and Verification



Risk Mitigation



Sales of CERs



Total Operational costs



Present value of total costs


Table 4.4: Revenue and Transaction costs


Risks in relation with CDM and risk management

To identify the different risk factors that could affect the value of CDM projects it is useful to distinguish between different categories of sources of uncertainty (see also table 1.5).

Economic risks: Immature market status, price risks and range of transactions structures for carbon assets.

Policy risks: Uncertainties in the Kyoto process and its implementation for the international and national context.

Technological risks: Technological risks are tied to the process of production. They imply uncertain output quantities. In the present context, technological risks imply uncertain quantities of emission reductions achieved.

Risks can be dealt through allocation to a party in the project structure, or it can be transferred out to third parties through risk mitigation products. This also applies to the CER asset, which can be guaranteed and insured against non-performance or under-performance. In the private insurance sector, companies are now providing carbon credit risk transfer services. In the next years, products for risk mitigation in relation to the flexible instruments will probably occur more and more on the market.

Economic risks

Even assuming the existence of a liquid market for emissions credits, there remains the unpredictability of future prices and market development.

Liabilities associated with credit quality are likely to be assumed by the buyer as it is for other existing tradable commodities like grain, minerals, etc. The credibility and reliability of the seller will largely determine the credit quality, and thus the price.

Policy risks

With or without ratification of the Protocol, CER value can be reflected through domestic regimes in purchaser countries that accept the CER value of a particular project or project type.

The capping of the amount of emission reductions that Annex 1 countries can recognize through the flexible mechanisms could impact the value of particular CDM investments.

It remains unclear which types of energy activities will be eligible for emissions crediting under CDM.

Different countries will perhaps implement their Kyoto ratification requirements in different ways, in accordance with their own national objectives and priorities. This could impact the viability of projects that fall outside those considerations.

CDM projects require host country approval.

In most countries, legalities relating to the allocation of carbon property rights, establishment of title, and carbon asset sales have not yet been addressed.

This is an important area where conventional risks associated with cross border investment are evaluated for a country's strengths, weaknesses and areas of potential concern.

Technological risks

Considerable uncertainties about the amount of actual emissions due to random quality of fuel inputs or stochastic weather variables such as wind and rain and other environmental factors.

Emission level may vary due to fluctuations in production and uncertain product demand.

Even if emission level is not random, measurement errors in monitoring may give rise to an uncertain level of emissions that is ultimately certified or recognized by a regulatory authority.

Table 2.5: Types of risks
Source: Harmelink 2001; own additions


Investment vehicles for CDM and carbon funds in practice

Until now, no market for CDM projects or CERs is established. But there are some initiatives, that are investing in CDM projects and buying CERs, like e.g. CERUPT. Through CERUPT, the Netherlands Certified Emission Reduction Unit Procurement Tender, the Netherlands wants to implement CDM by providing funds for acquisition of CERs. Responsibility for CDM in The Netherlands is with the Minister of Housing, Spatial Planning and the Environment. The Minister has appointed Senter as tendering authority for CERUPT. Within the first CERUPT program in 2001 an average price of 4,8 EUR/tCO2 has been paid. Comparing this price with the estimated certificate price for the first commitment period of about 15 EUR/tCO2 shows promising chances for CDM projects depending on the project specific transaction costs.

On the "carbon market", some financing sources have been already launched or announced (see [Janssen 2002]):


  • World Bank's Prototype carbon fund (
  • Dexia-FondElec Energy Efficiency and Emission Reduction Fund (
  • Clean Energy Fund sponsored by D&B Capital (
  • Renewable Energy and Energy Efficiency Fund initiated by the International Finance Corporation (
  • Other financial institutions including Credit Lyonnais and UBS have announced plans to launch indirect investment vehicles aimed at generating GHG emission permits
  • There also exist some renewable energy funds including Merril Lynch�s New Energy Technology Fund. So far, these funds have not announced any intentions to capture directly the value of GHG emission permits.

ASEM Green IPP network activities in this field

Within the ASEM Green IPP network a database about financing sources in the field of renewable energy projects will be established on the website, where more information about the above delineated carbon funds can be found. This database will be an inventory of lenders and investors who provide finance to the renewable energy and energy efficiency sectors. The project members hope it will assist the growing market of Green IPPs by lowering the cost to access information on available capital providers. This database will be designed to help investors and project developers seeking capital, as well as investors looking for financing vehicles in the renewable energy sectors.


Janssen, J. "Risk Management of Investments in Joint Implementation and Clean Development Mechanism Projects", Diss. Universit�t St. Gallen, 2002

Harmelink, M., and Soffe, P. "Financing and Financing Mechanisms for Joint Implementation (JI) Projects in the Electricity Sector", EcoSecurities Ltd, Ecofys bv, Utrecht, 2001. JOINT Project. 2002. <>

Michaelowa, A., Stronzik, M. and Eckermann F. "Transaction costs of the Kyoto Mechanisms", Climate Policy, Issue 3(2), 2003

Last modified 02/06/03    Top