Features, July/August 2000 Business baulks at CDM costs As the Kyoto process approaches the crucial Hague meeting in November, some participants are concerned that investors will steer clear of the Protocol's flexible mechanisms. Mark Nicholls reports The appearance of a 126 page draft negotiating text at the end of the June UN meeting on climate change in Bonn was met with dismay by many negotiators and observers. With all the options for the design of the Kyoto Protocol's 'flexible mechanisms' still on the table, they are concerned that the text will have done little to encourage private sector engagement in the process. Admittedly, the text will be whittled down before COP 6 in The Hague in November. At that meeting, many of the details of the flexible mechanisms - the Clean Development Mechanism (CDM), Joint Implementation (JI), and international emissions trading - will be clarified. But will there be enough clarity, simplicity, and certainty for the private sector to get involved in these flexible mechanisms? Their participation is vital to attract investment into projects that will qualify for emissions credits under Kyoto's flexible mechanisms - thus ensuring the success of the Protocol, an international agreement to cut greenhouse gases. As one senior G7 negotiator puts it, "the distribution of risk associated with some of the things being considered... would be potentially career-threatening for anyone who tried to put a Clean Development Mechanism project through their bank's credit controls." The CDM covers emissions-reducing projects in the developing world. Investors in such projects will receive emissions reductions credits that can be used to meet the obligations of industrialised countries to reduce their GHGs. While many private sector concerns apply to the other mechanisms, the CDM is arguably central to the success of the Protocol, and illustrates the kinds of issues that the private sector is keen to address. The process of having CDM projects approved and registered is shaping up to be overly bureaucratic, and potentially too costly for private sector entities to get involved, some negotiators and observers fear. If controls imposed by UN bodies and host governments are too onerous, too opaque, or the potential outcomes too uncertain, they say, the private sector will simply not participate - eliminating the benefits of a mechanism which could generate substantial direct investment flows to the South. Clearly, what is on the table - a text which contains numerous options and negotiating gambits - is far from the final word. But negotiators say that this is a crucial point at which the private sector must clearly reiterate its arguments to ensure a workable Protocol. What most concerns the private sector are the very nature of the emissions credits that will be generated; the transparency, certainty and costs of meeting UN project approval rules, and taxes on CDM credit flows. How best can the negotiators, in the run-up to COP 6 and beyond, ensure that what emerges is a workable Protocol that remains attractive to private sector participants without undermining Kyoto's environmental and sustainable development objectives? Environmental Finance circulated copies of the draft negotiating text (document FCC/SB/2000/4) to a number of companies which intend to participate in Kyoto-linked projects, and asked, with particular reference to the CDM, what they saw as the key concerns at this point in the negotiations. The over-riding concern is one of certainty. Prospective investors want to be sure that the process for generating credits is clear and transparent. There are also concerns of the costs - both in gaining approval for CDM (or JI) projects, and the amount of the proceeds from projects that will go towards an 'adaptation' fund. A basic concern is that proprietary rights over emissions credits - known as certified emissions reductions (CERs) - are agreed and identified. "I'm concerned that some countries are still taking the view that the CDM doesn't give rise to assets that can be held by non-governmental agencies," says Martin Bartlam, in the high-yield and leveraged finance group at Credit Lyonnais, a French bank. The issue is linked to the transferability of CERs, although Bartlam agrees that this is issue that is likely to be positively resolved. "But as long as its in the text, there's an element of doubt," he says. This is linked to longer-term issues surrounding the legal status of emissions reductions generated by projects. "Who will own these emissions - is it the host country, the owner of a project, or the operator of a project? What happens if there's a change of government? We will need to understand the institutional arrangements," says Tony Wheeler, director of Deutsche Bank's technical services group in London. He adds that there is currently too little attention being paid to Kyoto's legal basis. "Until the institutional, regulatory and legal framework is in place, it's very difficult for us to do business," he says. For many, the approval process is at the nub of the matter, and could impose heavy costs on CDM projects. "There's a worry that project accreditation will take so long as to hold up worthwhile projects, or prevent them getting done altogether," says Bill Kyte, head of corporate environment at PowerGen, a large UK electricity generator. The process needs to be transparent, and must ensure that it is clearly defined from the outset, say observers. One of the greatest possible disincentives is the risk of 'frustration', says Deutsche's Wheeler. "Investors need to be able to see that you will be able to pass through the process from the start - there can't be any risk of frustration through subjective or unpredictable decisions being taken late in the day", he says. Developers of, say, a $200 million power project can easily spend up to $20 million before any foundations are laid - and if there is any danger that a project that depends on emissions credits will not, ultimately, receive those credits, investors will shy away. FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE