CDM Costs and Benefits

Because many abatement opportunities are less expensive in developing nations, the CDM can help reduce the overall cost of achieving global GHG reductions.   And because GHG emissions contribute equally to climate change irrespective of their geographic location, the impact on the global environment is the same. 

The process of developing CDM projects and obtaining CERs is described below.  The CDM-specific development costs vary significantly depending on the size and scope of the project, but the minimum costs are likely to total about US$50,000, which creates a problem for small-scale renewable energy projects, including small grid-connected systems.   These costs must be invested at the time of project development, but the benefits from the sale of CERs do not start to be realized until one year after start of operation.  As such, they do not provide any funds during the development process, which is often when renewable energy project developers have the most critical need for funds.

A CDM project receives a CER for every ton of carbon dioxide equivalent that the project displaces.   The Table below¹ provides the typical emission reductions for grid-connected renewable energy projects based on hydro, wind, geothermal solar and sustainably harvested biomass.   At a CER price of $4 per ton CO2 equivalent, CDM provides added revenues of 1.6 to 6.0 US$ per MWh of electricity produced depending on the type of conventional fuel displaced.  This additional cash flow generally improves the IRR on a project by only 0.5 to 3.0 percentage points.    Higher CER prices would yield proportionally higher revenues. 

For renewable energy projects dealing with methane emissions, the CDM benefits are more significant, because methane has a 21 times higher GHG potential relative to CO2.  Therefore, a CER price of $4 per ton CO2 equivalent provides added revenues of 14 to 16 US$ per MWh of electricity produced depending on the type of methane gas displaced.  In addition, the projects that utilize the methane to generate electricity that displaces fossil fuels also get the fuel displacement CERs.   The total additional cash flow can improve the IRR on a these projects by more than 15 percentage points.  

Projects that agricultural and forest residues can get credit for methane emission reductions depending on how the residues are currently disposed.  These projects can realize an improvement to the IRR of 3 to 7 percentage points².  

The CDM Process

A CDM Executive Board (EB) was created by the Conference of Parties to the UNFCCC, which gave it the authority for implementing and supervising the CDM.  The key responsibilities of the EB, relative to the CDM project development process, are to:

• Approve new methodologies related to project baselines, monitoring plans and project boundaries
• Review provisions with regard to simplified modalities, procedures and the definitions of small scale project activities
• Be responsible for the accreditation of operational entities,
• Develop, maintain and make publicly available the approved rules, procedures, methodologies and standards for the CDM
• Develop and maintain the CDM registry to ensure accurate accounting of carbon credits generated - including issuance of certified emissions reductions
• Develop and maintain a publicly available database of CDM project activities

One of the eligibility requirements for CDM is that the “host” country must ratify the Kyoto Protocol and establish a Designated National Authority, or DNA, to review and approve CDM projects.  According to CDM rules, the DNA has two mandatory functions.  The DNA is responsible for issuing a written statement, on behalf of the government, confirming that (a) the country’s participation in a project is “voluntary” and that (b) a project activity assists in achieving sustainable development and is consistent with national priorities. 

All CDM projects must follow a well-defined series of steps and calculations, which must be validated and verified in order to earn certified emissions reductions (CERs).  These steps are illustrated in the figure below.

Project developers must submit their project to an independent, third party organization, called a Designated Operational Entity (DOE), which will review the project documents and “validate” the project if it satisfies all the necessary conditions for project eligibility stipulated by the CDM Executive Board. This is a necessary prerequisite for a project to receive CERs. The DOEs are similar to accounting auditors.  They must be independent and cannot benefit, in any way, from the outcomes of a CDM project.  The DOE is required to perform the following essential services in the CDM project cycle:

• Validation that the project design, as proposed by the project developer, meets all the requirements of the CDM.  The project validation work is carried out before the project is submitted to the CDM EB. 
• Registration of the CDM project with the EB.  Project proponents cannot submit projects directly to the Board.  The CDM rules state that the DOE is responsible for submitting projects to the Board.  This requirement exists to ensure that the CDM EB only receives documentation on projects that have already been “validated” by a DOE. 
• Verification of the emissions reductions that occur as a result of the project.  Verification work is done after the project starts and at fixed intervals. With the exception of SSC CDM projects, verification must be done by a different DOE than was used to validate the project.    
• Certification of emissions reductions.  The DOE that carries out the verification of emission reductions is responsible for submitting a letter to the CDM EB recommending the issuance of certification for the verified emissions reductions of the project. 

CDM Project Development Steps

Step 1:     Identify eligible CDM project opportunities

Step 2:     Collect technical information to screen a project

Step 3:     Conduct preliminary screening for CDM eligibility

Step 4:     Develop a detailed project design document (PDD)

Step 5:     Submit the PDD for national approval

Step 6:     Validate and register project with CDM Executive Board (CDM EB)

Step 7:     Secure financing and implement project

Step 8:     Monitor, verify and certify project emission reductions (CERs)

Step 9:     Monetize (sell) and transfer the project CERs

Risk Mitigation

Operational Risks and Mitigation Approaches

The table³ below highlights some of the key technology and operational risk issues affecting different renewable energy technologies.   Mitigation of these risks is essential to attracting appropriate commercial insurance cover.   Many of these risks can be addressed through program elements to support technical standards, resource assessment, and institutional capacity building.

Commercially Available Risk Insurance Options

The table below provides an overview of the various ‘traditional’ insurance products that are available (or have been transacted) for renewable energy projects.  It includes the types of risks addressed by each project and the issues and concerns for the underwriters.

The table below indicates the degree of ‘traditional’ insurance coverage that is available  for specific types of renewable energy projects.  Wind energy projects are the commercially renewable energy technology with which the insurance industry has most experience and capacity to respond at present.

¹ Kyoto and Beyond: Opportunities and Strategies for Carbon Finance.(PDF)
² Training, Carbon Finance and Risk Management, Prototype Carbon Fund (PPT)
³ Financial Risk Management Instruments for Renewable Energy Projects. (PDF)