El delito

The post Kyoto risk was associated with uncertainties about the form and direction the resolutions in Copenhagen conference in December of 2009 will take. Even with the Durban CMP17/COP 7 just recently concluded, issues are still not fully resolved about the future and the direction. However there is an appetite for the CDM to continue but no clarity about the form it will take. The uncertainties associated with the scope and future framework of interaction between Annex 1 countries and institutions and their future interactions with Non Annex 1 countries vis-á-vis the flexible mechanisms remains the most important and exigent

impediment to the investment decisions of current and potential investors in CERs related projects and could more so have a high risk impact in the long run on not only the project developers but also on the economies that depend on these projects.

A degree of assurance that there will be market for the ultimate sell of generated CERs is crucial to the investor (i.e. market continuity is important in making a decision as to whether it is expedient to invest in the production of a product). This market confidence and certainty of continuity are major indicators for the investor in investment decision and the actualisation of CERs trading. As the case is clearly

170 now with the uncertainties associated with EU ETS and the trading of CERs through this platform, the withdrawal of investment in CDM is expected. The author is of the opinion that investment decisions will be significantly affected by the cloud of doubt presently affecting the future of the flexible mechanism post 2012. The complexities of achieving a consensus on an internationally binding legal framework for post Kyoto climate change issues is brought to bear in different publications and dialogues surrounding the way forward for climate change post 2012.

From carbon market and pricing perspective, the multiplicity of approaches sequel to 2012 could almost certainly create a significant price variance that might reduce the size and liquidity of the market along with create a regulatory pool of different and disjointed requirements for both the investors and the developers to deal with.

The entry of Australia has undoubtedly redefined the dynamics of emissions trading in particular and the flexible mechanism as a whole and hopefully the Durban consensus having incorporated major polluters like China, India and Brazil in bringing about more credibility would create some level buoyancy to the carbon market by reducing (or possibly reversing) the risk impact so far caused by this

“wait and see” approach in industry.

Host Country risk considerably undermines the investors’ interest in investing in developing countries. The instability from socio-political frameworks and the deplorable state of most of the countries’ infrastructure is often highlighted as the reason for a poor representation of CDM projects in Africa. Except for countries like South Africa that has relatively more stable economic and socio-political infrastructure when compared to the rest African States, this particular risk type may not be of significant impact to it. EcoSecurities for instance use a CARE⁴⁶² tool for compounding 3 host country risk factors in a matrix into a single risk factor to determine the host country risk level. In considering the host country risk, the 3 risk indicators used by EcoSecurities include War, Expropriation and Government action, and Transfer risks. Using models like this does not only give clear risk

462Carbon Assets Risk Evaluation(CARE) tool is a bespoke excel based risk assessment tool is developed by EcoSecurities. It uses Monte Carlo simulations to give an initial assessment of the overall risk profile, screen individual projects at the early stages and help formulate a global strategy for the acquisition of CERs.

171 indications but provides CDM investment decision indices about different

countries and aerates the host country decision choice pathway for the investors and project developers Carbon Assets Risk Evaluation

According to Michaelowa (2006) “A lack of resources, institutional barriers and other development priorities impede the investment [in] developing countries...”

while in the case of Annex 1 investors investing in Non Annex 1 countries, the lack of confidence in the socio-political structures and other infrastructural barriers in most Non Annex 1 countries impede willingness to partner and invest in CDM projects hosted in the country. The need to ensure that a level of stability is guaranteed in the host country for an investor is paramount to his decision making and willingness to commit and wade through the other risks that would or could arise in the process of completing the project.

Ideally, host countries have a responsibility to ensure that the right socioeconomic and domestic regulatory framework are in place to influence the confidence of potential Annex 1 investors, stable political processes and provisions of working social, economic and physical infrastructure should be a top priority for host countries. It is important also to ensure that projects are facilitated without undue interference either directly or indirectly by the government or its officials.

Finally, the methodology risk vis-à-vis the issues of Additionality and baseline determinant factors is another risk element that would seriously affect investment decisions. The lack of clarity about the calculation and how to determine and monitor what is additional is still an area that is unclear and need further research.

The relatively high risk (in some cases up to 50% rejection) of rejections

consequent to CDM-EB rejecting methodologies⁴⁶³ does not incentivise investors to take the decision to follow new methodology. Albeit, the cost of even taking on the challenge could be out of reach for most investors as referred to above in Section 4.3 and 4.4.

Even with the use of approved methodologies as stated above, there are recorded instances where project approvals have been delayed due to the review and

463Supra note [Castro and Michaelowa, A. (2008)]

172 consolidation of two or more methodologies and complexities of the methodologies based on the requirements of the EB.⁴⁶⁴ The impact of this on small project investor is significant. As “time equals money to the investor”, it implies that for every time lost, a proportionate amount of money is lost it is therefore important that the risk assessment on a CDM methodology stage – as indeed for every other stage – is comprehensive and robust enough to mitigate any methodology risk impact on the project.

4.6 Conclusion

The risk of falling short of the projected 2.7 billion CERs by 2012 according to IETA is very likely and more so due to delays experienced in registration of projects and the ripple effect of these delays on the delivery by the project

developer and the obtaining of financing from investors for the implementation of the projects.⁴⁶⁵ The predictability of any project is vital to the success of the project as such it is important therefore that for there to be growth in the CDM sector and innovativeness, it is necessary that there is a high level of predictability in the process for security on investment. Every CDM project (as in any other project) has inherent in it risk elements that could be either externally imposed or internally induced. The full risk-impact assessment of CDM projects is needed to reach an informed and robust investment decision.

The dynamics of CDM project and its inherent risk elements should not be a one off engagement but rather ongoing and proactively engaging all the stakeholders in the project. Risks are apparent at the early stages of projects life cycle and have the same critical impact as risks that are imposed or induced by other unforeseen externalities. It is important that these risks are pre-empted and mitigated in the continuous risk assessment of the project life cycle. The CDM EB and other technical advisory bodies in the just concluded COP 17 to the best of my knowledge have not addressed any of this risk issues, it is important that a well-documented guidance is provided on the issues which would positively impact Africa’s share of CDM project in the next commitment period.

It is important also that investment decision makers, project developers and other project stakeholders understand the intricate nature of project risk management and

464Id

465IETA 2008

173 the interrelatedness of the different elements and project stages to ensure a robust proffering of needed mitigation strategies for any eventualities. The realities of the current uncertainties vis-à-vis the post Kyoto talks, CDM investment and risk analysis makes the Durban and subsequent COPs a make or break event for the global mitigation strategy on climate change.

Beyond the lack of progress in addressing CDM project investment risks at the international level, it is the author’s view that the following key measures should be considered by all stakeholders in CDM projects

- CDM Investment portfolio should be over a broad cross section of countries to avoid the host country risk from any one particular country holding down the project and affect the investment.

- Standardisation of accounts for treatment of CERs assets

- There is a need for project investors to attach importance to capacity building (what type of capacity building as this otherwise risks being too general a conclusion) for the project developers in order to articulate a robust risk management portfolio. And investment in this not only has immediate returns on the project but also a long term gain on future project.

- It is also important to secure a firm carbon contract that is an irreversible pledge to pay against delivery of emissions reductions.

- Investors should be able to float CDM bonds after due diligence and project risk assessment (this point is also supported by Deodhar et al 2003).⁴⁶⁶

466Deodhar, Vinay; Michaelowa, Axel; Krey, Matthias (2003): Financing structures for CDM projects in India and capacity building options for EU-Indo collaboration, HWWA Discussion Paper No. 247, Hamburg

174 Chapter 5

CARBON CAPTURE AND STORAGE REGULATORY RISK