Latin America well-positioned for CDM

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Courtesy of EcoAmericas

The coastal desert of Colombia’s La Guajira state is a world away from Kyoto, the temperate Japanese city where representatives of 159 countries in 1997 signed the Kyoto Protocol on reducing greenhouses gases. The Caribbean laps against rickety settlements. Herds of goats range across scorching sands. Months, whole years, pass without rain.

But Kyoto is well known to the inhabitants of La Guajira. A utility company called Empresas Públicas de Medellín is about to start building a $23-million wind farm in the territory of local Wayuu Indians. To do so, it will use $3.2 million from the World Bank’s Prototype Carbon Fund (PCF), an investment vehicle for governments and companies in Europe and Japan.

The PCF investment arrives thanks to a provision of the Kyoto Protocol that allows polluters in industrialized nations to meet their eventual emissions targets by funding greenhouse-gas-reduction projects in the developing world. The provision, called the Clean Development Mechanism (CDM) is meant to spur transfers of clean technology to developing countries.

By late 2003, 15 windmills, each one 60 meters high, will generate 20 megawatts for the national energy grid. That, project organizers say, will prevent 75,000 tons annually in carbon-dioxide emissions that would occur if the same amount of power were generated by conventional means.

The PCF’s developed-world contributors will earn emissions-reduction credits that they can apply against their own greenhouse-gas limits once the Kyoto Protocol takes effect, as expected, later this year. Meanwhile, hundreds of thousands of dollars in health, education and water projects will flow to some 500 Wayuu in exchange for use of their land.

“This project has enormous social benefits,” says Marta Castillo, head of the office within Colombia’s Environment Ministry that prepares projects under the Kyoto Protocol. “It shows how the PCF can stimulate projects in Latin America and benefit poor communities.”

Investors start to line up

The $180 million PCF is a pioneer in the arcane, yet avant-garde business of carbon trading. Established in April 2000, the fund comprises investors who want hands-on experience acquiring emissions-reduction credits under the CDM.

Its stakeholders—the governments of Canada, Finland, Japan, the Netherlands, Norway and Sweden, and 17 European and Japanese companies including BP-Amoco, Norway’s Statoil and Mitsubishi—seek to get into the game before the Kyoto Protocol takes force and the demand—and prices—for carbon credits soar.

PCF investors are bullish on Latin America, where they have invested in nine renewable-energy, energy-efficiency and forestry projects. No less than 30% of the $106 million in PCF investment earmarked through 2003 was for Latin American projects, compared to 23% for Eastern Europe, 20% for Africa, and 12% for East Asia. The fund has invested in four hydro and wind-power projects in Chile and Costa Rica. It has helped a Nicaraguan rice and flour mill to use rice husks rather than diesel for fuel. The fund also is considering investments in, among other projects, a Mexican plant that uses sugarcane bagasse for energy and a Brazilian power plant fueled by a landfill’s emissions of methane—one of the most potent greenhouse gases.

Latin America looms large in the PCF in part because it has shown early interest in carbon projects. Costa Rica negotiated agreements with Norway even before Kyoto, pledging to store carbon through renewable forestry projects. And Brazil was the country that proposed the Clean Development Mechanism at Kyoto. The region also has moved quickly to build the legal structures needed to design projects and court international funds.

“Latin America has the market orientation necessary for carbon trading, knows how the CDM works and has been extremely proactive in designing and promoting projects,” says Eduardo Dopazo, an Argentine consultant on the staff of the PCF. “If China and India ultimately have greater possibilities because of the size of their economies and potential scale of their projects, Latin America is moving fast to maintain its edge.”

Kyoto limits create incentives

The Kyoto Protocol requires industrialized nations that signed the treaty to reduce their output of such greenhouse gases as carbon dioxide (CO2) and methane to 5.2% below 1990 levels during the period 2008-2012. The restrictions could trigger significant investment in CDM projects by developed-world companies and governments. That’s because carrying out greenhouse-gas reductions is believed to be cheaper in developing nations than in industrialized ones.

In Latin America, those opportunities include reforestation, billed as a way to soak up or “sequester” atmospheric carbon in growing trees—creating so-called carbon sinks. The region also has ample room for renewable hydroelectric-, geothermal- and wind-energy projects. And relatively inefficient industries in Latin America provide fertile ground for projects aimed at slowing greenhouse-gas emissions by converting plants to cleaner technologies and fuels.

Potentially, the benefits for Latin America could be immense. Forestry projects financed with carbon sales could generate jobs while helping to restore biological corridors and deteriorated watersheds. The switch to cleaner technologies at industrial plants, meanwhile, could reduce pollution and thus benefit public health. And carbon sales made by switching mass-transit systems to cleaner fuels could help fund the expansion of those systems in such Latin cities as Bogotá, Quito and Lima.

Questions, to be sure, loom. An immediate one is when the Kyoto Protocol will take effect. The treaty must be ratified by at least 55 nations, including industrialized countries representing at least 51% of world carbon-dioxide emissions in 1990.

That process is far along: ratification by Russia, expected this year, is all that is needed to put the protocol into effect. But until ratification occurs, investors have no guarantee their carbon credits will hold value. The uncertainty has kept the demand for credits—and, thus, prices for them—weak. Currently, credits fetch $3 to $4 per ton of CO2 reduced, a level too low to sustain the majority of CDM projects planned for Latin America.

Against that backdrop, the World Bank’s Prototype Carbon Fund has proved pivotal. Its expertise and financing can make otherwise marginal, climate-friendly projects feasible.

“Regional investors are not willing to spend the extra money for environmentally friendly projects when they can expand energy capacity more cheaply through fossil fuels,” says Fernando Cubillos, commercial director at Hidroeléctrica Guardia Vieja (HGV), a private Chilean power company. “But the PCF’s carbon investments can help tilt the balance back towards renewable energy, like hydropower.”

HGV completed its 26-megawatt, run-of-river Chacabuquito plant near Los Andes city last July. Under a deal with the PCF, the power company will receive $3.5 million, while PCF investors will get emissions credits totaling 1 million tons of CO2. (Mitsubishi independently contracted for another 100,000 tons in CO2 credits.) As part of the investment, the project’s design was evaluated by two independent auditors, Norway’s Det Norske Veritas (DNV) and U.S.-based ICF Consulting; the emissions reductions are being verified by a third auditor—Germany’s TÜV Süddeutschland.

Cubillos says the sales of credits were instrumental in the company’s decision to proceed, though they only covered a portion of the project’s US$37 million cost. “Construction of the plant would have been less likely without carbon financing,” he says.

In Costa Rica’s Alajuela and Guanacaste provinces, the Compañia Nacional de Fuerza y Luz (CNFL), a state-owned energy company, is scheduled to begin operating a 6.3-megawatt run-of-river hydroelectric plant this month. The $9.7 million plant, using the waters of Cote Lake as they fall 86 meters to Arenal Lake, will displace fossil-fuel-based energy in the nation’s energy-expansion plans. The $600,000 PCF investment, though small, covers the costs of such environmental work as reforestation around the lakes and the monitoring of fauna.

CNFL officials say an eight-member PCF team helped design the project to meet sustainable-development criteria. The team sought to ensure the project eventually can receive verification of emissions reductions by independent auditors and be approved by the CDM’s executive board at the UN once the Kyoto Protocol takes effect. The experience, company executives say, will serve CNFL well once a carbon market develops.

Analysts expect the price for a ton of CO2 saved to rise from the current $3-$4 range to $10 after Russia ratifies the protocol. They estimate it would reach $20 if the United States were to enter the carbon market. The United States signed the Kyoto Protocol in 1997 under then-President Bill Clinton but has withdrawn its support under current President George Bush.

Experts forecast that Latin American companies and governments with experience in the carbon market will have an edge. “The PCF gives local developers experience and helps establish a carbon market in the region that could help push it towards renewable energy when prices eventually rise,” says Walter Delgado, CNFL’s project coordinator.

That know-how is invaluable to officials at Empresas Públicas de Medellín, the public utility building the wind farm in Colombia’s La Guajira state. They hope to tap the CDM to help finance eight other projects in the areas of hydropower, water treatment, solid-waste management and transportation.

“The PCF financing, though important, is not the crucial factor in our case,” says Luís Fernando Rodríguez, a member of the planning staff at the company. “It’s the learning that’s crucial. The experience will help us in formulating other CDM projects.”

Carbon projects have not escaped criticism. Some question whether PCF investments, especially in hydropower and forestry, are environmentally sound. Among the fund’s stated missions is to promote sustainable development in the developing world while helping to mitigate greenhouse gases worldwide.

Critics argue the PCF is thwarting this mission by sponsoring poorly designed “loophole” projects that effectively allow industrialized countries to meet emissions-reduction quotas without slowing overall emissions growth.

Two non-governmental organizations, the Berkeley-based International Rivers Network and Bali-based CDM Watch, share this view.

To qualify for carbon credits, they point out, organizers of a CDM project must show that under a business-as-usual scenario—in other words, without carbon financing—CO2 emissions would be greater. Yet hydropower, one of the fund’s preferred investments, already looms large in the energy expansion plans of many developing countries and likely would have been undertaken with or without carbon sales, these critics say.

Nor is hydropower necessarily innocuous from an environmental standpoint, critics point out. Methane from decaying leaves, trees and other biomass flooded by hydroelectric plants with conventional reservoirs can rival the greenhouse emissions of a fossil-fueled power plant, they say.

Forestry projects also questioned

Forestry projects intended to yield carbon credits also have raised questions.

The PCF is currently committed to a $5.3 million carbon deal with Plantar, a private company in Brazil’s Minas Gerais state that produces charcoal, pig iron and wood for pulp and paper producers. Plantar would generate carbon credits by maintaining a new, 5,700-acre (23,100-hectare) eucalyptus plantation—thus creating a carbon sink—and by using charcoal from the plantation as a substitute for coal in pig-iron production.

But some experts doubt replanted forests provide reliable storage for atmospheric carbon. They say carbon must be stored for at least 100 years to benefit the atmosphere since that’s how long a CO2 molecule remains in the atmosphere before being reabsorbed in plants or the sea. The storage period, they add, often is cut short when trees die or burn in forest fires, releasing carbon back into the atmosphere.

The issue of the “permanence” of carbon storage in forests is so controversial that allowing reforestation for carbon credits remains one of the undecided issues at the annual meetings where rules are set for emissions trading.

Industrialized nations can acquire 1% of their emissions credits through CDM reforestation projects. But the rules governing the calculation and verification of emissions reductions in such projects have yet to be defined. That has cast doubt over PCF forestry investments—particularly the Plantar project, whose emissions credits are by no means guaranteed.

Det Norske Veritas, the independent Norwegian auditing firm, was hired by the PCF to look into the Plantar project. The firm reported last July that given the uncertainty of rules governing forestry operations, it could not “arrive at a final conclusion as to whether the permanence of the carbon sequestration is sufficient to ensure long-term benefits related to the mitigation of climate change.”

CDM Watch was more blunt. “The value of Plantar’s sequestration credits should be zero,” it said in a report last year.

Kick-starting the carbon market

Still, even the PCF’s most ardent critics acknowledge that the fund has helped kick-start a carbon market that could bring technology transfers and renewable energy projects to the developing world.

Independently of the PCF, the Netherlands’ carbon-procurement agency, Senter International, is evaluating investments in hydropower in Peru, Panama and Costa Rica, a geothermal energy project in El Salvador and waste-management and energy-efficiency projects in Brazil, Bolivia and Central America.

Governments and private developers in the region have prepared hundreds of other projects for potential CDM sales.

The World Bank recently announced the creation of a $100 million Community Development Fund to extend carbon financing to small projects in poor, rural communities. It also has launched a $100 million BioCarbon Fund to finance agricultural and forestry projects, including some activities not yet recognized under Kyoto agreements.

The funds, expected to be operational between May and September of this year, build on the experience of the PCF. The Netherlands Clean Development Facility, a government entity operating independently of Senter, has announced a new, 140-million-euro carbon-investment fund. Similar to the PCF, the fund will be administered by the World Bank.

“The PCF is the groundbreaker in the financing, expertise and capacity-building needed for carbon trading in the developing world,” says Thomas Black-Arbeláez, director of the Andean Center for the Economy in the Environment, a Bogotá-based think tank. “It has led the way in Latin America for others to follow. We need the markets to develop now and take the experience further.”

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