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CREDITS FUND CLEANER TECHNOLOGIES
BY GEOFFREY CRAIG
It’s often not a mystery how factories can reduce pollution. With the right investment, a company can go from being a notorious polluter to a model corporate citizen. So why don’t more change?
One stumbling block is the high initial cost that tends to derail a project. An international donor might step in with soft loans or grants. In reality, that rarely happens.
Instead, companies are turning to another source of funding for environmental projects: the so-called “carbon market.”
Here, private investors are willing to front all or part of the capital to clean up a factory because the amount of pollution reduced from the project is monetized as credits, which can be sold to someone else.
And who would buy these credits? The demand comes from factories in countries that impose stringent emission caps, such as Japan and EU member states. Environmental regulations in these countries aim to conform with the Kyoto Protocol, an international treaty that requires industrialized countries to meet certain emission targets according to a timetable.
Companies are required to keep their total emissions of greenhouse gases below a specified cap. The penalty for exceeding these targets is so high that a company either takes the necessary steps to reduce emissions, or buys credits to offset them.
“It’s a fairly big market already, and we see it getting bigger,” says Pranab Ghosh, a Washington-based senior investment officer for the carbon finance division of the International Finance Corporation (IFC).
So big, in fact, that carbon finance has already spawned an entire industry of analysts, consultants and fund managers. Often a deal works this way: a representative from an investment fund approaches a polluting factory with a proposal. The investment fund will cover the cost of a project that will reduce the factory’s harmful emissions, and in return, both parties share the revenue generated from the sale of carbon credits.
The project must first pass muster with the host country’s regulator, and then with the United Nations. If accepted, the environmental project, or Clean Development Mechanism (CDM), earns credits that can be sold to another party – usually a carbon broker, who ultimately sells the credits to an end buyer.
Consider the real scenario of a landfill operator near Alexandria. Methane gas, a greenhouse gas that naturally forms as waste decomposes, was escaping into the air. The landfill was giving off bad odors and presented a health threat, yet it was fully compliant with Egyptian environmental law.
The company, Onyx Alexandria, recognized that installing equipment to collect and flare the methane gas would solve this problem. But the $3.1 million price tag was an excessively high cost to bear voluntarily, especially as the project would generate no additional revenue. So Onyx looked instead to the carbon market. In 2006, the company registered the methane flaring project as a CDM, and earned credits that offset the cost of the project.
Onyx’s CDM illustrates one of the merits of the carbon trading system: it provides financial incentives for environmentally responsible corporate behavior. Ghosh believes a few successful CDMs could encourage others to follow. “If you are a cement company and you see that the leading player in the industry gets an advantage by reducing the amount of energy consumed, then you’ll be forced to take action,” he told Business Monthly. “So it is a fundamental restructuring of the energy business away from greenhouse gas-intensive fuels.”
Currently, there are 1,029 CDM projects registered worldwide, with over E11 billion traded in 2007, according to Ghosh. India and China together had over half the registered CDMs. Egypt, which ratified the Kyoto Protocol in January 2005, is still a newcomer to the field – with only three CDMs in operation.
Abu Qir Fertilizer Company became the first CDM in Egypt when it completed construction in October 2006 on a new plant that eliminated nitrous oxide, a harmful byproduct of nitric acid. Carbon Egypt, the local subsidiary of an Austrian firm that invests in projects to reduce emissions of greenhouse gases, provided the money for capital and operating costs, and in return, agreed to split the carbon credits earned.
“Abu Qir Fertilizer wasn’t in the position to invest the money,” recalls Hani Riskalla, general manager of Carbon Egypt. “So we told them, ‘Okay, we are going to do all of the investment, and then we are going to share the profit.’ We would give them 30 percent of the profits earned by the [certified emission reductions] afterward.”
Being the first project in Egypt meant it required more explanation to make clear to Abu Qir’s management the business model behind carbon trading. “It was a new idea, and no one understood the concept,” Riskalla says. “We had long discussions. We explained Kyoto, and explained what our profit is. They [eventually] saw that it is a win-win situation.”
Once the plant began operating, the partners started earning carbon credits based on a formula that calculates the total volume of greenhouse gases reduced. Carbon Egypt is in charge of monitoring the plant, though an independent inspector ultimately certifies how much nitrous oxide has been reduced. The carbon credits can be sold either directly to an end user or through an auction. Several commodities markets around the world buy and sell carbon contracts.
In this case the Austrian government, which could use the credits to offset carbon emissions at power plants, and German energy giant RWE, agreed to purchase the credits from Carbon Egypt under long-term deals. The remaining credits were floated on the open market.
The broker can be cut out of the equation, but one Egyptian investor in a local CDM project warned against it. “If you have the right connections, sure, you can go straight to a buyer in Europe,” he says. “But you’re dealing with some huge companies. The negotiations could be really tough. You’ll be sitting across the table from a bunch of lawyers, and if they see you’re at all naïve... It’s better to just pay a broker his 7-percent commission.”
Following Abu Qir, two other CDMs in Egypt were registered – Onyx’s landfill project in Alexandria and a 120-megawatt wind farm in Zaafarana, on the Red Sea coast. Together, the three plants reduce the equivalent of 2.4 million tons of carbon dioxide a year, according to Sabry Mansour, the coordinator in charge of registering CDM projects at the Egyptian Environmental Affairs Agency (EEAA).
And more CDMs could be on the way soon. The EEAA is reviewing another 38 CDM applications. “Each country can nationalize the criteria it uses when reviewing a case,” Mansour says. “For some countries, maybe the economic or social benefits have the highest priority. In Egypt, due to the pollution, we put the environmental criteria the highest. If the technology doesn’t have an environmental benefit, then we cannot approve it.”
Final approval, however, comes from the United Nations Framework Convention on Climate Change (UNFCCC). And that depends on two factors, says Richard Szudy, president of IDEA Egypt, a local company that has a CDM project awaiting approval by the UNFCC. “If it’s a business-as-usual project, meaning you would do it anyway and it would make money, or if regulations require it – either of these kill the project.”
“A CDM is intended to facilitate an environment project to reduce carbon dioxide emissions that otherwise would not get done because it’s not economically viable,” Szudy explains. “It’s something you shouldn’t be able to afford otherwise.”
Carbon credits earned from the project enable the project to go forward. That doesn’t mean private investors aren’t looking to make money. On the contrary, carbon financing is a huge business. “Sometimes, there is an obscene profit, but it’s a gamble,” Szudy adds.
Riskalla says his company, Carbon Egypt, turned a profit of LE 12 million in 2007 from selling carbon credits, despite paying the amortized expense of E6 million worth of new machinery and related operating costs.
Indeed, other private investors are now showing interest. Last December, France’s Natixis Environnement & Infrastructures, an alternative energy asset manager, signed an agreement with Egypt’s New & Renewable Energy Authority (NREA) to purchase carbon credits in connection with a new 85-megawatt wind farm in Zaafarana. “We knew the NREA was an experienced entity and we trusted the technology of the wind turbines, so it was a good deal for us,” says Gauthier Queru, a portfolio manager at Natixis.
Investment is picking up, but the future of carbon financing grows cloudy after 2012, when the Kyoto Protocol expires. While most experts expect that a new treaty will likely be negotiated, the big question is whether or not it will carry the same stringent emissions targets. Queru points out that a watered-down version of Kyoto would undermine the financial incentives that drive carbon financing.
Already, uncertainty over the future of the Kyoto Protocol is having an effect on the carbon trade. “Two years ago, project owners didn’t raise this point,” Queru says. “But now, considering it takes 18 months from start to finish to register a project, there may be a decline [in business] if there aren’t any positive signals. There needs to be some visibility [among negotiators] to keep CDMs strong. Otherwise, there is a risk that fewer projects will be launched.”
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