Carbon Credits: Will Africa Benefit?

In November 2006, the Conference of Parties to the Kyoto Protocol held its climate change meeting in Nairobi, Kenya. One of the focus points of the conference was to highlight Africa’s position in the carbon world, in particular assessing its current (undervalued) status and drawing investor’s attention towards its potential. However, does this signal herald a new age for Africa’s Clean Development Mechanism (CDM) projects?

The negotiation of the Kyoto Protocol in 1997 imposed for the first time caps on greenhouse gas (GHGs) emissions for most of the developed world. The Clean Development Mechanism is one of the mechanisms agreed as part of this protocol with two main goals: 1) to enable countries with emission caps to source emission reduction credits abroad, potentially at lower cost than domestic emission reductions and 2) to ensure that developing countries benefit from increased investment and clean development and would as such be a major alternative to traditional development assistance. The tradable units generated by these projects are called certified emission reduction credits (CERs) and are subject to a UN-observed verification procedure. This procedure assesses the project against various criteria of which additionality is one of the most important, ie the fact that the project would not have occurred without the revenues obtained from selling the credits. After the emission reductions have been verified credits are obtained and can then be sold to either governments that need to meet their Kyoto target (eg Japan, Spain, Netherlands) or participants of the European Emissions Trading Scheme (EU ETS). The EU ETS started in January 2005 and covers electricity producers and large industrial sectors such as iron and steel, cement and refineries.

The total carbon market in 2006 is estimated to have reached over O20bn euros with the EU ETS representing the bulk of this value. Second to the EU ETS in terms of value are the project-based transactions such as CDM credits, which are estimated to have topped O3bn over 2006. Simultaneously, significant levels of investment have been ploughed into this new asset class and the project credit market now has more than 50 carbon funds with a cumulative value of approximately O6bn (see below). These funds have been specifically set up to source, trade and secure carbon credits. In addition to the funds, significant investment has been done on "balance sheet" by firms for whom the project is part of their business, but its magnitude is difficult to assess.

Targeted Investment in Carbon Funds by Year (€m/year)

Source: New Carbon Finance Fund Report October 2006 (2006 YTD = Jan to September).

Africa has only attracted a fraction of the investment flows piling into the CDM. Hence, at least for the African continent the mechanism’s promises of increased investment and clean development seem to have been largely unfulfilled.
The majority of the investment has been directed at large countries such as Brazil, China and India. Of the 1,400 CDM projects that have thus far started the UN approval process only 35 projects are located on the African continent (2.5%). Volume-wise, they correspond to almost 95 million credits until the end of the Kyoto Protocol (2012), only 6% of the total emission reduction currently under development (1.6 billion). At an average market price of O10/tCO2 (range is O5-15/ tCO2 depending on contract structure) this represents a value of approximately O1 billion resulting in a significant margin given the limited cost of doing these projects (anywhere in the range of O0-5/tCO2). Page 3 Volume 1, Issue 1 Although South-Africa has attracted the largest number of projects (almost 50%), more credits are being generated in Nigeria: 25 million with only two projects and in Equatorial Guinea: 24 million with only one. The reason for the large discrepancy in volumes versus projects is the type of technology applied. The projects in Nigeria and Guinea relate to the capture and subsequent processing of gas that would have otherwise been flared. These can save up to 70% of emissions and given the prominence of the oil and gas industry constitute significant CDM potential in these countries. South Africa on the other hand has received investment in a large variety of technologies: biomass electricity production, energy efficiency in industry, landfill gas utilisation and nitrous oxide.

CDM Potential in Africa
Despite Africa’s relatively little GHG contribution (6% of the world total) the potential for CDM projects in Africa is much greater than the figures above indicate and should be recognised by both private and public entities. Africa’s main potential lies in the following sectors:

• Energy Industries; fossil-fuel producers such as Nigeria, South-Africa and Angola have got substantial potential to increase production efficiency and to make use of waste products. The Nigerian and Guinean flaring projects mentioned above are examples.
• Mining; a significant proportion of the world’s minerals and raw materials are sourced from especially sub-Saharan Africa. Coal mining represents the largest potential for countries such as South-Africa as methane from these mines can be captured and utilised; similar projects are already under development in China.
• Electricity. The electricity generation sector is in most countries relatively underdeveloped and is mainly based on inefficient combustion of fossil-fuels. Brunhilda f6l3 Moreover, electricity demand is growing at more than 5% on average representing potential for projects improving efficiency, substituting fuels or developing renewable energy projects.
• Heavy Industries. Despite the relatively low prominence of heavy industry, there is still some potential in the continent’s cement, oil refining, iron and steel and other major industries.
• Agriculture. Agricultural GHG emissions represent a large proportion of Africa’s total emissions footprint and as such harbours significant potential. Biomass products including residues from sugar, timber, tea, and coffee production could easily be utilised to replace fossil-fuels.
• Forestry. There is significant potential for reforestation and afforestation projects in Africa and some projects have already been started.

So if there are so many possibilities to develop CDM projects on the African continent, why has Africa received so little attention?

Investment Barriers
Obviously, Africa is not the easiest place to invest, but apart from the standard country and market risks some aspects are particular to the Clean Development Mechanism process in Africa.
Firstly, many of the potential sources of emission reductions are currently not viable for the CDM process as no appropriate methodologies are available. A UN approved methodology is required for every project that enters the approval process. Whereas the emission reduction potential in Africa is largely based in the agriculture and forestry sectors most of the rules of the game (ie methodologies) have been designed for projects in the electricity and industrial sectors. In addition, those methodologies that have been developed are either not suitable for the African situation or require sophisticated data generally not available for most African countries. For example, a country with predominantly hydro electricity generation is moving towards increased capacity of coal and oil to meet electricity demand. Current methodologies do not take this trend into account and would argue that if say a wind farm would be built in this country it would be replacing non-emitting hydro and would as such not qualify for emission reductions. Naturally, such a distorting situation will need to change in order for such countries to benefit from the CDM.
Secondly, the capacity needed to support the CDM process is limited compared to other countries. Despite the accelerated growth over the past years, the position of the private sector is still relatively weak and it has consequently not been sufficiently engaged in the opportunities of the CDM. Capacity of governmental institutions is another impediment. In general, most African countries do not have the resources or knowledge available as other issues such as health care and education are higher up the political agenda. Language barriers and the lack of data to support the approval process are further constraints.
Thirdly, financing is particularly difficult for African companies as they generally cannot access global capital markets directly. Project finance should provide further possibilities, but so far lenders are still not willing to provide loans against the receipt of CERs. Uncertainties include the existence of any framework after 2012 and the facts that many of the CDM projects are small-scale (especially in Africa) and feature experimental technologies and unknown project developers.
So what can and will be done to make Africa grow in the CDM market?

Conclusion
One of the main decisions during the Nairobi Conference in November was the establishment of a joint framework to help less developed countries such as Africa participate in the CDM process. This framework is supported by financial resources and should boost capacity building (both on the private and public side) and methodology development in these countries. Although this is essential to ensure increased African participation in the carbon markets, it remains questionable whether this will be sufficient to accelerate African CDM development. Consequently, we think that despite the significant opportunities African CDM potential will remain largely untapped for the foreseeable future. Only several projects will be completed mainly in the electricity, oil/gas and landfill sectors with a geographical preference for South Africa, Nigeria, Kenya and North-Africa.
Milo is a senior associate at New Carbon Finance and is a leading expert on price forecasting in the EU ETS and the global carbon market. He is responsible for developing and supporting the Carbon Balances Model, and has worked with numerous clients in the financial, power and industrial sectors.

Sources:

• New Carbon Finance Carbon Fund report, October 2006
• New Carbon Finance Analysis
• Environmental Finance November 2006
• World Bank – State of the Carbon Market: Focus on Africa
• UNEP/UNFCCC pipeline of CDM projects