1 optional delivery of 0.7 mln ERUs
² average weighted price for the ERUs

For the ERUPT 2001 tender 26 Expressions of Interest were received by Senter and 6 projects were short-listed. The emission reductions per project range from 0.5 to 1.6 million tonne CO₂-equivelants with an average price of 4.8 Euro/tonne of CO₂. Five projects are situated in four countries of Central-Europe (Estonia, Slovakia, Hungary, and 2 in Romania) and one project is situated in New Zealand. In total these projects offer 5 million tonne CO₂-equivelants (Senter 2002)¹⁶. The project developers are currently in the phase of preparing their project design documents (PDD).

3.3 CERUPT

3.3.1 Introduction

In November 2001 the Dutch Government launched the first CERUPT (Certified Emission Reduction Unit Procurement Tender) programme. The programme is managed by the Dutch implementing agency Senter. Through CERUPT 2001 Senter aims to buy at least 3 million CERs (Certified Emission Reduction units) from investments in CDM projects. One CER equals one tonne of CO₂-equivelant.

3.3.2 Project requirements

According to the CERUPT programme (Senter, 2001b)¹⁷ the CDM-projects have to meet the following minimum requirements:

	The CDM projects should deliver a minimum of 100,000 tonnes of CO2-equivalent over the crediting period.
	The period in which the CERs can delivered depends on the crediting period. If a crediting period of 10 years is chosen the delivery should take place in the period before 2012. If one, two or three periods of 7 years have been chosen, in the first 7-year period the delivery should take place before 2012. If case 14 or 21 years have been chosen, deliveries may also be supplied after 201218.
	The project would not have taken place without CDM-funding.
	Projects should contribute to sustainable development in the host country
	Projects in the field of nuclear energy are not eligible for funding

Within CERUPT a technology preference is stated in order to promote sustainable development and assure a balanced project portfolio. CERs from renewable energy projects are offered a higher price than CERs from landfill gas projects (see Table 4).

Table 4
Maximum prices for different project types

3.3.3 Procedure and programme management

CERUPT consists of two phases, a selection phase and a contract-awarding phase. In the selection phase the project developer submits an Expression of Interest to Senter in which the potential suppliers expresses its interest to develop a JI project. The proposals are assessed on the basis of, among other criteria, the feasibility of the projected GHG emissions reduction and the experience of the project developer.

Items that have to be delivered with the Expression of Interest are among others:

	Annual accounts of the previous three financial years
	A certified statement of the suppliers turnover
	Project Idea Note (PIN)
	Letter of Endorsement of the host country
	Reference with respect to setting up and operating similar projects
	Reference with respect to the technology to be used
	Statement of social responsibility

In the contract-awarding phase the short-listed projects have to be worked out in more detail. In this phase, among others the following items have to be supplied:

	Offer of Claims on CER’s
	Letter of Approval from the host country
	Business plan
	Baseline study
	A report concerning public participation
	An environmental impact assessment (EIA) (if required by the host country)
	A validation report
	Registration of the project by the Executive Board

The validator has to put the baseline, the EIA, and the stakeholders comments on the Senter web-site in order to provide for the 30-day period for comments on the Project Design Document (PDD) from Parties, stakeholders and UNFCCC accredited NGOs.

3.3.4 Contracts

The Cerupt Terms of Reference (ToR) includes all terms and conditions pertaining to the contract. The main issues are similar to those valid under Erupt. The penalty procedure and payment conditions in Cerupt however differ from Erupt.

Penalty procedure

Whereas the penalty procedure in ERUPT applies when less then 100% of the total amount of ERUs is delivered, in CERUPT Senter is entitled to fine a penalty if less than 70% of the amount of CERs offered is delivered on the agreed schedule, except in case of force majeure. For the penalty procedure it makes no difference if 65 % or only 5 % of the amount of CERs has been delivered. Similar to the ERUPT procedure, the penalty is equal to 2.5% of the total purchase price per month of delay, up to a maximum of the agreed purchase price. Apart from the penalty procedure Senter still has the right to reclaim any advances paid by Senter to the contractor.

Payment conditions

Payments will be made as follows:

	on delivery of CERs in the 1st, 3rd, 5th etc year of the project being operational and generating emission reductions;
	on delivery of a monitoring report in the 2nd, 4th, 6th etc year. These payments will be considered as prepayments.

In exceptional cases and only if proven unavoidable, Senter may make prepayments in the period of project realisation, i.e. before actual delivery of CERs. Prepayments will negatively affect the supplier’s ranking. Senter will make a maximum of four prepayments, mounting up to 50 percent of the guaranteed contract value.

3.3.5 (Preliminary) results of the CERUPT programme

The first CERUPT tender was launched in November 2001. Senter received a total of 80 Expressions of Interest of which 26 projects were short-listed. The emission reductions per project ranges from 0.1 to 6.5 million tonne CO₂-equivelants and the average price per tonne is around 5 Euro. The projects are situated in 13 different developing countries, with India, Costa Rica and Panama as the front runners. Most frequently used technologies are wind energy and hydropower. The project developers are currently in the phase of preparing their project design documenst (PDD).

4 Handling of risks

Different kinds of risks are linked to project development and purchase of emissions reduction credits in the field of JI and CDM. Two types of risks can be distinguished policy risks and market risks, which affect three types of actors the host country, the investor country and the project developer. These actors have to evaluate their policy and market risks and need to develop strategies to mitigate these risks. The actors and type of risks are outlined in Table 5.

Table 5
Type of risks linked to JI and CDM projects and the involved actors

The different type of risks will be treated in more detail in this chapter and options will be presented to mitigate these risks. For the mitigation of risks we mostly look at the viewpoint of the investor country and refer to concrete projects or programmes as much as possible. It must be noted that this chapter only assesses the additional risks linked to the fact that the project is a JI or CDM project. Apart from these risks the actors will also have to assess the ‘conventional’ political and country risks associated with cross-border investments. These risks include a broad category such as social conditions (labour, literacy, health), economics (growth, revenue generation, balance of payments), government (sources of power, regime stability), and climate for business (investment and trade restrictions, banking and financial sectors).

4.2 Policy risks

Policy risks refer to the uncertainties in the Kyoto process and its implementation in the international and national context. The evolution and outcomes of climate change policy is still subject to uncertainty, related to both the international agenda, such as the Kyoto Protocol, and to individual countries’ domestic implementation of the Protocol and climate change-related policies.

Developments in international climate policy: International policy risks are mainly associated with the ratification of the Kyoto Protocol. The Kyoto Protocol is not a legally-binding document, until it has not been ratified under the terms of Article 25, which sets out detailed provisions governing the treaty’s entry into force. Lacking an operative Kyoto Protocol substantially increases the risks that particular project investments may prove relatively worthless.

Implementation of Kyoto protocol in the host country: There are risks associated with the host country’s implementation of the Kyoto Protocol, particularly the conditions under which JI/CDM investments will be allowed. It can be expected that different countries will implement their Kyoto ratification requirements in different ways, in accordance with their own national objectives and priorities. This could impact the viability of projects that fall outside those considerations. The Kyoto Protocol does futhermore state that emission reduction units from non-ratifying countries cannot be used to fullfill the Kyoto agreements. This means that investing in a country that has not yet ratified the Kyoto Protocol is more riskier than investing in a country that has already ratified the Kyoto Protocol.

Host Country Approval: Both JI and CDM projects require host country approval. Getting project approval for a JI or CDM project from a host country normally requires negotiation with the host country’s JI or CDM focal point. The ability of host countries to enter approval procedures varies.

Credit Sharing: Credit-sharing arrangements will be subject to host country criteria for JI projects. Currently few countries have such criteria in place. This means that each project is subject to contract negotiations for the credit split, until policies are established formalising a particular formula. Such a policy may well never emerge, meaning that all credit sharing arrangements would be negotiated as part of each individual project contractual arrangements, and in this will have to be clearly stated in a carbon purchase agreement (CPA).

4.3 Market Risks

Market risks refer to immature market status and a price risk for carbon credits.

Price uncertainty of emission credits. Even assuming the existence of a liquid market for emission credits there remains the unpredictability of future prices and market development, due to uncertainties in policies and strategies of actors on the carbon market.

Credit delivery. Liabilities associated with credit quality and chances of delivery are likely to be assumed by the buyer as it is for other existing tradable commodities like grain, minerals, etc. The credibility and reliability of the seller will largely determine the credit quality, the price and chances of delivery.

4.4 Assessment and management of risks on the project level

An assessment of the risk that the project developer and the key actors involved in the project will be exposed to is undertaken as part of the project planning process. Risk assessment is generally undertaken through the following steps:

A. Risk Identification: Identification of all risks associated with the construction and operation of a project. Typically expert risk analysts undertake this (often by insurance companies involved in the project).

B. Risk Matrix: Plotting of all risk categories against the various phases of a project. This forms the basis for the negotiations as to which project parties will absorb the various risks.

C. Quantitative Assessment: Evaluation of key risk parameters for individual JI and CDM projects. The quantitative assessment uses hard data, when applicable, as well as qualitative professional judgement.

The risk assessment methodologies are based on several parameters and can be applied in a number of quantifiable ways:

1. The likelihood of an event occurring (L): Past records combined with professional judgement are used to estimate the possible impact of an event on the expected outcome of a project.
2. The significance of its impact, were it to occur (S): Past records combined with professional judgement are used to quantify the impact that an event could cause during the lifetime of the project.

Absolute Risk is the product of {L x S} and is a measure of risk posed by a specific event without countermeasures being taken.

The assessment is modified to discount the absolute risk impact by a factor reflecting the intensity and quality of risk management currently applied by the project to avert the event’s occurrence or to minimise its impact. Therefore the following variables are introduced:

3. The risk response or risk management procedure (P): In order to reduce a risk or its impact, managers may establish countermeasures in the form of operational procedures. The technical adequacy of such procedures is evaluated making use of past records and the best professional judgement.
4. Management systems (MS); The success of such measures in addressing risk including communication, monitoring and actual success.

The level of Quantified Risk posed by each potential threat can be calculated according to the following formula: {L x S} x {P x MS}

D: Managing Risk: The risk that a project will not perform or under-perform can be managed through:

1. Allocation of a specific risk to a contracting party who will guarantee the particular project activity, in the construction or operational phases. Generally, in order to bear and manage risks, it is necessary to understand them. The entities best able to do so are those most closely associated with them. Guarantees could be provided in relation to supply of fuel or equipment, payment on delivery of electricity or energy savings, performance and arrival on time of equipment, etc.
2. Transferral to a third party. The transfer of risk to a third party involves the use of financial tools, such as hedging, guarantees and insurance products.

4.5 Conclusions

Different type of additional risks can be identified for CDM and JI project compared to ‘conventional’ projects:

Identified policy risks are non-ratification of the Kyoto Protocol, uncertainties in the implementation of the Protocol in the host country, approval of the host country and credit sharing. Within the CERUPT and ERUPT programme most policy risks are mitigated through legal arrangements in the contract between Senter and the project developer, with the exception of the political risks that the Kyoto Protocol with not come into force.

Identified market risks are price fluctuation and uncertainties in the delivery of contracts. Within CERUPT and ERUPT contact are awarded with fixed prices which rules out the risks of price fluctuation. Non-deliverance of credits by the project developers is covered through a penalty in the contract.

5 Transaction costs

This chapter examines the transaction costs of Joint Implementation and the Clean Development Mechanism for the investor country and the project developer. Transaction cost are defined as all costs that have to be made in order to be able to transfer ERU or CER from a host country to an investor country.

5.2 Transaction cost for the host country

Not many data are available on the costs that have to be made by the host country to import emission reduction units. We were only able to make rough estimates. Currently approximately 9 people¹⁹ with Senter are working on the CERUPT and ERUPT programme, which roughly amounts to 1,5-2 Million Euro. In 2002 Senter is planning to buy 6 Mtonne of ERUs and 3 Mtonne of CERs (see chapter 3), which represents a total purchase budget ranges from 20-45 mln Euro (depending on the price of the offered ERUs and CERs). This means that the transactions costs for the transaction of ERUs and CERs lies in the range of 3%-9% of the total purchase budget.

5.3 Transaction cost for the project developer

Project developers will only consider a JI or CDM project viable if the costs of transacting the ERUs or CERs are substantially lower than the revenues they will generate through the sale of ERUs of CERs.

Table 6 shows estimated transaction costs for CDM and JI projects, based on numbers from ERUPT and CERUPT and on Ecofys experiences in the field. It must be stressed that the numbers are very rough and can only be used to get an indication of the level of these transaction costs.

The transaction costs in the in the project preparation phase include a feasibility study, preparation of documents, registration of the project as a JI or CDM project and the legal work for the contract. Total estimated up front cost range from 45,000 – 95,000 Euro. The total transaction costs in the operational phase are even harder to determine because none of the JI and CDM projects has entered this phase and no practical data are available.

Table 6
Estimated ranges of transaction cost for JI and large CDM²⁰ projects (Euros)

	JI	CDM (large projects)
A) Preparation phase – Once only costs
Feasibility Assessment	10,000-20,000	10,000-20,000
Baseline, Monitoring and Verification Plan	10,000-15,000	15,000-20,000
Validation	10,000-30,000	10,000-30,000
Legal Work (contracts)	15,000-20,000	20,000-25,000
Total Up-front Costs:	45,000-85,000	55,000 – 95,000
B) Operational Phase Costs – Annual costs
Monitoring and Verification	10,000 - 15,000 per year	10,000 - 15,000 per year
Adaptation levy	Not applicable	2% CERs value annually
Sale of ERUs/CERs	No costs in case of a fixed contract. Success fee in case of sale on market. Rough estimate 5 -10% of CER/ER value. Higher for a small project than a large project.
Risk Mitigation	No information available on risk mitigation products on the free market.

The project transaction costs may differ (a little bit) depending on the type and the size of project. E.g. Monitoring and verification of a large energy supply side project or an energy demand side management project may require more time than for a small solar home systems project. However in most cases a similar amount of work will be required for all the transaction cycle activities regardless of project size and type and thus transaction costs will be almost similar in absolute terms for both large and small-scale projects.

Eventually transaction costs have to weigh out the total revenues from the sale of ERUs and CERs. E.g. the revenues from the sale of ERUs of the 4 project awarded a contract in the first ERUPT tender range from 4,5 – 13,5 mln Euro. The up-front transaction cost then range from 0.3% to 2.8% of the total revenues. According to Harmelink et al (2001)²¹ project developers generally expect transaction costs to be no more than 5-7% of the net present value of the revenue. This means that the transaction costs for the large ERUPT project are acceptable for project developers. However for smaller projects with revenues from carbon credit sale below 1 mln Euros the transaction cost would amount to 5% and 9% and are probably not acceptable any more.

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