The adoption of the legislation for the third phase of the EU emissions trading scheme (ETS) a few months ago added some optimism to the carbon market, which was already struggling with the financial credit crisis.

However, the more recent proposals from the European Commission to phase out the clean development mechanism (CDM) in advanced developing countries and to limit the use of the certified  emission reduction credits (CERs) from certain CDM project types coupled with the remaining uncertainty on the post-2012 framework under the UN make it increasingly risky for project developers to invest in origination of new CDM projects.

It is no secret that those advanced developing countries to which the commission is referring are the  ones that currently host the majority of CDM projects and cover the largest share of CER supply to the EU ETS market.

Uncertainty over what happens to the CDM projects implemented in those countries post-2012 should the CERs they produce become ineligible in the EU ETS or at the international level hampers new investment as the remaining period for generating credits under the current rules shrinks. 

These policy-related risks and the effect of the recession on financing new projects are being felt already on the growth of the CDM pipeline. The inflow of projects into validation is slowing down.

According to the recent data, CDM origination in 2009 fell by some 30 per cent compared to 2008, with the monthly average of projects going for validation coming down to 70 compared to the average of 130 a month in 2008.

Credit is tight due to policy uncertainty but also due to financing conditions.

Banks are reluctant to accept Kyoto-period emissions reduction purchase agreements (Erpas), the binding contracts between project developers and the buyers of the credits, as collaterals for new project financing.

Proposing a 2012 Erpa is often received with even more doubt.

At first sight a fall-off of the pipeline would not necessarily have a huge impact on the EU ETS - even out until 2020.

Most of the projects in the current pipeline have a European counterparty.

With current crediting rules, these projects can supply a large share of the EU demand by 2020.

However, if the crediting rules change or if there be a ¨black list¨ of host countries prevented from developing EU-bound credits, the supply might be at risk.

Times of scarcity would push up the price of the EU-eligible CERs while devaluing the ineligible ones. Thus the cost-containment function of this flexibility mechanism does not get fully realised.

A smooth transition to the post-2012 regime and the willingness to set up proper emission trading schemes in other geographies is dependent on a functioning carbon credit market.

Not only is this in the interest of the EU, which is pushing hard for a global climate solution, but also in the interest of the installations covered by the EU ETS as carbon markets become ever more global.

In an effort to bridge this policy and credit gap for post-2012 investments, the Post-2012 Carbon Credit Fund was set up by the European Investment Bank and four other European public banks, and enables the monetisation of post-2012 carbon revenue streams. 

In the current environment, the credit quality of the carbon stream purchaser is decisive. An Erpa with a solid buyer can be monetised to finance projects. 

Sponsored by AAA-rated investors, the Post-2012 Carbon Credit Fund, for which First Climate is an investment adviser, enables monetisation of post-2012 carbon streams.

The fund serves thus as a unique vehicle to contribute to the inflow of CERs into the EU ETS in difficult times and helps to maintain positive prospects for the carbon market post-2012.


Source: PointCarbon News, Carbon Market Europe, p. 7