Environmental Engineering Reference
In-Depth Information
countries have been able to streamline their CDM
project identification and approval procedures at
an early stage. Moreover, these countries offered
several large-scale project opportunities which
are generally attractive as they enable investors
to spread project transaction costs across a larger
number of CERs. Most projects are in the category
of renewable energy and biomass energy produc-
tion: 26% of CDM projects involve hydropower
technology, 15% biomass-based energy produc-
tion, and 14% wind energy. China concentrates
66% of hydropower projects, and India 68% of
biomass energy projects. Together, those countries
host 90% of wind energy projects. With such a
geographic concentration, CER prices are sensi-
tive to a large inflow of validated credits (e.g.
from China or India).
5
As for CDM distribution
by countries, Wang and Firestone (2010) reveal
two strands of literature. On the one hand, critics
argue that such distribution is unbalanced. This
interpretation gathers a majority of views. On
the other hand, such “unbalanced” distribution
may be due to the different GHG inventory and
other factors.
The risk factors specific to primary and second-
ary CERs are as follows. On the primary market,
there needs to be
(iii)
an increased predictability of
issuance and frequency of transfer CERs by the
CDM EB,
(iii)
an ITL operational and linked to the
EU registry system, and
(iii)
the development of a
robust options market. On the secondary market,
we need to account for
(iii)
the acceptance into EU
registries of CDM credits,
(iii)
the development
of new emissions trading schemes which increase
sCER demand and thus push CER prices to con-
verge with other carbon prices under compliance
schemes, and
(iii)
limitations on the use of CERs
compliance under the EU ETS. Finally, both pC-
ERs and sCERs are affected by the uncertainties
concerning the post-2012 climate regime.
There are three main sources of risk in the EU
ETS. First, the free permits distributed to existing
firms on a “first-come, first-served” basis represent
a market value of €40 billion that was created at
the same time as CO
2
emissions were capped.
This allocation methodology is also known as
grandfathering
. Since January 1, 2005 carbon
allowances form another asset in commodities
against which industrials and brokers need to
hedge. As the volume of transaction on the EU
ETS has increased steadily from 262 million tons
in 2005 to 1,443 million tons in 2007, this trading
activity reflects market participants' progressive
learning of this new financial market.
Second, during Phase I of the EU ETS
(2005-2007), EUAs experienced a high level of
volatility around each compliance event. Industrial
installations have the obligation to surrender to the
EC the exact number of allowances that matches
their verified emissions each year around end of
March. The official report by the European Com-
mission is disclosed by mid-May, but installation
operators have already a fair amount of informa-
tion between the publication of their own report
and the compilation of verified emissions by the
European Commission to approximate the total
level of emissions relative to allowances allocated
and to adjust their anticipations
6
.
Third, installations do not need to physically
hold allowances during the year to produce, but
only to match the required number of allow-
ances with verified emissions for their yearly
compliance report to the European Commission.
Consequently, the probability of a potential il-
liquidity trap exists if market participants face
a market squeeze during the compliance event.
Another specificity of emission allowances may
be highlighted: compared to stocks which are valid
during the entire lifetime of the firm, emission
allowances are vintaged for a given compliance
year and cannot be used for future compliance
periods, unless intertemporal flexibility mecha-
nisms are authorized. During Phase I of the EU
2. Risk factors specific the European carbon
market
