Financial Risks in CDM Forest Project Development

Carbon credits may provide the extra returns needed to make A/R projects profitable. This is illustrated in a list of draft PDDs provided by Neeff and

Notes:

The seller may choose to forego the sale (retire) lCERs to avoid their replacement after harvest.

R = Project Registration V1-V4 = Project Verification E = Project end + = Quantity of lCERs + = Lifetime of lCERs

Notes:

The seller may choose to forego the sale (retire) lCERs to avoid their replacement after harvest.

R = Project Registration V1-V4 = Project Verification E = Project end + = Quantity of lCERs + = Lifetime of lCERs

Figure 2.5e Alternative long-term CERs with harvesting in afforestation and reforestation

Henders (2007), showing the internal rates of return of projects with and without CERs. It is, however, noticeable that some of these projects are expecting CER prices well in excess of present market rate of around $3.00 to $4.00. The profits in forestry credits may be reduced by the costs of delivering social and environmental benefits required by CDM projects.

Long delays in income generation and high costs of establishment characterize forestry projects. Markets can fluctuate, adding to uncertainties surrounding financial yield. Rates of return can be lower than in other industrial sectors. Moreover, the validation of removal of CO2e and the need to replace losses and project CERs at expiry (as discussed above) also incur costs and risks (Neeff and Henders, 2007).

There are several methodologies available for large-scale forestry but the monitoring process in A/R projects is highly complex and may delay or even prevent projects from issuing CERs. Their complexity is illustrated

Note: Expiring credits need to be replaced either at 5-yearly intervals in the case of tCERs or at project expiry in the case of lCERs. At a 4% discount rate and assuming that the prices of credits do not change, a tCER with a fixed period of 5 years is worth 18% of a permanent CER. An lCER with a validity period of 60 years is worth 91% of a CER. The more that a replacement is delayed, the closer the expiring credit price is to the permanent credit price.

Figure 2.6 Percentage value of an expiring credit relative to permanent credit at 5-year intervals from the present, at constant prices by the case of a methodology that includes 134 equations in 103 pages of text (Neeff et al., 2007). After negotiating the steps in the project cycle (see Figure 2.3), most A/R projects are expected to be subject to the final verification that takes place after certification towards the end of the first commitment period in 2012. There is a risk that there may not be time to correct project deficiencies in time for verification, for example in data that has been collected over previous years (Neeff et al., 2007).

The process towards registration of A/R projects under the CDM requires specialized and often expensive advice from international consultants. To achieve registration of projects, up-front investment is needed to cover transaction costs, which tend to be higher than for most emission reduction projects. These risks are exacerbated by the uncertainty surrounding the arrangements for generating carbon credits from forestry projects after the expiry of the Kyoto Protocol in 2012.

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