Carbon Reduction Projects in Africa

Carbon Reduction Projects in Africa

June 01, 2008

Given its obvious need for foreign investment and the fact that, as a continent, Africa is especially at risk from climate change, it may be considered surprising that African countries have been slow to exploit the benefits that the “clean development mechanism” under the Kyoto protocol offers.

This article assesses some of the reasons for this and the continued barriers to CDM investment in Africa.

However, notwithstanding these barriers, there has been a discernible increase of late in CDM activity in Africa and this article also discusses some of the efforts to encourage this trend and highlights some of the advantages for developers in investing in CDM projects in Africa. African involvement in CDM projects not only offers African countries a chance to be a part of the solution to global warming but is also a market that will increasingly demand the attention of project developers, fund managers and other market participants.

Clean Development Mechanism

The Kyoto protocol is an international agreement that was adopted in 1997 linked to an existing United Nations climate change treaty, and has since been ratified by 180 countries, that commits the signatories to take steps to reduce greenhouse gas emissions that contribute to global warming to 5% below 1990 levels by 2012. Efforts are underway to negotiate new targets that will apply past 2012. China and India are both parties, but the protocol does not subject them to emissions limits; the United States signed but failed to ratify the protocol.

The “clean development mechanism” is a tool under the protocol to combat climate change. The CDM allows a country that has committed in the protocol to reduce its greenhouse gas emissions — a so-called “Annex B party” — to satisfy the commitment by undertaking an emission-reduction project in a developing country. Such projects can earn saleable “certified emission reduction credits” for each ton of CO2 reduced that can be counted toward meeting Kyoto targets. These credits or CERs are generally cheaper for the Annex B party countries than equivalent reductions in their own countries and, at the same time, offer the developing countries in which the projects are situated valuable foreign revenue in support of both sustainable development and climate change mitigation.

According to the CDM website of the “United Nations Framework Convention on Climate Change,” Africa is currently home to only 25 out of a total 1,078 registered CDM projects. Of these, almost half (13) are in South Africa — reflecting stronger institutions and a better general investment climate than elsewhere in Africa — four are in Morocco, three in Egypt, two in Tunisia, and there is one in each of Uganda, Nigeria and Tanzania. In contrast, China and India together make up over half of the registered projects (221 and 344 respectively), Brazil has 137, Mexico 105 and even Malaysia has more than Africa with 28.

Africa also contributes only a small share of the total certified emission sales from CDM projects. Of the 139 million tons of CERs that have been issued by the UN since 2005, only around 1.6 million have been to projects in Africa and the vast majority of these have gone to a single industrial gas project in Egypt. According to the World Bank’s “State and Trends of the Carbon Market 2008” report, Africa accounted for just 5% of certified emission reduction permit sales last year, with the majority going to China and India and with even Korea and Brazil attracting a greater share of CER sales each than all of Africa.

It is clear that Africa has been bypassed by the world carbon market, a lucrative and ever growing market that was worth $67 billion in 2007.

However, notwithstanding its small share of the CDM market, there are signs that CDM activity in Africa is picking up.

Konrad von Ritter, sector manager for sustainable development at the World Bank Institute, has pointed to real accomplishments in the past year: “There has been a notable increase in capacity development and a growing pipeline of CDM projects, including 14 with already signed emissions reduction purchase agreements with World Bank carbon funds.” Last year’s 5% share of worldwide CER sales was an increase on 3% in 2006, and Kenya, Uganda and Nigeria all reported sharp increases in transaction volumes. A number of countries in sub-Saharan Africa entered the project pipeline for the first time in 2007 and early 2008, among them Congo-Brazzaville, Mozambique and Senegal. Perhaps most importantly but hardest to measure, people are talking more frequently about CDM in Africa with conferences being held on the topic and developers keen to explore the potential of the market.

Barriers

Notwithstanding the buzz around CDM in Africa right now, it is worth noting some of the barriers to CDM investment in Africa.

It is true of almost any foreign investment that countries that welcome investors, with clear and transparent rules, regulations and policies will have an advantage. This is even more the case for CDM projects, which involve a unique combination of public and private sector cooperation.

CDM in Africa has suffered from lack of supporting institutions and implementing agencies. Until recently there were few capacity-building initiatives to improve this situation, although this is now no longer true. Some African governments still need to be convinced of the development benefits of CDM when faced with capacity constraints and priorities of health and education.

Only 40 of the 55 countries in Africa have ratified the Kyoto protocol, which is a prerequisite for hosting CDM projects or participating in emissions trading under the protocol. Of these, 37 have established the required “designated national authority.” It is unclear how many of those African countries have fulfilled the other prerequisites to hosting a CDM project and trading emissions under the protocol, which include having calculated and recorded one’s “assigned Amount,” having in place a national system for inventory, having submitted an annual inventory and having submitted supplementary information on the assigned amount.

There have also been difficulties in identifying eligible projects for CDM in Africa. One of the key reasons for this is difficulty in meeting project applicability criteria. Since Africa’s greenhouse gas emissions are low per capita, the potential for emission reductions is more limited.

Finally, much of Africa is very poor and has a shortage of people with the technical and management skills needed to meet CDM standards.

Advantages of Africa

The World Bank’s “State and Trends of the Carbon Market 2008” report said that “Countries in Africa . . . emerged in the carbon market and offered buyers an opportunity to diversify their China-overweight portfolios,” citing Kenya, Uganda and Nigeria as the main movers in 2007.

Investors have historically pursued so-called “low-hanging fruit,” meaning projects that yield the most CERs for the lowest investment. For this reason, larger projects in countries such as China, India and Brazil have predominated over smaller projects in Africa, since the administration costs, often up to $200,000, tend to be unrelated to project size and many have erroneously assumed that African countries’ emissions are too low for them to qualify to earn credits for carbon reductions. However, many of the more viable larger projects in the established markets have now been scoped, and in Africa there a number of countries that have hardly been explored for project potential. Opportunities abound in petroleum and gas production and flaring, the electricity sector, mining sector, agro-business and heavy industry, including cement, chemicals, petroleum refining, glass and smelting.

African CERs are usually cheaper than CERs elsewhere. This is partly due to the demand for foreign currency in many African countries.Local currency risk is a key concern for private investors in Africa. Exchange rates are often more unpredictable than those in developed economies, and these fluctuations can have serious negative effects on the rate of return from investments. Carbon credits, on the other hand, are traded internationally and have proven relatively stable since their inception, meaning that returns from CDM projects in developing countries are more secure than other forms of project finance in Africa.

The World Bank promotes the burgeoning carbon trading market as a “tool to help Africa’s poor.” CERs from Africa offer additional value to project developers and carbon buyers because of their significant contribution to sustainable development – termed byUNDP as the ‘development dividend.’ Developed country governments and private investors can help Africa meet the “millennium development goals” while simultaneously fulfilling their obligations under the Kyoto protocol.

The proceeds from the sales of carbon credits may only rarely be enough to fund CDM projects in Africa. However, Africa is the beneficiary of strong flows of development aid. There is nothing in the CDM rules that precludes using donor money to support project development, provided that the emissions credits do not go to the donor. The United Kingdom, Japanese and Austrian governments are among those governments that have prioritized CDM projects as a distinct component of their aid programs in Africa. Although much of this assistance is directed toward capacity building, there may be potential in the current climate for Africa to attract donor money for the capital investment required to make projects viable.

The International Finance Corporation and Canadian International Development Agency have identified Africa as an ideal destination for small-scale projects in areas such as off-grid renewable energy, energy efficiency and small aforestation and reforestaion. These can be bundled together for simultaneous registration by the CDM executive board.

Encouragement?

In late 2006, a coalition of UN and development agencies, including the UN Environment Program, the UN Development Program, the UN Framework Convention on Climate Change Secretariat, the World Bank and the African Development Bank launched the Nairobi initiative to encourage developing country involvement in the CDM, especially those from sub-Saharan Africa.

In 2007 the United Nations launched an internet-based CDM bazaar (www.cdmbazaar.net ) to bring African project developers together with investors, provide a venue for engineers, marketing firms and other service providers, and highlight the opportunities for CDM activities in Africa and other poor developing areas. The agencies participating in the Nairobi initiative are convening an all-Africa carbon forum in Senegal in September 2008 to highlight the potential of Africa for green development investors.

International negotiations on a successor treaty to Kyoto are scheduled to be concluded in Copenhagen in December 2009. In the meantime, efforts are underway to reform the CDM rules, including in ways that would encourage African involvement.

At the December 2007 climate change meeting in Bali, governments agreed to explore ways to expand the CDM into areas that have not been included, such as forest preservation, an area that offers huge potential to sub-Saharan Africa, especially given the continued prevalence and damage to the environment rendered by the high share of wood use in the energy mix of those countries and the vast forests in places such as the Congo basin. Scientists at the Woods Hole Research Center believe a proposal to pay the Democratic Republic of Congo for reducing deforestation could add 15 to 50% to the amount of international aid flowing to that country.

Governments at Bali also agreed to simplify the procedures for applying to the CDM and meeting its requirements. Without compromising environmental integrity, the CDM executive board also needs to reduce the cost of CDM project preparation and registration.

One particular area of recent controversy in CDM rules is the requirement to prove that a CDM project has “additionality,” meaning that the project underlying the offset would not have occurred anyway. Recent studies have shown that many CDM projects would have happened anyway and, on that basis, critics conclude most payments for carbon credits do not actually reduce emissions. This criticism goes to the heart of the integrity of the CDM mechanism and is a topic for another day. However, it is relevant to CDM in Africa as a change in the rules on additionality could make it easier to register CDM projects in Africa. This is because many contend that the baseline methodologies currently recognized by the CDM executive board are not suitable for projects in Africa. The CDM executive board has encouraged project participants to demonstrate ways to implement alternative methodologies to show additionality.

The agencies also agreed to launch an adaptation fund, financed in part with money from CDM projects, to support worthwhile green development projects that are not currently eligible under CDM guidelines.

The International Finance Corporation is also doing more to promote CDM projects in developing countries. It is launching a carbon credit guarantee program to reassure investors of the security of African CERs.

The United Nations is considering a new type of bond that would spur investment in clean-energy projects in the developing world, including Africa. The so-called climate bonds would be sold to investors by developing countries in Africa, Asia and Latin America and each security would finance emission reduction projects in those countries. The bonds would be backed by the issuing government, and once they mature, investors would receive carbon credits, tradable securities each guaranteeing a metric ton of carbon dioxide reductions were made. The proposal would simplify the funding of renewable projects in developing countries because each bond would group together multiple clean-energy projects. The advantage of this proposal for Africa is that it would allow African countries to access funding for smaller projects, without potential investors having to research and finance those projects directly as they do now. It is unclear at this stage whether the proposal will be developed as a potential funding source for CDM projects or a separate mechanism.

Overall in 2007, Africa as a continent registered 5.7% GDP growth and a per capita increase of 3.7%. Indications are that growth will only accelerate in 2008 and remain buoyant in 2009. It is clear that African growth is healthy against the background of a faltering global economy, even without involvement in CDM projects.

Notwithstanding this, with the global trade in carbon credits soon expected to top $100 billion annually, there are opportunities to bring Africa, the least developed of the world’s continents, more fully into the CDM market. This has enormous potential to encourage investment that would put the continent on a “low carbon development path,” encourage the supply of low carbon electricity to its people, reduce greenhouse gas emissions, and help Africa reduce its vulnerability to climate change. Realizing this potential will require not only the dedicated effort of African countries but also increased focus on this market from project developers, carbon fund managers and other market players too. The stakes are high for Africa but success is possible.