Such external Climate Change-related projects are developed under the Clean Development Mechanism (CDM) or the Joint Implementation (JI), as well as under various Voluntary arrangements, and lead to the delivery of so-called Carbon Credits. Carbon credits could be Certified Emission Reductions (CER) under the CDM, or Emission Reduction Units (ERUs) under the JI in addition to a host of other regional and voluntary standards.
Each project faces a number of hurdles on its way to validation, registration or verification, and statistics show that a vast majority of projects never reach those milestones. Furthermore, many projects that succeed on the registration front still exhibit weaknesses when the time comes actually to tally the emission reductions and to obtain issuance of tradable Carbon Credits.
Most projects face financial hurdles ahead of registration. They need a degree of certainty on the future value of the carbon credits they hope to generate. In most cases, the carbon credits represent a crucial incentive that will render feasible a project otherwise not financially viable. As loan collateral, a carbon credit also reduces a lender’s overall exposure.
Each project has its own delivery risk profile, which changes over time, influenced as it is both by internal factors (e.g. risks linked to the project owner’s ability to bring the project to registration and to operate it over time) and by external factors (risks linked to regulatory changes, weather patterns etc…).
The credits from carbon projects are often sold on a forward basis before they are generated, or even at very early stages of conception or implementation. By their very nature, forward carbon credits cannot be priced by direct reference to an established market price, unless the transaction volume is guaranteed and other conditions are met. The forward price will largely be dictated by delivery risk, measured by registration risk (until registration takes place) and by other technical, commercial or financial risks (prior to and after registration). No two projects exhibit exactly the same risk profile, and it is largely their specific profile that will dictate the forward price of their carbon credits.
The myriad of various transaction structures combined with the project risks results in a complex environment in which it is difficult to accurately value and price a carbon position unless key financial and technical parameters are analyzed in unison.
