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AfricaSeptember 2 2007

Including Africa

Jean-Louis Ekra explains why Afreximbank has introduced a carbon financing programme.
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Global concerns about climate change due to unsustainable emissions of greenhouse gases (GHGs) have led to concerted efforts to deal with the problem. On February 16, 2005, the Kyoto Protocol came into force involving 165 countries. Countries that ratify Kyoto commit to reduce their emissions of GHGs or engage in emissions trading if they maintain or increase emissions of these gases.

Reduction targets during the First Commitment Period (2008-2012) differ between parties to the conference, reflecting their common but differentiated responsibilities, so that Annex I (developed) countries will reduce their emissions by 5% below their 1990 levels, while no such commitments exist yet for non-Annex I (developing) countries.

Kyoto is ‘flexible’, allowing Annex 1 countries to meet their GHG targets by purchasing GHG emissions reduction from elsewhere, either from financial exchanges (the EU’s Emission Trading Scheme) or from projects that reduce emissions in non-Annex 1 countries under the Clean Development Mechanism (CDM) or in other Annex 1 countries under the Joint Implementation (JI) arrangement.

This ‘cap and trade’ mechanism created a carbon market where a new globally traded commodity was introduced. The commodity, which has a market value, is the “reduction of GHG emissions by the equivalent of one tonne of CO2”.

Two commodities are traded in this market: first, Emissions Allowances, being allowances to emit GHG allocated to companies by national governments of Annex I countries. Companies that emit less than their allowances can sell these to companies emitting more than their allocation, or to trading companies. In the EU Emission Trading Scheme (EU ETS), the allowances are called EU Allowances (EUAs). Second, project-based emissions reductions being emissions reductions generated by project activities, which are certified by an independent auditor. Certificates are called Certified Emission Reductions (CERs) or Emission Reduction Units (ERUs), depending on the origin. CDM projects generate CERs.

The carbon market is growing at an extraordinary pace, boosted by increased demand from the EU and Japan, which raised prices of CERs in recent months to about €15/CER for firm delivery from about €8/CER a few years ago. It grew eightfold between 2004 and 2005 to reach 800 million tonnes of CO2 equivalent valued at €9.4bn (25 times 2004 figures in financial value). The World Bank estimates that the market could be worth up to $25bn through 2012.

More than 300 projects have been approved worldwide under the Protocol’s Clean Development Mechanism, and deals amounted to $4bn in the first half of 2006 under the three broad types of projects allowed under the CDM, namely renewable energy, energy efficiency and others. Africa accounts for only 2.5% of the approved CDM projects. China and India account for about 63% and 12% respectively. The reason for this lop-sided distribution can be explained by the fact that regions with low shares of such projects also receive very low levels of the huge international financial flows the projects attract in the forms of foreign direct investments and CER sales proceeds.

Why has Africa, a well-known commodity economy, lagged so far behind in the commoditised carbon markets at a time when capital flows from such projects can help it deal with its development challenges in an environmentally friendly manner? There is enough blame to go round but most revolve around the saying that “markets have long memories but short vision”. Annex I countries, with the debt crisis of the 1980s still in their minds, are concerned that committing to African CDM projects will expose them to unacceptable CER delivery risk related to project completion, performance and country risks.

If the CER deliveries are not received during the Commitment Period, the Annex I country may breach its obligation under Kyoto. This risk has apparently attached more weight than the portfolio concentration risk that these countries are running in China. An additional incentive for the China preference is the lower price the Chinese are willing to accept for their CERs. There are other problems, namely lack of organisational arrangements in many African countries for certifying emission reductions; the high up-front transaction cost for CDM project preparations estimated at over $110,000 per project; limited methodologies for dealing with small-scale projects, preponderant in Africa; difficulty of proving ‘additionality’ – that the project in question will not survive but for the CDM revenue; lack of information about CDM project opportunities and methodologies; lack of access to project finance by CDM project promoters; and uncertainties regarding post-Kyoto arrangements and the carbon markets.

Carbon exports

The challenges identified can only be resolved through direct intervention that not only deals with the risks inherent in CDM projects and which limit their access to financing, but which also deals with the issue of transaction costs; development of CDM methodologies that recognise the peculiarities of Africa, for example using programmatic (rather than project-based) approaches to deal with small-scale projects; and ensuring that carbon ranching – projects that protect rain forests – become eligible under the CDM. Afreximbank has introduced a carbon financing programme that incorporates a wide range of instruments of intervention to deal with these challenges. In so doing, we hope that Africa can continue to sustain life not only through beverage exports but also through carbon exports for a cleaner environment for us all.

Jean-Louis Ekra is president of the African Export-Import Bank, Cairo.

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