Investment additionality of renewable energy projects under two carbon crediting mechanisms for greenhouse gas emission reduction

Abstract

Carbon crediting mechanism allows greenhouse gas emitters to purchase emission reductions elsewhere to offset their own emissions. These reductions should be additional, which means beyond the business-as-usual. Non-additional emission reductions could potentially result in more, rather than less, global emissions. This research focuses on the investment additionality of two international and domestic carbon crediting mechanisms, namely, Clean Development mechanism (CDM) and Chinese Certified Emission Reduction (CCER) scheme.

The notion of investment additionality suggests that an emission reduction project should be financially viable only with the revenues from selling carbon emission credits in the carbon market. Formal additionality assessment requires that these revenues significantly increase a project’s otherwise low internal rate of return (IRR) beyond a pre-determined benchmark. Such an assessment should be conducted reliably by project developers through an investment test. Previous studies have revealed several practical challenges when demonstrating the financial impact of carbon market, accurately estimating the IRR and operationalising the additionality assessment. However, these studies have not adequately addressed the issue that carbon revenues are estimated on the basis of expectations (e.g. future carbon price). Moreover, these studies examined the implementation of additionality assessment by small samples or fragmented case studies. This research aims to examine the actual financial impact of carbon market by using actual prices to estimate carbon revenues and investigate the practice of additionality assessment at the project level based on a large sample size (i.e. 2,405 CDM and 384 CCER renewable energy projects). The data are derived from the official sources and openly available market data. Semi-structured interviews on the key actors involved in additionality assessment, including international and domestic regulators and project developers, are also conducted. These data are used to address the research question ‘how additional are these emission reduction projects?’.

This research shows that the actual revenues from carbon markets are insufficient to enable the vast majority of CDM and CCER projects to achieve financial viability, primarily due to the low international carbon prices after 2011. This indicates a significant gap between expectation and reality of the financial impact of carbon market on project development. The assessment parameters that are used to calculate IRR, such as a project’s electricity output, are prone to remarkably change over time, which can lead to inaccuracy in IRR calculation. The practice of additionality assessment has also shown considerable inconsistencies, such as the use of different accounting methods, rendering the outcome of investment additionality assessment unreliable. Therefore, the additionality of existing emission reduction projects is questionable.

These shortcomings pose a challenge to the current approach of assessing investment additionality. The role of carbon market in driving emission reduction projects is difficult to be determined on the basis of expectation. The additionality of these projects is likely to be lower than previously expected, meaning that these projects could have been implemented without receiving finance through the carbon crediting mechanism. Insights from this research can inform the development of new additionality assessment tools and new carbon credit mechanisms under the Paris Agreement for reducing greenhouse gas emissions.