China Offers Chance to Cash in on Green Energy

When former U.S. Vice President Al Gore and the U.N. Intergovernmental Panel on Climate Change won the 2007 Nobel Peace Prize for their focus on global warming, the Nobel committee said climate change "must be treated with the utmost seriousness."

But it's not just politicians and academics becoming involved with the issue. The global capital markets are having their say. Peony Capital Ltd., a €400 million ($590 million) Beijing-based carbon trading fund backed by Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks) founder Bill Gates, said in August that it would buy 10 million tons of emission reductions by 2012 from projects in China.

Peony is just one of many. In their report on the "State and Trends of the Carbon Market 2007," Karan Capoor and Philippe Ambrosi of the World Bank said an estimated $11.8 billion had been invested in 58 carbon funds as of March 2007, compared with $4.6 billion in 40 funds as of May 2006.

"It all starts from the Kyoto Protocol," said Jeff Jiang, managing director of Renaissance Carbon Investment, the carbon investment and trading arm of Pivoton International, a U.S.-based private equity company. "According to the Protocol, industrial countries must reduce greenhouse gas emissions by 5.2% compared to 1990 levels in the period 2008 to 2012."

The Kyoto Protocol, a multilateral accord under the U.N. Framework Convention on Climate Change, came into force in February 2005. In order to give parties to the Protocol flexibility in meeting their emissions reduction targets, the Protocol developed three mechanisms -- Emissions Trading, Joint Implementation and the Clean Development Mechanism (CDM) -- that allow developed Kyoto signatories to earn and trade emissions credits through projects implemented in other places.

The mechanisms were meant to identify lowest-cost opportunities for reducing emissions and to attract private sector participation. Developing nations would benefit through technology transfer and investment brought about through collaboration with industrialized nations under the CDM.

"It's a complicated global process", Jiang said. "Therefore there has to be a strictly defined system to ensure its implementation. One of them is the methodology." So far, the Executive Board (EB) of the U.N. has issued 137 methodologies to rule explicitly on defining, measuring and valuating projects, Jiang said. "For example, on methane power generation, the EB has a detailed formula on how to process methane, how to measure the emission, etc."

The U.N. has a Designated National Authority to register and approve all projects domestically. In China, the Designated National Authority is the National Development and Reform Committee (NDRC). Once projects are approved, the Executive Board, through its Designated Operational Entity, will determine whether the project receives U.N. registration. If a project is successful after a year's trial, it will be reaudited on the way to earning a Certified Emission Reduction (CER) designation.

In short, Jiang explained, "CERs are emission reduction rights generated from CDM projects defined by the Kyoto Protocol. The CDM was created to allow transfer of emissions reduction rights from nonbinding countries of the Protocol to countries that have a binding interest to reduce greenhouse gas emissions by defined percentage quotas. And we believe there is a severe imbalance of demand and supply of the global emissions market under the Kyoto Protocol framework."

The Biggest Market

The World Bank estimates total demand for greenhouse gas reductions at 5 billion to 5.5 billion tons of carbon dioxide equivalent (TCO2e) by 2012, half of which can be met by developed countries themselves, and the other half to be met through flexibility mechanisms. Contracted CDM projects to date on the supply side will generate less than 300 million tons of carbon dioxide by 2012. So the gap that purchasers of emissions permits can tap is substantial.

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