Overall Context, basic concepts and scope of analysis
The Kyoto Protocol is one development that could have a significant impact on how
countries, companies and individuals operate in an emerging carbon-constrained
world. The Clean Development Mechanism (CDM) and Joint Implementation (JI) are
two international policy instruments developed under the Kyoto Protocol, that enable
developed countries , that are parties to the Kyoto Protocol to implement climate
change mitigation projects in (respectively) developing countries and developed
countries, and to benefit from emerging global greenhouse gas (GHG) markets. The
viability of such projects can be increased through the generation and subsequent
marketing of carbon credits. Arranging financing for CDM/JI projects is one of the
major challenges for successful participation in GHG markets. However, so far,
private finance for carbon offset though CDM/JI has been scarce. The objective of the
thesis is to ultimately understand the reasons behind the reluctance to invest in
CDM/JI projects from the point of view of investors.
The financing requirements of CDM projects correspond to the positive difference
between accumulated cash outflow and cash inflow, with the aim of financing GHG
abatement. Among the wide variety of different project financing options available,
the project focuses on external project finance, since:
• Self-financing (or internal finance, as opposed to external finance) is generally
not the most efficient route to finance a CDM/JI project, due to the fact that the
cost of equity is normally higher than the cost of debt.
• Project finance is probably the sole financing form where it makes a difference
whether the project is a CDM/JI project or not. Indeed, only in project finance
does the lender evaluate the project's financial viability on a stand-alone basis.
And as introduced before, the future cash flow associated with the generation and
sale of carbon credits might positively affect the creditworthiness of the project.
Key determinants of private investment for climate change mitigation projects
On the basis of literature review and stakeholders' interviews, the main reasons why
private investors are reluctant to get involved in CDM/JI can be summarised as
• The international policy framework is moving too slowly to get CDM/JI projects
beyond the point where they are considered as "complex and costly deals".
• Financial instruments to deal with additional risks of CDM/JI projects are still
under design, and need to get standardised before they are affordable.
• Most CDM/JI projects are too small for their carbon additional cash flows to
cover the current high transaction costs incurred.
• The core concepts of baseline and additionality remain vaguely or even
inconsistently defined/explained, further deterring the confidence of private
investors towards CDM/JI, and threatening the very concept of project-based
• The market structure is at its early steps, lacking of liquidity, which is the very
essence of functioning and trusted markets.
• In the post 9/11 investment climate, most actors have refined their philosophy to
the basics: secure the returns. Yet CDM/JI are considered as extremely risky.
• For irreversible, uncertain and information-poor investments such as CDM/JI,
investors' behaviour "lies between the two extremes: the fully rational and the
fully irrational" (Littleboy, 1990).