A new report prepared for the UNFCCC by Vivid Economics Ltd, explores the possible market impact of a CDM capacity fund. The report suggests that the fund would need at least €2.5–€3.0 billion to buy CERs from existing projects and boost CER prices in the current CDM market. However, to see substantial increase to Euro 2.5/CER levels would require funds between Euro 10-12 billion. For every Euro 0.5/CER increase an addition Euro 2 billion fund would be required
In their analysis, although a €500m fund will have a significant impact on the quantity of CERs used, it will do little to increase prices. In the base-case scenario, a Euro 500 million fund might allow an additional 1.4–1.7 billion Certified Emission Reductions (CERs) to be used, depending on the level of prior CER demand from the European Union Emissions Trading System (EU ETS), Australia’s carbon pricing mechanism and sovereign demand. However, prices are unlikely to be significantly affected; our analysis suggests prices would remain below €0.4/CER. A fund of this size would deliver some of the benefits expected, but leave other potential benefits unrealised.
The use of a large number of additional CERs will create a continued demand for monitoring, reporting and verification capacity which may otherwise be lost. It may also allow for some projects to continue to operate that would otherwise be unviable, although this effect is likely to be small: the main beneficiaries are likely to be projects that will continue to operate regardless of CER revenues. However, the price changes will not create a strong price signal for new mitigation investment in developing countries, nor help retain project origination capacity.
A larger fund, of around €2.5–€3.0 billion, could boost both CER use and CER prices, if the fund also practised price discrimination. A fund of this size could largely eliminate the current CER overhang and hence lead to a fundamental adjustment of CER prices. In turn, this would allow the fund to achieve a wider range of benefits including providing a price signal for new investment, sustaining project origination capacity and helping to restore market confidence in the CDM.
To be effective at this level of capitalisation the fund would need to offer different prices for different CERs. This would require an auction mechanism. Selective purchasing could focus the price and quantity impacts of a fund on certain parts of the market; this may be desirable but also carries risks of market fragmentation.
The choice of the credits that the fund purchased would need to be chosen carefully. Assuming a small amount of demand for CERs from the EU ETS, Australia’s carbon pricing mechanism and sovereign demand, then if a €500m fund were prevented from purchasing credits only from large hydro and industrial gas projects then there would be only a small difference in the price it might achieve for eligible credits and from not being at all selective (around €0.03 per CER).
At the other extreme, if the fund focussed only on credits from LDCs then it would struggle to spend €500m and would generate very substantial price differences between eligible and ineligible credits (a differential of around €15 per CER). A fund which did not purchase credits from any industrial gas or energy projects would have an intermediate impact: the price for eligible credits might rise to around €0.70/CER.
This analysis considers the impact of a CDM existing-project fund in the current market context; there are a number of other possible changes to that market context that could also help address the supply–demand imbalance. These would allow a smaller fund to have a more significant market impact.
For example, the development of new emissions trading schemes may lead to an increase in the demand for CERs. It could also result in some of the current potential supply of credits being withdrawn from the CDM so that they may be used domestically. Other commentators have discussed the possibility of supply-side regulatory measures to help reduce the future supply of credits or to restrict the eligibility of ERUs within existing schemes so as to boost the demand for CERs. Although the assessment of the combined impact of a CDM capacity fund with these other developments has not been an explicit part of this study, they may mean that a smaller fund could have a more significant impact on market prices.
Other analysis in the report indicates that to reach a target price of Euro 2.5/CER with a "no CER demand" scenario, a Euro 11.7 billion fund would be needed, while in a low CER demand scenario, the fund would require Euro 10.8 billion and in a medium CER demand scenario, the fund would need to be about Euro 9.8 billion in size.