A Study on Measures to Activate CDM Taking Project Risks into Consideration

Abstract

Global warming has been recognized as a serious issue since the fourth assessment report of the Intergovernmental Panel on Climate Change was published in 2007. Under these circumstances, Clean Development Mechanism (CDM) is expected to play a significant role, since it promises to reduce the economic gaps between developed and developing nations, as well as to economically reduce greenhouse gas emissions. In this paper, we first investigate how to evaluate risks in CDM. The real option theory is applied to quantify project risks in CDM, so that we can estimate the option values. In detail, a mathematical model of CDM is represented with a compound rainbow option, which includes continuous procedures from registration to investment. The evaluated results identify the condition of profitability, in which investment as CDM project is feasible. Our evaluation also quantifies how CDM projects become difficult to be executed due to the registration risk and the post-2012 risk. Then we investigate how to activate CDM projects. For this purpose, two options are considered: low interest loans by official financial institutions and the procurement of certified emission reductions, (CERs) by governments. The former relates to the low interest loans similar to environmental official development assistance (ODA), which certainly ease the financial burden of initial investments in CDM projects. Now that CDM projects related to ODA are already registered by CDM executive board, this option is worth evaluation. The latter, meanwhile, aims at lowering risks by the secure purchase of CERs by governments. Since the governments of the Netherlands and Japan have already established a system to purchase CERs generated by CDM, we need to assess the effect of the option to activate CDM. Based on actual financial data on CDM, we finally investigate how these options could increase the number of executable CDM projects.