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Transaction Costs of Carbon Sink Projects. Oscar Cacho School of Economics University of New England AUSTRALIA. www.une.edu.au/febl/Econ/carbon/. Outline. Background Overview of abatement and transaction costs Reducing transaction costs A model to analyze the effect of project design

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slide1

Transaction Costs of Carbon Sink Projects

Oscar Cacho

School of Economics

University of New England

AUSTRALIA

www.une.edu.au/febl/Econ/carbon/

FAO 2005 Seminar, O. Cacho

slide2

Outline

  • Background
  • Overview of abatement and transaction costs
  • Reducing transaction costs
  • A model to analyze the effect of project design
  • The measurement problem
  • Conclusions

FAO 2005 Seminar, O. Cacho

slide3

Background

Clean Development Mechanism (CDM) allows Kyoto signatories to reduce greenhouse gas emissions in developing countries (Article 12).

CDM projects can operate in the energy sector (reduced emissions) or in the land-use change and forestry (LUCF) sector (sinks).

Afforestation and reforestation projects are eligible within the LUCF sector.

FAO 2005 Seminar, O. Cacho

slide4

Submitting and approving CDM proposals

Project design

project developer

host government

National approval

project developer

Submit Project Design Document

Stakeholder

comments

Validation

operational entity

Registration

CDM executive board

Verification and certification

operational entity

CDM executive board

CER issuance

FAO 2005 Seminar, O. Cacho

slide5

Transaction Costs

cost of participating in the CER market (CT).

SA

P($)

CT

SP

PA

PP

D

QA

QP

Q(CERs)

Abatement Costs

opportunity cost of land-use change (SP).

FAO 2005 Seminar, O. Cacho

slide6

Buyer pays TC

Seller pays TC

C2

C1

C1

a

a

Buyer cost ($/Mg)

b

b

c

Emission offsets (Mg/ha)

c

TC

TC

Carbon price ($/Mg CO2)

Carbon price ($/Mg CO2)

Buyer

Seller

FAO 2005 Seminar, O. Cacho

slide7

Managing C stocks

Gliricidia in Jambi, Indonesia

initial soil carbon

low

medium

high

high

carbon stock (Mg/ha)

firewood harvest

medium

low

years

FAO 2005 Seminar, O. Cacho

slide8

Biomass C in Indonesian systems

FAO 2005 Seminar, O. Cacho

slide9

Abatement Costs

Modeling results for Sumatra, Indonesia

(degraded land)

FAO 2005 Seminar, O. Cacho

slide10

Reduce by:

  • generating and disseminating information;
  • allowing simplified baselines for smallholder projects.

Transaction costs

  • find site and group of landholders;
  • survey alternative land uses;
  • gather biophysical, social and economic information about the site;
  • establish relationships with the locals.
  • search
  • negotiation
  • approval
  • administration
  • monitoring
  • enforcement
  • insurance

FAO 2005 Seminar, O. Cacho

slide11

Reduce by:

  • working through farmer groups and local NGOs.

Transaction costs

  • search
  • negotiation
  • approval
  • administration
  • monitoring
  • enforcement
  • insurance
  • agree on required land uses;
  • assign responsibilities to parties;
  • agree on monitoring and payment schedule.

FAO 2005 Seminar, O. Cacho

slide12

Reduce by:

  • CDM Executive Board simplifying validation process.

Transaction costs

  • search
  • negotiation
  • approval
  • administration
  • monitoring
  • enforcement
  • insurance
  • cost of delays after submission of Project Design Document;
  • cost of project validation.

FAO 2005 Seminar, O. Cacho

slide13

will decrease as countries and market participants gain experience;

  • appropriate IT infrastructure is important.

Transaction costs

  • search
  • negotiation
  • approval
  • administration
  • monitoring
  • enforcement
  • insurance
  • keeping records of project participants;
  • administering payments and dealing with problems and disagreements;
  • may require establishment of a local project office.

FAO 2005 Seminar, O. Cacho

slide14

Reduce by:

  • sampling C stocks at longer intervals;
  • using remote-sensing technology;
  • involving landholders in sampling C stocks.

Transaction costs

  • search
  • negotiation
  • approval
  • administration
  • monitoring
  • enforcement
  • insurance
  • measuring C sequestration actually achieved;
  • certification and verification by Designated operational Entity (DOE).

FAO 2005 Seminar, O. Cacho

slide15

Reduce by:

  • providing smallholders with credible prospects and sufficient incentives to prevent abandonment of the project;
  • involving farmer groups and promoting monitoring within the community.

Transaction costs

  • search
  • negotiation
  • approval
  • administration
  • monitoring
  • enforcement
  • insurance
  • ensuring compliance with the terms of the project;
  • may include litigation.

FAO 2005 Seminar, O. Cacho

slide16

Reduce by:

  • deducting a risk premium from the price paid for C sequestration;
  • diversification of project portfolio (spatial arrangement and project types);
  • keeping a buffer of C stocks that is not converted to CERs.

Transaction costs

  • search
  • negotiation
  • approval
  • administration
  • monitoring
  • enforcement
  • insurance
  • no formal insurance for sink projects is available yet.

FAO 2005 Seminar, O. Cacho

slide17

Reducing transaction costs

  • Generate and disseminate information (LUCF systems, baselines).
  • Bundle projects.
  • Teach smallholders to measure carbon.
  • Encourage community self-regulation.
  • Bundle payments for other environmental services.
  • Promote secure land tenure.

FAO 2005 Seminar, O. Cacho

sampling intensity and cers
Sampling Intensity and CERs

FAO 2005 Seminar, O. Cacho

synergies
Synergies

* relative to natural forest

Data from Murdiyarso et al.

for Indonesia

FAO 2005 Seminar, O. Cacho

model of contractual arrangements

For buyer: if seller defaults, the cost of buying C offsets elsewhere (market price of CERs) + transaction costs already incurred.

  • For seller: if buyer defaults, the cost of converting back to preferred land use + establishment and learning costs already incurred.
Model of contractual arrangements

Transaction margin

= Revenue – Governance Costs

Governance costs

CT transaction costs

CA associated transformation costs (= 0)

CL cost of loss due to transaction failure

Based on Dorward (2001)

FAO 2005 Seminar, O. Cacho

the seller s problem
The seller’s problem

CG(s)

RG(s)

Governance costs and returns

acceptable to seller

free market

vertical

Contractual form

FAO 2005 Seminar, O. Cacho

the buyer s problem

CG(b)

Governance costs and returns

RG(b)

acceptable to buyer

free market

vertical

Contractual form

The buyer’s problem

FAO 2005 Seminar, O. Cacho

feasible solutions

CG(s)

RG(s)

CG(b)

Governance costs and returns

RG(b)

acceptable to both

free market

vertical

Contractual form

Feasible solutions

based on Dorward (2001)

FAO 2005 Seminar, O. Cacho

contractual forms

(A) Free Market

(B) Individual Farmer Contract

(C) Community Contract

(D) Vertical Integration

farmers and C brokers trade in free (local) market, brokers then sell C offsets in international market.

private entity establishes individual contracts with farmers to undertake certain land-use practices.

NGO establishes a program through farmer groups (farmer-group leaders play a critical role).

firm purchases land, establishes commercial plantations and sells C offsets in the international market (provides employment).

Contractual forms

FAO 2005 Seminar, O. Cacho

agents
Agents
  • Seller (farmers):
  • Buyer (NGO / government / private entity):

Sell C offsets at farm price PF

Buys C offsets from sellers at PF and sells them in the CER market at net price PB = PCER – CB

PF price obtained by seller per Mg C

PB net price obtained by buyer per Mg C

PCER price of C in the CER market ($/Mg)

CB brokerage costs per Mg C sold in CER market

FAO 2005 Seminar, O. Cacho

the buyer s problem1

buyer’s

expected utility

profit to buyer

probability (to buyer)

of seller behaviour j

proportion of C offsets

under contractual arrangement k

The buyer’s problem

k = contractual arrangements (1,…,K)

i = market conditions (1,…,I)

m = environmental conditions (1,…,M)

j = agent behaviour (comply, default)

FAO 2005 Seminar, O. Cacho

the buyer s problem2

net C market

price

farm

price

transaction costs

cost of

failure

The buyer’s problem

k = contractual arrangements (1,…,K)

i = market conditions (1,…,I)

m = environmental conditions (1,…,M)

j = agent behaviour (comply, default)

FAO 2005 Seminar, O. Cacho

the seller s problem1

seller’s

expected utility

profit to seller

probability (to seller)

of buyer behaviour j

proportion of C offsets

under contractual arrangement k

The seller’s problem

k = contractual arrangements (1,…,K)

i = market conditions (1,…,I)

m = environmental conditions (1,…,M)

j = agent behaviour (comply, default)

FAO 2005 Seminar, O. Cacho

the seller s problem2
The seller’s problem

farm

price

opportunity

cost

transaction costs

cost of

failure

k = contractual arrangements (1,…,K)

i = market conditions (1,…,I)

m = environmental conditions (1,…,M)

j = agent behaviour (comply, default)

FAO 2005 Seminar, O. Cacho

the measurement problem
The measurement problem

for each contractual arrangement (k), agent behaviour (j), market condition (i) and environmental condition (m), estimate:

B ,S probability of agent behaviour

(CT)B,Stransaction costs (for buyer and seller)

(CL)B,S losses due to transaction failure (for buyer and seller)

OS opportunity cost of land-use change to seller

PB price of C to buyer

Optimizing contract design

Max:

FAO 2005 Seminar, O. Cacho

slide31

Conclusions

  • Transaction costs are largely related to obtaining and processing information.
  • Designing efficient projects requires a good understanding of the abatement costs and transaction costs involved.
  • Next step: flesh out model to allow consistent measurement and to help reduce transaction costs.

FAO 2005 Seminar, O. Cacho