Following last week's article on liabilities arising from an outage at a carbon-emitting facility, John Startin and Jason Reeves introduce carbon-cutting green technology and the potential for unexpected losses
In addition to capping carbon emissions in signatory states, Kyoto and the Emissions Trading Scheme have implemented a wider framework of emission-reduction measures built around incentives. The Clean Development Mechanism and Joint Implementation are two Kyoto mechanisms that help developed economies meet their reduction targets through the use of green technology in developing economies where significant increases in carbon emissions are expected.
CDM projects are intended to reduce emissions in developing economies, generating green credits. In fact, green credits may be awarded for reduction of any one of six greenhouse gases, including carbon dioxide. Examples of typical CDM projects would be a hydroelectric project in China or a wind farm in Peru, both of which provide electricity to areas that would otherwise be supplied by carbon-emitting power stations. Such projects have two income streams: one from the provision of electricity to an identified domestic market; the other from the annual production of green credits.
JI projects are very similar to CDM projects, but are based in more-developed western economies where emissions are capped. They also generate green credits, but it is generally intended that projects are undertaken in less-mature economies (such as Poland) rather than in fully developed economies like France.
Rating green projects
CDM and JI projects are not token gestures - they must meet actual needs in a developing economic infrastructure. Each project is assessed on its merits by the respective CDM/JI United Nations' executive boards, which then rate them for the annual green credits a project will generate. Each green credit is considered the equivalent of one tonne of carbon that was not emitted as a result.
Applications for projects are comprehensive and freely available online. The rating takes into account a range of environmental, scientific, technological, sociological and economic factors, and both CDM and JI projects encourage private-sector investment alongside state-financed projects.
Green credits can be valued in two ways. They can be generated purely for trading purposes, but they can also be generated by the owner of an installation in a Kyoto signatory state that is operating under the ETS cap and trade scheme. A green credit is, in many senses, the equivalent of a carbon credit and can be used to account for exceeding an installation's carbon cap. Like allocated carbon credits, green credits can be transferred between installations, and they limit exposure to fines and market volatility, particularly at the end of an accounting period.
JI and CDM projects underline the fact that, under Kyoto, carbon emissions are a global issue. Alongside the expectation of a reinforced carbon cap and related increase in carbon-credit value, the importance and scale of CDM and JI projects - plus the resulting value and number of green credits - are likely to increase. As more projects are approved and commenced all over the world by potential insureds, their green-credit revenue streams are likely to rise in value.
What is at stake?
Insurers should consider the potential liabilities of the dual-income streams generated in CDM/JI projects. An outage at a project, such as a hydroelectric plant in China, may involve not just the loss of electricity, but also the stream of green credits at whatever their market value is. And, as already noted, the value of green credits is expected to rise.
In addition to risk exposure in these projects, there are other new exposures to outages of green technology. For example, a green boiler, or any other incorporated technology that reduces emissions, can be found at a range of installations. In the European Union, green technology is relied upon in installations to stay under a carbon cap and the same technology can be found as part of a CDM/JI project that generates green credits.
For different reasons, claims can arise from green-technology outages in both capped installations, where they reduce the demand for carbon, and in CDM/JI projects, where the generation of green credits may be delayed or otherwise interrupted. In the EU, an outage of a green boiler can result in a claim that includes the cost of additional carbon credits either to burn alternative/traditional fuel or in the replacement costs of a production unit that will include carbon credits as a production cost. In CDM/JI projects, an outage of a green boiler can result in a claim for the lost primary income stream and for the lost green credits.
Take the example of a CDM project in India that generates electricity from waste gas during steel production. It is rated for 1 267 392 green credits and, on average, will generate 3472 such credits per day, valued at approximately EUR10 (£6.81) each. A 90-day outage at the plant would result in a loss of 312 480 green credits - or EUR3.12m. There may be additional losses resulting from the outage, including the inability to supply electricity and increased cost of working claims from an installation in the EU that is dependent upon the stream of green credits to remain below its carbon cap.
Transparency in the adjustment of green-technology outages in CDM/JI projects is more likely than where carbon caps are in operation. Nevertheless, estimating the quantum of loss for green technology and revenue streams from green credits may be complicated, and perhaps beyond the purpose of property and business interruption insurance.
With fluctuating, volatile markets, green losses will have exposure similar to risks faced by commodities and hedge traders. Delayed start up and advanced loss of profit policies for green technology will be particularly vulnerable to the loss of revenue streams from green credits.
Mixed business portfolio
Insuring green technology as part of a mixed 'dirty and green' portfolio of business may not be sufficiently transparent. The generation of green credits may be funnelled into a business to avoid carbon caps at a range of installations. Simultaneously, the cost of these carbon credits may not be transparent, particularly where an insured transfers credits between facilities. Outages could have unforeseen outcomes.
Insuring green technology in the EU as stand-alone risks may result in unexpected losses. In the event of such a loss, an adjustment should take into account the additional costs of production from alternative fuel or replacement production units, which will almost certainly include purchasing additional carbon credits.
Carbon presents insurers with an opportunity to develop specialist emissions-reduction insurance products for both cap and trade and green risks. They may also wish to review wider policies for the impact of carbon, such as directors' and officers' liability, credit and political risk, professional indemnity, and financial lines and institutions.
- John Startin and Jason Reeves are solicitors with Clausen Miller. For further information on this issue email: [email protected]
See next week for a look at the future impact of carbon on insurers and strategy options, plus the consequences of the anticipated US inclusion in a similar carbon reduction scheme.
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