Fitch Ratings says that the credit profiles of Indian chemical manufacturers registered under the Clean Development Mechanism (CDM) could come under stress, in the event of a reduction of the benefits awarded through Certified Emission Reductions (CERs).

In Fitch's opinion, the reduction in benefits could arise from a complete refusal to recognise, or from a decrease in the number of recognitions of CERs generated from HFC-23 (hydrofluorocarbons) destruction projects before the 2012 expiry date (the expiry deadline for the first commitment period of the Kyoto Protocol). Fitch believes a reduction in benefits may also result from the non-acceptance of CERs for compliance under the emission trading schemes such as the European Union Emission Trading Scheme (EU ETS) from 2013 onwards, or even before 2012.

Though the protocol identifies six greenhouse gases responsible for global warming, HFC is one of the most potent greenhouse gases and thus commands a huge amount of CERs. As at December 2010, more than 570 projects in India had been registered under the CDM, while only four HFC projects (less than even 1% of total number of projects) accounted for more than 60% of the CERs issued.

Fitch estimates the cumulative net benefits of CERs to Indian chemical manufacturers at approximately INR27bn till 7 December 2010 and expects them to generate a further INR20bn up to 2012. They could, in addition, lead to another INR15bn, in the event that credits are made available for the full crediting period which goes beyond 2012 until 2018 for some companies.

However, globally HFC projects under the CDM have long been controversial on account of the huge benefits that have accrued to project proponents. The proponents are alleged to have been operating their manufacturing plants in a way to maximise the production of HFC-23 irrespective of the demand for the end-product, HFC-22, and then destroying the by-product to maximise CER generation.

As a result, Fitch notes that the number of CERs could be squeezed with European Union proposing a ban on CERs generated by HFC projects from 2013 (infact this could be introduced even before then) and with the reluctance of developed countries like Japan, Canada and Russia to accept binding emission cuts for the post-Kyoto regime. The agency believes that these factors collectively could hit the credit profiles and the profitability of Indian chemical manufacturers relying on these CERs to finance their capex plans. Fitch, however, will evaluate this in conjunction with the extent of the improvement in the core businesses and the ability of these companies to scale back capex, without affecting their long-term business profiles.