Clean Development Mechanism • Enables developed countries (known as Annex I countries) to meet their emission reduction commitments in a flexible and cost-effective manner • Assists developing countries (non-Annex I countries) in meeting their sustainable development objectives • Investors benefit by obtaining Certificates of Emissions Reductions (CERs) • Host countries benefit in the form of investment, access to better technology, and local sustainable development

What are the Criteria for CDMProjects? • Sustainable development • Host country criteria • Environmental Impact Assessment • Stakeholder consultations • Greenhouse Gas (GHG) emission reductions • Environmental additionality • Project additionality • Project viability • Technologically proven • Financially sound • Host country approval • Project validation and registration

CDM Project • Achieves Sustainable Development objectives for the host developing country • Reduces GHG Emissions

Simplistic numerical example Provide electricity for a barangay • “Business-as-usual” (baseline): Diesel generator sets • Cost of project $10 • Emissions 1 tC • Cleaner project (CDM-eligible): Micro-hydro • Cost of project $13 • Zero Emissions

Simplistic numerical example • CDM Investor (e.g. Japan) • Invests $3 ($13-$10, difference between cleaner and business-as-usual project) • Gains Certificate of Emissions Reduction of 1 tC, which it can meet some of its Kyoto Protocol commitments to reduce emissions

Simplistic numerical example WIN – WIN – WIN • WIN for the host country • Sustainable development benefit: Cleaner energy production technology • WIN for the Annex I country • Credits for emissions reduction • WIN for the Global Environment • Emissions reduction

Kyoto Protocol:Flexibility Mechanisms Annex I Emission Trading Emission Trading Clean Development Mechanism 1990 level Joint Implementation - 5% Domestic Actions Domestic Actions Assigned Amounts Present day 2012 (BaU) 2012 with KP

Price of a Unit of Emissions Reductions:A Competitive Market Cost of Reducing in the Host Country (Developing) Cost of Reducing in the Investor Country (Annex I) Price of a Unit of Emissions Reductions by CDM < <

Carbon Asset Creation and Maintenance Costs The PCF Experience:Transactions Costs Preparation and review of the Project Project completion • Upstream Due Diligence, carbon risk assessment and documentation: $ 50K 3 months Baseline Study and Monitoring Plan (MP) Up to 21 years • Baseline: $30 K • Monitoring Plan: $25K Periodic verification & certification 2 months • Verification: $10-25 K • Supervision: $10-20K Validation process 1-3 years 2 months • External consultant: $25K • Processing and documentation: $30k 3 months Construction and start up Negotiation of Project Agreements • Initial verification at start-up: $25K • Consultation and Appraisal: $75K • Negotiations and Legal documentation: $30K Total through Negotiations • All expenses: $265 K

2. Basics of CDM Financing

Starting Point: Viable Project • A potential CDM Project is a feasible project • Technologically feasible • Financially sound • A potential CDM Project is a project which has an Environmental Compliance Certificate (ECC)

Total Project Costs and Sources of Finance Total Project Cost Estimates • Investment costs, including development costs, up to commissioning of project Sources of Finance to be Sought or Already Identified • Critical to identify other debt and/or equity finance • Typical sources of funding: international development banks, government funding, private financing, supplier credit • CDM contribution = typically 5-15% of total project costs

Important Distinction • Project Financing • Equity • Debt • CDM Finance / CER Revenue

Financing Options in a CDM Project Equity • Annex I Investor co-finances part of a CDM project in return for shared financial returns and CERs • Local investors co-financing CDM projects in a host country may wish to share in CERs so that they have the opportunity to sell the credits at a later time

CDM Equity Financing Investor Banks Equity Debt CDM Investor Equity $$ Power Purchase Agreement $$ CERs Electricity

Financing Options in a CDM Project Loan • Annex I Investor provides loan or lease financing at concessional rates in return for CERs

CDM Debt Financing Investor Banks Equity Debt CDM Investor Debt $$ $$ CERs Electricity

Financing Options in a CDM Project Emission Reductions Purchase Agreement • Annex I investor agrees to buy CERs as they are produced by the project

Emission Reductions Purchase Agreement Investor Banks Equity Debt CDM Investor Power Purchase Agreement $$ $$ Electricity CERs Emission Reduction Purchase Agreement

Financing Options in a CDM Project Carbon Funds • Annex I investors contribute to a mutual fund • Mutual fund agrees to buy CERs as they are produced by the project • Examples • WB Prototype Carbon Fund • Netherland’s CERUPT

Technology $ Finance CO Equivalent CO Equivalent 2 2 Emission Reductions Emission Reductions How Carbon Funds Work.. Technology $ Finance Industrialized Governments and Companies Developing Countries and Communities Carbon Fund

$ $ Carbon Fund 2 2 Emission Reduction Purchase Agreement Nature of Carbon Financing Contract Investor Banks Equity Debt Power Purchase Agreement $$ Electricity $$ Carbon Credits

Emission Reduction Purchase Agreement • Will improve IRRs • Forward contract • Payment upon delivery of verified ERs • Upfront payments are rare • Will provide a hard currency revenue ($, €, £, ¥) • Helps secure financing and reduce project risk • Future ER payments as collateral for project loans • Can be paid into an escrow account, protecting lenders from currency convertibility and transfer risks

Without CERs not implemented; with CERs implemented Without CERs implemented With CERs not implemented No CDM CDM How CDM can matter FIRR CER income 0

Impact of Carbon Finance on Project Financial Rate of Return • Revolution in Solid Waste Management • Important impact on small-holder crop-processors and animal production

CDM Equity Financing ODA Non-ODA Investor Banks Equity Debt CDM Investor Equity $$ Power Purchase Agreement $$ CERs Electricity

CDM Debt Financing ODA Non-ODA Investor Banks Equity Debt CDM Investor Debt $$ $$ CERs Electricity

$ $ Carbon Fund 2 2 Emission Reduction Purchase Agreement Emission Reduction Purchase Agreement ODA Investor Banks Non-ODA Equity Debt Power Purchase Agreement $$ Electricity $$ Carbon Credits

3. Risks in CDM Financing

Risks in CDM Financing • Renewable energy projects are considered risky by financing institutions • Multitude of risks could reduce the value of the project to zero • Measures are needed to mitigate risks at different stages of the project

“Normal” Project Risks • Political/Country Risks • Sponsor Risks • Construction Risks • Technical Risks • Fuel Risks • Environmental Risks • Financial Risks • Legal Risks • Operation Risks

CDM-Specific Risks • Market/Price Risk • Will there be a market for project-based ERs? • Will contract price exceed market price? • Policy/Compliance Risk • What if no Kyoto Protocol? • What if host country does not ratify or comply? • What if host country does not approve project? • Market and Policy Risk are closely linked

CDM-Specific Risks • Baseline Risks • Eligibility--will ERs be Kyoto-compliant? • Will project be validated and registered? • Will ERs be verified and certified? • Baseline design--is the baseline robust? Will its assumptions remain valid over time? • Performance--actual performance will determine level of ERs generated

4. Emerging Trends in the Carbon Market

Summary of carbon markets currently in operation Project-based Emission Reduction purchases Allowance Trading “Pre-Compliance” Within National trading systems Fromvoluntary UK DK Intra-Firm trading Retail To Kyoto Pre-Compliance BP Shell

Market Intelligence:“Few Countries Benefiting,Little Private Sector Buying” • Market: cumulative 200 million tonnes CO2 traded ($500 million) since 1996 • Five-fold increase between 2001 and 2002 • Only 43% of all carbon transactions made in CDM/JI (2001-2002), dominated by Dutch and PCF • Only 13% of the private sector’s purchases were in CDM (2001-2002) • African countries, smaller countries and small-scale projects are largely bypassed

Carbon Market Volume has increased Source: Authors’ own calculation, as above, volume projection by PointCarbon

Who is buying ER Credits? 1996-2000 2001-2002 Source: Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon

Balance in Asset Classes Emerging Source: Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon

Carbon Finance flows 2001-2002 Australia Canada Asia Africa USA Latin America Source: Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon

Who’s buying where? (2001-2002) In 2001-2002, private companies acting alone have purchased only 13% of their reductions in developing countries. Source: Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon

World Bank Carbon Finance Vehicles Netherlands CDM Facility Italian Carbon Fund BioCarbonFund

World Bank’s Carbon Finance Business- at a Glance • Carbon Purchases agreed and under negotiation:~40, ~US$250 million • Number/Value of PCF and Netherlands Projects approved for carbon purchase:64, US$ 440 million • Carbon Asset portfolio: ~50 million tCO2e • Underlying CDM/JI project finance: ~$3.0 bn

Sample Projects • Latvia: $2.5 million PCF Purchase • anaerobic decomposition of about 20,000 tons of garbage a year • ERs from the existing landfill site gas recovery began June 2002 • Uganda: $3.9 million PCF purchase • a 5.1 MW and 1.5 MW small hydro generating facilities in the West Nile region • Displaces >200 small and few large public diesel gensets • Chile: $6 m PCF Purchase • 26MW run-of-river hydro generating 175 GWh to replace coal/gas • Brazil: $5 mm of PCF Purchase • Substituting coal/coke by sustainably produced charcoal in pig iron production, plus afforestation and ecosystem restoration, biodiversity and health benefits

Lessons from PCF: Carbon Prices

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