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The Global Carbon Market and Carbon Economics
Workshop on the Carbon Market and Brazilian Carbon Transactions
October 26th, 2005, Sao Paulo
Ken Newcombe
• Carbon finance is a revenue stream in foreign exchange tyically paid on delivery of emissions reductions into compliance registries.
• North-South CDM trade lowers the cost of compliance for OECD and mobilizes new resources for financing infrastructure and land management for developing countries
• Basic incentive to trade – difference in marginal cost of abatement:
– OECD: $10-50 per tonne CO2e (short run marginal abatement cost)
– LDCs: <$5 / tCO2e • Barriers to trade: project and country risk, regulatory risk and
uncertainty, closing window of opportunity
Carbon finance basics
Cash out
Cash in
Equity
Debt
Construction Capital for underlying climate friendly project
Yrs 0 1 2 3 4 5 6 7 8 …………………………………….15-20
Carbon Revenues for10-21 years
World Bank Emissions Reductions Purchase Agreement is bankable and additional revenue commitment helps bring projects to financial closure
= annual payments under carbon purchase agreement
= annual payments under power purchase or other source of revenues to underlying project
Carbon sales revenues are commonly in the range from 10-50% of total revenues for power and waste management projects
Construction
Operation
Understanding the impact of carbon finance on project financing and financial sustainability
Kyoto Protocol basics
• OECD shortfall of ~ 5.0-5.5 billion tCO2e
• May be met by:
– Domestic measures: ~ 50%– EU Emissions Trading Scheme– Trading via 3 Kyoto mechanisms:
• “Clean Development Mechanism”• “Joint Implementation” • “Internationall Emissions Trading”
• Entered into force Feb 16
Structure of the Carbon Market
Allowance Markets
UK ETS
EU Emissions Trading Scheme
Chicago Climate Exchange
New South Wales Certificates
Project-Based Transactions
Voluntary
RetailOther
Compliance
Clean Development Mechanism
Joint Implem.
Intl Emissions Trading
Project-based ER Volumes (million tCO2e)
(Jan-Apr)
0
20
40
60
80
100
120
1998 1999 2000 2001 2002 2003 2004 2005
0
100
200
300
400
500
600
1998 1999 2000 2001 2002 2003 2004 2005
Known Estimated
Project-based ER Contracts: >$1b (nominal U.S.$ m)
(Jan-Apr)
Prices Depend on Risks(weighted average prices from Jan. 2004 to April 2005 in U.S.$ per metric tonne of CO2e)
$0.00
$2.00
$4.00
$6.00
$8.00
ER VER CER ERU
Allowance Markets Exploding (in million tCO2e)
(Jan.-March)
0
5
10
15
20
25
30
35
40
2002 2003 2004 2005
Main Buyers: Europe % of volume purchased Jan.04 - Apr.05
Other EU32%
UK12%
Gov. Netherlands16%
Japan21%
New Zealand7%
Canada5%
Australia3%
USA4%
World Bank = 22 % (attributed pro-rata to carbon fund participants)
Project-based transactions by
sector (% of volume purchased Jan.04 - Apr.05)
Landfill GasCapture
10%
Hydro12%
Wind7%
Biomass11%
AnimalWaste18%
EnergyEfficiency
2%
Forestry(LULUCF)
4%
HFC25%
N2O4%
Other7%
Why is WBG involved?
Poverty reduction + sustainable devt:
• Catalyze climate-friendly investment in client countries
• Help OECD countries address CO2 shortfalls & diversify risk
• Inform buyers, regulators, public
• Bonn, Gleneagles commitments
World Bank Carbon Finance~$937 million under management
Italian Carbon Fund
Netherlands CDM Facility $ 180 m
$ 51.3 m to date
Community Development Carbon Fund. $128.6 mto date
Prototype Carbon Fund $180 m
Netherlands Europe and CentraI Asia Facility (with IFC)
Bio Carbon Fund
$ 80 mto date
~$ 40 m Netherlands ECAF
Spanish Carbon Fund $ 220 m
~$ 64 m Danish Carbon Fund
Impact by Technology
Sector Fossil fuel displacement
Methane mitigation
Renewables aEnergy efficiency aBiomass cogeneration a ( a )Gas flaring reduction aGas venting reduction ( a ) aCoalmine methane ( a ) aLandfill gas (to energy) ( a ) a
• Higher annual revenue streams and IRRs– ~0.5% to 2% for renewables / Energy efficiency– >15% for CH4
– Much higher for more powerful industrial gases (HFC23, N2O, …)
• High quality cash flow and contract value– Verified Emissions Reductions (bankable)– OECD buyers (investment-grade payers)– $ or € denominated– Long-term contract with no price fluctuation guarantees flowPayments abroad eliminates currency convertibility
and transfer risksValue added ER revenues + Financial engineering allow access to capital
markets and boost project bankability (borrowing against ER streams)
Impact of Carbon Finance
Fossil Fuel Displacement
Fossil Fuel Displacement
Fuel Displaced Generic Emissions Factor
(tCO2e/MWh)
Carbon Revenue at US$4/tCO2e
(US$/MWh)
Gas 0.40 $1.60
Coal 0.85-1.0 $3.40-$4.00
Diesel 0.75-1.50 $3.00-$6.00
ER cash flows improve IRRs by 0.5 – 2.5%
Typical elements of LFG project
3. Collection and treatment of leachate
1. Landfill gas recovery and flaring
2. Generation of electricity for
-Consumption on site
-Sale to the grid
Methane Mitigation
Brazil Nova Gerar LFG Production (two sites)
Mining Gas fromMining Gas from
Old LandfillOld Landfill
Tapping Gas at new Tapping Gas at new Sanitary LandfillSanitary Landfill
Limits of Gas Capture for ten yearLimits of Gas Capture for ten year
carbon purchase agreementcarbon purchase agreement
Leading Edge of Carbon Finance in Urban Waste Management
$8-10/t$8-10/t
$2-$4/t$2-$4/t
Methane Mitigation
Carbon Revenue* (methane only)
US$/tcm CH4 US$/MWh
Biomass cogen, landfill methane
up to $60 up to $16
Venting reduction, coalmine methane
up to $52 up to $14
* at US$4/tCO2e
Impact on IRR can be >15 percentage points
Impact by projectSector Country/Project
Incremental IRR .
Discounted Payback Per.
Landfill CH4 Brazil: Nova Gerar 32.70% 0.3
Landfill CH4 South Africa: Durban 32.60% 0.5
Landfill CH4 Argentina: Olavarria 13.30% 0.7
Energy Eff. Indonesia: Indocement 12.80% 1.1
Coalmine CH4 China: Jincheng 8.00% 1.5
Biomass+CH4 Bulgaria: Svilosa 5.00% 3.6
Biomass Hungary: Pannonpower 2.00% 4.9
Forestry+Bio Brazil: Plantar 4.70% 1.8
ForestryRomania: Afforestation 0.60% 6.2
Hydro Ecuador: Abanico 2.10% 6.8
Hydro Peru: Poeches 0.70% 12.4
Wind Philippines: Northwind 0.40% 20.0
Wind Colombia: Jepirachi 0.70% 23.1
TIST Tanzania: without project
Abandoned land Fuelwood shortage
Damaging practices Decreasing fertility
TIST Tanzania: with project
Village nurseries Groups with a purpose
Trees line up houses, paths
Grass grows under trees
• Revenue boost
– $3 to $5 per MWh for renewables, EE
– Up to $20 per MWh /$60/tcm for CH4 mitigation
• High quality cash flow
– OECD - sourced – Investment-grade payor– $- or €- denominatedEliminate FX riskFinancial engineering helps tap capital
Impact of Carbon Finance
Host Country
Sponsor/ Project
CF
ERPA
Engagements re:• Regulation (e.g. tariffs)• Kyoto Protocol compliance
ERs
Ltr. of Approval
ER pmt
Securing Underlying Finance
Host Country
Sponsor/ Project
CF
ERPA
Engagements re:• Regulation (e.g. tariffs)• Kyoto Protocol compliance
ERs
Ltr. of Approval
ER pmt
Securing Underlying Finance
Lender?Loan ??
Host Country
Lender Sponsor/ Project
CF
ERPA
Financing Agr.’s
Letter of Approval
ER payment $ $ $
SPVERs
Permits, etc.
Carbon Transaction Structure
Financing structure eliminates convertibility and transfer risk
Up-front finance $ $ $
Brazil Plantar Sust. Fuelwood
-4000
-2000
0
2000
4000
6000
1 2 3 4 5 6 7
Year
Cash
Flo
ws (
$000)
LoanDisbursementPCF Payments
LoanAmortization
ER payments to amortize 100% of commercial loan principal
Ecuador: Abanico Hydro• 30 MW ROR hydro• 85% capacity factor• $33.3m cost• IRR 15.6%
• 800,000 tCO2e ERs
• ERPA $4m
• IRR 0.73% => 16.3%
CER payments enabled project to meet IIC’s investment criteria
Impact of Carbon Finance in the Project's Debt Service
($2,000)
($1,000)
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
2004 2005 2006 2007 2008 2009 2010 2011 2012
Year
US
$ ('0
00)
Loan amortization
Loan disbursement
CERs
33.3% 19.4% 41.4% 44.5% 48.0% 52.1% 57.0%
CF Impact in Annual Debt Service, including interest (%)
Abanico Cash Flows
Abanico Project
• Carbon finance enabled project to:
– Meet IIC’s investment criteria– Lower interest rate by 100 bp– Expedite financial closure
…In one of L. America’s riskiest countries