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