Carbon Finance: Risks and Opportunities for Financial Services Providers

By:

Patrick M. Ayota, Chairman, Cenergy Global Ltd Kampala, Uganda

Africa Carbon Exchange ConferenceNovember 12-16t, 2012. Nairobi Kenya

Basics of Carbon Finance

Topics

Role of Financial Institutions

Opportunities in the Carbon Market

Risks in the Carbon Market

Towards an East Africa Carbon Exchange

1

2

3

4

5

Basics of Carbon Finance

Due to the many ways and efforts underway to reduce carbon emissions and promote activities that help store and remove carbon from our environment, carbon has become a tradable valuable economic commodity- willing buyers and willing sellers create value.

Initially, internationally negotiated treaties committed most industrialized nations to reduce their green gas emissions. Individual targets were set to meet these commitments.

Companies that produce fewer emissions can sell their excess allowance to those that exceed their targets.

If a company fails to surrender allowances they pay a fine of 100 euros per ton.

Carbon Finance –a payment to a project to purchase its emissions reductions.

The currency for trading carbon emissions is the carbon credit. 1 carbon credit = 1ton of CO2 emissions.

The Carbon Market (bn Euros)

Source: ICE FUTURES EUROPE NOV 2012

• Including AAU, ERU, & Others, 2012 volumes expected to exceed 8.5 billion tons, with value that approximates 100 billion euros.

• Market value is 3 times Kenya’s GDP and approximately 7 times NSE market capitalization.

• Prices have been falling due to uncertainty of the post Kyoto regime.

• Only approximately 2% of the carbon projects are in Africa.

Basics of Carbon Finance : CDM process

Project Idea Note

•Feasibility Assessment

Project Design &

Documentation

•Calculating Baseline & Savings * stakeholder concultation

3rd party Validation of

project

Registration of project

Monitoring & Verification

Project Developer

3r party

UN Certified

Project Concept

Carbon Credits

Buyer 12-24 mths.

$100k-200k

It is expensive. Normally cover 10-30% of project cost.

Type and Role of Financial InstitutionsCarbon credits are often bought and sold by several intermediary companies who have specialized knowledge in carbon finance. They find and develop projects, provide support and financing for carbon projects and bring them to market as part of their daily business. The carbon market has grown over the years, and both public and private sources of funding are available for projects that generate carbon credits.

Governments

Multilateral financiers

Private Equity &

sector

NGO

Funding Entities

Usually offer financing for PIN and PDD May focus on certain sectors Have set eligibility criteria Will cover developing regions.

Includes -World Bank, IFC, ADB May provide technical assistance Favor Pro- poor projects Can provide upfront financing

Actively invest and hold carbon credits as assets. Offer speed & flexibility May come in as equity investors

Pro-poor projects. May offer grants & flexible debt Can act as Intermediaries.

Carbon credit offer EA financial institutions to become intermediaries, hold carbon assets, lend to viable projects and boost their image as “Green institutions”.

Risks

Carbon credit projects are complex, thus risky, and yet can be quite rewarding.

1. Lack of sufficient volume of emission reductions: A minimum size of emission reductions is essential to ensure the viability of the project. A rough rule of thumb is that at carbon credit prices of US$ 7 per tonne of CO2, the viability threshold of projects is around 10,000tCO2/year for voluntary market projects and twice or three times as high for CDM projects.

2. Lack of expertise expertise : There are stringent procedures and methodologies are very demanding, and usually require engaging professional consultants.

3. Exposure on upfront investment: If the carbon is sold on a forward basis, the risk of non performance may cause financial loss. Furthermore, project may not be registered for carbon finance after putting considerable time, money and effort in it. Can take up to 12-24 mths to implement thus eating into start up time.

4. Difficulty in demonstrating ‘additionality’: A project needs to demonstrate the difficult proposition that without the additional revenue from selling the carbon credits, it would not take place.

5. Lack of government support for enabling process and standards.

Towards an East Africa Carbon Exchange The lack of emission reduction projects in Africa is often cited as one of the biggest failures of the Clean

Development Mechanism.

But the system was not designed to accommodate Africa’s needs. The Clean Development Mechanism (CDM) was to help industrialized countries achieve compliance

with their emission reduction commitments under the Kyoto Protocol while financing long-term sustainable development in the developing host countries. But to date, “market efficiency” has resulted in carbon finance being directed into projects that reduce emissions cheaply, often with low social benefits, shunning projects with higher sustainable development benefits but higher per unit abatement costs.

The complexity of CDM procedures and modalities, the lengthy time involved in working through the CDM project cycle, and uncertainty of outcome in combination with weak institutional and technical capacity make private investors reluctant to invest in Africa.

Since CDM projects in Africa present higher risks, investors expect higher returns. As carbon value is as good as uniform on the private market – all CERs are treated equally in the secondary market –the return on the CDM investment in Africa is relatively lower than a similar investment in China, India or Brazil (which between them host around 70% of all registered projects).

There is, therefore, a need for Africa to develop its own carbon trading mechanism

Institutional Building

1.Colloborate with EAC climate

change Commission to create an

EAC private sector led technical

forum.

2.Develop alternative customized

methodology that meet global

criteria

3.Harmonize EA policies across the

EAC, e.g tax & commodity trading

4.Build instutional relationship

with bodies such as the World

Bank , European union etc.

Towards an East Africa Carbon Exchange

Production Capacity Trading Mechanism

1.Educate the population on benefits of carbon trading.

2.Conduct, develop & standardize common key baseline measurements

across borders and products.

3.Bundle and pool

individual projects into “umbrellas” to maximize volumes.

1.Raise awareness within EA based companies

2.Lobby CDM Executive board to increase threshold for small scale projects to above 60,000

tones of Co2.

3.Build the technical capacity to

trade, price, package

4.Cross list on major commodity exchanges.

In conclusions

Managing the climate change is all our responsibility. Air Pollution has no borders. Carbon trading is one way in which Africa can greatly contribute to the solution.