Glenn S. Hodes UNEP Risø Center

1. CARBON FINANCE Glenn S. Hodes UNEP Risø Center

2. Why a Carbon Market? • Regulations, present or anticipated, create constraints on greenhouse gas (GHG) emissions of governments, firms (e.g. Kyoto Protocol obligates industrial Parties to reduce emissions by avg 5 % below their 1990 emissions over 2008-12. • Since GHGs mix in the atmosphere, it does not matter where emissions are reduced • Compliance with regulation can be achieved through in-house (“make”) or flexibly through purchase (“buy”) “GHG commodities”. The market has responded to the entry into force of Kyoto and the EU ETS – and is now a real compliance market.

3. Benefits of Carbon Finance • As a new source of private investment for development + public goods, carbon finance offers an unique opportunity to increase private and public investment in clean technologies in developing countries. • Between 10-50% of revenue for waste management + renewable energy projects can come from CF. • Powerful leverage effect on other FDI. • Payment on regular schedule and in hard currency  smoothes cash flow and can securitize critical up-front capital for project construction (e.g. bridge loans). • Help increase sustainability and extend the social and community impacts/benefits of typical energy projects

4. Project-Based Transactions Allowance Markets EU Emission Trading Scheme JI and CDM UK ETS Voluntary New South Wales Certificates Other Compliance Chicago Climate Exchange Retail Structure of the Carbon Market

5. - Emissions Allowance Market - Joint Imple-mentation - Clean Development Mechanism Annex B The Kyoto Protocol • 3 Flexibility Mechanisms Non-Annex B • Assigns GHG emission targets to Annex B countries between 2008 and 2012

6. EU Emissions Trading Scheme • JI and CDM authorized… • But NOT LULUCF (review in 2006) • Caps over 40% of EU CO2 emissions • 2 phases : 05-07 and 08-12

7. Canada • Sectoral covenants under negotiation • Domestic carbon market • Strategy calls for some use of CDM; could be largest bilateral buyer program

8. Japan • National Policies still in the making • Firms and government active on CDM market

9. USA • Policies constraining GHG emissions in various States (e.g., Oregon, Mass., etc.) • Chicago Climate Exchange (CCX), private allowance market

10. Kyoto Compliance Gap • CERs from CDM projects are in high demand • OECD almost 6.0 Billion tCO2 below KP target. • Assuming 50% met from domestic measures, projected gap of 3 Billion tons. Less than 20% booked for delivery by 2012. • But supply market is highly competitive • And CDM competes with domestic/internal measures!! • Gains from trade fundamental to carbon market: country mitigation cost curves matter.

11. Growing Voluntary Market • A large and growing number of companies have engaged in programs to reduce their GHG ‘footprint’ absent regulations • Various motivations: corporate responsibility, public relations, strategic positioning, competitive advantage, learning-by-doing, etc. • These firms have large-scale emissions (2002 survey: 18 firms with more CO2 emissions than France had voluntary targets for 2010) • Individuals and Firms have engaged in purchases of carbon credits to be “carbon neutral” (event, corporation, or product) • Example: World Cup, G8 Summit, BA travel

12. 2005 State and Trends of the Carbon Market Report • Funded by World Bank CF-Assist Program. • Based on material provided by Evolution Markets LLC, Natsource LLC, and on interviews with many market players. Limited public information on transactions. • Database of 487 project-based transactions (signed or advanced stage of negotiation) + aggregated data on allowance markets Report downloadable from: www.carbonfinance.org

13. Total Value of Contracts over 1 b$ (data in million U.S.$, nominal) (Jan-Apr)

14. Buyers: European Governments and Firms In percent of volume purchased From Jan.04 to Apr.05

15. Supply Concentrated In percent of volume sold from January 2004 to April 2005

17. Prices Depend on Risks(weighted average prices from Jan. 2004 to April 2005 in U.S.$ per metric tonne of CO2e)

18. Key Price Determinants • Guarantee of deliveryof registered ERs • Creditworthiness of project sponsor • Viability of underlying project, and liabilities of seller in case it under-performs • ER vintage: pre- or post-2012 • Cost of validation and potential certification • Host country support or barriers • Additional environment and social benefits

19. Allowance Markets Exploding (in million tCO2e) (Jan.-March)

20. Insights on Price Differential • Large price differential: • EU Allowances: 7 up to 25 euros / tCO2e (spot and forward contracts) • Project-based: 3 to 7+ dollars / tCO2e (forward contracts on expected CERs) • Allowances and project-based contracts have very different risk profiles: • Project and country risks: high in CDM, none in allowances • Compliance/regulatory risks: high in CDM, none in allowance • Delivery risks: higher in CDM

21. Intermediation - a key to success • Identify project opportunities at lower cost • Get equity and debt financing when the intermediary is a financial institution • More effectively design and/or evaluate projects • Reduce transaction costs • Example of Infrastructure Development Finance Corporation (IDFC), India, one of the most successful intermediaries agreement with over a dozen opportunities identified/ evaluated • Development Bank of Southern Africa

22. Conclusions and Caveats • Volumes should increase rapidly for CERs … • Almost 600 CDM projects already registered or in process of validation. • Uncertainties still need to be addressed. • How many allowances will Russia and Ukraine bring to market? • How much volume will CDM deliver? Issue of projects lead-time • Will UN and EU emission registries be fully operational and compatible by 2008 (i.e. extent of arbitrage)?