How can CDM help project finance?

How can CDM help project finance? Jan-Willem Martens, Bangkok, 5 April, 2005

Renewable Energy Project Finance can be expensive • Unsystematic risks • Long Development Lead Times • Smaller – therefore higher Project risk to reward ratios • Unsympathetic tariff structures • Technology Unfamiliarity among bankers and utilities (especially in developing world) • Systematic risks • Political risk • Currency Risks • General Economic Uncertainty

How does CDM impact the development of renewable energy projects? CDM revenue CDM cash flow The gap between the project return and the required return on investment threshold Project return excluding CDM revenue Project return including CDM revenue Required return on investment threshold

What determines the gap between the project return and required return? • Project return • Size of the installations (MWh capacity installed) • The local price of electricity • Availability of renewable sources (e.g. hours of sunlight, wind) • Investment cost • O&M cost • The return on investment threshold • Investor requirements (e.g. company specific, or based on country bond rate) • Risk mark-ups (e.g. technology risk, relocation risk)

Impact of CDM on Return on Equity • Weighted Average Costs of Capital: • IRR = RoE * equity/Total Capital + interest rate *debt/total capital • Example: IRR w/o CDM = 10%, interest rate is 7%, 50% Debt, 50% equity • => Return on equity is: 13% • Example: IRR with CDM = 12% (+2%), interest rate is 7%, 50% Debt, 50% equity • => Return on equity is: 17% (+4%)

Carbon Sales Can Improve Debt Capacity Debt Service ERs “Carbon capital” could help increase debt leverage of project by increasing DSCR levels …and boost ROE Debt Project Investment Equity

How Carbon Cash Flow Can Improve Capital Structures Carbon Cash Flow Can Improve Debt Service: • Sale of CERs involve minimal costs – therefore is essentially Free Cash Flow • This cash flow can be readily applied to Debt Service • Direct Payments on Annual Debt Service Requirements • Funding Debt Service Reserve Accounts • Using Forward EPRA Sales as Collateral • Funding an Account to “smooth out” variations in cash flow

How Carbon Cash Flow CanImprove Capital Structures Carbon Cash Flow Can Improve Debt Service: • Applying Carbon Cash Flow to Debt Service Can Result in more favorable Capital Structures • Higher DSCR (More Debt Carrying Capacity) means less Equity Requirement – Thereby Increasing ROE • Allows Project to be Financed Because Increases DSCR past Predetermined Threshold set by the Lender • Either Way, Both Project Developer and Project Lender are Better Off.

A Wind Project Example BLUE Indicates Extra Debt Capacity

Contract Structure to Facilitate Project Financing • Priority: Seller should deliver CERs on priority to buyer whose ERPA is being monetized; • Accelerated Delivery: If Buyer agreeable, front-load contract so all CERs generated go towards contract obligation • Replacement CERs: Seller can have obligation to source replacement CERs in event of under-delivery – ensure buyer will accept these CERs and make payments • Delivery Flexibility: Seller has flexibility to make-up delivery in later years, establish reserve accounts for buffers • Escrow: Establish escrow with Buyer so that payments flow from Buyer to financier without going through Seller

Impact of CDM on raisinginvestment capital • In the non CO2 CDM project categories dedicated firms emerge who invest in CDM projects purely based on CDM revenues • Example: EcoMethane - EcoSecurities investment vehicle for landfill gas to energy projects • EcoMethane provides: • Feasibility study of the relevant side • All necessary technology to capture and destroy methane and, if possible, to generate electricity • 100% of investment requirements • All transaction costs related to CDM project development • Share of profits for owner of the landfill

2E Carbon AccessFacility for small-scale projects • 2E Carbon Access offers one-stop access to all the services required to access carbon finance • Use innovative procedures that allow project developers to get past the barriers of up-front payment, complicated procedures and lack of options. • ‘Bottom-up’ approach to developing small-scale CDM projects tailored to meet the needs of project developers and integrated into their existing project development efforts. • Deliver developed CDM projects to CER buyers, or CERs to market.

How can CDM and ODA go together?

No Diversion of ODA • According to the Marrakech Accords “public funding for CDM projects coming from parties in Annex 1 should not result in the diversion of official development assistance and not be counted towards the financial obligations of Parties included in Annex I” • What does this imply? • The statement refers to the CERs generated by the project and not to the financing project to the project itself; • CERs resulting from ODA financed projects that are provided to the donor as a return to the publiv funding are seen as a diversion of ODA; • However, it is possible to provide public financing from Annex I Parties to a project as long as the CERs generated by that project are not provided to the donor for free as a return; • Public funding sources for the project itself are allowed, as long as it is clearly stated that the CERs generated by the project are not considered as a compensation to public funding.

Examples of use of ODA • EcoSecurities has worked on two project cases where ODA has been used • 1. Wind project in Jamaica – the Wigton wind project • 2. Wind project in Morocco – the Essaouira project • For Wigton – grant from the Dutch government for use of Dutch technology of wind turbines. Grant from Ministry of Foreign Affairs. CERs of the project are sold to Dutch government as well, but paid for separately and from a different budget. • For Essaouria – a grant was provided by KfW. The CERs generated by the project will not be sold to the German government and the government will not receive any CERs in return for the grant provided • In both cases, a letter of the government has been issued stating that no CERs were claimed in return for the public funding. This has been accepted by the DOE as sufficient proof of non-diversion of ODA.

Thank you!

How can CDM help project finance?