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OVERVIEW: CDM FINANCING DENR Training Course November 4-6, 2003 Climate Change Information Center Manila Observatory A

OVERVIEW: CDM FINANCING DENR Training Course November 4-6, 2003 Climate Change Information Center Manila Observatory Ateneo de Manila University. Contents. Basics of CDM Financing CDM Transaction Costs Risks in CDM Financing State of the Carbon Market. 1. Basics of CDM Financing.

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OVERVIEW: CDM FINANCING DENR Training Course November 4-6, 2003 Climate Change Information Center Manila Observatory A

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  1. OVERVIEW:CDM FINANCING DENR Training CourseNovember 4-6, 2003Climate Change Information CenterManila ObservatoryAteneo de Manila University

  2. Contents • Basics of CDM Financing • CDM Transaction Costs • Risks in CDM Financing • State of the Carbon Market

  3. 1. Basics of CDM Financing

  4. Starting Point: Viable Project • A potential CDM Project is a feasible project • Technologically feasible • Financially sound • A potential CDM Project is a project which has an Environmental Compliance Certificate (ECC)

  5. Total Project Costs and Sources of Finance Total Project Cost Estimates • Investment costs, including development costs, up to commissioning of project Sources of Finance to be Sought or Already Identified • Critical to identify other debt and/or equity finance • Typical sources of funding: international development banks, government funding, private financing, supplier credit • CDM contribution = typically 5-15% of total project costs

  6. Financing Options in a CDM Project Emission Reductions Purchase Agreement • Annex I investor agrees to buy CERs as they are produced by the project

  7. Emission Reductions Purchase Agreement Investor Banks Equity Debt CDM Investor Power Purchase Agreement $$ $$ Electricity CERs Emission Reduction Purchase Agreement

  8. Emission Reduction Purchase Agreement • Will improve IRRs • Forward contract • Payment upon delivery of verified ERs • Upfront payments are rare • Will provide a hard currency revenue • Helps secure financing and reduce project risk • Future ER payments as collateral for project loans • Can be paid into an escrow account, protecting lenders from currency convertibility and transfer risks

  9. Financing Options in a CDM Project Carbon Funds • Annex I investors contribute to a mutual fund • Mutual fund agrees to buy CERs as they are produced by the project • Examples • WB Prototype Carbon Fund • Netherland’s CERUPT

  10. Technology $ Finance CO Equivalent CO Equivalent 2 2 Emission Reductions Emission Reductions How Carbon Funds Work.. Technology $ Finance Industrialized Governments and Companies Developing Countries and Communities Carbon Fund

  11. $ $ Carbon Fund 2 2 Emission Reduction Purchase Agreement Nature of Carbon Financing Contract Investor Banks Equity Debt Power Purchase Agreement $$ Electricity $$ Carbon Credits

  12. $ $ Carbon Fund 2 2 Emission Reduction Purchase Agreement Emission Reduction Purchase Agreement ODA Investor Banks Non-ODA Equity Debt Power Purchase Agreement $$ Electricity $$ Carbon Credits

  13. Financing Options in a CDM Project Full or partial equity • Annex I Investor finances all or co-finances part of a CDM project in return for full or shared financial returns and CERs • Local investors co-financing CDM projects in a host country may wish to share in CERs so that they have the opportunity to sell the credits at a later time

  14. CDM Equity Financing ODA Non-ODA Investor Banks Equity Debt CDM Investor Equity $$ Power Purchase Agreement $$ CERs Electricity

  15. Financing Options in a CDM Project Loan • Annex I Investor provides loan or lease financing at concessional rates in return for CERs

  16. CDM Debt Financing ODA Non-ODA Investor Banks Equity Debt CDM Investor Debt $$ $$ CERs Electricity

  17. 2. CDM Transaction Costs

  18. Pre-implementation costs • Search costs • Negotiation costs • Baseline determination costs • Approval costs • Validation costs • Review costs • Registration costs

  19. Implementation costs • Monitoring costs • Verification costs • Review costs • Certification costs • Enforcement costs

  20. Trading costs • Transfer costs • Registration costs

  21. Source: Michaelowa et al (2003)

  22. Project size, types & total transaction costs Source: Michaelowa et al (2003)

  23. Project size thresholds • PCF considers any project with a volume below 3 million € greenhouse gas benefits would not be attractive due to transaction costs • Threshold of about 50,000 t CO2 per year for a 20–year project • Transaction costs should not be more than 25% of proceeds of CER sales to make a project viable (Shell, 2001) • Cost threshold of about 1 € / t CO2

  24. Viability of CDM Projects • Given CER market price estimates of 1 – 5 € pet t CO2 (Jotzo and Michaelowa, 2001) • Given PCF transactions priced at 3 – 4 € per t CO2 • Only projects classified as large and very large are viable • Many small-scale projects would not be viable

  25. Ways to reduce transactions costs Bundle projects to jointly undertake each step of the project cycle 2 1 3 4 5

  26. Ways to reduce transactions costs • Do verification and certification not annually but at long intervals • Exempt projects from one or more steps of the project cycle • Streamline the information needs on each step of the project cycle • Standardization of parameters Source: Michaelowa et al (2003)

  27. Ways to reduce transactions costs • Do unilateral CDM projects that reduce search and negotiation costs • Registration and certification fees proportional to the size of the project • Validation and verification fees proportional to the size of the project Source: Michaelowa et al (2003)

  28. 3. Risks in CDM Financing

  29. Risks in CDM Financing • Renewable energy projects are considered risky by financing institutions • Multitude of risks could reduce the value of the project to zero • Measures are needed to mitigate risks at different stages of the project

  30. “Normal” Project Risks • Political/Country Risks • Sponsor Risks • Construction Risks • Technical Risks • Fuel Risks • Environmental Risks • Financial Risks • Legal Risks • Operation Risks

  31. CDM-Specific Risks • Market/Price Risk • Will there be a market for project-based ERs? • Will contract price exceed market price? • Policy/Compliance Risk • What if no Kyoto Protocol? • What if host country does not ratify or comply? • What if host country does not approve project? • Market and Policy Risk are closely linked

  32. CDM-Specific Risks • Baseline Risks • Eligibility--will ERs be Kyoto-compliant? • Will project be validated and registered? • Will ERs be verified and certified? • Baseline design--is the baseline robust? Will its assumptions remain valid over time? • Performance--actual performance will determine level of ERs generated

  33. 4. Emerging Trends in the Carbon Market

  34. Summary of carbon markets currently in operation Project-based Emission Reduction purchases Allowance Trading “Pre-Compliance” Within National trading systems Fromvoluntary UK DK Intra-Firm trading Retail To Kyoto Pre-Compliance BP Shell

  35. Market Intelligence:“Few Countries Benefiting,Little Private Sector Buying” • Market: cumulative 200 million tonnes CO2 traded ($500 million) since 1996 • Five-fold increase between 2001 and 2002 • Only 43% of all carbon transactions made in CDM/JI (2001-2002), dominated by Dutch and PCF • Only 13% of the private sector’s purchases were in CDM (2001-2002) • African countries, smaller countries and small-scale projects are largely bypassed

  36. Carbon Market Volume has increased Source: Authors’ own calculation, as above, volume projection by PointCarbon

  37. Who is buying ER Credits? 1996-2000 2001-2002 Source: Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon

  38. Balance in Asset Classes Emerging Source: Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon

  39. Carbon Finance flows 2001-2002 Australia Canada Asia Africa USA Latin America Source: Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon

  40. Who’s buying where? (2001-2002) In 2001-2002, private companies acting alone have purchased only 13% of their reductions in developing countries. Source: Authors’ own calculation, based on transaction database assembled with Natsource, Co2e.com and PointCarbon

  41. World Bank Carbon Finance Vehicles Netherlands CDM Facility Italian Carbon Fund BioCarbonFund

  42. World Bank’s Carbon Finance Business- at a Glance • Carbon Purchases agreed and under negotiation:~40, ~US$250 million • Number/Value of PCF and Netherlands Projects approved for carbon purchase:64, US$ 440 million • Carbon Asset portfolio: ~50 million tCO2e • Underlying CDM/JI project finance: ~$3.0 bn

  43. Sample Projects • Latvia: $2.5 million PCF Purchase • anaerobic decomposition of about 20,000 tons of garbage a year • ERs from the existing landfill site gas recovery began June 2002 • Uganda: $3.9 million PCF purchase • a 5.1 MW and 1.5 MW small hydro generating facilities in the West Nile region • Displaces >200 small and few large public diesel gensets • Chile: $6 m PCF Purchase • 26MW run-of-river hydro generating 175 GWh to replace coal/gas • Brazil: $5 mm of PCF Purchase • Substituting coal/coke by sustainably produced charcoal in pig iron production, plus afforestation and ecosystem restoration, biodiversity and health benefits

  44. Historical Emissions Low Surplus (High Demand, Low Supply) High Surplus (Low Demand, High Supply) 1990 2000 % change 2000-2010 Carbon Balance % change 2000-2010 Carbon Balance GROSS DEMAND 220 53 EU Carbon 911.4 895.5 7% 120 -3% 30 Japan Carbon 305.3 313.7 10% 58 -3% 17 Canada Carbon 128.6 158.0 15% 61 0% 37 + Net other GHGs (+5, -5%) 12 -2 - Managed forest allowance -30 -30 Buyers of Carbon Credits[MtCe/yr](Source: Grubb, March 2003)

  45. Historical Emissions Low Surplus (High Demand, Low Supply) High Surplus (Low Demand, High Supply) 1990 2000 % change 2000-2010 Carbon Balance % change 2000-2010 Carbon Balance SUPPLY 331 587 Russia Carbon 647 450.7 20% 106 0% 196 Ukraine Carbon 191.9 104.5 20% 67 0% 87 Accession 10 Carbon 245.2 146.6 25% 45 5% 75 Other EITs 87.8 45.4 25% 24 0% 36 Other GHGs (10, 20%) 24 79 + Managed forest allowance 40 40 CDM 15 50 Sellers of Carbon Credits[MtCeq/yr](Grubb, March 2003)

  46. Kyoto Protocol:Flexibility Mechanisms Annex I Emission Trading Emission Trading Clean Development Mechanism 1990 level Joint Implementation - 5% Domestic Actions Domestic Actions Assigned Amounts Present day 2012 (BaU) 2012 with KP

  47. Probable prices for CERs(£/tCO2e)(Grubb, March 2003) • Renewable energy and energy efficiency projects under CDM fast-track procedures for small scale projects • £10 – 25 per tCO2e • Land use and other CDM projects • £ 5 – 15 per tCO2e

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