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CDM: A Catalyst for Renewable Energy in Developing Countries Lessons from Early Projects

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Title: CDM: A Catalyst for Renewable Energy in Developing Countries Lessons from Early Projects


1
CDM A Catalyst for Renewable Energy in
Developing Countries?Lessons from Early Projects
  • Veronique Bishop, Franck Lecocq
  • World Bank, Carbon Finance Business
    Development Economics Research Group
  • International Energy WorkshopParis, 22-24 June
    2004

The opinions expressed in this presentation are
the sole responsibility of the authors. They do
not necessarily represent the views of the World
Bank, its executive directors or the countries
they represent, nor do they necessarily represent
the views of the Carbon Finance Business or the
Participants in the funds it manages.
2
Motivation
  • About 5,000,000,000 of investment in power
    generation and transmission required over next 30
    years to meet electricity demand in developing
    countries (IEA, WEO 2003)
  • To do so, private capital is needed, but private
    investment flows have been decreasing steadily
    since 1997
  • Can the CDM help overcome barriers to investment
    in clean energy, especially renewables, in
    developing countries?

3
Outline
  • Introduction
  • The CDM Definition and activity
  • Direct cash-flow Benefits of CDM on renewable
    energy projects
  • Indirect benefits of CDM contracts
  • Conclusion Replicability of early project
    examples

4
The Clean Development Mechanism (CDM)
  • Flexibility mechanism of the Kyoto Protocol.
  • Project-based mechanism by which
  • an entity in Annex B can participate in the
    financing of a project which is located in a
    non-Annex B country
  • and reduces emissions compared with what would
    have happened otherwise
  • to get emission credits (CERs) in returns.

5
Can the CDM contribute to renewables penetration?
  • S. Mathy, J.-C. Hourcade C. de Gouvello (2001)
    the CDM can leverage development because
  • It puts a value on the global environment
    benefits of projects which reduce GHG emissions
    (direct cash-flow benefits)
  • And it provides foreign capital, which is cheaper
    than domestic capital (indirect benefits)
  • Do early CDM experience in renewables support the
    MHG hypothesis?

6
The CDM So FarVolume traded in CDM and JI
transactions, million tCO2e
(Jan-May)
Source Lecocq F. (2004) State and Trends of the
Carbon Market 2004, Washington DC
7
Technology DistributionIn percent of volume
purchased from Jan. 2003 to May 2004
Source Lecocq F. (2004) State and Trends of the
Carbon Market 2004, Washington DC
8
Impact of Payment for Carbon on Projects IRRs
Sources PCF (2003) PCF Annual Report, Washington
DC, Authors calculation
9
Renewables Carbon Revenues per Unit of Output
Source PCF (2003) PCF Annual Report, Washington
DC
10
Direct Benefits of CDM on Project Finance Summary
  • At current prices (4/tCO2e), direct cash-flow
    impact of CDM is significant for projects
    mitigating non-CO2 gases
  • For renewable energy, on the other hand, the
    impact is positive but small not sufficient,
    in general, to make project viable
  • In addition, CERs paid on delivery in most
    contracts (commodity model) and not upfront as
    postulated in MHG The upfront financial gap
    persists

11
Indirect Benefits of CDM
  • Emission Reduction Purchase Agreements (ERPA)
    generate high quality cash-flow
  • OECD sourced
  • Investment-grade payor (usually governments or
    highly rated private companies)
  • - or - denominated
  • Exchange Rate Risk can be eliminated
  • In addition, financial engineering can help tap
    additional upfront capital through monetization
    of ERPA

12
Securing Underlying Finance
Host Country
Letter of Approval
  • Engagements, e.g.
  • Regulation (e.g. tariffs)
  • Kyoto Protocol
  • compliance

Carbon Buyer
ERPA
ERs
ER payment
Sponsor/ Project
13
Securing Underlying Finance
Host Country
Letter of Approval
  • Engagements, e.g.
  • Regulation (e.g. tariffs)
  • Kyoto Protocol
  • compliance

Carbon Buyer
ERPA
ERs
ER payment
Sponsor/ Project
Loan ??
Lenders
Debt service?
14
Securing Underlying Finance
Host Country
Letter of Approval
  • Engagements, e.g.
  • Regulation (e.g. tariffs)
  • Kyoto Protocol
  • compliance

Carbon Buyer
ERPA
ER payment
ERs
Special Purpose Vehicle
Financing Agr.
Sponsor/ Project
Loan
Lenders
Debt service
ER payments are placed in offshore escrow.
15
Example PCF Plantar Sustainable Fuelwood
  • No currency-risk insurance available beyond 2
    years in Minas Gerais (Brazil) for this type of
    projects No debt beyond 2-year tenor
  • With carbon finance revenues placed on offshore
    escrow account, an OECD commercial bank willing
    to lend for 5 years
  • Loan amortization structured to match expected
    payments for CERs

16
Example PCF Plantar Sustainable Fuelwood
17
Other Possible Structures
  • Bank provides letter of credit to the carbon
    buyer to secure upfront payment of emission
    reductions (Pannonpower Biomass, Hungary)
  • Combining ODA resources, CDM and commercial bank
    lending (West Nile Hydro, Uganda)
  • Subordinated debt finance with mezzanine
    financiers (several projects at advanced stage of
    preparation)
  • Insuring upfront payments made to portfolios of
    small-scale projects (in discussion)

18
Indirect Benefits of CDM on projects finance
Summary
  • Carbon finance provides high-quality cash-flow
    which can avoid currency risk, and thus
  • Overcome barriers to investment (e.g., absence of
    currency insurance on the market, cheaper
    capital)
  • Allow lenders to provide upfront cash flow
  • Financial engineering can improve availability
    and cost of upfront capital
  • MHG hypothesis verified on some CDM projects, but
    under unique conditions

19
Is this Replicable for Renewable Energy?
  • Hardly! There are still considerable barriers
  • Cash flow generated by CDM remains small
  • CDM process still too complex
  • High transaction costs Policy risks (host
    country approval, non-registration) cannot be
    mitigated by the private sector
  • Additionality paradox The best projects are also
    the most vulnerable to registration risk
  • Market too thin (lt 600m) for financial
    institutions to invest human / financial capital

20
Unlocking the CDM Potential
  • To attract commercial financial institutions, we
    need
  • Evidence of sizeable, profitable market
  • Acceptable Host Country investment climate
  • Adequate risk mitigation
  • Therefore, specific measures can increase
    leverage of carbon finance
  • Host Countries can improve investment climate for
    renewables

21
Unlocking the CDM Potential (2)
  • Regulators can reduce policy risk
  • Additionality rules (CDM EB, COP)
  • Project approval (CDM EB, COP)
  • Rules for combining renewable energy subsidies
    and green premiums with ODA and CDM resources
    (OECD DAC)
  • Validity of post-2012 credits (COP, EU ETS)
  • Development Finance Institutions can provide risk
    mitigation instruments, e.g.
  • Contract frustration insurance
  • Policy Risk Mitigation

22
To Sum Up
  • CDM has benefits beyond the simple cash-flow
    associated with purchase of CERs
  • For non-CO2 projects, cash-Flow Additional
    benefits already make a huge difference
  • For renewables, CDM is no silver bullet
  • Cash-flow benefits are too thin at current prices
  • Indirect benefits can help some projects go
    through, but under rather unique conditions
  • But policy measures can unlock the potential of
    the CDM to foster clean power generation

23
www.carbonfinance.org
24
ANNEXES
25
Barriers to Power Generation Investment
  • High upfront cost long payback period
  • Long lead times high development costs
  • Country risk (political unrest, etc.)
  • Exchange rate risk
  • Policy and regulatory risk
  • Notably inadequate electricity tariffs
    enforcement of tariff policy
  • Individual buyers with poor credit ratings
  • Poor revenue collection

26
Additional Barriers for Renewables
  • Resource risk (intermittency)
  • Technology efficacy risk (limited data)
  • Small projects high transaction costs
  • Less experienced sponsors with low credit
    rating scarce, expensive capital high
    margin insurance short tenors
  • Policy and regulatory risk
  • Trend towards long-term PPAs

27
Other Structure Subordinated Debt Finance
Host Country
Letter of Approval
ER payment
  • Engagements, e.g.
  • Regulation (e.g. tariffs)
  • Kyoto Protocol
  • compliance

SPV
Carbon Buyer
(1st)
ERPA
ERs
Subordinated Lender
(2nd)
Debt service (2nd)
Loan
Sponsor/ Project
Senior Lenders
Loan
Debt service (1st)
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