The Global Carbon Market and Carbon Economics Workshop on the Carbon Market and Brazilian Carbon Transactions October 26 th, 2005, Sao Paulo Ken Newcombe

Carbon finance is a revenue stream in foreign exchange tyically paid on delivery of emissions reductions into compliance registries. North-South CDM trade lowers the cost of compliance for OECD and mobilizes new resources for financing infrastructure and land management for developing countries Basic incentive to trade – difference in marginal cost of abatement: –OECD: $10-50 per tonne CO 2 e (short run marginal abatement cost) –LDCs: <$5 / tCO 2 e Barriers to trade: project and country risk, regulatory risk and uncertainty, closing window of opportunity Carbon finance basics

Cash out Cash in Equity Debt Construction Capital for underlying climate friendly project Yrs …………………………………… Carbon Revenues for years World Bank Emissions Reductions Purchase Agreement is bankable and additional revenue commitment helps bring projects to financial closure = annual payments under carbon purchase agreement = annual payments under power purchase or other source of revenues to underlying project Carbon sales revenues are commonly in the range from 10-50% of total revenues for power and waste management projects Construction Operation Understanding the impact of carbon finance on project financing and financial sustainability

Kyoto Protocol basics OECD shortfall of ~ billion tCO2e May be met by: –Domestic measures: ~ 50% –EU Emissions Trading Scheme –Trading via 3 Kyoto mechanisms: Clean Development Mechanism Joint Implementation Internationall Emissions Trading Entered into force Feb 16

Structure of the Carbon Market Allowance Markets UK ETS EU Emissions Trading Scheme Chicago Climate Exchange New South Wales Certificates Project-Based Transactions Voluntary Retail Other Compliance Clean Development Mechanism Joint Implem. Intl Emissions Trading

Project-based ER Volumes (million tCO 2 e) (Jan-Apr)

Project-based ER Contracts: >$1b (nominal U.S.$ m) (Jan-Apr)

Prices Depend on Risks (weighted average prices from Jan to April 2005 in U.S.$ per metric tonne of CO 2 e)

Allowance Markets Exploding (in million tCO 2 e) (Jan.-March)

Main Buyers: Europe % of volume purchased Jan.04 - Apr.05 World Bank = 22 % (attributed pro-rata to carbon fund participants)

Project-based transactions by sector (% of volume purchased Jan.04 - Apr.05)

Why is WBG involved? Poverty reduction + sustainable devt: Catalyze climate-friendly investment in client countries Help OECD countries address CO2 shortfalls & diversify risk Inform buyers, regulators, public Bonn, Gleneagles commitments

World Bank Carbon Finance ~$937 million under management Italian Carbon Fund Netherlands CDM Facility $ 180 m $ 51.3 m to date Community Development Carbon Fund. $128.6 m to date Prototype Carbon Fund $180 m Netherlands Europe and CentraI Asia Facility (with IFC) Bio Carbon Fund $ 80 m to date ~$ 40 m Netherlands ECAF Spanish Carbon Fund $ 220 m ~$ 64 mDanish Carbon Fund

Impact by Technology

Higher annual revenue streams and IRRs –~0.5% to 2% for renewables / Energy efficiency –>15% for CH 4 –Much higher for more powerful industrial gases (HFC 23, N 2 O, …) High quality cash flow and contract value –Verified Emissions Reductions (bankable) –OECD buyers (investment-grade payers) –$ or denominated –Long-term contract with no price fluctuation guarantees flow Payments abroad eliminates currency convertibility and transfer risks Value added ER revenues + Financial engineering allow access to capital markets and boost project bankability (borrowing against ER streams) Impact of Carbon Finance

Fossil Fuel Displacement

Fuel DisplacedGeneric Emissions Factor (tCO 2 e/MWh) Carbon Revenue at US$4/tCO 2 e (US$/MWh) Gas0.40$1.60 Coal $3.40-$4.00 Diesel $3.00-$6.00 ER cash flows improve IRRs by 0.5 – 2.5%

Typical elements of LFG project 3. Collection and treatment of leachate 1. Landfill gas recovery and flaring 2. Generation of electricity for -Consumption on site -Sale to the grid

Methane Mitigation

Brazil Nova Gerar LFG Production (two sites) Mining Gas from Old Landfill Tapping Gas at new Sanitary Landfill Limits of Gas Capture for ten year carbon purchase agreement carbon purchase agreement

Leading Edge of Carbon Finance in Urban Waste Management$8-10/t $2-$4/t

Methane Mitigation Carbon Revenue*(methane only) US$/tcm CH4US$/MWh Biomass cogen, landfill methane up to $60up to $16 Venting reduction, coalmine methane up to $52up to $14 * at US$4/tCO2e Impact on IRR can be >15 percentage points

Impact by project SectorCountry/Project Incremental IRR. Discounted Payback Per. Landfill CH4Brazil: Nova Gerar32.70%0.3 Landfill CH4South Africa: Durban32.60%0.5 Landfill CH4Argentina: Olavarria13.30%0.7 Energy Eff.Indonesia: Indocement12.80%1.1 Coalmine CH4China: Jincheng8.00%1.5 Biomass+CH4Bulgaria: Svilosa5.00%3.6 BiomassHungary: Pannonpower2.00%4.9 Forestry+BioBrazil: Plantar4.70%1.8 ForestryRomania: Afforestation0.60%6.2 HydroEcuador: Abanico2.10%6.8 HydroPeru: Poeches0.70%12.4 WindPhilippines: Northwind0.40%20.0 WindColombia: Jepirachi0.70%23.1

TIST Tanzania: without project Abandoned land Fuelwood shortage Damaging practices Decreasing fertility

TIST Tanzania: with project Village nurseries Groups with a purpose Trees line up houses, paths Grass grows under trees

Revenue boost –$3 to $5 per MWh for renewables, EE –Up to $20 per MWh /$60/tcm for CH 4 mitigation High quality cash flow –OECD - sourced –Investment-grade payor –$- or - denominated Eliminate FX risk Financial engineering helps tap capital Impact of Carbon Finance

Host Country Sponsor/ Project CF ERPA Engagements re: Regulation (e.g. tariffs) Kyoto Protocol compliance ERs Ltr. of Approval ER pmt Securing Underlying Finance

Host Country Sponsor/ Project CF ERPA Engagements re: Regulation (e.g. tariffs) Kyoto Protocol compliance ERs Ltr. of Approval ER pmt Securing Underlying Finance Lender? Loan ??

Host Country Lender Sponsor/ Project CF ERPA Financing Agr.s Letter of Approval ER payment $ $ $ SPV ER s Permits, etc. Carbon Transaction Structure Financing structure eliminates convertibility and transfer risk Up-front finance $ $ $

Brazil Plantar Sust. Fuelwood ER payments to amortize 100% of commercial loan principal

Ecuador: Abanico Hydro 30 MW ROR hydro 85% capacity factor $33.3m cost IRR 15.6% 800,000 tCO 2 e ERs ERPA $4m IRR 0.73% => 16.3%

CER payments enabled project to meet IICs investment criteria 33.3%19.4%41.4%44.5%48.0%52.1%57.0% CF Impact in Annual Debt Service, including interest (%) Abanico Cash Flows

Abanico Project Carbon finance enabled project to: –Meet IICs investment criteria –Lower interest rate by 100 bp –Expedite financial closure …In one of L. Americas riskiest countries