“Financing Renewable Energy in Emerging Markets – Opportunities & Approaches” Frank Joshua Montreal, 28 September 2004 Workshop on Innovative Options for Financing the Development and Transfer of Technologies Montreal, September 2004

I 2 Contents  Investor Expectations in Emerging Markets  Returns on Investment & Impact of Carbon Finance  Assessing Risks & Rewards in Emerging Markets  Opportunities for Private Equity Funds & Debt Providers  Role of Climate Investment Partnership (“C.I.P.”)

I 3 1 Investor Expectations in Emerging Markets

I 4  Emerging markets offer major opportunities for Renewable Energy projects  In the best markets (for example: China, India, Brazil, Chile, Mexico, Korea, Thailand, Philippines) common characteristics of good potential include:  Huge and growing energy demand (e.g. China recently announced that it plans to invest USD120 billion to double generation capacity by 2010)  Centralized power sector (need for re-organization)  Good wind speeds and/or small scale hydro resources  Healthy “start up” growth rates and returns  Increasing environmental awareness  Relevant national and/or local policies in place  Ability to utilize CDM benefits  Emerging markets have significant long term potential compared to North America and Europe  However, until recently, lack of reliable local developers, regulatory risk, and wind data risk have tended to depress investments. Rationale for Investing in Renewable Energy Projects in Emerging Markets

I 5 Investor Expectations & Opportunity for Strong Emerging Market Returns  Equity investment IRR:  India15 – 25%  China10 – 15%  Korea10 – 15%  Brazil15 – 20%  Chile10 – 15%  – 5% from carbon credits  Expected IRR of individual wind farms: +/- 15% + carbon + country risk premium  Expected IRR of Landfill gas: >15%, + carbon + country risk premium  Exit Strategy: Possible Sale of Equity to local utility or through IPO If equity is sold after 3 – 5 years of operating history a significant capital gain can be made IPOs of bundled RE projects have been successful in mature markets (Europe) but have yet to be tried in emerging markets

I 6 2 Returns on Investment & Impact of Carbon Finance

I 7 Impact of Carbon Finance Carbon Finance Deal Structure Host Country Lenders Sponsor/ Project CF ERPA Financing Agreement Letter of Approval ERs ER payment Debt service SPV Permits, etc. Source: World Bank

I 8 Impact of Renewables Fuel Displaced Generic Emissions Factor (tCO2e/MWh) Carbon Revenue US$/MWh at US$4/tCO2e Gas0.50$2.00 Coal0.85$3.40 Diesel $ Source: World Bank

I 9 Impact of Carbon Finance At $4/ ton CO2e Technology  Hydro, Wind, Geothermal % Crop/Forest Residues3-7% Municipal Solid Waste5-15%+ Source: World Bank

I 10 Profitability of a Subset of CIP Projects Source: Climate Investment Partnership (CIP)

I 11 Impact of Carbon Finance  Increased cash flow boosts IRRs  ~0.5% to 2.5% for renewables/EE  5-15% for CH4  High quality cash flow reduces risk  OECD - sourced  $- or €- denominated  Investment-grade payer  Eliminate currency convertibility or transfer risk  Financial engineering helps access capital markets

I 12 3 Assessing Risks & Rewards in Emerging Markets

I 13 Understanding Carbon Risk (1)  The GHG business involves many poorly understood but widely perceived risks:  Regulatory risk  Performance risk  Delivery risk  Counterparty Credit risk  Price risk  Etc.  Proposition: Investors’ inability to accurately assess “Carbon Risks & Rewards” will drive resources towards “Carbon Trading” instead of “Project Finance”

I 14 Understanding Carbon Risk (2) The Evidence: Volume of carbon reductions traded since 2001 has doubled year-on-year to over 100 mtCO2e per year Yet most carbon projects (CDM) have not achieved financial close. Why? Perceived Risks will: Discourage investment in RE & GHG Projects by major financial institutions, and Drive resources towards “Carbon Trading” instead of “Project Finance”…  Carbon is not their core business  Hedge trading via Forward Contracts with “payment-on-delivery” terms  Governments & Multilateral Financial Institutions as Investors (e.g. Dutch, UK, PCF, etc)  Missing: Investment Banks; Fund Managers; Debt Providers

I 15 Enabling Carbon-linked Project Finance  But as the GHG market matures “Carbon Procurement” will face supply constraints  And rising carbon prices  Companies and governments could face serious financial exposure  RE & CDM project developers need early upfront financing  In the form of Equity, Debt, & Mezzanine Finance, & Risk Mitigation  Carbon as Collateral: i.e. utilizing the market value of emission reductions to enable projects to proceed  Carbon as financial security (€, $, £)  Carbon as risk mitigation asset  Renewable Energy Certificates (RECs & ROCs)

I 16 4 Opportunities for Private Equity Funds & Debt Providers

I 17 Attracting Private Equity & Debt Providers The Problem:  Strong market interest exists in emerging markets (private equity and debt) but bundling opportunities are lacking  Investors often lack resources to find, screen, and evaluate projects  And few RE & GHG projects are well structured from a technical, financial and risk point of view; hence access to project debt and equity is poor  Risk perceptions: Investors often see RE & GHG projects as combining: (i) a risky sectors with (ii) high risk markets & (iii) a risky commodity…

I 18 Opportunities for Private Equity Funds Solution: Renewable Energy Equity Funds Create commercially attractive diversified investment opportunity by bundling replicable high quality projects Stick to proven replicable cost competitive technologies, mainly on-grid, and mostly Wind Power, Hydro Power, and Landfill Gas Projects Work with strong developers to reduce risk of investment delays Raise equity mainly in the private sector & look to increase returns through soft debt Lock in advantageous pricing and future cash flow for carbon ROI of Funds expected to exceed that of individual project investments (i.e. 15 – 20%, plus carbon) Benefit from opportunity for early exit through bundling and sale of investments after construction and safe operating period.

I 19 Where’s the Money? Some Examples:  European Investment Bank (EIB) renewable energy investments in 2003: €500m  EIB Climate Change Facility: €500m  EIB/EDFI Cotonou Investment Facility: €2.2 billion  World Bank Carbon Finance Business: $450m  Citigroup (Renewables, private equity): US$500m  Government of Netherlands: €500m  Japan Carbon Fund  Development Bank of Japan: US$100m  Japan Bank for International Cooperation: US$100m  Government of Austria: €360m (€36 million per year for 10 years)  Government of Canada: C$50m (C$10 million per year for 5 years)  Other possible sources of funds:  Fortis Bank… World’s largest investor in wind power  Rabobank…  ABN AMRO…  Others…

I 20 5 Role of Climate Investment Partnership (“C.I.P.”)

I 21 A GHG Project Finance Facility (for project-by-project investing) Project 2 Project Finance Facility (PFF) PFF Manager (Swiss Re) Project 1Project nProject 3 Equity Investors Grant Providers Delivery Insurance Providers Credit Guarantee Providers Loan Providers Financiad Returns Carbon Credits $

I 22 The Challenge of Structuring a Deal Case Example: 100MW Indian Wind Farm (€100 m.) Sources of Funds (1) Developers’ Equity Private Equity Export Credits Senior Debt (Lead Bank) Subordinated Debt Mezzanine Finance Other Sources of Funds (2) Grants Development Finance Financial Guarantees Vendor Finance Suppliers Credit Carbon Finance

I 23 CIP’s “Project Finance Capacity Development Initiative for Latin America”  Objectives:  Improve access to project finance by raising technical and financial standards of small and medium size project developers;  Develop analytical tools to better assess carbon risks;  Develop risk mitigation tools to improve the use of carbon as financial collateral in project finance, and enhance the bankability of emission reduction purchase agreements; and  Support direct negotiations between CDM project developers and investors.  Participants: Argentina, Bolivia, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay  Sponsors: Climate Investment Partnership (CIP) [possibly with CF Assist & WBCSD]  Duration: 2 Years, 6 Months  Cost: €2.0 million (Donor enquiry welcome)  Plan to Launch at COP10 in Buenos Aires.

I 24 Contact Details: Frank Joshua, Chief Executive Officer, CIP Karen McClellan, Director, Investment, CIP 7-9 Chemin des Balexert, 1219 Châteleine, Geneva, Switzerland. Tel. (Frank): ; (Karen): Tel/Fax