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Opportunities and Challenges for Financing the Development Dividend

IISD Bonn PanelMay 17, 2006

Diana SmallridgeManaging Director

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IISD Multinational, Multi-Discipline Task Force Goal Increase understanding of the challenges in

providing enhanced socio-economic and environmental benefits – the “development dividend” – via CDM

Present options for enhancing the CDM development dividend while recognizing the need of Annex I countries to access cost-effective emission reduction credits

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Financing the Development Dividend Understanding the Challenge

Case Studies

Existing Finance Support Mechanisms

Supply and Demand Side Finance Gaps

Possible Solutions

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Understanding the Challenge

Project proponents face several key financing challenges:

Seeking financing from a variety of local and international sources

Understanding what investors and lenders are looking for in a “bankable” project

Thinking like a banker, investor or buyer of carbon credits

Finding the right risk/reward balance for each project funder

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Understanding the ChallengeProject funders need to assess not only “traditional”

risk/rewards but also new CDM risk/rewards:

Investment environment in host country traditional project risk analysis plus commitment to

environment Project viability

traditional project risk analysis plus new technology, non-traditional feedstock, non-traditional purchasers and new stakeholder communities

Carbon credit revenues New potential source of finance, security enhancement, and

contribution to equity ROI

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Understanding the ChallengeAs a result, development dividend projects often

give rise to financing gaps in terms of:

Defining the risk/reward balance Assessing these risks and rewards Valuing the risk-factored rewards in terms of

enhanced ROI to investors or security to lenders

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Case Studies Four projects were reviewed, each having a

strong development dividend but difficulty sourcing financing:1. Low cost housing energy upgrade project in South Africa

2. Bellville South landfill gas recovery project in South Africa

3. The Vanilla Jatropha project in Kenya

4. Solar technology for electricity provision in Kenya

Case study analysis included country, project, and carbon credit challenges

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Case Studies: Country Challenges

South Africa – relatively stronger investment climate Weak labour skills and education

Crime, theft & disorder

Kenya – relatively weaker investment climate Crime, theft & disorder, corruption

Cost of financing Anti-competitive practices, tax administration Weak infrastructure Uncertain economic and regulatory policy

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Case Studies: Project Challenges

Insufficient local supply capacity, retail level credit risks capacity to supply solar water heaters

credit risk of purchasers of bio diesel fuels

Relatively small carbon credit flow, ownership and delivery is uncertain

Kyoto - CDM process and carbon credit benefits not well understood by project decision makers

Need for grant funding or similar financial assistance

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Case Studies: Carbon Credit Challenges

CER delivery risk uncertainty

CER volume may be too small to justify costs and risks to buyers

Voluntary market/offset buyers not aware of the projects and their relatively high SD/DD value

Ownership of carbon credits may not be clear: Kenya solar project – carbon credits owned by project

sponsors or rural schools and home owners?

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Existing Financing Support Mechanisms

Traditional and emerging potential sources of financing include:

Multilaterals, Carbon Funds, ECAs, Equity Providers

Commercial Banks (local and international), Regional Development Banks

Other stakeholders (e.g. local, regional and national governments)

Individual Carbon Credit Buyers

ODA and Others

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Existing Financing Support Mechanisms

Key themes: Not driven primarily by sustainable development

Carbon funds focus on compliant CERs ECAs focus on “export” benefits Banks, equity, insurers prefer large scale projects where

transaction costs can be absorbed more easily Risk/reward is not in balance

Equity focus on ROI Debt providers focus on min. term, max. interest and

adequate security Scarce technical and resource capacity to handle “one

off” or more complex projects

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Summarizing the Financing Gap

Demand-side project proponents seek: More flexible, risk tolerant debt & equity sources Up-front purchases of carbon credits CERs and offsets (voluntary) ODA/grants Sustainable development funds

Supply-side sources of financing need: Good “bankable” projects regardless of the DD Credible, timely, cost-effective CDM and host country

approval processes Risk sharing

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Possible Solutions: Country Level

Build CDM capacity within host country governments to make better use of carbon finance for projects

Link projects with high DD potential to national priorities and grant finance sources

Develop national/regional “clearing house” for DD project assessment and prioritization

Expand role and risk capacity of rural and community development banks to leverage financing

Engage ODA to catalyze CDM projects with high DD potential

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Demystify the financing process for local project developers in terms of potential carbon credit revenue streams

Improve capacity building on small volume project commercialization in host countries

Develop tool to screen cost/benefit of developing projects with high DD potential

Develop tailored insurance and other risk mitigation instruments for use in ERPAs to enhance the attractiveness of projects with high DD potential

Possible Solutions: Project Level

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Explore CDM transaction cost reduction strategies via bundling of small volume projects, sector- and policy-based CDM, and programmatic CDM

Greater understanding of the risk perception of carbon revenue streams, including in the carbon offset market

Possible Solutions: Carbon Credit Level

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GCA specializes in advisory services relating to the financing for sustainable investment and development.

Extensive work globally with stakeholders in the areas of environment and carbon finance:

United Nations Environment Programme World Bank Carbon Finance Business World Energy Council Environment Canada Natural Resources Canada Industry Canada Green Municipal Fund National Roundtable on Environment and the Economy

GCA is an affiliate of International Financial Consulting Ltd., a leading provider of advisory services to multilateral, public, and private sector clients.

Green Capital Advisors Ltd.