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Creating an International Climate Finance System — the Need for an International Green Bank

Coalition for Green CapitalKenneth Berlin, General Counsel(202) 371-7350Kenneth.Berlin@Skadden.com)www.coalitionforgreencapital.com

May 2011

Presented at: 2nd Climate Consensus Workshop Amsterdam, May 18-19, 2011

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Who we are and what we want to do The Coalition for Green Capital (CGC) is a non-profit consortium of energy

industry leaders including renewable resource developers, original equipment manufacturers, investors, lawyers, financial advisors, and consultants dedicated to a clean energy economy built on low-cost, profitable, sustainable energy generation and consumption

The CGC seeks to build a productive, expanding, and sustainable economy by: Creating a U.S. Energy Investment Trust (EIT) that provides long-term,

low-cost financing for clean energy solutions Reducing taxes on innovative goods and services in the clean energy sector Removing market and infrastructure regulatory barriers to innovation in

clean energy goods and services Creating state-level Green Banks Creating an International Green Bank, also known as the “Global

Investment Trust for Clean Energy”

www.coalitionforgreencapital.com

Reed Hundt, CEO (202 777 7700, rehundt@yahoo.com) | Ken Berlin, General Counsel (202 371 7350, kenneth.berlin@skadden.com)

Alex Kragie, Vice President (202 579 2354, alex@coalitionforgreencapital.com | Sarah Davidson, Vice President (202 577 1605, sarah@coalitionforgreencapital.com)

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The Challenge

Providing financing to energy projects in the developing world is critical to arresting climate change and to bringing clean energy deployment to scale.

Political constraints on the U.S. climate negotiating position and on providing public funds, will limit for many years the role the U.S. will play in providing public funding to the Green Climate Fund established in the Cancun Agreement, making it difficult to bring public financing mechanisms to scale.

Multilateral development banks will play a key role in meeting developed world financing obligations, but limitations on multilateral bank financing will require a new international, single-purpose “green bank” that would foster widespread deployment of clean energy by providing low cost financing to private clean energy projects.

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Background At the UNFCCC conventions in Copenhagen and Cancun,

developed countries committed themselves to a goal of jointly mobilizing $100 billion a year to address the high costs of adapting to and mitigating the effects of climate change in developing countries

Agreed that financing would come from a wide variety of sources, public and private, bilateral and multilateral, including alternative sources of funding

On November 5, 2010, a team of experts submitted the “report of the Secretary-General’s High-level Advisory Group on Climate Change Financing”

The Advisory Group noted that the “revenue potential from private financing was estimated to be up to $500 billion in 2020, generated from a leverage factor of 2 and 4 on public flows and carbon market offsets”

The Cancun Agreement established a Green Climate Fund to be designated as an operating entity of the financial mechanism of the Convention. The Green Climate Fund will be accountable to and function under the guidance of the Conference of the Parties. The World Bank was invited to be the interim trustee of the Fund.

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Background

The political constraints on the U.S. negotiating position in global climate negotiations at Copenhagen, Cancun and beyond

Impact of those constraints on recommendations of the Secretary-General's high-level Advisory Group on Climate Change finance

The barriers to the private sector providing financing at this scale

The options for overcoming those barriers

Whether the $100 billion a year in developed country commitments and $500 billion in private financing can be met depends on a number of factors:

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Constraints on U.S. Negotiating Position

Unlikely the U.S. will pass climate change legislation for many years Will not have a flow of funds raised by cap and trade or a tax

to devote to international finance Strong opposition in the U.S. to treaties that do not require

binding participation by China and other major developing countries – makes it hard to agree to measures that do not include China

Crushing budget problems and opposition in the U.S. to increased public funding of international commitments

Strong opposition to any tax measures Opposition to any measures perceived as raising the cost of

energy in the U.S. at a time of rising oil prices and weak economic recovery

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Constraints on U.S. Negotiating Position Strong opposition in the U.S. to a treaty is hindering the ability

of the parties to create a binding cap and trade system Without a binding system, there will either be no markets or at

best constrained markets for carbon credits Many of the mechanisms being debated required a market for

their success CDM REDD

Voluntary markets are not enough Could rely on regional markets like an EU cap and trade system

for a period of time Few constraints on U.S. proposing measures designed to

encourage energy projects implemented by private entities, but still many barriers that have to be overcome before private capital flows reach the needed level

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Recommendations of the Advisory Group

Advisory Group stated that reaching the $100 billion goal will likely require taking a systematic approach to the financing of climate action. The Advisory Group grouped potential financing sources into four categories: (a) Public Sources, (b) Carbon Market, (c) Multilateral Banks, (d) Private Capital

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Recommendations of the Advisory Group: Public Sources (revenue from a price on carbon)

Key to the Advisory Group’s recommendation is a carbon price of $20 - $25 per ton of CO2 equivalent.

This would generate around $30 billion annually, but requires:

A cap and trade system or a carbon tax Willingness to devote a portion of these revenues to

international activity Willingness to agree to treaty in the absence of similar

requirements for participation in a cap-and-trade system for developing nations like China (Advisory Group makes it clear that carbon price will be limited to developed countries) U.S. proposed this approach in Waxman/Markey legislation in 2009,

but currently, politically impossible to propose, so it will be hard for the U.S. to negotiate an agreement requiring this approach

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Recommendations of the Advisory Group: Public Sources (taxes and budget contributions) Various taxes and wire charges such as

a financial transaction tax, taxes on international aviation and shipping, redirecting fossil fuel subsidies to international financing ($20 billion)

Direct budget contributions

Extremely unlikely the U.S. will commit to any of these in the foreseeable future.

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Recommendations of the Advisory Group: Carbon Markets A carbon price of

$20-$25 would generate increased carbon market flows (e.g. CDM markets) of between $30 and $50 billion in gross flows and about $10 billion of net transfers

Debate about whether to count gross or net flows, but irrelevant if no market

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Increasing Private Investment – What are the Requirements Two basic requirements for investment in

any energy project The technology cannot significantly raise the

delivered price of electricity The investors have to earn an adequate rate of

return

Most clean energy is more expensive then fossil fuel energy. Without the ability to raise the delivered cost of electricity, must lower the cost of the project to the project sponsors

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Lowering the Cost of Electricity – Subsidies and FITs Governmental subsidies can lower the price

of electricity National government can provide tax credits,

interest rate by-downs and other direct subsidies Likely to be limited appetite for these measures

given fiscal constraints in U.S. Feed-in tariffs for specific technologies can

increase payments to the project sponsor Likely to be highly effective As they reach scale, they will have an increasing

impact on rates and this might limit their use

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Lowering the Cost of Electricity – Low Cost Financing in the U.S. The Coalition for Green Capital has done

extensive work on developing low cost financing concepts in the U.S. at the state, federal and international level

At the federal level, Waxman-Markey included $7.5 billion in seed capital for a “Green Bank.” The Bingaman Senate Energy Bill in 2009, which passed in Committee, included seed capital of $10 billion for a somewhat different Green Bank

We are involved with a series of states which are considering setting up their own state green bank

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Lowering the Cost of electricity – Low Cost Financing Outside the U.S England is in the process of setting up a well financed

green bank Various national development banks like BNDES in

Brazil provide low cost financing Low cost financing is very effective in attracting

investment “China's real advantage lies in the ability of solar panel

companies to form partnerships with local governments and then obtain loans at very low interest rates from state-owned banks.” Michael El-Hillow, Evergreen Solar CEO, explaining Massachusetts plant closure

“If you change the interest rate half a percent or 1 percent, the difference is amazing, because the cost is all at the beginning.” Dennis Bracy, CEO of the U.S.-China Clean Energy Forum

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Example: Lowering cost of debt will reduce delivered price of wind generated electricity

Prepared by an energy investment firm using public data sources

Low-cost financing reduces the delivered electricity prices of these actual wind projects by 15-20% to the point of being cost-competitive with new-build conventional coal and gas-fired power plants in each region to meet incremental energy demand growth:

•With low-cost financing provided by the Energy Investment Trust, the internal rate of return can be maintained while keeping the cost to consumers at or below current delivered electricity costs (see highlighted sections above, where the cost of delivered electricity is reduced by $10/MWh or more because of the low-cost financing offered in the right column versus available bank financing in the left column).

Notes:-Assumes that all after-tax

free cashflows from the project are financeable, net of cover ratios

-CAPEX costs do not include significant transmission system upgrades

-The CAPEX here is based on reported project cost data for the ARRA grant program through November 2010, with a 10% discount to account for reductions in equipment costs since 2009 in projects being built in 2011 and 2012 timeframe

-The two cases describe the identical project, but commercial banks will finance a more conservative wind case (requiring the 1.4x cover ratio)

-The two cases assume the sale of identical quantities of electricity

- Note (1): LIBOR rate based on LIBOR swap curve for last 5 years, Treasury based on rates for the same period.

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Assumptions: Market Financing EIT Financing

CAPEX - Northeast (Rhode Island) [$/kW] $4,180 $4,180CAPEX - Plains (Kansas) [$/kW] $4,190 $4,190CAPEX - Southwest (Arizona) [$/kW] $4,190 $4,190

Tenor Years 10 20

Solar Case/Coverage DSCR 1.40x 1.30x

Interest Rate [%] 6.8% 4.5%

Balance at Maturity Balance Fully Repaid Balance Fully Repaid

IRR to Equity (Leveraged) 11.0% 11.0%

Revenue Requirement (2012 Power Price)@ 2% Escalation

Northeast [$/MWh] $152/MWh $118/MWhPlains [$/MWh] $140/MWh $109/MWhSouthwest [$/MWh] $112/MWh $87/MWh

Example: Low-cost long-term financing can lower the delivered price of solar photovoltaic projects

Notes:- CAPEX is the EPC price

of a solar photovoltaic system priced at $3.75/W, plus $.25/W debt service reserves, $.08/W development expenses, $.04/W financing fees, $.06/W for interest during construction, working capital, and maintenance reserves.

- Project is depreciated using MACRS, and assumes a 30% investment tax credit

- Both financing cases assume the same system sizes, production, O&M, etc.

- Production estimates for each region:

Northeast: 1208 kWh/kWp 13.8% NCF

Plains: 1382 kWh/kWp 15.8% NCFSouthwest: 1675

kWh/kWp 19.1% NCF

- Assumes a 1MW distributed generation project.

•Low-cost financing reduces the delivered electricity prices of solar photovoltaic projects by 20-25%, this puts solar within striking distance of current peak power prices, and generates electricity at the time when its most needed (peak hours) at the location where its most needed (close to the load).•With low-cost financing provided by the Energy Independence Trust, the investors’ internal rate of return can be maintained while keeping the cost to consumers at or below current delivered peak power prices. The cost of delivered electricity is reduced by $25-34/MWh because of low-cost financing offered in the right column versus currently available bank financing in the left column.

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CA

AK

WA

OR

NV

ID

MT

WY

COUT

AZ NMOK AR

ND

SD

MN

IA

LA

NE

MOKS

WI

FL

SC

IL INOH

WV VA

MS AL GA

NCTN

KY

NH

VT

MA

RICT

NJDEMDDC

HI

MI

TX

NY

PA

ME

Example: in the U.S. low cost financing will create substantial additional solar investment in at least 14 states without raising their electricity prices

Illustrative

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With U.S. Green Bank (EIT) support, equity investors can fund more projects – small changes to capital structure have big impacts

34% NCF, $57/MWh power price (~20% reduction through use of EIT)

10.5% leveraged rate of return When considering returns to both debt (interest) and

equity, the up-front capex and the returns on the required capital are still 85% of the total cost of a wind project, with only 15% of the lifecycle cost being the operating expenses; but with the EIT the debt capex has increased from 9% to 16%, so that the effective power price can be ~20% lower

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Without EIT Financing – 20:80 Debt/Equity ratio Including EIT Financing – 34:66 Debt/Equity ratio 34% NCF, $70/MWh power price 11% leveraged rate of return When considering the net cashflows to the equity investor, the

present value of equity capex is equal to the sum of the present value equity cashflows and the net tax benefit (26%+9%=35%); this value equals the up-front equity capex at the hurdle discount rate

85% of the total cost of a wind project is related to capital cost and the return on the investment, with only 15% of the lifecycle cost being the operating expenses

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The role of the World Bank Group and other Multilateral Development Banks World Bank Group and other Multilateral development banks

will play a key, but partial role in achieving $500 billion per year in private investment in energy in developing countries

The Advisory Group concluded that the banks “can play a significant multiplier role and leverage additional green investments.” For every $10 billion in additional resources, multilateral banks could deliver $30 billion to $40 billion in gross capital flows and $10 billion in net capital flows.

Multilateral banks play a key role in supporting two strategic pillars considered by the World Bank Group as essential for a reliable, efficient and sustainable energy sector: Improving the operational and financial performance

of the energy sector Strengthening governance to improve the contribution

of energy to equitable economic development.

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The World Bank Group Energy Strategy In October 2009 the World Bank Group published

its draft Energy Strategy Approach Paper. The World Bank Group’s Board Committee on Development Effectiveness is now reviewing the draft.

In FY2010 World Bank lending for energy projects totaled $13 billion of which lending for energy efficiency and renewables reached $3.6 billion.

“The WBG will continue to support multiple objectives of policy and institutional reforms, including creating an enabling environment for private sector participation and investment. Public-private partnerships will be actively pursued.”

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Limitations on WBG financing World Bank Group and other multilateral banks have certain

limitations that require the development of other institutions that can help provide the financing needed for $500 billion a year in clean energy investments in the developing world The WBG strategy is to play a catalytic role in energy

development, not to finance all of the hundreds of projects needed to reach scale

Because the WBG and other multilateral development banks support many kinds of loans other than clean energy loans, they do not see themselves as being able to raise all the financing needed for clean energy projects

Because they are country-oriented with many policy objectives, within and outside the energy sector, WBG and similar banks have to address many concerns in developing their strategy for each country

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An International Green Bank: Global Investment Trust for Clean Energy (GITCE)

A single purpose entity for financing clean energy is needed to bring energy finance to scale. The GITCE is unique in that it would: Focus on electricity as specific sector

Allocate funds directly to projects in countries where there is the greatest need for financing and development

Financing that complements existing funding sources Does not replace or displace multilateral development

banks or trust funds Would have governance and operational structure that

allows flexible and quick response to demand and market conditions

Would have institutional independence to focus on this set of investment objectives and the flexibility to work with all parties

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Financing the GITCE

The GITCE would be chartered so it could receive funding from a wide range of public and private sources, such as Investment by national development banks. Would

receive a return on equity adequate to attract investment, but below market and at a rate that when combined with other sources of capital would still allow it to provide low cost loans

Borrowing at low interest rates from national treasuries

Other equity investors Ability to issue bonds

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Achieving Scale in Private Financing Multilateral development banks will play a catalytic

role in private energy financing and in establishing the two strategic pillars needed for renewable energy investment

The GITCE would seek to bring clean energy projects to scale by lowering the cost of energy projects

GITCE financing would be complemented by national measures like feed-in-tariffs or other incentives needed to make clean energy projects cost competitive. The amount of these incentives will be considerably lower when complemented by low cost financing

Public financing based on measures similar to those proposed by the Advisory Group will increase in scale as those measures become politically viable.