Financing Sustainable Development

Emerging Environmental Commodity Markets

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PART I

Emerging Environmental Commodity Markets

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Demand for Environmental Finance

• Many environmental strategies exist only on paper, and lack a budget to facilitate their implementation

• $60 to 90 billion per year will be needed to address poverty-environment –sustainability goals over the next 10-15 years, and possibly $80 billion more per year to tackle global climate change over the next half century.

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Environment and ODA

• Annual ODA flows could increase to about $100 billion by 2010. (This would still be about $50 billion short of the ODA levels needed just to meet the MDGs.)

• Environment has traditionally accounted for less than 2% of ODA. Hence, this would amount to about $ 2 billion per year by 2010.

• Other sources of finance need to be explored to address pressing environmental priorities.

•CDM flows to date have been driven by market driven factors,not conducive to several of the UNDP client countries.

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The Emerging Environmental Commodities Markets

• Economists have long argued that market-based regulations could achieve greater results at a lower cost than traditional “command-and- control” approaches

• US Clean Air Act in 1990 piloted the first cap-and-trade environmental market for SO2 (a major culprit for acid rain)

• Around the world, new markets are being set up to create economic incentives to protect global environmental goods.

• Global environmental commodities markets received a boost in 1997 with the Kyoto Protocol, and an even bigger boost in 2005 with its entry-into-force following ratification by Russia.

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Examples of Environmental Commodities MarketsS

ou

rce

: F

ore

st T

ren

ds

(20

05

)

Market Goal

Products Suppliers Customers Market Size by 2012 ($ Billion)

Cap-and-trade carbon markets 

Abatement credits for reducing CO2 emissions (carbon offsets, AEU, ERUs, CERs)

Permit tradersEfficiency and GHG capture project developers

GovernmentsEnergy intensive industries

14

Water trading

Acres of forests and wetlands preserved, restored or created

Landowners and private wetland mitigation banks

GovernmentsWater basin agenciesReal estate developers

6

Habitat Conservation

Acres of restored or conservation managed land. 

Landowners and private conservation banks.

GovernmentsReal estate developersConservation organizations

4 

Sustainable fisheries

Permits to catch a set weight of fish speciesCertified marine fish.

Governments issue quotas; Retiring fishers sell quotas; Certification organizations issue certificates (e.g., Certified Marine Fish Council)

Fishing fleetsVoluntary purchase of certified marine fish 

60

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Aggregate Pool Attributes

GHG Emission Reduction

Poverty Alleviation

Biodiversity Protection

Other MDG Benefits

CDM vs. MDG components by project type

e.g. a renewable electricity project with employment effects, rural electrification and local air quality improvement

e.g. a reforestation project with watershed and protection of endangered species

e.g. a landfill gas project with small local air benefits

e.g. a school building project with a small photovoltaic entity

# 1

# 2

# 3

# 4

CDM component

MDG component

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The Good News for Financing for Sustainable Development

After 2012:

• Carbon Finance could raise resources 10 times greater than what is available through ODA

• Market transformation could channel over 1000 times more funds to renewable and clean power technology sectors

Market transformation and development of renewable and clean power technology sectors

By 2010: $234 to $625 billion

By 2020: Up to $1,900 billion

ODA

By 2010: < $2bn

Carbon Finance

By 2012: $1-$4 billion

Up to $14 bn thereafter

Relative Importance of Various Financing Sources for Climate Change

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Part II

UNDP Services in Environmental Finance

Carbon Finance as a first Step

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UNDP Environment Finance Services

• Support in developing sustainable national strategy for environment and energy

• Identification of potential funding sources to implement strategy (ODA, global environment trust funds, carbon finance, other commodity markets, and environmental fiscal reforms)

• Develop capacity for well-functioning environmental commodity markets (This would include support for strengthening planning, legal, and financial institutions).

• Provision of a one-stop shop for technical assistance in accessing each financial source, including GEF, MP, carbon finance and other environmental commodities markets.

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Overview of MDG Carbon Pooling Process

… and aggregates credits into pool of

standardized MDG-grade units.

UNDP purchases unique, project-specific carbon

credits…

Participants(governments, companies and carbon funds)

UNDP MDGCARBONFINANCE

$Pooled units sold

to meet compliance requirements

Pooled units retired on behalf of Participants to meet voluntary offset commitments

MDG-GradeKyoto Portfolio

Voluntary MDG-GradeOffset Portfolio

MDG-Grade Carbon Projects

$Carboncredits

CERs VERs

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Bank

• CERs and VERs (ongoing)• Carbon Rights and Limited Management Control Rights• Guarantee Fee (ongoing)

LoanInterestPayments(ongoing)

LoanGuarantee(5% of portfolio)

• ERPA issued by UNDP , and $’s transferred (ongoing)• Project Development & Validation Services (ongoing)

Project Developer

ProgramParticipants

$Pooled CERUnits

UNDP Funding, Project Development and Carbon Credit Purchase Process

UNDP MDGCARBONFINANCE

1

Sequential Processes1) Program participants fund MDG Carbon Pool2) UNDP & Project Developer sign ERPA*3) Bank issues loan to Project Developer; For small-scale, high-MDG projects, UNDP may

guarantee up to 50% of loan (not to exceed 5% of value of MDG Carbon Pool)4) UNDP distributes pooled MDG carbon units (CERs and VERs) to Program Participants

Ongoing Processes• UNDP MDG Carbon Finance provides ongoing project development & validation services• CERs and VERs are transferred from Project Developer to UNDP MDG Carbon Pool• UNDP Carbon Pool pays Project Developer for credits• Project Developer makes interest payments to Bank• Project Developer pays guarantee fee to UNDP MDG Carbon Finance (as above, only in

those cases where UNDP guarantees loan)

2

23

3

4

* Emissions Reduction Purchase Agreement

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Roles of financial partners

•Establish Trust account for CDM/JI;•Establish Trust account for the voluntary trading arm of MDG Carbon;•Develop a global registry system/database for all VERs;•Provide VERs Business Development Services•Enter into ERPAs on behalf of the Trust with project proponents•When the ERs are delivered into the Trust, deposit the purchase price of ERs into the Trust and pay the project proponent for the appropriate amount of credits;•Make the necessary transfers within the CDM/JI registries •Transfer pre-agreed project development and technical advisory fees to MDG Carbon•If required, assist MDG Carbon in providing financing arrangements for project proponents.

Roles of financial partners

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Environment Finance Manager

•Supervise the operations of MDG Carbon, under the authority and guidance of MDG Carbon Supervisory Board, and be fully accountable to the Supervisory Board. In this context, the Environment Manager:

• Manage trade-offs and develop synergies between UNDP Global Environment Funds (GEF TF, Adaptation Funds; CDM/JI/VER; MP; etc.);

• Authorize issuance of ERPAs to Proponents;• Transmits PDDs to DOEs;• Issues Letters of Delegation of Authority to UNDP RRs to create Awards and

start implementation;• Oversees the work of the MDG Carbon team;• Reports to MDG Carbon Supervisory on Facility performance on a semi-

annual basis;• Implement Supervisory Board’s meeting decisions.

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UNDP Competitive Advantages

• One-stop shop approach • Key market players typically only issue ERPAs or provide limited project development

services. UNDP Carbon Finance will provide a simple, cost-effective approach to Carbon finance, from screening of eligible project ideas to project management and transaction of ERs. UNDP will also provide limited project financing to small scale, MDG-grade projects through a partial guarantee fund.

• Universal presence and Trust• Is universal presence and trust will enable UNDP to provide project endorsement, pre-

validation and verification services at a much lower cost than other market players and to transfer these savings to project developers.

• Kyoto risk mitigation• Through the option of trading ERs either on the voluntary carbon offset market (VERs) or

the Kyoto market (CERs), UNDP will mitigate the risk that a CDM project is not ultimately considered additional by the CDM Executive Board and other non-issuance risks.

• Innovation capacity• Build capacity to trade ERs on the voluntary markets, UNDP will be able to develop

innovative projects not eligible to CDM yet (biological carbon sequestration through integrated land management, etc.)

• Sequencing different funding sources• By sequencing and/or combining different funding sources (GEF, MP, CERS/VERs, public

transfers, etc.) UNDP will be able to address a broader range of climate change needs in developing countries.

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MDG CARBON FINANCE ORGANIZATIONAL STRUCTURE

BDP/EEGDirectorate

Environment Finance Manager Regional Bureaux

RBARBAPRBASRBEC

RBLAC

AfricaDakar

Asia & PacificBangkok

Arab StatesBeirut

Europe & CISBratislava

Latin America &Caribbean

Panama City

Regional Coordination Units (RCUs)

AfricaPretoria

PROJ

ECT C

YCLE

MAN

AGEM

ENT

EmissionSequestration(afforestation,

deforestation etc…)

Emission Reduction(renewable energy,methane recovery,energy efficiency

etc…)

Chemicals

CapacityDevelopment

UNDP COUNTRY OFFICES

MDG Carbon Supervisory Board

MDG CarbonTechnical Unit

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Start-Up Costs

1. 2006-2008: Pilot phase• First batch of projects to focus on renewable energy and biological carbon sequestration.• UNDP Carbon Initiative to be established as an EEG unit servicing Country Offices, under

the supervision of an advisory board including all co-financiers (Regional Bureaux, BDP, bilateral donors).

• $ 5 million start up funds required to establish UNDP Carbon Funds (signed companies, develop carbon offset methodologies, market carbon pools…) and finance upfront project management costs (development, certification, commissioning, monitoring of CERs revenues).

• Financial break down: $ 2.5 million from bilateral donors (Nordic countries); $ 2.5 million from UNDP global and regional programmes ($750,000 from RBAP and RBA; $200,000 from RBEC, RBLAC and RBAS; $500,000 from BDP)+ WB PCF funds in the range of $20 – 25 mill.

2. 2009-2012: Wrap-up or scale-up phase

• Project development extended to energy efficiency.• Scale-up would require up $ 7 to 10 million of additional start-up cost, one option would

potentially be to establish UNDP-MDG Carbon Facility as a Not for Profit Organization to scale-up operations.

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Carbon Finance Projects

PROCESS

PROJECT

MARKET

COUNTRY

Risk Nature of Risk Mitigation Approach

Established Methodologies

• Reliance on fully developed methodologies during start-up phase;

• Partnership with key DOEs

Due Diligence

• CDM/JI eligibility appraisal by UNDP Carbon Methodology Advisers (MA).

• Host Country Carbon Appraisal (DNA, legal framework, etc.)

• Policy/Cap. Dev. to DNA

• Monitoring and pre-verification of CERS by UNDP COs and MAs

•DNA refusal to approve the project/change in DNA policy

•Failure to comply with rules and requirements for validation and registration under the CDM

•Inaccurate validation/verification by DOEs

•Failure to correctly monitor ERs

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Carbon Finance Projects

PROCESS

PROJECT

MARKET

COUNTRY

Risk Nature of Risk Mitigation Approach

Due Diligence

• Project design and Developer Appraisal leveraging UNDP climate change project risk management system

• Enhanced development benefits

• Carbon Certification of COs EFPs and RTAs

• Independent assessment of project performance criteria

• Buffer of ERs retained

• Time/cost overrun

• Miscalculated ER project performance

• Project operation not up to technical specs

• Changes to project assumptions making project unviable

• Facility management

• Damage to equipment

• Project proponent default

• Interest rate/currency fluctuation

• Natural catastrophes

Financial Instruments

Standard Insurance

2020

PROCESS

PROJECT

MARKET

COUNTRY

Risk Nature of Risk Mitigation Approach

Market and Product Diversification

• Compliance and voluntary markets (market hedge)• Basic & premium carbon products uniquely differentiated and appeal to different buyers

Financial Risk Mgmnt• Framework partnerships

with investment grade firms• Utilizing financial products

and services to outsource key financial risks

• Partial ER prepayments

• Demand/Price risk – evolution of ER markets

• Failure to negotiate optimal terms for project participants in an ERPA

• Failure to pay ERs/breach of contract owning to fall in market prices for ERs

• Post Kyoto risks

Carbon Finance Projects

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PROCESS

PROJECT

MARKET

COUNTRY

Risk Nature of Risk Mitigation Approach

Insurance Policies

•As required by Financial Partners

Due diligence

• Host Country Investment Appraisal

• Drafting of contracts by UNDP counsel

• Contract enforcement

• Currency inconvertibility

• Nationalization of assets/host Country Gov. claiming title to ERs

• Weak Governance

• Host Country non compliance with KP.

UN Country Presence

•Mainstreaming of Carbon Finance into UNDP Country Programming

•SBAA

Carbon Finance Projects

2222

PROCESS

PROJECT

MARKET

COUNTRY

Risk

Carbon Finance Projects

Key Players

Methodology/Carbon Process Advisers

Regional Technical Advisors

For carbon project development

Business Development Advisors

Country Offices

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Roles of Regional Service Centers/Regional Bureaux

•Develop a regional CDM/JI strategy;•Incorporate Carbon Finance into Regional Policy Dialogue and Programming;•As required, participate in semi-annual meetings of MDG-Carbon Supervisory Board;•Identify and maintain consultants /experts/buyers’ profiles roster to assist in formulating PINs/PDDs;•As required, organize validation/verification missions of DOEs•Regional carbon training workshops for UNDP programme officers•Mobilize ODA for carbon finance capacity development at the regional level.

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Capacity Building to handle Carbon Financing Options

UNDP MDG Carbon will carry out regular EFP Carbon Workshops to help EFPs meet the new challenge:

•need for CO EFPs to undergo a formal certification process to manage carbon projects. •MDG Carbon is developing a comprehensive Carbon Programming Site, mirroring the UNDP-GEF Intranet. •This space will be accessible through the EEG workspace and will aim to provide EFPs all relevant information on carbon programming (e-programming manual, KM products, contacts, project database, etc.). •It should be up and running by 1 July 2006.

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Roles of UNDP Country Offices

• Upon carbon training certification of CO EFPs, COs will: • Identify/mainstream carbon project proposals into UNDP country

programming;• Carry out project design’s pre-appraisal, including MDG impact;• Carry out developer appraisal (legal title to future CERs; track record,

etc.);• Assist RTA in PIN/PDD formulation process at the country level;• Help project developer to understand and navigate the existing

regulatory framework to secure DNA endorsement;• Resolve project non-performance issues due to a construction or

contractual dispute;• Ensure that project operation data are collected and archived in

accordance with monitoring plan, including MDG impact;• Mobilize/manage ODA to provide policy and technical advisory services

to relevant national institutions (DNA, etc.) and project developers.

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Roles of Regional Technical Advisers

•Upon carbon training certification, Regional Advisors will:–Conduct core Appraisal of project design (eligibility, technical

feasibility, economic viability, etc.);–Evaluate applicability of existing baseline methodologies to

proposed projects;–Manage the PIN/PDD formulation process;–Selection of optimum crediting period depending on non-renewal

risk associated with policy change that could negate project’s Additionality (watch out for perverse incentives to delay positive policy change);

–Advise project proponents on structuring and financing of CDM/JI projects

–Advise on how to combine/sequence carbon finance with other environment sources (ODA, GEF, MP, TREC, etc.)

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ODA Vs CDM funding

Compromise language which emerged in the preamble of Decision 17/CP7 on modalities and procedures for a clean development mechanism:

“Emphasizing that public funding for clean development mechanism projects from Parties in Annex I is not to result in the diversion of official development assistance and is to be separate from and not counted towards the financial obligations of Parties included in Annex I,”  In practice, it is widely interpreted as meaning that using ODA to purchase CERs is a “no-no”, while using ODA to develop the capacity of DNA is OK. Co-financing CDM projects with ODA remains a gray area !b

BDP/UNDP currently preparing a paper on sequencing/combining different funds for global environment (ODA, GEF, MP, Carbon, TREC)