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Financing the Development Dividend

This chapter explores ways to increase financing for CDM projects that yield a development dividend. It discusses finance support mechanisms, financing risks, and bridging the finance gaps. Case studies are provided to illustrate the challenges and potential solutions.

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Financing the Development Dividend

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  1. Financing the Development Dividend IISD Task Force Meeting Copenhagen, Denmark October 19, 2006

  2. Objective of Chapter 3 To explore ways to increase available financing for CDM projects which yield a development dividend.

  3. The Financing Challenge • Review Finance Support Mechanisms • Including Role of Carbon Credits: See Section 2 and 3 • Identifying and Weighing Financing Risks • Project Financing Risks including Cases: See Section 4 • Cases: 2 in Kenya and 2 in South Africa: See Annexes • The Financing Challenge • Bridging the Finance Gaps: See Section 5 • Increase the Financing for SD Projects • Supply Side and Demand Side: See Section 6 • Conclusions: • Key Players and Potential Impact of Development Dividend: see section 7

  4. 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

  5. Understanding the Challenge Project funders assess “traditional” risk/rewards but must now understand 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

  6. Understanding the Financing Gaps Projects in CDM Countries with a significant SD often give rise to financing “gaps” between sources and users due to: • Need for both to better understand, define and balance risk with reward • Need for users to identify new CDM SD risk takers • Need for sources to value the risk mitigating effects in CDM SD

  7. Case Studies • Four projects were reviewed, each having a strong development dividend but difficulty sourcing financing: • Low cost housing energy upgrade project in South Africa • Bellville South landfill gas recovery project in South Africa • The Vanilla Jatropha project in Kenya • Solar technology for electricity provision in Kenya • Case study analysis included country, project, and carbon credit challenges

  8. Case Studies: Country Challenges • Many CDM Countries must • improve their investment environment to attract financing for good CDM projects • identify and prioritize SD CDM projects, • Provide support and funding for building knowledge of financing structures and sources for local project proponents and local stakeholders, including carbon credit markets as additional source • Provide local financing support where appropriate and links to Annex 1 countries sources of financing

  9. Case Studies: Project Challenges Project Proponents, including local developers should seek to • Improve local supplier capacity and credit risks • Improve knowledge of sources of financing, both local and international, equity and debt, grant and advisory • Optimize sale of small carbon credit to improve cash flow • Address issues of carbon credit ownership and delivery • Improve knowledge of Kyoto- CDM process and carbon credit benefits and potential of voluntary buyers of carbon credit buyers • Seek support of host countries provision of more flexible, timely and adequate local financing

  10. Case Studies: Carbon Credit Challenges Project proponents and other stakeholders must address Carbon Credit issues such as: • Volume may be too small to justify costs and attract buyers • Voluntary market buyers are not aware of good projects with high SD value • Uncertain ownership of carbon credits • Delivery risk should be mitigated to acceptable level for buyers (political and project risks) • Pooling of carbon credits by host country and project sponsors may help to address some of above issues

  11. Supply and Demand Gaps • Suppliers of Funding are not SD “driven” • ECAs focus on “export” benefits • Banks, equity, insurers prefer large scale projects where transaction costs can be absorbed more easily • Carbon funds focus on compliant CERs • Users do not address supplier needs, such as • Equity ROI based on risk stage • Debt term, interest rate and security • Suppliers, Users and Other Key Stakeholders • scarce technical and resource capacity to handle “one off” or more complex projects, particularly small scale

  12. Bridging the CDM Financing Gap • Demand-side project proponents seek: • More flexible, risk tolerant debt & equity sources • Up-front purchases of carbon credits • Compliant and Voluntary Carbon Credits • 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

  13. Possible Solutions: Country Level • Build CDM capacity within host country governments to make better use of carbon finance for projects • Link projects with high SD potential to national priorities and grant finance sources • Expand role and risk capacity of rural and community development banks to leverage financing • Engage ODA to catalyze CDM projects with high SD potential

  14. Possible Solutions: Project Level • 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 SD potential • Develop risk mitigation financing instruments to enhance the attractiveness of projects with high SD potential

  15. Conclusions • Local development banks, IFIs and Annex 1 public sector programs to take leadership role • for supporting SD projects • for capacity building of local, small scale project proponents and local sources of financing • Voluntary carbon credit buyers could be a factor if internationally accepted standard for determining SD benefits in projects can be developed along with a registry system • A credible method for determining the SD benefits introduced to the credit decision process as an acceptable risk mitigant

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