INTERNATIONALBANK FOR WORLD BANK R E T C N O E N STRUCTION PM AND DEVELO November 2002 No.13 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region THE PROTOTYPE CARBON FUND IN LATIN AMERICA: LESSONS LEARNED Francisco Fernandez-Asin "Continued global warming is in nobody's interest, but the simple facts of the matter are that developing countries will suffer the most damage, and their poor will be at an even greater disadvantage. I see the Bank's role in climate change as providing every opportunity to developing countries to benefit from the huge investment OECD must make in reducing climate change" James Wolfensohn, World Bank President United Nation's General Assembly, June 1997 Introduction The Prototype Carbon Fund (PCF) Reducing emissions of carbon dioxide and other The PCF is a public-private fund established in 2000 and greenhouse gases that affect climate change is one of the administered by the World Bank acting as Trustee. It key challenges facing the international community. The operates under the Clean Development Mechanism Bank's Prototype Carbon Fund (PCF) provides a principles of the Kyoto Protocol to the UN Framework framework for action, learning, and research to demonstrate Convention on Climate Change (UNFCCC). The PCF aims how greenhouse gas emission reduction transactions can to demonstrate the potential of market-based mechanisms contribute to sustainable development, while lowering the for reducing the cost of mitigating climate change. It does costs of compliance with the Kyoto Protocol--the 1997 this by buying Certified Emission Reductions (CERs) from agreement to cut industrialized world emissions of projects that reduce greenhouse gas emissions in Bank greenhouse gases. client countries, particularly projects that replace fossil fuels with renewable energy sources and those that improve The Latin American and the Caribbean (LAC) Region has a end-use and supply-side efficiency. In return for their growing number of successful Prototype Carbon Fund shares in the PCF, developed country governments and (PCF) projects (see Figures 1 and 2), that have yielded use- private sector companies receive CERs, which they can use ful experience for developing additional projects. This note towards their obligations under the Kyoto Protocol or highlights the lessons learned in the Region, to date. domestic regulations. Figure 1 - Regional Distribution of PCF Project Pipeline Figure 2 - Technology Distribution of the PCF Project Pipeline Waste Management (10%) Eastern Europe (23%) Biomass (19%) Latin America (30%) Hydro (12%) LULUCF (2%) Gas Flaring (1%) Central Asia (6%) Fuel Switch (12%) South Asia (9%) Geothermal (3%) Africa (20%) Energy Efficiency East Asia 12% (23%) Wind (18%) 1 To date, six governments and 17 companies, all from Colombia Jepirachi Wind Farm is a 20 MW wind project in the industrialized countries, have contributed funds to the PCF, North East of Colombia. It will displace 68.3 GWh annually of and have already approved projects with emissions coal and gas energy for a purchase of $3.5 million CERs, and reduction potential of more than $100 million. PCF projects bring numerous economic and social benefits to the local are all subject to indigenous people. independent validation and verification, and may be Nicaragua's Gemina/ potentially certified to Box 1 - Objectives: What will the PCF produce? Bronzeoak Biomass receive carbon credits. project will produce 2 High-Quality Emission Reductions MW of clean energy for a In June 2002, Fund The PCF is intended to invest in projects that will produce rice and flour mill that participants expanded their high quality greenhouse gas emission reductions that could will use its own rice husk contributions to the PCF from be registered with the United Nations Framework Conven- waste as fuel. It will $145 million to $180 million. tion on Climate Change (UNFCCC) for the purposes of the avoid methane emissions These companies see the PCF Kyoto Protocol. To increase the likelihood that the reduc- that result from husk as a powerful tool for learning tions will be recognized by the Parties to the UNFCCC, in- dumping activities and how market-based dependent experts will follow validation, verification and will reduce carbon mechanisms can help mitigate certification procedures that respond to UNFCCC rules as emissions by replacing climate change. they develop. electricity in a heavily diesel-powered system. Knowledge PCF Projects in LAC This project is the first By transacting the business of reducing emissions, the PCF component of an will develop a major knowledge base. The PCF will maxi- umbrella framework to be Currently, there are close to mize the value of its experience by collecting, analyzing, set up in Nicaragua. twenty PCF projects in the and disseminating information and knowledge to NGOs, LAC Region under governments, private sector interests, and any other stake- Other projects in the PCF preparation. Most use hydro holders involved in the climate change negotiations. pipeline in LAC include: or wind power, although wind and hydro power cogeneration, biomass, Public-Private Partnership plants in Honduras; geothermal, solid waste Finally, PCF resources will be provided by both the public geothermal and bagasse management, and gas flaring and private sectors. The PCF aims to demonstrate how in- cogeneration in El reduction technologies are sights and experience from both sectors can be pooled to Salvador; hydro and also represented. mobilize additional resources for sustainable development geothermal in Guatemala; and address global environmental concerns. The active par- wind power, gas flaring The first PCF project in LAC ticipation of both sectors ensures that the PCF will operate reduction and sugarcane to reach the stage of a efficiently and in accordance with the Kyoto Protocol bagasse cogeneration in negotiated Emissions while serving the interests of World Bank client countries. Mexico; biomass and Reductions Purchase solid waste management Agreement (ERPA), and the in Brazil; bagasse third such project in the PCF's cogeneration in Guyana; history, is the Chacabuquito Hydropower project in Chile. gas-to-liquid technology in Peru; hydro in Ecuador; nitrous Chacabuquito is a 25 MW run-of-river hydro power plant. It oxide abatement in Chile; run-of-river hydro in Colombia; will generate 175 GWh to replace coal/gas energy that would and wind farms in Argentina and Jamaica. New project have produced greenhouse gas emissions. The project entails ideas from the Region are being received by the PCF nearly the largest purchase of CERs for the PCF so far; $6.7 million every week. over the next 14 years. The Brazil Plantar project was the second one negotiated in Lessons Learned the Region, and involves the purchase of $5.3 million in CERs. Instead of coal fuel in pig iron production, the . project will substitute high energy-content biomass and Many lessons have been drawn so far from the charcoal fuel that will be planted specifically for this implementation of PCF projects in LAC: purpose. The project is unique in that it also includes additional forestry activities that will offset carbon. First Lesson: Climate-Friendly Market Mechanisms Work PCF projects not only help mitigate climate change globally, Preparation of the Costa Rica Umbrella Project for Renewable but also catalyze new and additional investments in clean Energy Resources is well advanced. It currently includes three technologies in developing countries. OECD countries are small-scale sub-projects ­ two windfarms and one hydro power actively looking for investment opportunities in the LAC re- plant, and will result in over $2 million in CERs. gion in order to help comply with their Kyoto Protocol (KP) 2 commitments. Some countries develop investment facilities Project Financing. Another financial advantage of carbon to promote opportunities and encourage their national cor- finance results from endorsement of projects by the PCF porations to invest; others arrange the concession of export and World Bank. Project financing is not necessarily se- credits for local renewable technologies to developing coun- cured at the time that a project sponsor submits a project tries. These foreign direct investment flows into LAC bring idea to the PCF. Letters of intent from PCF have helped se- in cleaner energy and other economic and social benefits. cure underlying finance in a number of LAC projects, con- tributing to their viability. The introduction of market mechanisms into climate change mitigation is also attracting private players such as commod- Third Lesson: PCF Projects catalyze broader Clean Devel- ity and energy traders and bankers to intermediate between opment action. carbon buyers and sellers. The prospect of a CER commod- Even though many LAC countries are moving towards ity market is boosting competition among selling countries elaborating a Clean Development Mechanism (CDM) strat- in order quickly to develop the right investment climate to egy, only countries that have succeeded in "pushing" a PCF attract buyers. There is also competition among buying project through their regulations and institutions are ready to countries, eager to position themselves to acquire the scarce compete in the CER market. CDM requires a fair amount available CERs to comply with their own KP requirements of capacity building and regulation reform in the energy and or to resell their excess to third countries. environmental areas. PCF projects are the catalysts that trigger all those changes, and help fulfill the PCF commit- Second Lesson: Carbon Finance ment to "learning by doing". works Higher Rates of Return. PCF Fourth Lesson: PCF projects are good projects have demonstrated that car- examples of cross-functional World bon finance can be a very useful re- Bank activities. source in project financing. Adding PCF Projects are typically not just the the sale of CERs to the project cash result of isolated efforts to seek carbon flow has increased project Financial finance in a particular country, but part Internal Rates of Return (FIRRs) of a wider World Bank country strategy. considerably (Table 1). The increase For example, the Nicaragua Umbrella in the FIRR of projects in LAC project came after FPSI's efforts to im- ranges from 20 to 500 basis points, prove rural electrification and to build which translates into relative in- capacity for the electricity market liber- creases of 2.5% to 70%, increasing their attractiveness for alization process.1 The Bank is also offering to the Govern- the private sector. ment of Nicaragua the possibility of participating in the Central America National Strategy Study (NSS) program ad- ministered by ESSD.2 Similarly, the Costa Rica Umbrella Table 1 - Impact of Carbon Finance on Project Financing Project was conceptualized in the framework of an ESSD (PCF Pipeline projects) Ecomarkets project, and the Colombia Jepirachi project was the fruit of a previous NSS program, which also involves other CDM capacity building projects. Each PCF project re- Technology FIRR Increase (%) quires technical assistance from different Bank units that Energy Efficiency/ District Heating 1.4 work together to achieve a common goal, and learn from each other in the process. Wind 0.3 - 1.0 Hydro 0.2 - 0.8 Future Plans Bagasse 0.5 - 3.5 Biomass with methane kick Up to 5.0 The PCF manages $145 million on behalf of its sharehold- ers. The fund's management has recently sought an increase Solid Waste with methane kick > 5.0 of $35 million from its shareholders to take advantage of the $180 million maximum fund size. With $90M already com- mitted in the second year of the investment phase, the suc- The methane kick. The increase is exceptional in projects cess of the fund has also attracted investors to set up new involving methane emission reductions on top of the more funds. The Dutch Environmental Facility (VROM) has usual carbon ERs, due to the higher carbon-equivalence in- signed an agreement with the World Bank to set up a similar tensity of methane. This "methane kick" generates higher fund to purchase CERs on its behalf for an amount up to CERs and therefore biomass and solid waste projects benefit $140M over four years. Other plans are in the making, the most from carbon finance. Project differences are also such as a Community Development Carbon Fund (targeting due to the particular emissions baselines in each country. small projects and small countries, aiming to lower transac- Highly carbon-intensive baselines yield higher CERs. tion costs through streamlined procedures, see Box 2)); and 3 a BioCarbon Fund (specializing in land use, land use change Notes and forestry activities, see Box 3). Dialogue is on-going with other governments (Spain and Austria) on setting up bilateral 1 funds similar to the Dutch one. In the near future, it is highly FPSI is the group in the Bank that deals with financial likely that LAC will participate in these new initiatives as one and private sector institutions. of the leading regions in the Bank. 2 ESSD is the Environment, Social and Sustainable Devel- opment group in the World Bank. ******* Box 2 - Linking Climate Change to Biodiversity Conservation The BioCarbon Fund Under its governing articles, the PCF can only invest a maximum of 10 percent of its funds on activities focusedi n land use, land use change, and forestry (LULUCF). This mirrors developments under the Kyoto Protocol, where only reforestation and afforestation have been recognized as eligible activities for emissions trading with developing countries under the CDM, although a much wider range of LULUCF projects are potentially eligible for economies in transition under joint implementa- tion. This wider range of activities, from conservation to sequestration, also has a significant influence on the Box 3 - Enhancing Income Opportunities for the Poor global carbon cycle. Many opportunities in these areas The Community Development Carbon Fund (CDCF) are likely to be found in the agricultural and forestry sectors. The BioCarbon Fund--a new fund currently in The Bank is also launching the Community Development the design and marketing phase--will help improve our Carbon Fund (CDCF), in collaboration with the Interna- understanding of the linkages among climate change, tional Emissions Trading Association (IETA), to ensure biodiversity conservation and management, and desertifi- that carbon finance might enhance the income opportuni- cation and land degradation. Projects will provide infor- ties of the rural poor, especially communities in smaller, mation to the UNFCCC parties as they make decisions poorer countries and in small island developing states. about eligibility rules under the CDM in the first commit- Projects may provide communities with either direct or ment period for emissions reductions from 2008 to 2012. indirect benefits. A community cooperative-based shade The projects will also provide the parties with practice- coffee project, for example, may directly benefit the live- based insights on activities they may wish to consider for lihoods of the local community. Or, a wind energy facility subsequent commitment periods. The BioCarbon Fund located on tribal lands that generates electricity for the will support projects in areas such as improved forest national grid may provide indirect benefits by using car- management, agroforestry, improved agricultural prac- bon finance to support a clean water or literacy project tices, the prevention of land degradation, watershed man- for the local community. agement, and wetland protection and restoration. Both the BioCarbon Fund and the Community Develop- The BioCarbon Fund will be launched at the Katoomba ment Carbon Fund will have a target size of $100 million. Forestry meeting in Tokyo in early November 2002. The CDCF was launched at the World Summit on Sus- tainable Development in September. About the Author Useful Links Francisco Fernandez-Asin is an energy specialist working http://prototypecarbonfund.org within the Prototype Carbon Fund Unit of the World Bank's http://www.worldbank.org/climatechange Environment Department. Useful feedback and comments http://www.unctad.org/ghg/ were also received from Charles Feinstein and Odil Tunali Payton. To Subscribe to "en breve" please send an email to Additional material for this article was taken from "Environ- "en_breve@worldbank.org" or write to: ment Matters 2002" (visit http://www.worldbank.org/environ- Editor, En breve ment) and the website of the Prototype Carbon Fund (http:// MSN I6-604 www.prototypecarbonfund.org) The World Bank 1818 H Street NW Washington D.C. 4