The Trade Finance Bank for AfricaThe Trade Finance Bank for Africa

Commoditizing Carbon for Emissions Commoditizing Carbon for Emissions Reduction: Afreximbank Approach to Reduction: Afreximbank Approach to

Carbon FinancingCarbon FinancingBy

Mr. Kofi Adomakoh, Director

Dr. Christiane Abou-Lehaf, Manager

[Project and Export Development Finance]Presented at Afreximbank 2010 Annual

Trade Finance Seminar during November 29 – December 2, 2010 in Cairo - Egypt

Presented at Afreximbank 2010 Annual Trade Finance Seminar during November 29 – December 2, 2010 in Cairo - Egypt

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Contents Contents

Introduction The Kyoto Protocol and the Carbon Market The Clean Development Mechanism (CDM)

– Issues and Challenges CDM in Africa Afreximbank Carbon Financing Programme

(CFP) About Afreximbank (www.afreximbank.com)

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1. Introduction1. Introduction

Global concerns about climate change due to unsustainable emissions of Green House Gases (GHGs) (e.g. carbon dioxide )CO2(, chlorofluorocarbons, methane, and nitrogen oxides) have led to concerted efforts to deal with the problem.

On February 16, 2005, the Kyoto Protocol to the UN Framework Convention on Climate Change (UNFCC) came into force involving 165 countries and other governmental entities.

Countries that ratify this protocol commit to reduce their emissions of GHGs or engage in emissions trading if they maintain or increase emissions of these gases.

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The Protocol is “flexible” allowing so-called Annex I (developed) countries to meet their GHG targets by purchasing GHG emissions reduction from elsewhere, either from financial exchanges (e.g. The EU’s Emission Trading Scheme) or from projects which reduce emissions in non-Annex I (developing) countries under the Clean Development Mechanism (CDM) or in other Annex I countries under the Joint Implementation (JI) arrangement.

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For Africa which is the lowest emitter of green-house gases, this development creates an immense opportunity to attract finance for implementing important projects in an environmentally-friendly manner.

For banks supporting such projects, there is an added advantage in that such projects can be financed with better security.

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2. The Kyoto Protocol and the 2. The Kyoto Protocol and the Carbon MarketCarbon Market2.1 About the Kyoto ProtocolThe Kyoto Protocol aims to stabilise GHG concentrations in the atmosphere to a level that would prevent dangerous anthropogenic interference with the climate system. The target for the first commitment period (2008-2012) is to reduce global GHG emissions to 5% below 1990 levels. Reduction targets differ between parties to the conference, reflecting their common but differentiated responsibilities, so that Annex I countries will reduce their emissions, while no such commitments exist yet for non-Annex I countries.

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The commodity is the “reduction of Green House Gas (GHG)

emissions by the equivalent of one tonne of CO2”.

This commodity has a market value, and similar to wheat or oil can be traded across borders on the market.

This commodity is produced by those with a comparative advantage, and consumed by entities requiring emissions reduction credits to meet their regulatory or treaty obligations.

2.22.2 What is the Carbon Market? What is the Carbon Market?

The carbon market, which was established as part of the Kyoto Protocol, is the business of buying and selling greenhouse gas emissions. The carbon market has essentially created a new globally traded commodity where:

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Two commodities are traded in this market:

Emissions allowances: allowances to emit GHG allocated to companies by national governments of Annex I countries. Companies that emit less than their allowances can sell these to companies emitting more than their allocation, or to trading companies. In the European Union Emission Trading Scheme (EU ETS) the allowances are called EU Allowances (EUAs).

Project-based emissions reductions: emission reduction generated by project activities, which are certified by an independent auditor. Certificates are called Certified Emission Reductions (CERs) or Emission Reduction Units (ERUs), depending on the origin. CDM projects generate CERs.

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The carbon market covers the three Kyoto Mechanisms:

a) the CDM, for emission reduction projects in non-Annex I countries;

b) Joint Implementation, for emission reduction projects in Annex I countries for which the emission reductions are credited to another country than the host country; and

c) International Emission Trading, for direct trading of emission allowances between Annex I countries.

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2.32.3 Size of the Carbon MarketSize of the Carbon Market

The global carbon market in 2009 saw 82 billion metric tonnes (gigatonnes or Gt) of carbon dioxide, up 68% on 2008, according to a recent report published in Carbon Market Research – and released by Point Carbon.

In 2008, trade was also up an impressive 83% on 2007, reflecting the rapid expansion in global carbon trading despite difficult global economic conditions.

Despite this impressive growth in trade, however, the value of the global carbon market in 2009 remained virtually unchanged against 2008 figures. The carbon market was worth €94bn (US$136bn) in 2009, €92bn (US$133bn) in 2008 and €40bn (US$58bn) in 2007.

Annual Volumes (MtCO2e) of Project-Based Emission Reduction Transactions (vintage up to 2012)

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Source: Capoor, K. and Ambrosi, P. , 2009 “State and Trends of the Carbon Market”, May, pg. 32, World Bank as cited in www.siteresource.worldbank.org

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Several European financial institutions have set up procurement vehicles designed to purchase CERs/ERUs directly from project developers and sell them to emitters under the EU ETS.

Similar vehicles have been set up in Japan. In addition to private sector funds, publicly funded government-led procurement programmes have been set up throughout Europe and in Japan to purchase CERs from project developers in order to support national level compliance efforts under the Kyoto Protocol.

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2.42.4 Prices for CERsPrices for CERs

The range of CER prices reflects differences in the delivery. CERs that are available for immediate delivery are priced at €12 on overage, whereas for future delivery are discounted to about €8-11. There are also price differences between countries. Generally, sellers in China and other countries are willing to accept lower prices than those in India.

Prices have also been adversely affected by the global economic crisis and the lack of progress on extending Kyoto at Copenhagen in 2009.

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Source: Point Carbon, 2006.

Historical CER Prices

0

5

10

15

20

25

2002-03 2004 2005 2006

Eu

ro

1. Registered project w/a firm delivery guarantee

2. Registered project w/o a firm delivery guarantee

3. Non-registered project with no delivery guarantee

Historical CER Prices and DriversHistorical CER Prices and Drivers

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CER and ERU price categories (March CER and ERU price categories (March 2007)2007)

Contract category CDM (€/t)

JI(€/t)

1. Non-firm volume; buyer assumes regulatory risk

5 – 7 5 – 6

2. Standard off take, non-firm volume

6 – 10 6 – 9

3. Firm volume, compensation upon non-delivery

10 – 12 6 – 12

4. Guaranteed delivery, seller assumes all delivery risk

11 – 13 n.a.

Source: Point Carbon (2007), “Carbon Market 2007” a paper presented by Gassan-zade, Olga during the Seminar on “Industrial Energy Efficiency Projects in the Clean Development Mechanism and Joint Implementation” organized by UNIDO during 19-20 March 2007.

Lower risk for the seller

Higher risk for the seller

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3.3. The Clean Development Mechanism The Clean Development Mechanism (CDM) – Issues and Challenges(CDM) – Issues and Challenges

3.1 What is CDM?

The Clean Development Mechanism (CDM) was decided on at the 7th Conference of Parties (COP) to the UNFCCC in Marrakech in 2001, as outlined in the Marrakech Accords. The CDM procedures were approved and adopted during the 11th COP in Montreal in 2005.

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By funding and implementing projects in non-Annex I countries, Annex I countries reduce GHG emissions in the non-Annex I countries. The emissions saving, expressed in the Certified Emission Reduction (CER) credits will be added to the total emission cap of the Annex I country, helping it to meet its target. In effect, this increases the total Annex I emission allowance, because non-Annex I countries do not have emissions reduction targets.

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In 2009, the CDM Market saw 1.6Gt (1.6 billion

Mt) of carbon traded, worth about €17.5 billion.

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Egypt10%

Morocco11%

Tunisia3%

Côte d'Ivoire

1%

Cameroon3%

Cape Verde

1%

Congo DR3%

Equatorial Guinea

0%Ethiopia

1%

Ghana1%

Kenya11%

Liberia1%

Madagascar1%

Mali1%

Mauritius1%

Mozambique0%

Nigeria6%

Rwanda2%

Senegal2%

South Africa26%

Sudan1%

Swaziland1%

Tanzania4% Uganda

9%

Zambia1%

Source: www.cdmpipeline.com

Geographical Distribution of CDM Projects in Geographical Distribution of CDM Projects in the CDM pipeline, as of October 2010 the CDM pipeline, as of October 2010 In the CDM pipeline: 148 projects in Africa with total 30 million tCO2/year

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3.2 CDM Principles3.2 CDM PrinciplesThe CDM is based on three global principles:

1. Participation of the project partners is voluntary

2. The project results in real, measurable and long term benefits related to the mitigation of climate change.

3. The reduction of emissions through the CDM project must be additional to reductions that would occur without the CDM project (Additionality principle).

The implication of principle 2 is that the emission reductions that can reasonable be attributed to the project activity must be directly quantifiable, and long-term. The Additionality principle implies that the project would not be implemented in absence of CDM revenue, because of economic or other barriers, and contributes to a net reduction in emissions from a concrete baseline scenario, in which the project would not happen.

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3.3 3.3 CDM’s Organizational StructureCDM’s Organizational Structure

Global National Project

• Conference of the Parties (COP)

• CDM Executive Board (EB)

Designated National Authority (DNA)

• Annex I Party• Non-Annex I Party• Investors (CER

buyers)

Designated Operational Entity (DOE)

3.3.1 CDM Project Participants

Source: Dijkstra, S. (2006), “Clean Development through Cogeneration” (October) a paper presented to the UNIDO/CTI/UK Trade and Investment Seminar on Energy Efficiency in CDM and JI, Vienna, 19-22 March 2007.

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3.3.2 CDM’s Organizational Structure 3.3.2 CDM’s Organizational Structure

COP/MOP*

CDM Executive Board

Methodologies Panel

Afforestation & Reforestation

Working Group

Small Scale Working Group

CDM Accreditation

Panel

Accreditation Assessment

Team

Registration Team

Source: Institute for Global Environmental Strategies, CDM in Charts, 2006 as cited in Dijkstra, S. (2006), “Clean Development through Cogeneration” (October).

* The Conference of the Parties serving as the Meeting of the Parties to the Kyoto Protocol

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3.43.4 Types of CDM ProjectsTypes of CDM Projects

Type I. Renewable Energy Projects1. Electricity generation by the user2. Mechanical energy for the user3. Thermal energy for the user4. Renewable electricity generation for a grid

Type II. Energy Efficiency Improvement Projects1. Supply side, Demand side and fuel switching

Type III. Other Projects1. Methane recovery, Transport, Agriculture and Land

use, etc…

Number (%) of CDM projects in each category, as of October 2010*

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•In the CDM pipeline•Renewables include Hydro, Wind, Solar, Geothermal, Biomass, and Tidal.Methane avoidance includes Fugitive gas, Agriculture, Cement CO2 usage, coal bed/mine methane.

Source: UNEP Risoe CDM Pipeline (www.cdmpipeline.org)

3.4 Types of CDM Projects (cont’d)3.4 Types of CDM Projects (cont’d)

Expected CERs Until 2012 (%) in each category

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•Renewables include Hydro, Wind, Solar, Geothermal, Biomass, and Tidal.Methane avoidance includes Fugitive gas, Agriculture, Cement CO2 usage, coal bed/mine methane.

Source: UNEP Risoe CDM Pipeline (www.cdmpipeline.org)

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3.5 Costs and Outputs of a CDM Project3.5 Costs and Outputs of a CDM Project

Eligible CDMProject

Normal Project Costs- Planning costs- Capital costs- Operation costs

CDM Related Costs- Project design costs- CDM Procedural costs- CER transaction costs

Normal Project

Revenues

CERs

Source: Wade, 2006 as cited in Dijkstra, S. (2006), “Clean Development through Cogeneration” (October) a paper presented to the UNIDO/CTI/UK Trade and Investment Seminar on Energy Efficiency in CDM and JI, Vienna, 19-22 March 2007.

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3.6 Challenges facing CDM Projects3.6 Challenges facing CDM Projects1. Transaction costs are relatively very high. One reason why small scale projects are at a disadvantage

CDM Project Cycle Carbon Transaction: Consultant’s Estimate of Costs (US$)

A) Up-Front Costs:

1. Feasibility Assessment 5,000 – 20,000

2. Preparation of the Project Design Document (PDD)

25,000 – 40,000

3. Registration 10,000

4. Validation 10,000 – 15,000

5. Legal work 20,000 – 25,000

Total Up-Front Costs 70,000 – 110,000

B) Operational Phase Costs

1. Sale of CERs Success fee of 5-10% of CER value

2. Risk Mitigation 1-3% of CER value annually

3. Monitoring and verification 3,000 – 15,000 per year Source: Ecosecurities, 2003: Quoted in UNEP Energy and Environment Group, the CDM-A User’s Guide, 2003.

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3.6 Challenges facing CDM Projects 3.6 Challenges facing CDM Projects (cont’d)(cont’d)

2. Additionality of CDM Projects Difficult to Prove

3. Political Uncertainty: Post-Kyoto Arrangements

4. Financial Uncertainty: Carbon Markets and Carbon Prices

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3.73.7 Financing RisksFinancing Risks3.7.1 CDM Project Risks

3.7.1.1Registration/Regulatory risk3.7.1.2Performance/Delivery risk3.7.1.3Counter-party risk3.7.1.4Market risk3.7.1.5Country risk

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3.7.1.1 Registration/Regulatory Risk3.7.1.1 Registration/Regulatory Risk

Registration risk refers to the likelihood that the project will not be validated by a Designated Operational Entity (DOE) and registered by the CDM EB (Executive Board). There can be several reasons for this to happen:

Non-approval of a new baseline methodology.

Unsuccessful validation of methodology of calculating emission reduction.

Non-approval by the host country.

Request for review at registration by CDM-EB.

Request for review at CER issuance by CDM-EB.

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3.7.1.2 Performance/Delivery Risk3.7.1.2 Performance/Delivery Risk

This risk is related to delivering uncertainties as to whether the project will produce the volume of emissions reductions that are estimated in the PDD.

Typical risks include:

Will the project be completed at all?

Delays in Commissioning: Will the project start as planned?

Unreliability of Fuel Resource Supply: Will sufficient fuel be

available at affordable price for the project throughout its lifetime?

Breakdown in Technology: Will the technology remain reliable throughout the project lifetime?

Unreliable Financial Flows: Will the project face problems through unreliable non-CER?

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3.7.1.33.7.1.3 Counter-party RiskCounter-party RiskThe CERs from projects are generally transacted through forward contracts in which the Buyer agrees to pay the Seller for delivery of a specific volume of CERs on a specific date at a price negotiated at the time of initial contract. Because contracts are private agreements between two parties there is always a risk that a party may default on its side of the agreement. Some of the issues relating to the likelihood of default are:

Insolvency: Will the CER Buyer remain financially solvent for the duration of the contract?

Fraud/Wilful misconduct: Will the Buyer and the Seller follow through on the contract, especially if prices move adversely from their respective points of view?

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3.7.1.4 Market Risk3.7.1.4 Market Risk

In addition to the uncertainty in financial flows faced by conventional project developers, CDM projects face an additional risk associated with the income they will receive from the sales of CERs, based on carbon market developments.

CER prices are determined by the supply and demand in the market for emissions reductions. Since market conditions change, prices fluctuate and as a result project developers are not certain of the additional income they will earn from CER sales. This can endanger the viability of CDM projects, if they rely heavily on the CER revenue and prices are not fixed and firm.

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3.7.1.5 Country Risk3.7.1.5 Country Risk

Will host government of project expropriate the project; place embargoes on imports and exports.

Number of CDM Projects in Africa by Type, October 2010*

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•In the CDM pipeline•Renewables include Hydro, Wind, Solar, Geothermal, Biomass, and Tidal.Methane avoidance includes Fugitive gas, Agriculture, Cement CO2 usage, coal bed/mine methane.

Source: UNEP Risoe CDM Pipeline (www.cdmpipeline.org)

Volume of CERs until 2012 in Africa by type

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•In the CDM pipeline.- Renewables include Hydro, Wind, Solar, Geothermal, Biomass, and Tidal.- Methane avoidance includes Fugitive gas, Agriculture, Cement CO2 usage, coal bed/mine methane.

Source: UNEP Risoe CDM Pipeline (www.cdmpipeline.org)

Country 2004 2005 2006 2007 2008 2009 Oct. - 2010

              Number %

Egypt 0 0 5 6 10 13 15 10%

Morocco 1 3 4 4 8 9 16 11%

Tunisia 0 0 2 2 2 3 4 3%

North Africa 1 3 11 12 20 25 35 24%

Côte d'Ivoire 0 0 0 0 1 3 2 1%

Cameroon 0 0 0 0 0 2 4 3%

Cape Verde 0 0 0 0 0 1 1 1%

Congo DR 0 0 0 0 1 4 5 3%

Equatorial Guinea 0 0 0 0 0 0 0 0%

Ethiopia 0 0 0 0 1 1 1 1%

Ghana 0 0 0 0 0 1 1 1%

Kenya 0 0 1 2 5 14 17 11%

Liberia 0 0 0 0 0 1 1 1%

Madagascar 0 0 0 0 1 1 2 1%

Mali 0 0 0 1 1 1 1 1%

Mauritius 0 0 0 0 0 1 2 1%

Mozambique 0 0 0 1 1 1 0 0%

Nigeria 0 2 2 2 4 7 9 6%

Rwanda 0 0 0 0 1 3 3 2%

Senegal 0 0 0 0 1 2 3 2%

South Africa 1 7 14 21 24 30 38 26%

Sudan 0 0 0 0 0 0 2 1%

Swaziland 0 0 0 0 1 1 1 1%

Tanzania 0 0 1 1 4 5 6 4%

Uganda 0 1 1 2 8 11 13 9%

Zambia 0 0 0 0 1 1 1 1%

Sub-Sahara Africa 1 10 19 30 55 91 113 76%

Total Africa 2 13 30 42 75 116 148 100%

Total Global 52 488 1,122 2,205 3,579 4,696 5,619

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Cumulative Number of CDM Projects, 2004 – October 2010

Source: UNEP Risoe CDM Pipeline (www.cdmpipeline.org)

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5. Afreximbank Carbon Financing 5. Afreximbank Carbon Financing ProgrammeProgramme5.1 Purpose5.1 Purpose

To support environmentally-friendly projects in Africa by promoting project-based trading of certified emission reductions (Carbon Credits) under the Kyoto Protocol’s Clean Development Mechanism (CDM) as well as pre-financing receivables from carbon credits earned and traded by African businesses and governments thereby contributing to reductions in carbon emissions and abating consequential climate change.

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5.2 5.2 ObjectivesObjectives

The Bank’s CFP has the general objective of supporting African private and public environmentally-friendly projects, some of which would otherwise not be bankable, by leveraging the credit of off-takers of carbon credits earned by those projects to complement other revenue flows supporting such deals.

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1. to stimulate investment in environmentally-friendly projects under the CDM

2. To leverage additional carbon finance and supporting investments into Africa through partnering with developed country governments and private corporations wanting to buy carbon credits in African markets;

3. strengthening the capacity of African countries to benefit from the emerging market for carbon credits;

The specific objectives are:The specific objectives are:

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4. to play a major role in building, sustaining, and expanding a market-based approach for carbon emission reductions by piloting the development in Africa, of new techniques for achieving carbon emission reductions while attracting finance for new types of projects (e.g., clean coal, urban infrastructure, sustainable agriculture, aforestation, etc.).

5. to promote awareness about the dangers of GHG emissions and to encourage entrepreneurs to pursue projects that recognize these dangers.

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5.35.3 BeneficiariesBeneficiaries

5.3.1 African corporates and governments implementing projects that have earned or are likely to earn carbon credits;

5.3.2 African banks and financial institutions financing trade in carbon credits and/or projects that have earned or can earn carbon credits; and

5.3.3 NGOs and environmental groups seeking finance to promote projects that have earned or can earn carbon credits.

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5.45.4 Eligible TransactionsEligible Transactions

5.4.1 African Projects under the CDM; and

5.4.2 Carbon traders that have accumulated carbon credits earned by environmentally friendly projects in Africa and who have sold those credits to acceptable parties.

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5.55.5 Implementing ModalityImplementing Modality

Advances to projects against assignment of binding and enforceable carbon credits sales contracts entered into with parties acceptable to Afreximbank;

Country Risk Guarantees to mitigate policy risks for prospective investors in African CDM projects;

Letters of Credit, etc. in support of Eligible Transactions, against carbon credits sales proceeds assignment;

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Performance guarantee covering delivery risk for projects that have sold their CER’s on long term basis;

completion risk guarantees for CDM projects if needed by a prospective purchaser of carbon credits; and

Brokerage/ Advisory Services for CER certification process and trading of carbon credits.

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5.65.6 Financing InstrumentsFinancing Instruments

5.6.1 Direct Advance;

5.6.2 Guarantees; and

5.6.3 Advisory/Brokerage services to assist eligible projects earn carbon credit and trade same in the international markets.

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5.7 Tenor5.7 Tenor

Maximum tenor is 4 years, subject to no deal exceeding 2012 unless the Kyoto Protocol is extended.

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5.85.8 PartnershipsPartnershipsThe Bank implements its CFP using a partnership approach. Such partners include:

1. African, non-African Multilateral Development Institutions.

2. African and non-African EXIM Banks.

3. African and non-African banks and Carbon Funds.

4. African and non-African governments.

5. African and non-African corporates, including brokerage firms.

6. NGOs and environmental groups.

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7. About Afreximbank 7. About Afreximbank (www.afreximbank.com)(www.afreximbank.com)

Established in 1993 as a multilateral financial institution. Shareholders include African governments and/or their

Central Banks; African Multilaterals (Class A Shareholders); African private investors (Class B Shareholders); and non-African investors (Class C).

Authorized capital = US$750 million. Mandated to finance and promote intra- and extra-

African trade. Headquartered in Egypt with Branch offices in Abuja,

Nigeria; and Harare, Zimbabwe.

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ContactsContactsHeadquarters:The PresidentPhysical Address: 72 (B) El Maahad El Eshteraky Street - Heliopolis,

Cairo 11341, EgyptPostal Address: P.O. Box 613 Heliopolis, Cairo 11757, EgyptTelephone Nos.: (202) 24564100/1/2/3; (202) 24515201/2Fax No.: (202) 24564110; (202) 24515008Website: http://www.afreximbank.com

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Thank you Thank you

forfor

ListeningListening