“Financing Renewable Energy in Emerging Markets – Opportunities & Approaches”

Frank Joshua

Montreal, 28 September 2004

Workshop on Innovative Options for Financing the Development and Transfer of Technologies

Montreal, 27-29 September 2004

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Contents

Investor Expectations in Emerging Markets

Returns on Investment & Impact of Carbon Finance

Assessing Risks & Rewards in Emerging Markets

Opportunities for Private Equity Funds & Debt Providers

Role of Climate Investment Partnership (“C.I.P.”)

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1Investor Expectations in

Emerging Markets

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Emerging markets offer major opportunities for Renewable Energy projects

In the best markets (for example: China, India, Brazil, Chile, Mexico, Korea, Thailand, Philippines) common characteristics of good potential include:

Huge and growing energy demand (e.g. China recently announced that it plans to invest USD120 billion to double generation capacity by 2010)

Centralized power sector (need for re-organization)

Good wind speeds and/or small scale hydro resources

Healthy “start up” growth rates and returns

Increasing environmental awareness

Relevant national and/or local policies in place

Ability to utilize CDM benefits

Emerging markets have significant long term potential compared to North America and Europe

However, until recently, lack of reliable local developers, regulatory risk, and wind data risk have tended to depress investments.

Rationale for Investing in Renewable Energy Projects in Emerging Markets

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Investor Expectations & Opportunity for Strong Emerging Market Returns

Equity investment IRR:

India 15 – 25%

China 10 – 15%

Korea 10 – 15%

Brazil 15 – 20%

Chile 10 – 15%

+ 2.5 – 5% from carbon credits

Expected IRR of individual wind farms: +/- 15% + carbon + country risk premium

Expected IRR of Landfill gas: >15%, + carbon + country risk premium

Exit Strategy: Possible Sale of Equity to local utility or through IPO

If equity is sold after 3 – 5 years of operating history a significant capital gain can be made

IPOs of bundled RE projects have been successful in mature markets (Europe) but have yet to be tried in emerging markets

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2Returns on Investment & Impact of Carbon Finance

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Impact of Carbon Finance

Carbon Finance Deal Structure

Host Country

LendersSponsor/ Project

CF

ERPA

Financing Agreement

Letter of Approval

ERs

ER payment

Debt service

SPV

Permits, etc.

Source: World Bank

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Impact of Renewables

Fuel Displaced Generic Emissions Factor (tCO2e/MWh)

Carbon Revenue US$/MWh at

US$4/tCO2e

Gas 0.50 $2.00

Coal 0.85 $3.40

Diesel 0.75-1.00 $3.00-4.00

Source: World Bank

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Impact of Carbon Finance

At $4/ ton CO2e

Technology IRR @$4/tCO2e

Hydro, Wind, Geothermal 0.5-2.5%

Crop/Forest Residues 3-7%

Municipal Solid Waste 5-15%+

Source: World Bank

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Profitability of a Subset of CIP Projects

TechnologyExpected

project IRR

Expected carbon

premium 1Expected total

IRR incl. carbonBiomass electricity

15% 4% 19%

Biomass heat

15% 5% 20%

Energy Efficiency

16% 1% 16%

Hydro 15% 3% 18%

Landfill Gas 16% 11% 27%

Wind 14% 1% 15%

15% 4.3% 19%

Source: Climate Investment Partnership (CIP)

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Impact of Carbon Finance

Increased cash flow boosts IRRs

~0.5% to 2.5% for renewables/EE

5-15% for CH4

High quality cash flow reduces risk

OECD - sourced

$- or €- denominated

Investment-grade payer

Eliminate currency convertibility or transfer risk

Financial engineering helps access capital markets

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3Assessing Risks & Rewards in

Emerging Markets

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Understanding Carbon Risk (1)

The GHG business involves many poorly understood but widely perceived risks: Regulatory risk

Performance risk

Delivery risk

Counterparty Credit risk

Price risk

Etc.

Proposition: Investors’ inability to accurately assess “Carbon Risks & Rewards” will drive resources towards “Carbon Trading” instead of “Project Finance”

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Understanding Carbon Risk (2)

The Evidence:

Volume of carbon reductions traded since 2001 has doubled year-on-year to over 100 mtCO2e per year

Yet most carbon projects (CDM) have not achieved financial close. Why?

Perceived Risks will:

Discourage investment in RE & GHG Projects by major financial institutions, and

Drive resources towards “Carbon Trading” instead of “Project Finance”… Carbon is not their core business

Hedge trading via Forward Contracts with “payment-on-delivery” terms

Governments & Multilateral Financial Institutions as Investors (e.g. Dutch, UK, PCF, etc)

Missing: Investment Banks; Fund Managers; Debt Providers

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Enabling Carbon-linked Project Finance

But as the GHG market matures “Carbon Procurement” will face supply constraints

And rising carbon prices

Companies and governments could face serious financial exposure

RE & CDM project developers need early upfront financing

In the form of Equity, Debt, & Mezzanine Finance, & Risk Mitigation

Carbon as Collateral: i.e. utilizing the market value of emission reductions to enable projects to proceed

Carbon as financial security (€, $, £)

Carbon as risk mitigation asset

Renewable Energy Certificates (RECs & ROCs)

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4Opportunities for Private

Equity Funds & Debt Providers

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Attracting Private Equity & Debt Providers

The Problem:

Strong market interest exists in emerging markets (private equity and debt) but bundling opportunities are lacking

Investors often lack resources to find, screen, and evaluate projects

And few RE & GHG projects are well structured from a technical, financial and risk point of view; hence access to project debt and equity is poor

Risk perceptions: Investors often see RE & GHG projects as combining: (i) a risky sectors with (ii) high risk markets & (iii) a risky commodity…

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Opportunities for Private Equity Funds

Solution: Renewable Energy Equity Funds

Create commercially attractive diversified investment opportunity by bundling replicable high quality projects

Stick to proven replicable cost competitive technologies, mainly on-grid, and mostly Wind Power, Hydro Power, and Landfill Gas Projects

Work with strong developers to reduce risk of investment delays

Raise equity mainly in the private sector & look to increase returns through soft debt

Lock in advantageous pricing and future cash flow for carbon

ROI of Funds expected to exceed that of individual project investments (i.e. 15 – 20%, plus carbon)

Benefit from opportunity for early exit through bundling and sale of investments after construction and safe operating period.

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Where’s the Money?

Some Examples: European Investment Bank (EIB) renewable energy investments in 2003: €500m

EIB Climate Change Facility: €500m

EIB/EDFI Cotonou Investment Facility: €2.2 billion

World Bank Carbon Finance Business: $450m

Citigroup (Renewables, private equity): US$500m

Government of Netherlands: €500m

Japan Carbon Fund

Development Bank of Japan: US$100m

Japan Bank for International Cooperation: US$100m

Government of Austria: €360m (€36 million per year for 10 years)

Government of Canada: C$50m (C$10 million per year for 5 years)

Other possible sources of funds:

Fortis Bank… World’s largest investor in wind power

Rabobank…

ABN AMRO…

Others…

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5Role of Climate Investment

Partnership (“C.I.P.”)

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A GHG Project Finance Facility (for project-by-project investing)

Project 2

Project Finance Facility (PFF)

PFF Manager (Swiss Re)

Project 1 Project nProject 3

Equity Investors

Grant Providers

Delivery Insurance Providers

Credit Guarantee Providers

Loan Providers

Fin

an

ciad

Re

turn

s C

arb

on C

red

its

$

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The Challenge of Structuring a Deal

Case Example: 100MW Indian Wind Farm (€100 m.)

Sources of Funds (1)

• Developers’ Equity

• Private Equity

• Export Credits

• Senior Debt (Lead Bank)

• Subordinated Debt

• Mezzanine Finance

Other Sources of Funds (2)

• Grants

• Development Finance

• Financial Guarantees

• Vendor Finance

• Suppliers Credit

• Carbon Finance

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CIP’s “Project Finance Capacity Development Initiative for Latin America”

Objectives:

Improve access to project finance by raising technical and financial standards of small and medium size project developers;

Develop analytical tools to better assess carbon risks;

Develop risk mitigation tools to improve the use of carbon as financial collateral in project finance, and enhance the bankability of emission reduction purchase agreements; and

Support direct negotiations between CDM project developers and investors.

Participants: Argentina, Bolivia, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay

Sponsors: Climate Investment Partnership (CIP) [possibly with CF Assist & WBCSD]

Duration: 2 Years, 6 Months

Cost: €2.0 million (Donor enquiry welcome)

Plan to Launch at COP10 in Buenos Aires.

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Contact Details:

Frank Joshua, Chief Executive Officer, CIP

Karen McClellan, Director, Investment, CIP

7-9 Chemin des Balexert,

1219 Châteleine, Geneva, Switzerland.

Tel. (Frank): +41 78 772 4183; (Karen): +44 77 9250 1109

Tel/Fax. +41 22 776 5078

Email: frank.joshua@climateinvestors.com

karen.mcclellan@climateinvestors.com