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To address climate change and promote the transfer of finance and climate-friendly technology to developing countries, the World Bank earlier this week launched the first global, market-based mechanism—the Prototype Carbon Fund (PCF)—to accomplish these goals. (See PCF Q&A sidebar.)

"The PCF offers a tremendous opportunity to boost financial and technology flows to developing countries at a time when government-to-government transfers have fallen to historically low levels," said James D. Wolfensohn, World Bank president.

Through its establishment of the PCF, Wolfensohn said the World Bank hopes to explore how market-based mechanisms and the "considerable financial muscle of the private sector" can contribute to addressing the twin challenges of environmental stewardship and sustainable development.

"We are concerned about the vulnerability of poor people in poor countries to the threat of climate change. For an institution whose task is to alleviate poverty, we would be negligent if we failed to explore innovative ways of making the climate change convention work," he said.

In recognizing the need to address environmental issues and concerns, governments negotiated the Framework Convention and the Kyoto Protocol during the 1990s. The protocol, which guides implementation of the Convention, includes specific emissions reductions targets for industrialized countries. It also contains provisions allowing them some flexibility so they can meet these commitments to reduce emissions in the most cost-effective manner.

Similar to the sulfur dioxide emissions trading program set up by the U.S. Environmental Protection Agency, the PCF—established with contributions from governments and private companies—creates a market in emissions reductions under these "flexibility" provisions. The PCF offers companies operating in industrial nations credits against future carbon dioxide emissions limits if they invest in emissions-lowering projects in developing countries.

To date, four governments and nine companies have approved participation in the PCF, bringing the total of committed contributions to US$85 million. The fund is capped at US$150 million, and plans to start operations in April 2000. As the manager of the PCF, the World Bank acts as a broker, negotiating a price for the emissions reductions that is reasonable for both buyers and sellers.

"There are many opportunities to reduce emissions of greenhouse gases in developing countries at a cost of between $5 and $15 dollars for a ton of carbon," said Ken Newcombe, the World Bank's PCF manager. "This compares with a marginal abatement cost of upwards of $50 for a ton of carbon in advanced economies. It is the difference in cost to industrialized and developing countries of reducing greenhouse gas emissions that provides the opportunity for mutually beneficial trading relationships."

Newcombe said the PCF plans to strive for emissions reduction prices at about $20 for a ton of carbon ($5 for a ton of CO2), thus covering the regulatory and market risks to contributors while providing adequate incentives to project sponsors and their governments in developing countries.

Governments set to participate in the PCF are Finland, The Netherlands, Norway, and Sweden. Private sector participants include the electric power companies of Tokyo, Chubu, Chugoku, Kyushu, Shikoku, and Tohoku, the trading houses Mitsubishi and Mitsui, Electrabel of Belgium. Companies currently discussing participation include Statoil and NorskHydro of Norway, Gaz de France of France, Environment Banc and Exchange LLC (EBX) of the United States, and SK Power of Denmark.

PCF Advantages
For poor countries, the PCF represents an opportunity to access climate-friendly technologies and earn revenues from selling emissions reductions. Currently, the World Bank has approved two projects—a solid waste project in Latvia and a renewable energy fund in Costa Rica—for PCF participation. (See Project Profiles below.)

During the next three years, the World Bank plans to invest all the fund's capital in 20 or more projects. Most are expected to be linked to projects identified by the World Bank Group as part of its regular work, but they may also originate from the private sector, other multilateral development banks, and bilateral donors.

The primary focus centers on renewable energy technologies, including wind, small hydro, and bio-mass, that wouldn't be profitable without revenue from emissions reductions sold to the PCF. In some cases, the PCF will finance these types of projects through local carbon funds modeled on the PCF but using financing from local commercial and development banks, and private companies. About 20 countries have already declared interest in hosting PCF projects.

For the industrial nations, contributors receive low-cost emissions reductions to help them meet their commitments arising from the Kyoto Protocol. Under the protocol, industrial nations must reduce greenhouse gases to at least 5.2% below their 1990 levels by the end of 2012. Whether the emission reductions earned by the PCF will count toward these commitments depends on rules being developed by the parties to the UN Framework Convention on Climate Change. These rules should be developed when the parties meet in The Hague in November of this year.

Project Profiles
Latvia's solid-waste management project hopes to implement a self-sustaining modern waste management system for the city and region of Liepaja, and with the PCF contribution, to install state-of-the-art energy cell technology for maximum collection of generated methane that wouldn't be affordable otherwise. This will lead to lower greenhouse gas emissions by capturing the methane emitted by decaying waste and substituting this methane for fossil fuels to generate electricity and heat.

The Government of Latvia plans to upgrade or close all existing disposal sites, many of which pose a risk to local groundwater resources. With 65,000 tons per year, the Liepaja region generates about 10% of the country's annual municipal waste. The site in the city of Liepaja is the largest in the region, receiving about 45% of total regional waste. As with all sites in the region, it is inappropriately located because of its geology and high water table, and it lacks an effective barrier to protect the groundwater against percolating leachate.

To remedy this situation, the project will close all existing landfills in the Liepaja region and create a regional waste treatment facility, meet sanitary landfill standards through technical and operational improvements at the new regional waste treatment facility, separate recyclable materials and transport hazardous waste to another appropriate site. The project also will employ energy cells for enhanced degradation of easily biodegradable waste, collect landfill gas containing 50% methane, and use the captured methane to generate electricity.

Total project costs are estimated at US$12 million to US$15 million, and the PCF contribution is likely to be in the range of US$2 million to US$3 million. The least-cost way of upgrading existing disposal sites to meet the minimum environmental requirements is through a sanitary landfill. It is estimated that, relative to this baseline, during its life the project will mitigate 106.6 million m³ of landfill gas emissions containing 50% methane. Over the project lifetime of 20 years, this translates into 0.762 million tons of CO2-equivalent, or 0.208 million tons of carbon (tC).

Project managers expect to complete the project appraisal this month, with negotiations starting in February and implementation set for September.

The PCF plans to co-finance Costa Rica's proposed Renewable Energy Fund under the World Bank's Eco-Markets project. The Eco-Markets project supports the development of markets at the local level for environmental services provided by forest ecosystems, at the national and regional level for energy, and at the global level for carbon offsets.

The Renewable Energy Fund will support the development of small renewable energy projects to meet increased demand for energy within Costa Rica and neighboring countries. Specifically, PCF financing will create the local Renewable Energy Fund through the Costa Rican Office of Joint Implementation and deliver carbon offsets payments to small renewable energy projects. The project will also provide value-added services, including certification and verification of carbon baseline and flows, new projects identification, and financial advisory services.

The 1996 Treaty on Electricity Markets of Central America, signed by the presidents of the six nations of Central America, created one regional electricity market supporting the interconnection of electricity systems in Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica, and Panama. As a result of this interconnection, the most cost-effective additional power generating capacity in the six countries to date is fossil fuel-based power plants.

The PCF plans to give up to US$10 million to the Renewable Energy Fund. Project preparation completed in September 1999, with appraisal set for January of this year, negotiations set for February, and loan effectiveness expected in May.

By April C. Murelio
editor@poweronline.com

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Prototype Carbon Fund Q&A

Why should the World Bank be taking a proactive stance on promoting a global emission reductions market?

• Studies demonstrate that the World Bank's borrowing member countries are particularly vulnerable to climate change. Serious efforts to promote sustainable development, therefore, have to take into account the problem of climate change.

• The Fund provides an example of how the Bank can work in partnership with both public and private sectors to mobilize new capital for the development of its borrowing member countries.

• The developing countries benefit directly from the Emission Reductions market through the opportunities it offers to transfer additional financial resources and technology to promote sustainable development.

• The Bank generates knowledge on how public and private entities can participate in the global market for project-based emissions reductions in the framework of the Kyoto Protocol. The United Nations Framework Convention on Climate Change (UNFCCC) recognizes the need for reliable channels through which this knowledge can be transferred.

Why is the fund called a "Prototype"?

• The fund is considered a prototype because it is the first mechanism of this kind to be developed internationally. Emphasis is placed upon the ‘learning-by-doing' aspect of this mechanism. Other entities may gain from this experience and possibly replicate it with similar mechanisms on a larger scale.

• The term "prototype" doesn't refer to any intention by the Bank to develop additional funds.

Why is the fund called a "Carbon" fund?

• The fund's name evolved out of a popular shorthand for all six greenhouse gases covered by the regulatory framework of the UNFCCC/Kyoto Protocol (carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexaflouride). It does not intend to imply that the fund will only develop projects that aim to reduce or sequester carbon emissions.

• Fund management gives due attention to the possibility of investing in projects involving non-fuel related greenhouse gases (GHGs) and carbon-based fuel use derived GHGs.

What does a typical PCF deal look like?

• The PCF invests in projects where positive climate change reduction benefits can be achieved and independently validated at a reasonable cost.

• PCF investments follow a set of project selection criteria, including funding allocation guidelines. The PCF invests in generating additional emissions reductions from 20 or so projects, covering a range of technologies and countries, under both Joint Implementation (JI) rules and the Clean Development Mechanism (CDM).

• Most projects will be in small- to medium-scale renewable energy development. In most cases, PCF funding either results in a switch in fuel source, from a fossil fuel to a renewable or alternative lower carbon fuel source, or in a change of technology to a cleaner more efficient technology, or both.

• PCF management seeks projects that result in a price of about $20/ton of carbon ($5/ton of CO2) can be negotiated providing adequate incentives both to the project sponsor and the government concerned to ensure that emissions reductions are generated and certified and can be transferred to PCF participants.

How will the payments for PCF Emission Reductions be distributed?

• PCF negotiates agreements with both host country governments and project sponsors to finance specific projects, which produce emissions reductions.

• Agreements with governments are essential because the governments must agree to recognize emissions reductions generated in their economies if those reductions are to be recognized by the parties to the UNFCCC and its Kyoto Protocol.

• Agreements with project sponsors are necessary to ensure investments are made and projects are managed so that emissions reductions not only occur, but also that these emissions reductions can be verified and certified.

• Project sponsors will negotiate a price and a payment schedule for emissions reductions and this price will typically include a profit.

• Host country governments stand to benefit from a trade in emissions reductions through additional private sector investment stimulated by the trade. How governments generate revenue from the trade is a matter of public policy for each government. Governments have at their disposal the usual range of fiscal policy instruments if they choose to generate revenue from PCF transactions, including taxation on increased profits of PCF deals, transaction fees and levies.

What is the likely size of the market for emissions reductions?

• All estimates of market volume are speculative at this early stage in the market's development.

• To meet their obligations of a 5 percent reduction in their 1990 levels of emission, industrialized nations must reduce about one billion tons of carbon emissions between 2008 and 2012.

• If half this volume of reductions occurs through trade and the price range is $20 to $40 per ton of carbon emissions, the trade volume is in the range of $10 billion to $20 billion per year. Because developing countries have opportunities to achieve carbon emissions reductions at around this price, a significant proportion of the trade is likely to occur between them and the industrialized countries under the Clean Development Mechanism (CDM).

Does the Bank have a clear exit strategy?

• The Bank doesn't intend to remain a player in this market once private sector confidence has been established and the market is open and functioning.

• No plans exist for the development of a second fund. Review of the Bank's continued involvement will take place on the basis of experience gained with the fund after consultation with the Bank's executive directors.

What is the position of the Fund in relation to the CDM (Article 12, Kyoto Protocol)?

• The Fund is designed to support the Clean Development Mechanism (CDM) and be subservient to it as one of the entities that may participate in serving the purposes of the Kyoto Protocol. A central objective of the Bank in establishing the fund is to demonstrate how the CDM can be an effective vehicle to help developing countries meet their sustainable development objectives.

• The Bank doesn't wish to position itself as the institution that implements the CDM. The Bank wishes to participate in the CDM like any other entity permitted to do so under the mechanism by the CDM's executive board as indicated in Paragraph 9 of Article 12 of the protocol.

• Potential fund participants indicate an interest in including Article 12 projects in the fund portfolio and after the results of the Fourth Conference of the Parties to the UNFCCC in Buenos Aires, potential participants indicated a preference to shift the initial emphasis of project development to developing countries.

• The fund will operate under the CDM modalities and use CDM procedures once they are established to "register" these projects, subject to the UNFCCC and Kyoto Protocol rules.

Is the Bank getting ahead of the UNFCCC by establishing the Fund?

• The Kyoto Protocol provides for the transfer or acquisition of emission reductions from project activities in countries with economies in transition (Article 6) and in developing countries (Article 12) beginning in the year 2000. The Buenos Aires Plan of Action provides for a work program (with priority to be given to CDM) with a view to taking a decision at the Sixth Conference of the parties in 2000 on the detailed modalities of these mechanisms (Decision 7/CP.4).

• The Bank works closely with the UNFCCC Secretariat and other specialists to increase the learning value and transparency of the process. In doing so, the Bank tries to be responsive to requests from UNFCCC and its Secretariat to share relevant information and contribute to the ongoing discussion about the rules, guidelines and modalities of the Kyoto Protocol, in particular Articles 6 and 12. The Bank expects that its development of the fund and the experience gained will provide insights that may contribute to the design of the regulatory framework.

• The Bank aims to make the fund operational in April 2000. This provides those participating in the November 2000 (COP-6) negotiations of the rules and procedures for Kyoto Protocol an opportunity to gain insights on possible interpretations of the Kyoto Protocol under implementation as they consider options to regulate the market for emissions reductions under Articles 6 and 12.

What is the relationship between the fund and the Global Environment Facility?

• The Bank and the Global Environment Facility (GEF) have created an informal but comprehensive GEF-Bank consultation process to ensure synergy with and avoid competition between GEF and fund operations. Therefore, the GEF and the Bank have agreed to have GEF Secretariat representation on the fund strategy discussions and to observe the consultative process.

• GEF and fund managers also agreed to compare respective climate change project pipelines before commitments are made to detailed preparation activities. The GEF has first rights of refusal on all projects to be considered for the fund portfolio.

How does the Fund differ from the GEF?

• The fund aims to generate emissions reductions, which can be used by Annex I countries to meet their obligations under the Kyoto Protocol. The fund's objective is to illuminate, in close collaboration with the parties to the Convention, how to facilitate, in a manner consistent with sustainable development, a high volume flow of public and private capital from industrialized to developing countries and economies in transition, while meeting the objectives of the Convention. GEF funding for climate projects is provided primarily as grants and emphasizes a strategic approach to reducing greenhouse gas emissions.

• In addition, the fund aims to promote the conclusion of a fair deal for host governments and project sponsors that will be negotiated to include a benefit that is additional to the incremental cost of the cleaner technology. Thus, the fund creates the opportunity for developing countries and countries with economies in transition to capture a resource rent in return for the resulting emission reductions. The GEF provides funding for agreed incremental costs of projects.

• The fund expects to rely heavily on private sector funding and to stimulate mostly private sector financing in emissions reductions in the context of Articles 6 and 12 of the protocol. The GEF is supported essentially by public funds even though it is also interested in mobilizing private sector financing.

• The GEF largely finances projects that are consistent with its well-articulated Long-term Operational Programs. The GEF includes a window for financing short-term measures but this doesn't exhaust the many cost-effective measures. Among its objectives, the GEF demonstrates projects for replication. In coordination with the GEF, and with the first right of refusal with the GEF, the fund finances cost-effective, verifiable and certifiable greenhouse gas reduction projects, which are consistent with the UNFCCC and the Kyoto Protocol regulatory regime.

Will the Bank dominate the emissions reductions market, and crowd out private sector investment?

• No, the Bank neither seeks a favored nor monopolistic position under the UNFCCC. The Bank merely seeks to catalyze the development of an efficient and equitable global emission reductions market at a time when the private sector has not yet become engaged.

• By creating the fund's knowledge base and by sharing information on the creation and transfer of emissions reductions before its client countries and industrialized countries, the Bank tries to support other organizations, including the private sector, to develop similar instruments and simulate a competitive market for emission reductions.

Will JI/CDM create perverse incentives to fund projects or plants that should simply be closed down rather than invested in to reduce GHG emissions?

• The potential for perverse incentives is not specific to the fund but is a general concern for any emission reduction transactions required for any project under the Kyoto Protocol. The fund hopes to make a contribution to containing such perverse incentives.

• The fund's baseline policy for projects will be based on the Bank's overarching energy and environment policies, as well as its specific country assistance strategies and other relevant Bank policies, plus any guidelines, modalities and procedures of the emerging regulatory framework of the UNFCCC.

• The Bank has a lot of experience with baseline determination through its GEF project portfolio and a number of Activities Implemented Jointly (AIJ) pilot projects. The Bank can also rely on a large pool of information regarding its borrowing member countries' policies in preparing the baseline. Finally, the Bank has undertaken substantive research on baselines and related methodological problems, and has contributed to the body of work now internationally available.

• Subject to the procedures established by the Kyoto Protocol, it is intended that for projects financed by the fund, an independent third party will validate the design of projects, in particular the baseline, before implementation. An independent third party will periodically verify the GHG reductions achieved by the project and the project's continuous compliance with UNFCCC and Kyoto Protocol rules.

• Perverse incentives in economies in transition are diminished by their international commitment to reduce or limit their GHG emissions and the accounting provisions provided for in the Kyoto Protocol.

(Questions and answers provided by the World Bank and edited by April C. Murelio)
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