World Bank broadens its carbon reach

Following its success with the Prototype Carbon Fund, the World Bank is to launch two new carbon funds. Ken Newcombe and Michael Rubino explain the Bank’s latest initiatives

Two and a half years after it launched its carbon finance business with the Prototype Carbon Fund (PCF), the World Bank is expanding its carbon products and their reach with two new proposed funds.

At the World Summit for Sustainable Development in September, the Bank is planning to launch the Community Development Carbon Fund (CDCF).This fund – which has a target size of $100 million – aims to link small-scale projects seeking carbon finance with companies, governments, foundations, and non-governmental organisations (NGOs) seeking to improve the livelihoods of local communities and obtain verified emission reductions (ERs).

Energy projects have been the main beneficiaries of PCF investment

And, in late autumn, the World Bank also intends to begin raising up to $100 million in contributions for the BioCarbon Fund, which is designed to demonstrate and test the use of carbon finance to generate ERs from a wide range of agriculture, forestry, and land use projects in developing countries and economies in transition.

Both funds will be public–private initiatives, building on the Bank’s experience with the PCF. All three funds grew out of the realisation that climate change will have a significant impact on the World Bank’s client countries – in some cases putting past development gains at risk, particularly in poorer, rural communities.

Building on experience
The World Bank’s first carbon fund, the PCF, began operations in April 2000. Fund participants, in June 2002, expanded their contributions to the PCF from $145 million to $180 million.

Six governments and 17 companies, all from industrialised countries, have con-tributed funds to the PCF, which has already placed over $90 million in carbon reduction projects in developing countries (so-called Clean Development Mechanism (CDM) projects) and economies in transition (under Joint Implementation, or JI). Its projects are all subjected to independent validation and verification and may be potentially certified to receive carbon credits under the rules of the Kyoto Protocol, the 1997 agreement to cut industrialised-world emissions of greenhouse gases.

Participants, including power and oil companies from Japan and Europe and leading global banks, benefit from pioneering the business of carbon asset creation and management, disseminating a knowledge base that endows competitive advantage, and supporting stakeholder awareness. The PCF and its participants sit uniquely astride private project finance, carbon asset creation, and, through the World Bank, the intergovernmental process of market regulation.

New carbon finance initiatives
The two new funds will build on the success of the PCF, which purchases ERs from larger renewable energy projects (with a few notable exceptions) in developing countries and economies in transition.

The first fund, the CDCF, will provide carbon finance to small-scale projects in small developing countries.The CDCF is essentially version of the PCF for small-scale projects with significant and measurable community development benefits. The emphasis within the CDCF will be on renewable energy, energy efficiency, methane capture and agroforestry projects.

The second fund, the BioCarbon Fund, will buy cost-effective ERs from sequestration and conservation (forestry and agriculture) projects. It will be a prototype fund demonstrate the use of carbon finance in wide range of land use, agriculture, and forestry projects through two separate lending windows. The first window will generate Kyoto-compatible reductions and the second will generate reductions that can be used voluntary and other markets. Project proposals already submitted for consideration show strong interest in community-based agroforestry and in biodiversity protection coincidental benefits.

Early indications about pricing are that the BioCarbon Fund will deliver projects that are at the same level or slightly lower than the PCF (the PCF pays around $3–4/ton of carbon dioxide or equivalent), while high transaction costs for small-scale projects may result in slightly higher prices for CDCF projects. The World Bank will examine techniques to bundle projects, explore the use of standard contracts, try to work with local intermediaries and explore financial innovation further reduce the project and transaction costs. The Bank will also endeavour mobilise parallel resources from donors support technical assistance and project preparation.

The CDCF
Many project proposals already received the Bank that might be eligible within the CDCF have distinct health or livelihood components. For example, there are large numbers of communities all over the world that go without electricity or have only intermittent electrical power.Yet these same communities sit on untapped renewable energy sources in the form of crop residues from coffee, sugar cane or rice farming. They use imported diesel fuel or oil while burning their crop wastes.

One proposed CDCF project in Thailand offers a different scenario: farmers would turn waste from their rice fields into a profitable and environmentally friendly carbon business. A newly formed power company will buy rice husks from the farmers to burn in the new power plant, providing electricity for villages. The farmers will obtain additional employment and income and, after the first year, the project is intended to be carbon-neutral.

Barriers to the flow of carbon finance to small-scale projects include higher business costs and risks in small and less developed countries – particularly in the poorer rural communities of these countries. Because of this, they are likely to be bypassed by carbon investors. Concern over this market bias has led the Parties to the United Nations Framework Convention on Climate Change (UNFCCC) – which led to the Kyoto Protocol – to find ways to reduce the transaction costs of small-scale projects by simplifying methodologies and procedures.

By working through local intermediaries such as financial institutions, micro-credit institutions, cooperatives and NGOs, and by applying streamlined project procedures compatible with small-scale Kyoto projects, the CDCF will seek to lower transaction costs and the risks involved in developing such projects. The Bank is committed to independent monitoring of the development benefits that would come out of CDCF projects such as the one described above, bundling these community development attributes with emissions reductions to create ‘Development plus Carbon’ and using financial innovation to improve the lives of the poor.

The BioCarbon Fund
Many developing countries have large agricultural economies, many with substantial forests. BioCarbon Fund projects will target agricultural and forestry sectors, where there is an opportunity to improve the livelihoods of local people. Host countries could potentially earn carbon credits by sequestering carbon in a way that increases agricultural productivity and puts their natural resource use on a more sustainable footing.

Afforestation and reforestation activities for CDM and a much wider range of land use, land use change and forestry (LULUCF) activities under JI (for economies in transition) are potentially eligible for carbon credits under decisions made on the Kyoto rulebook in Marrakech last October. Many rules on permanence, leakage and additionality need to be finalised and the Protocol calls for an examination of the expansion of LULUCF eligibility after several years.

Meanwhile, various voluntary, state-based and regional emissions trading programmes are being developed, which are examining potential avenues for their participants toabate, offset or sequester emissions. This holds out the promise of enlarging the possibilities for emissions reductions in agriculture, forestry, and other land use activities, and creating an unprecedented opportunity for poor smallholder farmers all over the developing world.

Take the example of a hillside farmer in Oaxaca, Mexico, on the verge of abandoning his small, exhausted plot of land. Carbon sequestration would offer this farmer several new possibilities. By practising no-till cultivation and inter-planting tree crops (such as shade coffee and fruit trees) and growing live fences, he can sequester carbon – at the same time improving soil fertility, crop yield and income. There are many such examples that could be replicated all over the world. These improved agricultural practices, integrated with carbon, biodiversity, water management and income benefits, would assist rural families to shift to sustainable agriculture.

The BioCarbon Fund could also measure the biodiversity, watershed management, community development or other sustainable development benefits – in addition to carbon emission reductions – in each project, in anticipation of the potential development of traded markets in these environmental goods.

Who benefits?
The World Bank believes that these new funds will create benefits for a wide variety of people, companies and communities. They are an opportunity for developing countries to attract private sector resources that in usual circumstances would not come their way. Host countries and local communities will gain access to investment in clean technologies, best management practices and capacity building.

Potential participants in the new funds have expressed many reasons for their interest: all wish to obtain verified greenhouse gas reductions for possible use in a variety of subnational, national, regional, international or voluntary programmes. Some wish to offer their customers a carbon-neutral product or service. Several want to expand the tools for compliance by benchmarking a wide range of conservation and sequestration options. All want to leverage existing efforts to demonstrate corporate support for sustainable communities.

The private sector knows that there are cheap reductions to be had but, right now, most companies don’t have the appetite to become direct participants in small-scale development projects in unfamiliar countries, in order to meet a possible emissions reduction obligation. These new funds offer a degree of comfort: much of the groundwork is being done for them by the experienced carbon finance team at the World Bank; and the ERs generated will likely have lower risk because of the benefits of a diversified portfolio of projects. EF

Ken Newcombe is a senior manager at the World Bank and manager of the PCF. Michael Rubino is manager, new funds development, for the Bank’s carbon finance team.
E-mail: cfcontacts@worldbank.org. Karan Capoor, Anita Gordon, Mina Guli and Charlotte Streck contributed to this article.
For more information on the World Bank’s carbon finance operations please visit www.prototypecarbonfund.org