Report o n Implementation o f the Global Carbon Funds

March 2006

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Table of Contents

A. INTRODUCTION ............................................................................................................................................... 1

B. IMPLEMENTATION PERFORMANCE OF THE PROTOTYPE CARBON FUND, THE COMMUNITY DEVELOPMENT CARBON FUND, THE BIOCARBON FUND, AND THE UMBRELLA CARBON FACILITY ................................................................................................................................................................. 2

B.l B.2 B.3 B.4

THE PROTOTYPE CARBON F ~ D (PCF) ................................................................................................. 2 THE COMMUNITY DEVELOPMENT CARBON FUND (CDCF) .................................................................. 3

THE UMBRELLA CARBON FACILITY (UCF) ........................................................................................... 6

C. SUMMARY OF THE ESTABLISHMENT AND IMPLEMENTATION PERFORMANCE OF THE OECD COUNTRY FUNDS. ..................................................................................................................................... 7

The Netherlands Clean Development Mechanism Facility (NCDMF). .... ................................... 7 The Netherlands European Carbon Facility (NECF) ....... ..................... ................................... 8 The Italian Carbon Fund (ICF) ................. ................................... 8 TheSpanish Carbon Fund (SCF) ..... ................................... 9 The Danish Carbon Fund (DCF) ............ .......................................................................................... 9

D. DISSEMINATING CARBON FINANCE EXPERIENCE AND RESEARCH ........................................... 10

Collaboration with UNFCCC Parties and Other Actors in the Carbon Market ........................... 10 Contribution to the regulatory framework for CDMprojects .................... Carbon Finance Asstst. .............................................................

Training. ................................................................................... Partnership with the Private Sector - Carbon Financ

Research ....................................................................... Internet Services., .........................................................

THE BIOCARBON FUND (BIoCF) ............................................................................................................ 5

Host Country Committee. ......................................................

Fellowships .................................................................... .......................

........................ . .

E. CONTRACTING AND R I S K MANAGEMENT IN CARBON FINANCE ................................................. 12

Agreements. ........................... ........ .............................................................................. 12 Sharing Benefits and Risks ... ................................................................................................... 12

F. NEXT REPORT ................................................................................................................................................. 13

ANNEX 1: FUNDS UNDER CFU MANAGEMENT .......................................................................................... 14

ANNEX 2: STATUS OF PROJECT DEVELOPMENT I N THE PCF ............................................................. 15

ANNEX 3: STATUS OF PROJECT DEVELOPMENT IN THE CDCF .......................................................... 22

ANNEX 4: STATUS OF PROJECT DEVELOPMENT IN THE BIOCF ........................................................ 25

Report on Implementation o f the Global Carbon Funds

A. Introduction

1. The World Bank’s involvement in the carbon market started on July 20, 1999, when the Executive Directors approved Resolution 99- 1 authorizing the establishment of the Prototype Carbon Fund (PCF). The PCF i s a public-private partnership aimed at catalyzing the market for project-based greenhouse gas (GHG) emission reductions (ERs) within the framework o f the Kyoto Protocol, while contributing to sustainable development. At the time of establishment of the PCF, Management agreed to provide periodic reports on the implementation o f the PCF to the Executive Directors. On December 6, 2005, the Executive Directors of the International Bank for Reconstruction and Development (ccIBFW’ or “the Bank”) approved the proposed activities of the World Bank in the carbon market as described in “The Role o f the World Bank in Carbon Finance and the Proposed Umbrella Carbon Facility,” dated November 9, 2005 and numbered R2005-0230. While approving the Umbrella Carbon Facility, the Executive Directors requested Management to report on the progress with the Facility in the subsequent semi-annual progress reports.

2. This i s the ninth report on the PCF to the Executive Directors.’ This report provides an overview of the activities of the PCF since January 2005. Consistent with guidance from the Executive Directors at the time of approval o f the Community Development Carbon Fund (CDCF), BioCarbon Fund (BioCF), and Umbrella Carbon Facility (UCF), the implementation progress of these Funds i s also covered in this report.

3. The report also contains a brief description of the establishment and implementation progress of the various carbon funds that have been established for specific OECD Countries: the Netherlands Clean Development Mechanism Facility (NCDMF); the Netherlands European Carbon Facility (NECF); the Italian Carbon Fund (ICF); the Spanish Carbon Fund (SCF); and the Danish Carbon Fund (DCF).2 The capitalization of al l of the Bank’s carbon funds, including the Umbrella Carbon Facility, i s expected to total approximately $1.752 billion by the end of the Fiscal Year 2006.3

4. For the period covering July 1, 2004 through August 3 1, 2005, the World Bank carbon funds consolidated the fund annual reports into one Carbon Finance Annual Report, intended for public consumption. The first joint annual report of the PCF, CDCF, BioCF, NCDMF, NECF, SCF, DCF, and ICF was distributed on the occasion o f the f i rs t Meeting of the Parties to the Kyoto Protocol in conjunction with the eleventh session of the Conference of the Parties (COP 11 and COP/MOP 1) to the United Nations Framework Convention on Climate Change (UNFCCC), held in Montreal, Canada, from November 28 to December 9, 2005, and posted simultaneously on the carbon finance website at www.carbonfinance.org. The annual report wil l also be circulated to the Executive Directors in keeping with the PCF, CDCF and BioCF commitment to keep the Executive Directors informed on fund implementation.

’ The “Eighth Report on the Implementation of the Prototype Carbon Fund; First Report on the Implementation of the Community Development Carbon Fund and BioCarbon Fund” (December 2004) i s numbered SecM2004-0570. All o f the OECD Country Funds provide separate progress reports and business plans to the relevant Government

agencies and private sector participants o f the Fund partnerships.

A table with basic details on all Funds i s provided as Annex 1.

5. For additional background information on carbon finance and the World Bank Carbon Funds, see “The Role o f the World Bank in Carbon Finance and the Proposed Umbrella Carbon Facility,” discussed by the Board o f Directors on December 6,2005 (dated November 9,2005 and numbered R2005-0230).

B. Implementation Performance of the Multi-Participant Carbon Funds: the Prototype Carbon Fund, the Community Development Carbon Fund, the BioCarbon Fund, and the Umbrella Carbon Facility

B.l The Prototype Carbon Fund (PCF)

6. The PCF has been operational since April 2000 and i s the first carbon fund to be established with participants from more than one country. Six governments and 17 companies al l from industrialized countries have contributed $180 mil l ion in funds to the PCF. Projects in the Fund cover a variety o f technologies including renewable energy, energy efficiency, solid waste management and industrial gas emissions abatement.

7. At the end o f i t s sixth year o f operation, the PCF has reviewed more than 490 project proposals. Of these, 63 were presented to the PCF Participants’ Committee (PC) and received i t s approval. Four o f these projects were reallocated to other funds due to over subscription to the PCF. Thirty-four projects were dropped from the portfolio due to the projects being unable to reach financial closure or project sponsors deciding to sell to another buyer. The PCF has now closed its pipeline to new projects. The final portfolio consists o f 25 projects with a total value o f $153 million, allowing $27 mil l ion or 15 percent for administrative expenses. The Fund Management Unit (FMU), which i s responsible for the day-to-day operations o f the Fund, will now focus on project implementation. In fiscal year 2006 the annual drawdown on Participants i s predicted to be 7 percent, which brings the level o f contributions to date to about 23 percent.

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The status o f the PCF project portfolio i s as follows:

The 23 Emission Reductions Purchase Agreements (ERPAs) that are signed have a carbon asset volume o f 30.3 mi l l ion tons o f carbon dioxide equivalent (tCO2e) with a value o f $138.3 million, including a 5 mil l ion tC02e purchase with a value o f $36 mil l ion (€30 million) through the Umbrella Carbon Facility (UCF). There are two remaining ERPAs that are expected to be signed before June 2006. Together with these two projects, the volumes contracted to the PCF will be 32.7 mi l l ion tCOze. The two remaining projects to be signed are the Brazil Lages Cogen Facility and China Huitengxile Wind Farm, with the India Nitrous Oxide ( N 2 0 ) Removal project as a reserve. China Huiteiigxile Wind Farm i s expected to be signed by April 2006. The ERPA signature for Brazil Lages Cogen Facility i s delayed due to methodological issues and i s expected in March 2006. To cover potential under-delivery, the PCF has options from eight projects which are capable o f covering 14 percent o f the carbon asset volume. Two projects have been submitted for registration by the Clean Development Mechanism (CDM) Executive Board (EB) under the UNFCCC. Eight projects will be submitted for registration shortly. 19 projects have started to generate emission reductions.

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Figure 1. Status o f Project Development in the PCF

Projects with Emission Reductions Purchase Agreements Signed

Carbon Finance Documents Approved, Emission Reductions Purchase

lgreements Under Discussion

Carbon Finance Documents :leared by Fund Management Committee and Participants’

Committee

Project ldea Notes Submitted

0 50 100 150 200 250 300 350 400 450 5€

Wicative contract value in US$ millions Number of pipeline projects 1

B.2 The Community Development Carbon Fund (CDCF)

9. The Community Development Carbon Fund (CDCF) was created to extend the benefits o f carbon finance to the poorest countries and poor communities in al l developing countries, which would otherwise find it difficult to attract carbon finance because o f country and financial risk. The CDCF was proposed by the President o f the Wor ld Bank at the World Summit on Sustainable Development held in Johannesburg in September 2002 and was approved by the Board o f Directors o f the IBRD on March 25, 2003. The CDCF became operational on July 15, 2003. With a capitalization o f $128.6 million, the Fund was closed to further subscription in January 2005. Contributors to the CDCF support projects that measurably benefit poor communities and their local environment and will receive in return, emission reductions from these projects. Parallel resources from donors are mobilized to support technical assistance and CDCF project preparation.

10. Pursuant to the Instrument Establishing the Community Development Carbon Fund, 25 percent o f CDCF resources are to be invested in purchasing emission reductions generated from projects located in priority countries. These are defined as (i) World Bank’s International Development Association (IDA) l i s t o f countries; (ii) countries commonly referred to as “IDA blend” with a population o f less than 75 million; or (iii) countries designated as Least Developed Countries (LDCs) by the United Nations. Currently, priority countries account for 49 percent o f CDCF resources in terms o f carbon finance commitments, with projects located in Ethiopia, Guyana, Honduras, Moldova and Nepal.

1 1. The unique feature o f CDCF projects i s that they provide significant and measurable development benefits to communities living in the immediate project vicinity or with a historical, cultural or economic affiliation to the project. Each project has an individual monitorable Community Benefits Plan. Benefits

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may arise from the project itself, such as village or neighborhood electrification, improved air quality or increased employment and income, or they may be additional to the project and include basic social services, such as schools or health centers, or basic infrastructure such as water, irrigation, local roads or markets. In the latter case, the project implementers typically work with the communities to identify priority need, and organize and implement projects that address these needs.

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The most significant challenges to CDCF’s continued development are:

Increased competition to the Bank’s product as the carbon market moves rapidly from a buyers’ market to a sellers’ market, coupled with the fact that the fund agreement constrains the Bank’s ability to be price-flexible;

High transaction costs relative to other carbon funds due to larger numbers o f smaller projects (the average size o f a CDCF transaction i s $3 mil l ion in carbon revenue)

L o w capacity o f poor developing countries to identify and develop projects. Priority countries, in Africa in particular, suffer from weak business environments, and high project-related currency and country risks.

Methodological constraints imposed by the C D M EB, such as rigid bundling rules that slow down the registration o f CDCF projects and, in certain cases, actually prevent it.

Several actions have been taken by the Bank to mitigate the impact o f these factors, including undertaking fewer and larger projects (minimum contracted volume was set at 500,000 tCO*e), and seeking scalable, programmatic carbon deals. The FMU successfully sought and obtained from CDCF Participants the removal o f the small scale limit in priority countries, and in non-priority countries for bundled projects, which helped expand the pipeline from $67 mi l l ion to $100 mill ion.

14. The status o f the CDCF project portfolio i s as follows:

J 35 projects identified and cleared for Carbon Finance Document (CFD) preparation for a cumulative purchase o f 21.5 mil l ion tCO2e o f ERs, representing a commitment o f $109.77 million. Thirteen out o f the 35 identified projects in the CDCF pipeline are in sub-Saharan Afiica, representing 40 percent o f the Fund’s capi ta l i~at ion.~

14 CFDs approved for a cumulative purchase o f six mil l ion tC02e o f ERs, representing a commitment o f $29 mill ion.

J 4 ERPAs signed for a cumulative purchase o f 0.78 mil l ion tCOze o f ERs, representing a commitment o f $3.61 million.

J 3 Projects have been registered with the CDM EB under the UNFCCC.

J One project, Honduras L a Esperanza Hydroelectric Project, has begun generating emission reductions and payments were made for the purchase o f Verified Emission Reductions (VERs). These credits were successfully converted into Certified Emission Reductions (CERs).

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Several initiatives are under-way to identify and prepare projects in sub-Saharan Africa, including a $1 million World BanWnited Nations FoundatiodUnited Nations Environment Programme partnership entitled Using Carbon Finance to Promote Sustainable Energy Services in Africa (CF-SEA) that has resulted in several promising PINS from Mali, Cameroon, Ghana, and Mozambique; PHRD grants for Kenya, Senegal, Uganda, and Mozambique; and perforniance-based project development contracts in Ethiopia, Kenya, Uganda, and Zambia.

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Figure 2. Status of Project Development in the CDCF

mission Reductions Purchase Agreements Signed

Carbon Finance Documents 4pproved and Taken Foward

Project Idea Notes Approwd and Taken Forward

0 20 40 60 100 1 20 14

B.3 The BioCarbon Fund (BioCF)

15. The BioCarbon Fund (BioCF) was designed to provide carbon finance to demonstrate and test projects that sequester or remove greenhouse gases in forest, agricultural, and other ecosystems. Tranche One o f the BioCF was closed to further participation on August 31, 2005. Four governments and 10 companies have contributed $53.8 mil l ion - 55 percent from private companies and 45 percent from public entities. Tranche Two was opened to contributions in September 2005, and the Trustee expects to declare it operational once contributions in the amount o f approximately $10 mil l ion have been received.

16. The BioCF provides a rare opportunity for rural populations to participate in the carbon market through activities improving natural resource management. Without this opportunity, the carbon market would be primarily focused on the infrastructure, energy, and industrial sectors.

17. The status o f the BioCF project pipeline i s as follows:

4 The BioCF Participants’ Committee has approved 22 projects worth an estimated $48.3 mil l ion worth o f emission reductions, subject to negotiations and without taking into project delivery risks. A twenty-third project was submitted for approval by the Participants’ Committee in February 2006.

4 $48.3 mil l ion i s distributed over four regions: Latin America & Caribbean, 34 percent; Africa, 47 percent; Europe & Central Asia, 10 percent; East Asia & Pacific, 5 percent; and South Asia, 4 percent.

4 18 letters o f intent worth $36.7 mil l ion have been signed. The f i rst ERPA will be negotiated in April 2006.

4 The BioCF has been pioneering the development o f new methodologies. The first methodology for an Afforestation and Reforestation project was approved by the C D M EB under the UNFCCC in December 2005. This project i s included in the BioCF portfolio.

4 One project i s under validation by an Operational Entity and i s expected to be registered by June 2006.

18. One risk involving the use o f biological sinks to comply with Kyoto targets i s whether sequestered carbon will remain sequestered indefinitely. To cover this “non-permanence risk”, the BioCF will replace the temporary carbon credits issued from land use and forestry projects with permanent credits generated by non-sequestration projects under development by other carbon funds managed by the World Bank.

Figure 3. Status o f Project Development in the BioCF

ERPAs under negotiation

LOIS Signed

CFDs Approved

I 0 10 20 30 40 50 60

B.4 The Umbrella Carbon Facility (UCF)

19. The UCF i s an aggregating facility to pool funds from existing IBRD-managed carbon funds and other participants for the purchase o f emission reductions from large projects. The UCF will purchase very large volumes o f carbon emissions, at least 10 mil l ion tons each tranche. Funds will only be mobilized once a project i s identified, Priority i s given to the existing carbon funds to participate in the UCF by amending the existing Participation Agreements.

20. The First Tranche o f the UCF i s dedicated to purchasing Certified Emission Reductions (CERs) from two China HFC-23 destruction projects. Five existing funds (PCF, NCDMF, SCF, ICF, DCF) expressed interest in the First Tranche, and their contribution i s indicated to be €202 million although the total contribution from these funds may increase to approximately €240 mi l l ion depending on the final registration o f the projects. The First Tranche o f the UCF was open to private sector subscription on December 12, 2005. The investors to the First Tranche o f the UCF signed Participation Agreements in December 2005 and will receive pro-rated shares o f actual CERs over the lifetime o f the contract, to be determined after project registration in April 2006.

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21. Two EWAs with the Jiangsu Meilan Chemical Co. Ltd., and Changshu 3F Zhonghao New Chemicals Material Co. Ltd. were signed on December 19, 2005 in Beijing. The r i a l contracts were signed for a total value o f €776 million (equivalent to $93 1 million) over a 7-year period (2007 to 2013). Depending on review by the CDM EB, the total eligible ER could potentially be dropped to a value to about $605 m i l l i ~ n . ~ In anticipating uncertainty related to the CER amount, the EWAs include provisions that allow adjustment o f the final contract CERs to be the amount that i s accepted by the CDM EB upon Registration.

22. The project has completed its public commenting period on the UNFCCC website on January 4, 2006. Moving forward, there are three decision points at which this volume of total ERs subject to purchase could be reduced:

(i) The third-party qualified validator’s opinion- the validator plans to submit the request for registration by the CDM EB in March 2006.

(ii) The registration o f the project with the CDM EB at the recommended volume, expected in April 2006.

(iii) The verification and certification of the actual emission reductions which could result in measured ERs being lower than or equal to the baseline. This wil l be carried out semi-annually throughout the duration o f the project after the project starts commissioning on January 2007.

23. A major accomplishment, linked to the HFC 23 transactions, was achieved On December 19,2005, when the World Bank signed a MOU with the People’s Republic o f China, represented by the Ministry of Finance (MOF), on the Establishment of the Clean Development Fund (CDF). Through the MOU for the Establishment of the CDF, and the Agreement on the Advance Funding for the Establishment of the CDF, the MOF has agreed on a program to use the advance to support development o f institutional operations, feasibility studies, an enabling environment, capacity building, and public awareness to stimulate and scale-up investments in China for clean energy, The advance payments from the two China HFC-23 destruction projects wil l be provided to MOF to establish the CDF, conditional to the establishment firstly of an Inter-Ministerial Steering Committee to supervise the CDF, and secondly to the establishment of the CDF itself. An advisory group, funded by the World Bank and supervised by MOF, has started designing CDF. The draft outputs, including by-laws, operating manual, business plan, and f i rs t year work program will be prepared by March 3 1, 2006, The CDF expects to be operational by June 2006 after consultation and endorsement by the Inter-Ministerial Steering Committee. This development i s particularly noteworthy because the Government o f China has determined that al l CDM transactions in China wil l be required to contribute an appropriate level of revenues to the CDF.

C. Country Funds.

Summary of the Establishment and Implementation Performance of the OECD

24. The Netherlands Clean Development Mechanism Facility (NCDMF). The NCDMF was established in May 2002 between the IBRD and the Netherlands, as a facility to purchase greenhouse gas emission reduction credits. The agreement, signed with the Ministry o f Housing, Spatial Planning and the Environment o f the Netherlands (VROM), supports projects in developing countries in exchange for

As was noted in the paper “The Role o f the World Bank in Carbon Finance and the Proposed Umbrella Carbon Facility,” discussed by the Board o f Directors on December 6, 2005, one o f the significant risks, outside o f Bank control, i s the uncertainty o f decisions by the CDM EB. The wide range o f possible final contract value for the two China HFC23 ERPAs exemplifies the need for a stable, predictable regulatory governance structure for CDM.

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emission credits under the Clean Development Mechanism (CDM) established by the Kyoto Protocol to the UN Framework Convention on Climate Change (UNFCCC). The NCDMF's initial target was to place up to €70 million in projects over the f i rs t two years o f i t s agreement, leading to Emissions Reductions o f approximately 16 million tCOze. Following subsequent negotiations between the IBRD and the State o f the Netherlands (represented by VROM), the total capitalization o f the fund now stands at approximately €209 million for the purchase o f 38 million tC02e.6 It has been agreed that the average price across the portfolio should be increased to €5.50/tC02e, and that the price wi l l continue to change to reflect market changes, after consultations between VROM and the IBRD.

25. As o f January 2006, the purchase o f about 20 million tCOze was concluded, including a 15 million tCO2e purchase through the UCF. While it i s hoped that the purchase o f the remaining amount needed to complete the portfolio should be concluded by June 30, 2006, VROM accepts the possibility that there may be a need to extend the Agreement to the end o f calendar year 2006 to meet targets, given the experience to date with delays on methodology approval and in obtaining secure financing for projects. VROM's decision to not recognize emission reductions generated after 2012 as contributing to meeting the NCDMF emission reduction targets has necessitated a change in the composition o f the NCDMF portfolio, with a heavier emphasis than originally planned on non-renewable energy projects - landfill gas and industrial gases projects. The objective o f the Fund Management Unit i s to garner as many ERs as possible for the Fund while limiting insofar as possible the higher transaction costs entailed by the shorter purchase period.

26. The Netherlands European Carbon Facility (NECF). The Netherlands, acting through i ts Ministry o f Economic Affairs (EZ), the IBRD, and the International Finance Corporation (IFC) signed an agreement on August 11, 2004, appointing the IBRD and the IFC as Trustees o f the IBRD Netherlands European Carbon Facility (NECF) and the IFC Netherlands European Carbon Facility (NECaF), respectively, in order to purchase greenhouse gas emission reductions for the benefit o f the Netherlands. The Agreement intends to purchase 10 million tCOze, valued at €55 million. Initially, the IBRD and IFC aim to purchase 5 million tC02e each, but this can be reallocated based on respective performance. The NECF purchases emissions reduction credits from renewable energy, energy efficiency, waste management and fuel switching activities, as well as from reforestation and other types o f carbon sinks projects.

27. The NECF currently has three projects in i t s portfolio with Term Sheets Agreed for an expected purchase o f 1.6 million tCOZe and a value o f €8.25 million. An additional three PINS are under development.

28. The Italian Carbon Fund (ICF). On March 19, 2004, the World Bank entered into an agreement with the Ministry for the Environment and Territory o f Italy to establish an Italian Carbon Fund (ICF), with an initial capitalization o f $15 million. The Italian Government committed an additional $30 million in 2005, resulting in a current capitalization o f $45 million. Upon replenishment by the Italian Government and the inclusion o f private sector participants, the total capitalization o f the ICF i s expected to reach $200 million by the end o f 2006. The ICF intends to purchase emission reductions from projects that both benefit the global environment and transfer clean technologies for sustainable development to developing countries and countries with economies in transition. The fund wi l l purchase emission reductions from projects in developing countries, under the C D M o f the Kyoto Protocol, and in economies in transition, under the Joint Implementation (JI) instrument o f the Kyoto Protocol. The ICF i s open to the participation o f Italian private and public entities and the minimum contribution from each participant i s set at $1 million. As with other carbon finds administered by the World Bank, the income

This amount includes an Umbrella Carbon Facility purchase o f 15 million tC0,e.

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from payments received from the participants in the fund wi l l be held in a separate t rust and used for project preparation and capacity-building in developing countries. The Fund’s project portfolio supports a wide range o f technologies (wind, hydro, biomass, municipal waste, energy efficiency, and carbon sequestration) and regions (including China, the Mediterranean and Latin American regions, as well as the Balkans and the Middle Eastern countries).

29. The ICF project portfolio includes a $43.20 million (€36 million) purchase through the UCF. Three projects have approved CFDs for the expected purchase o f 5.22 million tC02e, valued at $27 million. In addition, six projects have approved PINS and are under development.

30. The Spanish Carbon Fund (SCF). The Spanish Carbon Fund (SCF) was established between the IBRD and the Kingdom o f Spain in November 2004 and became operational in March 2005, as a facility to purchase greenhouse gas emission reduction credits. The agreement, signed with the Spanish Ministries o f Finance and Economy and the Ministry o f the Environment, supports projects in either developing countries under the C D M or in economies in transition under JI, in exchange for emission reductions credits. In addition, the SCF will also purchase project-based emission reductions eligible for the Emissions Trading Scheme o f the European Union. Furthermore, it aims to complement Spanish private sector development in the emerging carbon market and seek ways to support carbon market development. The SCF seeks projects in all World Bank borrowing member countries that are Parties to the UNFCCC and have signed the Kyoto Protocol, with special emphasis on defined priority regions, namely, Latin America, Northern Africa and Europe. Also, priority i s given to projects with a sustainable development component in renewable energy, biomass and agricultural waste products, urban waste management and industrial processes.

3 1. The SCF started operations using financial resources provided by the Spanish Government, with a target to purchase 34 million tCOze, leading to a fund size o f €1 70 million. As of January 2006, the Fund was open to the participation o f Spanish private entities with commitments under the National Allocation Plan, expecting to receive up to €50 million additional funds for a total fund size o f €220 million.

32. Since the fund became operational in March 2004, the fund has approved nine projects totaling €108.43 million, including €34 million from participation in the UCF and the f i rst ERPA signed by the Fund in November 2005, the Mexico City Transport Project, for a value o f nearly €1.5 million.

33. The Danish Carbon Fund (DCF). The Danish Carbon Fund i s a private-public partnership that aims to mobilize new and additional resources to address climate change and promote sustainable development. The DCF was established in January 2005 with an initial capitalization o f €26.4 million (200 million DKr) contributed in equal parts by four Fund Participants-the Royal Danish Ministry o f Foreign Affairs and the Ministry o f Environment and two private sector companies, Elsam Kraft A.S. and Energi E2-as a facility to purchase greenhouse gas (GHG) emission reductions (ERs). The Fund’s First Tranche was subsequently opened to other Danish private sector entities. By June 30, 2005, the DCF included three other participants: Aalborg Portland A.S., Maersk Olie og Gas A.S., and Norjysk Elhandel, and three o f the original participants increased their contributions. The DCF capitalization more than doubled and now stands at €58 million.

34. The World Bank acting as Trustee o f the DCF administers the DCF according to the terms and conditions set-out in the Instrument Establishing the Danish Carbon Fund. The DCF can support projects in all World Bank borrowing member countries that are Parties to the UNFCCC and have signed the Kyoto Protocol, but it seeks geographical diversification with no more than 30 percent o f the DCF capital to be committed to projects located in the same country. At least 11 percent o f the contribution i s to be committed to projects located in countries with economies in transition from Eastern Europe and Central Asia. The DCF has also adopted a pragmatic and flexible approach with respect to the technologies that it

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considers for i t s portfolio, albeit it has a preference for projects in the areas o f wind power, combined heat and power (co-generation), hydropower, biomass, and landfills.

35. A portion o f the DCF (Le. $5.125 million) has been committed to the World Bank Community Development Carbon Fund (CDCF) to contribute to emission reductions and to achieving sustainable development in world’s most economically disadvantaged communities. The DCF has also agreed to participate in the first tranche o f the World Bank’s Umbrella Carbon Facility (UCF) through an investment o f €12 mill ion. Moreover, in 2005, the DCF has approved the CFDs for two projects (a coal mine methane project in China and a municipal solid waste management project in Iran), which together represent emission reduction purchases o f €5 million.

D. Disseminating Carbon Finance Experience and Research

36. Collaboration with UNFCCC Parties and Other Actors in the Carbon Market, In accordance with CFU’s objective o f disseminating the knowledge gained through the implementation o f JI and CDM projects, the unit i s an important reference point and an important source o f information for all actors in the carbon market. The procedures, documentation and methodologies developed by the CFU, f i rs t for the PCF and now increasingly for other World Bank carbon funds, are helping to structure C D M and JI projects and carbon transactions beyond those in which the Bank has an interest. The CFU continues to share knowledge gained in the course o f Fund operations with UNFCCC Parties, Bank client countries, development institutions, and other CDM market participants. The CFU continues to provide input to the UNFCCC Secretariat, the CDM Executive Board and the Article 6 Supervisory Committee on various matters related to the modalities and procedures for CDM and JI projects. The CFU used the occasion o f the Conference o f the Parties to the UNFCCC in Montreal in December 2005 to launch a research paper on a programmatic approach to the CDM, an idea that found entry into the final negotiation text on the CDM. In Montreal, the CFU also delivered two expert workshops on methodologies for energy generation and energy efficiency C D M projects. Earlier in the year, the CFU presented its work at Carbon Expo 2005, the Bank’s Energy Week, and events organized by the International Emissions Trading Association and other partners. Through this work the CFU i s making significant contributions to the evolution and shaping-up o f the carbon market and contiiiues to influence i ts future.

37. Contribution to the regulatory framework for CDM projects. Over the past year, the C D M Executive Board has again made progress regarding decisions on CDM methodologies to determine baselines, additionality and emission reductions. The CFU has contributed significantly to this bottom-up process. As o f January 25, 2006, the CFU submitted 26 percent o f al l approved methodologies; in addition, six o f eight consolidated methodologies are based in large parts on submissions by the CFU. In the past year, the rate o f methodology approval has accelerated, but the process was s t i l l hampered by resource constraints at the level o f the Climate Change Secretariat and the CDM Executive Board and i t s Methodology Panel. To date, at total o f 3 5 methodologies, including eight consolidated methodologies, have been approved (up from seventeen methodologies in 2004) and can now be used for similar projects without further approval. A total o f 77 projects have been registered under the C D M since November 2004, o f which 10 (almost 13 percent) were submitted by the CFU for i ts various funds. The CFU continues to prepare methodologies for project types that are currently not wel l covered such as transportation and energy efficiency projects, both large-scale and small projects that benefit poor communities. The CFU i s also intensifying i t s work on modalities and methodologies for JI projects in response to the election by the first Meeting o f the Parties o f the Supervisory Committee for Joint Implementation. N o w that the first Meeting o f the Parties has formally adopted the rules for JI and C D M projects, has established the related institutions and has pledged additional financial resources, it seems fair to expect a marked improvement in the governance o f the mechanisms.

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38. Carbon Finance Assist (CF Assist). Following the successful launch o f Carbon Finance Assist in 2005, the World Bank's capacity building vehicle for carbon finance, CF Assist now has more than $10 million in hand from international donors. CF Assist seeks to enable developing countries to fully participate in the carbon market. So far, CF Assist has designed a substantial capacity building program for Africa, and i s negotiating detailed implementation plans for country-based capacity building programs in Mexico, China, Philippines and Sri Lanka. In Argentina, CF Assist i s working with financial institutions to build the Argentine Carbon Facility - a financial vehicle intended to provide project finance and advisory serves to project developers wishing to enter the carbon market. The carbon finance capacity building program for sustainable energy (implemented in partnership with UNEP) continues i t s implementation, with capacity building programs in Cameroon, Ghana, Mali, Mozambique and Zambia.

39. Host Country Committee (HCC). The HCC i s a vehicle by which the Bank obtains advice and feedback on i ts carbon finance capacity building and training activities. It i s comprised of all those countries that have signed MoU's to participate in the HCC or that benefit from a CDM/JI project supported by a Bank-managed carbon fund. Consistent with the objectives of the HCC in their advisory roles to the World Bank, a meeting o f the Steering Committee was convened in October 2005, with a discussion that centered on carbon prices. The meeting was accompanied with a high-level roundtable discussion to exchange views on ways to improve the functioning o f the Clean Development Mechanism and expectations for COP 11 in December 2005. The annual meeting o f the HCC i s scheduled for May 8 to 9, 2006 in Cologne, Germany, and wil l be designed in a similar consultative manner to discuss options for extending the Kyoto Protocol beyond its current regulatory period, which ends in 2012.

40. Training. The CFU delivered nine training workshops for World Bank Staff, and 14 external workshops, including in countries that have yet to benefit from carbon finance, such as Cameroon, Mali, Georgia and Pakistan. Workshops were both technical (on methodologies for grid-connected electricity and energy efficiency projects) as well as general (the carbon market and its constituents).

41. Partnership with the Private Sector - Carbon Finance Day and Carbon Expo. The CFU joined forces with the International Emissions Trading Association (ETA) to organize Carbon Finance Day during COP 11. Carbon Finance Day was designed to foster market participation, bringing together project developers, buyers and sellers to share experiences on CDM and JI project development.

42. With similar objectives, Carbon Expo i s being organized for the third consecutive year, in partnership with E T A and KolnMesse - a leading expert in the delivery o f trade fairs. Carbon Expo I11 wil l be held in Cologne, Germany, from May 10 to 12, 2006, and the level of subscription to booths for the Fair i s higher than in the previous two years. Carbon Expo provides an opportunity for buyers of carbon, in particular those European entities that were recently allocated emission reduction targets, to discuss specific opportunities to purchase emission reductions with experts Erom developing countries and economies in transition. Conference attendees also discuss lessons learned with early buyers in the market, and inform the market o f the latest regulatory and policy developments. Carbon Expo also provides an opportunity to sign Letters of Intent and Emission Reduction Purchase Agreements with project sponsors.

43. One o f the main objectives o f the CFU i s to facilitate learning by doing and disseminate knowledge and information. Within the CFU, significant emphasis i s placed on achieving these objectives through Participant and Host Country Committee (HCC) Fellowships whereby Participants and HCC members send staff to the CFU to observe and learn specific aspects o f carbon asset creation and management. 2005 saw four fellows - from the Moroccan Designated National Authority (DNA) for the CDM, from Danish Carbon Fund Participant Energi E2, from PCF Participant Electrabel and the chairman o f the HCC.

Fellowships.

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44. PCFplus Research i s administered by the World Bank’s Development Economics Research Group, which provides extensive expertise in various relevant topics. In 2005, PCFpIus Research notably prepared the “State and Trends o f the Carbon Market - 2005”, which was released at CarbonExpo in Cologne (May 2005) and posted on the carbon finance website. The market study has been widely distributed, reported and cited ever since as an authoritative source o f information on the price o f carbon across the different segments o f the market (Kyoto Protocol and i t s regional offspring, compliance schemes other than Kyoto and voluntary and retail markets). It has also contributed to the analysis o f the potential for “Greening Allowances” markets in Eastern Europe.

Research.

45. Internet Services. The primary vehicle to disseminate procedures, documentation and methodologies to both CFU participants and stakeholders in the C D M and JI remains the website, www.carbonfinance.org, which was revamped to improve accessibility in December 2005. The goal o f the new architecture and design o f the website i s to consolidate the various carbon fund websites into one umbrella website which has a cohesive look and feel but provides space for each o f the carbon funds to maintain their unique identity. One o f the objectives o f the new architecture i s to appeal directly to specific target audiences, such as project developers and host country delegates. Therefore, areas on the website have been created where specific audiences can easily access the information that i s relevant to them. The website has averaged over 3 10,000 hits per month in the past year. Specific quest ions45 per month-continue to be addressed through the Carbon Finance Helpdesk.

46. In June 2005, the CFU online project database was launched. I t i s the primary monitoring tool used by al l funds. Access i s restricted to World Bank staff directly involved with carbon finance. The online database allows for more detailed tracking and reporting on projects and provides information to the Participant ER databases (PCF and CDCF) that are accessible from the external site by Fund Participants.

E. Contracting and Risk Management in Carbon Finance

47. Agreements. Last year, the Carbon Finance Unit signed 13 ERPAs, including five ERPAs for the PCF, three for the NCDMF, two for the CDCF, and the first ERPA for the SCF. Additionally, the Carbon Finance Unit created an entirely new carbon finance facility, the Umbrella Carbon Facility (UCF), which purchases emission reductions from large projects through different tranches. The f i rs t tranche o f the UCF was established to purchase approximately $930 mil l ion in certified emission reductions generated from two Chinese HFC-23 destruction projects.

48. To reduce transaction costs and accelerate the pace o f transaction the Legal Vice Presidency developed streamlined ERPAs, which include the use o f General Conditions for those terms that apply to al l ERPAs. As part o f i t s support for fund participant meetings, Legal also conducted workshops or special meetings on ERPA terms and other legal matters for members o f the PCF, CDCF, BioCF, and the NCDMF. Currently, the Carbon Finance Unit i s pioneering the development o f ERPAs and due diligence protocols for BioCarbon Fund operations, and the first BioCarbon Fund ERPA i s expected to be signed within the next two months.

49. Sharing Benefits and Risks. In order to reduce the uncertainty regarding the expected volumes o f future emission reduction transfers, the PCF has developed a risk management strategy along three major axes: risk assessment (including project screening, review and appraisal), structuring o f the transaction (including over-collateralization o f ERs in each project), and risk management across the portfolio (including diversification, supervisiodrnonitoring, and hedging through call options). Together, these risk management policies and tools have enabled Participants to better plan the expected greenhouse gas emission reduction deliveries from the PCF. N o w that a number o f PCF deals (and some NCDMF and CDCF projects as well) are delivering ERs, real data on target vs. actual deliveries i s available and i s being built into delivery projections. Similar risk management strategies were proposed to DCF and CDCF in 2005 and are now under implementation.

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50. Since the last report to the Board, the CFU has continued i ts careful upstream screening o f projects through early financial and technical assessment o f projects. During project appraisal, a team o f experts ensures the project’s consistency with the World Bank Group’s standards for economic, financial, technical, social and environmental sustainability, and for coherence with the host country’s development objectives and Country Assistance Strategy. By helping to assess the major issues o f the project in an early stage, these improved screening tools have assisted project sponsors to achieve better project design, and the CFU to identify potential project r isks at an early stage in project development and take the necessary actions to mitigate them.

5 1. Similarly, during contract negotiations, r isks are shared among the project partners according to the principle o f allocating r isks to the parties best able to assume them. In general, CFU transactions are structured so that the project sponsors and their creditors assume most project risks, while the CFU bears most o f the Kyoto Protocol-related risks, except in the case o f CER contracts.

52. The FMU continues to manage portfolio r isk in accordance with i t s policies o f identifylng and quantifying the exposure o f Bank carbon funds to delivery risk (i.e., the risk that projects with signed ERF’As will not deliver the contracted volume o f emission reductions), purchasing call options, and monitoring the evolution o f risk over time. In addition, in FY 2004 the FMU developed a PCF Portfolio Hedging Strategy and indicators for a Long-Term Financial Plan, which was approved by the PCF’s Participants Committee. These tools will reduce delivery risk and improve financial planning and forecasting of emission reduction deliveries. To monitor the evolution o f the portfolio, the FMU established an online ER database available to Participants in 2003 that continues to be periodically updated and allows Participants to track the volume o f contracted and expected emission reduction deliveries, as well as the amount o f emission reductions already transferred to the PCF. A similar database was made available to CDCF participants in December 2005.

53. The Financial Specialists o f the CFU have increased efforts in 2005 to solicit underlying finance, including through CF Assist, credit risk insurance, and discussions with potential private and public financiers. The diff iculty o f securing underlying financing for climate-fhendly development has been identified as a key constraint by the CFU and the G8, especially in renewables and clean energy.

54. A new key risk i s emerging from competition in signing deals, which the CFU i s responding to with a more competitive, market-based pricing strategy in order to ensure that the funds meet their carbon purchase targets and that the sellers obtain a fair price. A Pricing Advisory Committee i s being established to confirm benchmark prices and to advise the CFU on this.

F. Next Report

55. Given the scaling up o f Carbon Finance operations in line with the Executive Director’s discussion on December 6, 2005 (see paragraph 1 above), it i s intended to report semi-annually to the Board. The next report will be presented in July 2006.

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Figures A1 and A2: Geographic and Technological Distr ibut ion o f PCF Portfolio

Regional Distribution of PCF Portfolio (Total $1 53.21 million)

Africa 3%

Latin America & Carib be an

Europe & Central Asia

16% 1st Asia Pacific

61 %

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Technological Distribution of PCF Portfolio (Total $153.21 million)

Wind Biomass 9%

Bagass 4 %

Waste Management

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Land Use, Land- Use Change and

Forestry 5%

Destruction 23%

Efficiency 13%

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Figures A3 and A4: Geographic and Technological Distribution of CDCF Portfolio

Regional Distribution of CDCF Portfolio (Total $29.1 million)

South Asi 42%

st Asia 81 Pacific

15%

&rope Latin America 8 Central Asia

7% Caribbean 12%

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Technological Distribution of CDCF Portfolio (Total $29.1 million)

Hydro 20%

Bagase 8%

Waste inagement

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Land

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B e r g y Efficiency

Use Change and Forestry

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List of Common Acronyms

AAU BioCF CDCF CDF CDM CER CF CFD CFU DCF DNA EB ER ERPA ERU FMU GHG HCC

IBRD HFC-23

ICF JI lCER LDC LOA LO1 MOU NCDMF NECF N20 OECD PC PCF PAD PDD PHRD PIN SCF tCER tCO2e TSA UCF UNEP UNFCCC VER

Assigned Amount Unit BioCarbon Fund Community Development Carbon Fund Clean Development Fund of the Umbrella Carbon Facility Clean Development Mechanism Certified Emission Reduction Carbon Finance Carbon Finance Document Carbon Finance Unit Danish Carbon Fund Designated National Authority Executive Board emission reduction Emission Reductions Purchase Agreement Emission Reduction Unit Fund Management Unit Greenhouse Gas Host Country Committee Trifluoromethane International Bank for Reconstruction and Development, “The World Bank” or “The Bank” Italian Carbon Fund Joint Implementation Long-term Certified Emission Reduction Least Developed Country Letter of Approval Letter o f Intent Memorandum of Understanding Netherlands Clean Development Mechanism Facility Netherlands European Carbon Facility Nitrous Oxide Organization For Economic Co-operation and Development Participants’ Committee Prototype Carbon Fund Project Appraisal Document Project Design Document Japan Policy and Human Resources Development Fund Project Idea Note Spanish Carbon Fund Temporary Certified Emission Reduction ton o f carbon dioxide equivalent Term Sheet Agreed Umbrella Carbon Facility United Nations Environment Programme UN Framework Convention on Climate Change Verified Emission Reduction

Figures A5 and A6: Geographic and Technological Distribution o f B i o C F Portfolio

Regional Distribution of BioCF Portfolio (Total $51.53 million)

East Asia & Pacific

5% South Asia

Europe & Ce Asia 15%

Africa 44%

ltin America & Caribbean

32%

Asset Class Distribution for BioCF Portfolio (Total $51.53 million)

Sustainable Agroforestry

1 10% Fuelwood agriculture

101

Environmental restoration

plantations 7%

Assisted reaenera tion

7 Silvopastoral -1 3%

Community ' reforestation

Commercia I plantations

21 %

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