The Abanico Hydroelectric Project is a 30 MW run-of-river mini hydroelectric power plant located in Southeastern Ecuador developed by a local Ecuadorian firm. The location of the project is also one of the most economically depressed zones in the country. The project aims to generate electricity to the national grid and reliable supply of clean water to the nearby communities through a canal to be built within the project design.

Despite Ecuador’s substantial hydropower capacity, which provides about 60 per cent of the country’s electricity, there has been no private investment in hydropower in the country to date. This has been a function of historical risky business environment as viewed by international credit agencies, high real interest rates (14-15 per cent in US$ terms), low external capital investments, low national savings rates, and poor payment record of power off-takers (i. e. energy distributors).

In 2004, the private firm Hidrobanico S. A. developed the Abanico project. The company had assured 65 per cent of the capital expenditure through private equity from several shareholders and had sought financing from the Inter-American

Investment Corporation (IIC), the private-sector arm of the Inter-American Development Bank, for the remaining 35 per cent necessary for building the hydroelectric power plant.

Although the project had strong fundamentals such as high Internal Rate of Return (I RR) of 15.6 per cent, low investment cost of $ 1.1 million per MW installed, capacity factor above 85 per cent, and secured Power Purchase Agreements (PPAs) with the Company’s shareholders for some 35 per cent of power sales, the project fell short of IIC’s investment criteria. ICC requires over 50 per cent of sales to be under firm PPA contracts and assigned to the repayment of the loan’s debt service in order to mitigate credit (i. e. delivery) risks.

The project’s eligibility to the Clean Development Mechanism (CDM) allowed the project sponsors to generate emission reductions along with electricity. The equity IRR increased by 0.7 per cent only with the inclusion of the emission reductions in the project’s cash flow. However, the proportion of project revenues under contract reached the threshold defined by the lender, thus meeting the IIC’s minimum off-take requirement.

Based on the high creditworthiness of the off-taker (World Bank), the IIC agreed to consider the proceeds of the sales of emission reductions in its investment analysis, allowing the borrower to comply with the above-mentioned covenant. According to the IIC, this played a role in securing an IIC loan and reduced the average time spent by private project developers in Ecuador to reach financial closure from the expected 5 years to less than 2 years.

Equally importantly, the financial engineering of the Emission Reduction Purchase Agreement was structured in the same way as the previous cases, so that the proceeds accrued directly to a debt reserve account in favour of IIC, thus eliminating the Ecuadorian sovereign risk. The lender’s recognition of the additional benefits from this financial engineering in the loan’s risk matrix was directly reflected in the loan’s reduction in the interest rates by 100 base points (i. e. 1 per cent) to the borrower immediately after the ERPA signature with the NCDMF. This reduction may be translated into a cumulative economy of over US$ 300000 in interest payments. These factors enabled IIC to extend a $ 7m, 8-year loan to Hidrobanico, facilitating financial closure for the private project.

13.2. CONCLUSIONS

In some projects in the PCF portfolio, the emission reductions are the sole source of reliable income for sponsors. It is, therefore, essential that lenders understand the value of emission reductions. This may be the trigger that will secure financing for some projects and make them viable. Special attention should be paid to the ERPA structure as explained in the text. The ERPA may and can significantly mitigate specific risks of the project, materially improving its bankability.

We looked at three different cases where carbon finance played different roles. Nevertheless, in all the three projects presented, carbon finance was of fundamental importance for the project’s implementation.

• In the Plantar deal, the financial engineering in the ERPA and the anticipated revenue streams from carbon finance in the project allowed the monetization of the ERPA receivables and loan approval by a commercial bank.

• In the NovaGerar deal, the creditworthiness of the carbon credits buyer (i. e. the World Bank) allowed the project sponsors to become attractive to an international energy solution’s provider, who agreed to use the carbon credits as payment for the supplier’s credit offered to the project.

• In the Abanico deal, the revenue streams from carbon finance, although not relevant in terms of incremental IRR, allowed the project sponsors to reach the lender’s covenant of threshold for the project’s off-take contracts, resulting in the loan’s approval by the lender.

In summary, the experience of these projects indicates that the qualitative value of the emission reductions in most CDM projects can exceed their quantitative value (i. e. their nominal price) as the benefits of the emission reductions and ERPAs are maximized.