Project finance: Environmental commodities & innovative financing
The “green premium”, made famous by Bill Gates over the past years, refers to the cost gap between clean technology and emitting technology. In some industries, like cement, the premium can be significant. In other areas, say comparing EVs to gas-powered cars, the premium has rapidly declined over the past years. Through the Inflation Reduction Act (IRA), tax credits have received a lot of attention as a mechanism to reduce the green premium. But what other alternatives exist?
The need for alternative revenue streams
A project with fully contracted output and a strong off-taker unlocks many doors. Lenders clearly find contracted projects more financeable, with direct impact on lowering the DSCR, margins and loan syndication. Alternative revenue streams are treated as just that, alternative, and may be excluded in the lender’s view of CADS. Renewable Energy Certificates (RECs) and carbon credits often take the backseat, but as the mantra goes with low-emissions technologies, all contributions count.
Renewable Energy Certificates (RECs) come in many forms. Solar (SRECs) and offshore wind (ORECs) are commonly traded in the U.S., either on a voluntary basis or through state markets. Although they vary in name, RECs represent the renewable property of every MWh of electricity generation. RECs can be sold in a “bundled PPA”, including both the electricity and RECs. Utilities often fall into this category, as certain states have mandated Renewable Portfolio Standards (RPS) to generate a certain amount of electricity from renewable sources. RECs can also be sold “unbundled”, where the electricity and commodity are split between different buyers.
The value of stand-alone RECs is tied to corporate Scope 2 emissions. Scope 2 emissions represent electricity, steam, heat and cooling consumption and can be calculated using location-based (average emission intensity of grid) or market-based factors. In the latter, corporate procurement of RECs can reduce the overall reported emissions.
On a global stage, renewable energy commodities can be transacted with co-benefits – certified labels demonstrating greater social and community benefits of the project. Both Microsoft and Google have purchased Peace Renewable Energy Credits (P-RECs) in recent years, which is an attribute for electricity generated in fragile and low-electrified regions.
Enter the jungle of carbon credits & offsets
As you might wonder, if RECs only cover Scope 2 emissions, how do projects generate environmental commodities to cover Scope 1 and 3 emissions? Carbon credits (mainly regulated cap and trade) and offsets (voluntary markets) are generated by reduction, removal or avoidance of carbon emissions. Projects compare CO2 emissions saved compared to a baseline, and issue a corresponding number of credits (tonne of CO2 equivalent).
The highest standard (and most expensive) is represented by Direct Air Capture (DAC), as the technology often ensures a high degree of certainty and long-duration permanence of the carbon removal. Given the current accounting framework, where one tonne of carbon removal is counted equally regardless of quality, coupled with at times “creative” framework of counting carbon removals, there are pitfalls for sourcing this commodity. Green LNG transacted by oil & gas majors, projects owned by the Nature Conservancy and even Taylor Swift can’t escape the controversies.
A new color-spectrum for bonds
Since the first green bond was issued by the World Bank in 2008, the asset class has matured with annual issuance growing to $665B in 2023. Blue bonds were introduced about a decade later, as a financing source to support sustainable oceans. In 2023, Ørsted became the first energy company to issue a blue bond, combining owning renewable energy assets with a target to have a net-positive impact on biodiversity. With both blue and green bonds, the use of proceeds should fall under pre-defined categories set by voluntary guidance. Lastly, transition bonds have acquired the label “brown bonds”, in their efforts to bridge the gap between polluting and greener assets.
Also worth mentioning in this category is sustainability linked bonds (SLBs). These bonds are tied to KPIs and Sustainability Performance Targets (SPTs). If the targets are missed, step-ups apply to the interest rates to act as an enforcer to meet the environmental targets.
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