Project Catalyst: Carbon Finance after Copenhagen

About Project Catalyst Initiative of the ClimateWorks Foundation, a global, non-profit philanthropic foundation headquartered in San Francisco, California with a network of affiliated foundations in China, India, the U.S., and the European Union Launched in May 28 to provide analytical and policy support for the United Nations Framework Convention on Climate Change (UNFCCC) negotiations on a post-kyoto international climate agreement Provide a forum where key participants in the global discussions can informally interact, conduct analyses, jointly problem solve, and contribute ideas and proposals to the formal UNFCCC process Organized in working groups: mitigation, adaptation, technology, forestry, climate-compatible growth plans, and finance with a total of about 15 climate negotiators, senior government officials, representatives of multilateral institutions, business executives, and leading experts from over 3 countries. Analytical support from the international consulting firm, McKinsey & Company www.project-catalyst.info for latest papers, news and background 1

17 Gt of reductions below Business as Usual in 22 are required for a 45ppm, 2 C pathway Global GHG emissions, Gt CO 2 e per year 75 7 65 6 55 5 52 61-17 7-35 Reference pathway Business as Usual Current proposals* 8-11 Gt abatement in 22 45 44 4 35 199 2 21 22 23 45ppm pathway (with overshoot) Change relative to 199 Percent 17-7 * US 17-28% below 25 level by 22; EU 2-3% from 199 level by 22; China - Reduce energy consumption per national income by 2% between 25 1; Russia - stabilise emissions at ~3% below 199; Brazil - Reduce deforestation rates by 7% by 217, equivalent to 4.8b tons less CO2 emitted cumulatively; Japan - Reduce 8% by 25 from current levels; Canada - 2% reduction from 26 level by 22; Mexico - Reduce emissions from 22 levels by 5% by 25, plus proposals from 12 smaller Annex 1 countries. Assumptions have been made on timeline and pathway to calculate abatement in 22 Source: McKinsey Global GHG Abatement Cost Curve v2.; Houghton; IEA; US EPA; den Elzen, van Vuuren; Project Catalyst analysis 2

But current proposals leave us on track to 3 C or more! Global GHG emissions and pathways for GHG stability Gt CO 2 e per year 7 65 Low range of proposals Peak at 55 ppm, long-term stabilization 55 ppm Peak at 51 ppm, long-term stabilization 45 ppm Peak at 48 ppm, long-term stabilization 4 ppm 6 55 High range of proposals 5 45 4 35 3 25 2 15 1 Probability of temperature increase under 2 C 15-3% 4-6% Expected temperature increase 3. C 2. C 5 7-85% 25 21 215 22 225 23 235 24 245 25 Source: IPCC WG3 AR4,, den Elzen, van Vuuren; Meinshausen; Global GHG Abatement Cost Curve v2., Catalyst analysis 1.8 C 3

The McKinsey Cost Curve identifies 19 Gt of abatements by 22 making it technically feasible to achieve 45ppm McKinsey global GHG abatement cost curve, 22* (up to costs of 6/t, excluding transaction costs, 4% discount rate) 6 5 4 3 2 1-1 -2-3 Best Practice Policies Rice management Shift coal new build to gas Electricity from landfill gas New waste recycling REDD and RPS Solar PV Reduced intensive agriculture conversion Solar conc. Organic soil restoration Wind (high penetration) Grassland management Pastureland afforestation Biomass Reduced deforestation Wind (low penetration) from pastureland conversion Nuclear Reduced deforestation from slash-and-burn agriculture conversion 1 Tech development and deployment 15 17 Gt 19 Gt 2 Abatement potential Gt CO 2 e -4-5 Cars ICE improvement -6-7 -8-9 -1 Cars aerodynamics improvement Retrofit building envelope (commercial) Lighting switch incandescents to LED (residential) Breakdown by geographic location: 5 Gt in developed country geographies 14 Gt in developing country geographies Breakdown by abatement type: 9 Gt for terrestrial carbon 6 Gt for energy efficiency 4 Gt for low carbon energy supply Source: McKinsey Global GHG Abatement Cost Curve v2. 4

Global Greenhouse Gas Abatement Cost Curve 23 McKinsey global GHG abatement cost curve, 23 (up to costs of 1/t, excluding transaction costs, 4% discount rate) Waste Transportation Power Industry Forestry Buildings Agriculture 1 9 8 7 6 5 4 3 2 1-1 -2-3 -4-5 -6-7 -8-9 -1-11 -12 5 Recycling new waste Industrial efficiency outside of cement, chemicals, iron & steel, or petroleum & gas Forestry: Reduced deforestation from slash & burn agriculture conversion Forestry: Reduced deforestation from pastureland conversion 1 15 2 25 3 35 Agriculture: Grassland management Agriculture: Organic soils restoration Buildings: New build efficiency package, residential Forestry: Pastureland afforestation Power: Coal CCS, new build Forestry: Reduced intensive agriculture conversion Power: Off shore wind Power: Solar PV Power: On shore wind Power: Coal CCS retrofit Forestry: Degraded forest reforestation Abatement potential Gt CO 2 e Power: Solar concentrators Power: Nuclear Source: McKinsey Global GHG Abatement Cost Curve v2. 5 5

Mexico 23 Greenhouse Gas Abatement Cost Curve 535 Mt of abatement potential GHG abatement cost curve for Mexico, 23 Cost, US$/t CO 2 e, excluding transaction costs Cost of abatement /tco 2 e 1 8 6 4 2-2 -4-6 -8-1 -12-14 -16-18 5 1 15 2 25 3 35 4 45 Livestock antimethanogen vaccine LDV* gasoline package 4 LDV* gasoline package 3 Landfill gas direct use Electronics, residential New build lighting controls, commercial LEDs LDV* gasoline package 2 Tillage and residue management Appliances, residential Cropland nutrient management Landfill gas electricity generation Other industry Biofuels 1st generation Recycling waste Small hydro Cogeneration in oil and gas Geothermal * LDVs = light duty vehicles; HDVs = heavy duty vehicles Note: The cost estimate for the light-colored bars is approximate Source: McKinsey GHG abatement cost curve v2.; McKinsey analysis Grassland management Biofuels 2nd generation Organic soils restoration Reduced deforestation Increased and more efficient bus transport Oil to gas shift in power Smart grid Agronomy practices Nuclear Solar PV On shore wind Degraded forest reforestation Forest management Solar CSP Off shore wind Pastureland afforestation New build efficiency package, residential Reduced flaring in oil and gas HDV* diesel package 4 CCS in oil and gas 5 Increased electric public transport Abatement potential Gt CO 2 e Wastewater treatment 144 abatement opportunities identified at a price below US$9/tCO 2 e abated (excluding transaction and information costs) 4 percent of the abatement potential is negative or zero cost Weighted average abatement cost is about US$2/ tco 2 e No silver bullet to emissions reduction exists action is required in all sectors Many abatement opportunities are fragmented, e.g., energy efficiency and process improvements in industry 6 55

Brazil 23 Greenhouse Gas Abatement Cost Curve 1,9 Mt of abatement potential Curva de custos de abatimento de gases do efeito estufa para 23 por iniciativa /t CO 2 e 6 5 4 3 2 1-1 -2-3 -4-5 -6-7 -8-9 -1 Construção - pacote de eficiência para novos prédios, comercial Agricultura - práticas de plantio direto e gestão de resíduos Agricultura - gestão de nutrientes em plantações Agricultura - gestão de nutrientes em pastos Química - mudança de combustível petróleo para gás, novas Transporte - veículos leves grupo 2 Transporte - veiculos leves grupo 3 Transporte - veiculos leves grupo 4 Resíduos - reciclagem de lixo, novo Agricultura - pecuária - vacina anti-metano Transporte - etanol de biomassa Agricultura - restauração de solos orgânicos Agricultura - gestão de pastos Transporte - etanol de cana Outras indústrias Transporte - veículos leves - híbridos Resíduos - geração de eletricidade de aterros Energia - PCHs Cimento - combustível alternativo - resíduos 1,2 Gtons Floresta redução do desmatamento 1 2 3 4 5 6 7 8 9 1. 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 Floresta - aflorestamento de pastos Floresta - restauração de florestas degradadas Agricultura - práticas agronômicas Agricultura - restauração de terras degradadas Siderurgia - eficiência energética (geral) Agricultura - suplementos alimentares para gado Transporte - leves híbridos com plug-in Cimento - CCS pós combustão, novos Siderurgia - CCS, novos Petróleo - CCS Transporte - veículos pesados grupo 4 Siderurgia - eficiência energética II (geral) Siderurgia - CCS, retrofit Cimento CCS pós combustão, retrofit 1.9 Potencial de abatimento Mt CO 2 e/ano Source: Global Abatement Cost Curve v2. estudo Caminhos para uma economia de baixa emissão de carbono no Brasil 7

China 23 Greenhouse Gas Abatement Cost Curve 6,5 Mt of abatement potential 减排成本欧元 / 吨 CO 2 e 1 城市固体废弃物直接燃烧 8 经济性旧房改造, 公用农业废弃物发电 6 木质素纤维素乙醇 l 草地恢复 4 经济性旧房改造, 民用, 北方草地管理 2 填埋气利用煤层气核电废水处理甲烷利用 -2 氟化物处理先进过程控制, 化工 -4 水泥生产农业废弃物共燃煤层气 -6 被动设计, 北方水泥熟料替代煤层气 -8 煤电 CCS+EOR, 新建煤层气 -1 地热发电 CCPP 氟化物处理 -12 高效办公设备被动设计, 民用, 北方 -14 节能照明, 公用区域供暖控制系统小水电 -16 内燃机效率提升, 轻型车, 汽油 -18 节能照明, 民用 1,5 3, 陆上风能, 强风太阳能光伏发电, 日照非常强烈内燃机效率提升, 中型车, 柴油再造林造林海上风能柳枝稷发电优化建筑自动系统, 公用 IGCC 太阳能聚集式发电使用天然气替代煤生产氨工业 CCS, 新建太阳能光伏发电, 日照强烈煤电 CCS, 改造煤电 CCS, 新建工业 CCS, 改造工业 CCS, 新建工业 CCS, 新建充电式混合动力车, 轻型车, 汽油 4,5 6, 减排潜力 ( 百万吨 CO 2 e) Source: China climate change cost curve team 8

Process for a developing country LCGP as part of agreement Implement as part of national development plan High level support and signaling Develop plan, goals & targets Gather and analyse data Engage stakeholders 9

Under a 25% (199) target for developed countries, carbon markets contribute to, but not alone finance, developing country LCGP costs Required abatement in 22, Gt 17 Required abatement for developed country target of 25% Offsets (flexible mechanism) 5 9 3+ 6+ Potential abatement in developing countries Support for capacity building and loans for capital investment where required Support for incremental cost, e.g., concessional loans, grants, payments 3 Required abatement for 45ppm pathway Developed countries abatement < 6/t Total incremental cost required Developing country abatement (NPV positive) Source: McKinsey Global GHG Abatement Cost Curve v2., Project Catalyst analysis 1

Action in six selected policy areas could deliver 4 percent of needed abatement List of selected best-practice policies Developed country abatement, 22, GtCO 2 e Avg. incr. cost, /tco 2 e Developing country abatement, 22 GtCO 2 e Avg. incr. cost /tco 2 e Renewable energy.7 34 1.4 26 Industry efficiency.7-2 1.8 2 Building codes.9-19 17 Vehicle efficiency standards Fuel carbon content standards Appliance standards.3.2.1-23 9-62.1.4.1.2 8 4-58 Total 2.9-3 4. 13 Source: McKinsey Global GHG Abatement Cost Curve v2.; Project Catalyst analysis 11

Developing countries would require up to 65 1b p.a. to cover incremental costs Annual financing flows requirement for developing countries bn on average p.a. 21 2 Costs of 12 Gt of developing countries abatement Adaptation cost ~65 1 5 55 8 1 2 1 2 5 3 35 1 55 8 Required flows for abatement at cost to society* Additional cost for higher developing country financing rate (1%) Estimated transaction costs for the whole curve of 1 5 per tonne carbon abated Financing need for high cost technology deployment with high learning potential Total financing requirement for abatement in developing countries Adaptation estimate** Total financing requirement for developing countries * Assumes all abatements delivered at average cost; 4% discount rate ** Based on increased financing for global public goods (incl. research), expected funding required priority investments for vulnerable countries (based on NAPA cost estimates), and provision of improved disaster support instruments (based on MCII work) Source: McKinsey Global GHG Abatement Cost Curve v2.; Bosetti; Carraro; Massetti; Tavoni ; UNFCCC; Project Catalyst analysis 12

Depending on its ambition level, China can consider three pathways in clean tech adoption x% GDP energy intensity reduction Ambition Target Structure Technology Tech adoption by segment % of full potential No-regret Strategic Aspirational Moderate 15% 8% 7% 1 25 55 Emit 1.3 Gt CO 2 e Peak by ~225 Strong 2% 8% 12% 35 5 9 Emit 9.5 Gt CO 2 e Peak by ~22 Aggressive 25% 8% 17% 1 95 95 Emit 8.6 Gt CO 2 e Peak by ~215 Source:12th FYP cost curve model; Project Catalyst analysis 13 13

China 23 Greenhouse Case Cost Curve 6,5 Mt of abatement potential PRELIMINARY GHG abatement cost curve for China, 23 Cost, US$/t CO 2 e, excluding transaction costs 1 MSW direct incineration Coal CCS, retrofit Retrofit, commercial CCS retrofit, cement 8 Agriculture waste power Onshore wind, strong Solar PV, abundant Solar PV, very abundant 6 LC ethanol Grassland recovery HDV, fuel efficiency, Diesel 4 Retrofit, residential, NORTH Reafforestation Grassland mgmt Afforestation 2 LFG landfills Coal mine methane Nuclear Waste water gas utilization Offshore wind Coal CCS, new -2 Fluorocarbon Switch grass power CCS industry, retrofit -4 Process Automation Agriculture waste co-firing, cement Optimized BAS, commercial IGCC Switch grass power CCS industry, new -6-8 Coal mine methane LDV, hybrid Plug-in, gas Coal CCS+EOR, new Coal mine methane Solar CSP CCS industry, new Clinker substitution Ammonia from coal to NG -1 Coal mine methane CCPP Geother -12 Fluorocarbon Passive design, residential, NORTH -14 District Heating Controls Small hydro -16 LDV fuel efficiency, gas Passive design, commercial -18 Lighting, HE office electronics residential Lighting, commercial 1,5 3, 4,5 6, Source: China climate change cost curve team Abatement potential Gt CO 2 e 14

Preferred model: Country level funds Intermediation on supply and/or demand side; direct access to carbon market only in places without intermediation Markets primarily in form of sector programmes, plus some sector (no-lose) caps Coordination/Oversight Sources of funding Market (AAU and ETS) Public finance CER, Allocation/aggregation mechanisms Intermediary Contributor trust funds Carbon market (sectoral & programmatic) Global fund Intermediary Recipient trust funds CER, Delivery CCGP/NAMA/NAPA Power, afforestation Energy efficiency Deforestation, agriculture Adaptation Contributor countries provide financing in form of cash to contributor funds Contributor and recipient funds go through matching process Global fund (~2%) created for Adaptation Mitigation action not funded by national contributor funds Recipient trust funds compete for funding based on quality of LCGPs/NAMAs/NAPAs Recipient funds could be national or regional They are sole issuer of credits 15

Developing country financing needs and potential sources of financing Financing needs and sources assuming 25% caps in developed countries, billion, annual average 21 2 rounded to nearest 5 billion 55 8 1 2 65 1 1 15 5 15 5 2 AAU auctioning ( 5-3 bn) and government offset purchases (~ 5 bn, 5-1 bn with intermediation) could be ways to channel public fiscal revenues and ETS auction revenues into the international system. 45 5 1 2 4 8 31 22 Mitigation Adaptation Total need Direct carbon markets Carbon market interventions ETS markets ETS auction revenues Other public and international sources International transport levies Concessional debt Public fiscal revenues Source: Project Catalyst analysis 16

Developing countries require different types of support for mitigation activities Developing country abatement cost curve, 22 (up to costs of 6/t) Cost of abatement / ton Forestry Agriculture Industry Power Transport Buildings 6 4 2-2 -4-6 -8 * Energy efficiency in buildings, transportation and industry 2 4 6 Agriculture and forestry 8 1 12 14 Power supply Abatement potential Gt CO 2 e Demos / investment in emerging technologies Support to overcome barriers (best practice info, capacity building,loans) Support to compensate incremental costs, e.g. through offset market or grants Technology follows investment Source: McKinsey Global GHG Abatement Cost Curve v2.; Project Catalyst analysis Support to compensate incremental costs (grants) and international cooperation 17

Carbon markets might create significant surplus for investors/intermediaries ILLUSTRATIVE Forest sector cost curve Non-Annex 1, 22 Carbon markets under 25% target, bn 21-2 p.a.* Cost /t CO 2 e 4 3 FORESTRY EXAMPLE Surplus Opportunity cost 15-3 Offsets are only purchased for cost positive abatement (i.e., right hand side of cost curve) 2 1-15 5-15 1 1, 2, Note: the surplus could be much smaller if 7 Gt of AAUs are allowed to be carried over to next commitment period Source: Project Catalyst analysis, UNFCCC 3, 4, 5, 6, Abatement potential Mt CO 2 e Price paid for offsets Cost of abatement Potential surplus to investors/ Intermediaries 18

Different market interventions are required for different parts of the surplus Preferred market interventions Indicative price Project schemes Programmatic and sectoral no-lose schemes ETS price ~1-5 /t Demand side Discounting Discounting Marginal cost (offset price) ~5-3 /t Supply side Taxation Intermediation and baseline setting Average cost ~3-15 /t Source: Project Catalyst analysis 19

Principle of intermediation 2 Offsets sold 1 Offsets bought Developed countries 2 Market value Intermediary 1 Incremental cost Developing countries 3 Difference Intermediary leveraging mechanism 1 2 Intermediary purchases offsets by financing the incremental cost of emissions reductions in developing countries Intermediary sells offsets at market prices to developed countries 4 Additional abatement or adaptation measures financed 3 4 Intermediary captures difference between incremental cost of emissions reductions in developing countries and the market cost of emissions sold to developed countries Intermediary uses the difference to finance either incremental costs of further abatement in developing countries or adaptation measures 2

Sensitivities in public finance requirements FINANCING REQUIREMENT TO REACH 45 PPM PATHWAY Resulting public financing need to achieve 45ppm, 21-2 annual average requirements Very ambitious 45-9 bn bn 1-2 bn 4-5 bn Finance supply from carbon markets (direct and indirect)* Ambitious 2-5 bn 1-25 bn 45-5 bn 75-8 bn Current proposals ~ 1 bn 3-45 bn 55-9 bn 85-12 bn Low 4-55 bn Base case 65-1 bn High 95-13 bn Financing need for 45 ppm pathway * Including offset purchases, full carbon market intervention and ETS auction revenues Source: McKinsey Global GHG Abatement Cost Curve v2.; Project Catalyst analysis 21

There are six essential elements of a Copenhagen mandate: North-South amounts/designs first; then intra-annex 1 divisions 1 Global Objective (19 Gt emissions cap in 25?) 2 Collective developed country obligation in absolute tons for (domestic?) reductions, with firm and credible mid-path milestones to 25 cap of 3 Gt 3 All nations develop low carbon growth plans 4 Registry for unilateral & supported NAMAs/LCGPs 5 6 Collective Annex II commitment on financial and technology support (for adaptation and mitigation); highlevel agreement on institutional framework; fast-start fund MRV, with varied forms of surveillance and technical review for unilateral and supported NAMAs Source: Project Catalyst analysis 23