NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

In northwestern Zambia, a small micro-hydro facility set in the Zambezi River provides electricity to pineapple farmers, allowing them to can and export their crops for the first time. In northern India, a company called D.light is distributing hundreds of thousands of solar lanterns to people without access to the energy grid. And in Ghana, Toyola Energy, a cook-stove manufacturer that sold only a few hundred units in 2006, is now ramping up production to more than 50,000 clean-burning stoves-the estimated demand for 2010.

Each one of these projects is, in part, financed by the creation and sale of carbon offsets. Carbon finance, which is increasingly being used to subsidize the cost of green products, improves the products’ value proposition by providing additional revenue streams to make them financially viable and available at a lower price point for end-users.

The carbon market has its roots in the Kyoto Protocol, a treaty that saw most developed nations agreeing to reduce greenhouse gas emissions by capping carbon dioxide emissions and other climate warming gases in key industries. Companies that exceed the cap can purchase emissions reductions credits from other domestic polluters or developing countries through a trading program called the Clean Development Mechanism (CDM). Parallel to the CDM is a much smaller, voluntary market, utilized by companies, organizations, and individuals.

When you pay extra for an airline ticket to offset your carbon footprint, you are participating in the voluntary market for carbon. Tapping into the carbon markets requires a long and costly process of documentation, monitoring, and verification. With high transaction costs, the potential for failure has prohibited most small-scale projects from accessing this complex market.

Because of these constraints, carbon finance is generally better suited for large-scale projects such as wind farms, geothermal facilities, and waste-to-energy plants that generate a large number of offsets and are easier to monitor. The economics of smaller products – cook stoves and solar lanterns, the types of projects undertaken by MFIs – makes the value proposition less attractive.

According to Erik Wurster, carbon finance manager at E+Co, which focuses on cook stoves and other clean technologies for the poor, the costs for implementing and maintaining a carbon finance project are between US$120,000 and US$200,000 up-front, and US$40,000 to US$70,000 annually. By Wurster’s calculations, this would require a minimum annual distribution of 15,000 efficient household cook stoves, each with a lifespan of three to five 3-5 years. Some organizations, such as D.light, which distribute hundreds of thousands of solar lanterns each year, have already reached a sufficient scale. But D.light is an exception, rather than the rule, and the high rate of failure has caused some in the industry to view carbon finance as a form of fool’s gold that distracts enterprises from building sustainable businesses without carbon subsidies.

The documentation required to register a project, in particular, presents a challenge to distributed devices, like cook stoves and solar lanterns. The target clients for these two types of products are often the rural poor, and most of the 1.6 billion people that are “off the grid” live in areas with a low population density. Another key component of carbon finance is regular monitoring to verify that the product is still functioning, which can be both expensive and time-consuming. To mitigate these costs, two companies, in particular – MicroEnergy Credits (MEC), a carbon credit aggregator founded in 2008, and E+Co – have created mobile technologies that allow field staff such as loan officers and salespeople to easily monitor and track the products as they are distributed.

MEC recently developed a software program called the Credit Tracker to assist in the documentation process. Every three months, a loan officer visits the client as part of the monitoring requirement. The Internet-based device works with a mobile phone and is equipped with a GPS to confirm the location and ensure that the product is still in use. E+Co has developed a similar software program called ASSIST, which allows cook stove salespeople to record each sale via SMS. Each time a salesperson distributes a stove or returns to pick up subsequent payment installments, they send a text message, which automatically updates a sales database. This database can generate reports for independent auditors who certify projects and sign off on their legitimacy. These are just two examples of how organizations are using technology to reduce transaction costs and are bridging the gap between the carbon markets and the BoP.

Going forward, there are still challenges to accessing carbon finance. On a macro-economic level carbon are often volatile. The global economic downturn caused fluctuations in carbon offset prices, but carbon markets have been resilient, increasing from US$135 billion in 2008 to US$144 billion in 2009. However, the biggest risk facing carbon finance at the moment is that there is no post-2012 agreement to replace Kyoto and no clear progress toward one, halfway through 2010. A project with some scale right now could only hope to generate credits – at the very earliest – by the second quarter of 2011, just before the expiration of the treaty. The conclusions from the recent Cancun convention on climate change are still being distilled by media and experts alike.

It’s likely that, with time, it will become easier for smaller projects to access carbon finance. According to Wurster, the costs and complexity of the current process cause most organizations to fail to actually realize revenues from offsets. But good news are also to be found: last month, the Gold Standard, a carbon credit certification organization, began its Community-focused Micro-scale Scheme. The purpose of this scheme “is to allow for streamlined procedures and lowered transactions costs for poor community-focused micro-scale project activities.” This is a potentially groundbreaking development, as it will hopefully open the market to a much wider pool of projects focused on the world’s poor. As more organizations begin looking to carbon credits as a means of financing projects in the developing world, innovations to make this market more accessible will follow.