The World Bank is home to many climate finance initiatives that encourage environmental action and low-carbon, climate-resilient development, with the overall goal of reducing greenhouse gas (GHG) emissions. For some programs, climate finance is provided upfront to support a project, while other initiatives use a type of contract that provides payments to governments, communities, or individuals once activities have achieved GHG reductions. These Emission Reductions Payment Agreements, or ERPAs, can also help developing countries build a track record of generating and selling carbon credits or applying them to their own emission reductions targets.
Over the last two decades, the World Bank has made $2 billion in emission reduction payments through more than 200 ERPAs in 65 countries. The Climate Change Fund Management Unit (SCCFM) uses ERPAs to support programs that preserve forests, reduce the use of dirty fuels, and increase the uptake of renewable energy. SCCFM houses a variety of climate-related trust funds supported by donor countries and the private sector, including the Forest Carbon Partnership Facility focusing on sustainable forests and land use; the Carbon Initiative for Development (Ci-Dev) supporting clean energy access; and the Carbon Partnership Facility (CPF) focusing on clean energy generation and distribution, low-carbon transport, and sustainable waste management.
To learn more about ERPAs, we spoke to the three Fund Managers: Environmental Specialist Matt King (Ci-Dev), Senior Carbon Finance Specialist Nuyi Tao (CPF), and Senior Financial Officer Simon Whitehouse (FCPF).
First of all, what is an ERPA?
An ERPA is a legally binding contract that allows one party to deliver verified carbon credits to another. For us, this contract generally involves a government or business in a developing country selling carbon credits to the World Bank’s trust funds. Certain conditions govern the exchange and activities, and prices are negotiated before an ERPA is signed: all parties must agree on the volume of GHG emissions to be reduced during the contract period and by what means, the financing amount, and the results metric that triggers payments. World Bank trust funds sign ERPAs usually ranging from 5 to 10 years and make payments at regular intervals based on reported and verified results.
For example, in 2019, the FCPF signed an ERPA with the government of Mozambique committing $50 million for the reduction of 10 million tons of CO2 emissions. The agreement, running through to 2024, involves forest conservation, climate-smart agriculture, and sustainable land management and is now well underway. The first payment is expected later in 2021.
How do ERPAs help stimulate climate action in developing countries?
ERPAs provide significant financial incentives to spur governments, local communities, private sector players, and other stakeholders to participate in and benefit from climate-smart activities. Moreover, ERPAs often show their worth well before payday and well beyond getting countries to reduce the emissions in the agreement. Even early on in its lifecycle, an ERPA can act as a powerful tool to engage the private sector, which can mean long-term economic and social benefits for the communities where programs take place. This is because the financial commitment implied by an ERPA can boost investor confidence, attracting more financiers to a program and, ultimately, drive increased investment and emission reductions.
Ci-Dev, for instance, has signed ERPAs worth $76 million with countries and businesses across Africa and Asia working in clean cookstoves and home solar systems. These countries and businesses have used their ERPAs with Ci-Dev to leverage another $250 million in private financing from banks and other investors.
Walk us through the process. How does an ERPA work?
For Ci-Dev, for example, it may start with a company in a country like Madagascar that sells ethanol cookstoves to rural households that currently burn wood for cooking and heating. Clean, efficient cookstoves are not only good for the environment but also good for business as the emission reductions they deliver can be monetized and sold. The company enters into the ERPA with the buyer (in this case, Ci-Dev) that commits to purchasing the emission reductions that will be generated by households switching from wood-burning to ethanol cookstoves.
Once terms are negotiated and the ERPA is signed, the seller company gets to work. Over time, the company tracks sales and household adoption of clean cookstoves to calculate emissions reductions. It compiles this data into a report that complies with the carbon crediting standard being used, for example, the Clean Development Mechanism. A third party audits and verifies the report, which then goes to the United Nations, where the emission reductions are certified, and credits are issued. These credits are transferred to Ci-Dev, which pays the company for the proven results. This process usually occurs annually over the life of the ERPA.
In Madagascar, ERPA proceeds are helping to lower the cost of the stoves, allowing local partners to sell them to households at an affordable price. The company was also able to deploy additional equity investment into the program once the ERPA was signed, as the additional revenues from carbon payments made returns to its private investors sufficiently appealing. The program is showing how carbon revenue can open a market for a sustainably produced clean cooking fuel and efficient cookstoves while leveraging private investment.
Under the FCPF or the CPF, the ERPA is a contract between the World Bank, as a trustee, and the government of a country focused on curbing deforestation or implementing clean technologies. The emission reductions are independently verified, certified by the UN or another authorizing body, and credits are issued. The World Bank then buys the carbon credits from the country and passes them on to FCPF or CPF contributors, most of which are developed countries.
So far so good, but what are the challenges with getting ERPAs signed and underway?
Contracts are often complicated and time consuming to negotiate, and carbon crediting entails a steep learning curve. That is why the Bank helps country authorities and private sector partners through the ERPA process. Capacity building programs, like those provided by the FCPF’s Readiness Fund prior to ERPA development, help reduce those transaction costs and put sellers in a better position to engage with future buyers. In some cases, however, both parties will agree not to proceed with the ERPA if, for example, all the necessary systems are not in place within an agreed funding timeframe, or if a country decides to prioritize other activities.
Given that payouts go to governments or companies, how do local communities benefit from ERPAs?
Certainly, ERPAs help cut GHG emissions, which benefit us all. But they also bring vital new opportunities to local communities and incentivize activities that directly affect them – including reducing local pollution, cost of living, and health issues.
In Vietnam, for example, an ERPA with the CPF supported small hydropower development, opening up the industry to private sector investors with new jobs and boosting overall economic growth, well-being and more reliable energy access. The project spurred development of 1,850 megawatts of new capacity in small hydropower, increasing its share of Vietnam’s energy mix to nearly 6% in 2018 from virtually zero in 2008.
Even before signing an ERPA, the FCPF requires countries to have a Benefit Sharing Plan in place specifying how results-based payments for the carbon credits will be shared with Indigenous Peoples and local communities who participate in emission reductions activities in forest landscapes. The local communities and Indigenous groups that live in forested areas are key to the success of these programs. The benefit sharing plan is designed in a consultative, transparent, and participatory manner and reflects inputs from relevant stakeholders, including broad community support by affected Indigenous Peoples. Typically, 80 to 95% of benefits go to local communities in the form of financial payments or small development projects identified by the communities themselves. Countries like Costa Rica have also incorporated Gender Action Plans into their programs to target more support for women.
Can ERPAs support a green and resilient recovery from COVID-19?
Yes, the potential is huge! The climate emergency cannot be solved with public funding alone—we need tried and tested financial instruments like ERPAs to bring more private investors into the action. Results-Based Climate Financing provided through ERPAs also offers an important, alternative source of liquidity at this critical moment when national budgets and traditional development assistance are already pinched to support a green, resilient, and inclusive recovery.
With the introduction of new Umbrella Trust Funds such as the Climate Emissions Reduction Facility, (CERF), the Bank will manage and implement the next generation of finance instruments, working even harder and faster to deliver more impactful results. Through the CERF, we can further simplify processes, speed up payments, and bring the finance as part of an overall financial solution to drive climate action and work at scale – specifically pivoting from piloting to impact. We will also be able to broaden our work into new areas such as mangroves, financial reform and large-scale renewable energy access for the most vulnerable.
Ever since the World Bank established the world’s first carbon fund 20 years ago, we have played a crucial leadership role in developing methodologies and streamlining the way carbon transactions are done for greater efficiency and environmental integrity. We have a wealth of experience in helping countries, companies, local banks, and other investors better understand how to unlock the economic opportunities of low-carbon, resilient development and get money flowing from buyer/donors to seller. We are now applying that to help countries with their nationally determined contributions (NDCs) and to prepare for Results-Based Climate Finance and carbon market mechanisms taking shape under the Paris Agreement. Instruments like ERPAs offer an innovative, secure, results-based framework to harness the power of markets and results-based financing to help countries shape a climate-smart recovery. We continue to draw on our experience to develop and innovate climate finance solutions to ensure a green, resilient inclusive future for all.