Public and private risk sharing in the financing of low-emitting urban infrastructure projects: The case of CDM projects in the waste sector

Low CO₂ emitting urban infrastructure projects are expected to play an important role in mitigating climate change. By enabling projects to sell their CO₂ emission reductions on the international carbon market, the Clean Development Mechanism (CDM) turns the positive environmental benefits of such projects into financial cash flows. However, investors and lenders to these projects frequently face significant financial risks relating to the realisation of these cash flows, reducing the attractiveness of such projects for investors. This paper both identifies and proposes ways of mitigating project and partnership risks of CDM projects in the waste sector based on a literature review and several examples of CDM projects. The paper concludes that public-private partnerships and the integration of external financial institutions can be used to mitigate certain exogenous and endogenous project risks by allocating them to that partner (public project sponsor, private operator or external investors and lenders) who has private information on these risks or is most capable of assuming the risks. However, the relationship structures of the projects will become more complex. Partnership risks arise, which concern the distribution of carbon revenues between the partners. These risks differ from one contract type to the other. A concession contract (which allocates the carbon revenues directly to the contracted private operator) can be preferred against a management contract (under which the operator is remunerated by a management fee) as this aligns the incentives between builder and operator of the infrastructure and mitigates partnership risks. Public and private financial institutions can assume project risks. Bank debt may be preferred over external equity as it increases the efforts of the operator in terms of CO₂ emission reductions. (author)