3 Opportunities for Funders at the Frontlines of Inclusive Carbon Markets

Battered by accusations of green washing and exploitation, the past year has not been kind to proponents of carbon markets. At the same time, an emerging cohort of carbon project developers have set out to demonstrate that carbon markets can both deliver on emissions mitigation and improve the lives and livelihoods of millions across the developing world. But for these innovators at the frontier of building more inclusive carbon markets, access to capital has emerged as a critical constraint. This presents a key opportunity for development funders seeking to realize a world free of poverty on a livable planet.

In a new working paper, CGAP outlines how innovative carbon projects are increasingly leveraging financial services to drive impact for people living in poverty – what we’re calling inclusive carbon projects. Based on CGAP’s conversations with funders and carbon project developers, this blog post explores the role of donors, development finance institutions, and impact investors in supporting inclusive carbon project innovation. 

High costs and volatile prices stifle inclusive project development

Despite the potential of inclusive carbon projects, the truth is they remain the exception rather than the norm. Many of the most promising project developers grapple with high costs, which can reach as high as 3-5 million USD in some cases. Meanwhile, the lead time between projects’ upfront investments and the sale of carbon credits can be anywhere between two to seven years, making access to capital critical to their success. 

However, volatile carbon prices and the risks associated with long project timelines and operating in unpredictable emerging market contexts create uncertainties that prevent many commercial banks and investors from investing in inclusive carbon projects. As a result, these carbon projects struggle to obtain the capital they need to prove, scale, and replicate their models. 

Three ways development funders can help build more inclusive carbon markets

Development funders, development finance institutions, and investors all have important roles to play in addressing the funding barriers that prevent inclusive financial services-enabled carbon projects from achieving scale. For example, technical assistance and grant capital can drive early-stage innovation and the development of new models that unlock opportunities for people living in poverty to participate in and benefit from carbon projects. Impact investors can deploy patient capital that provides promising projects with the runway they need to prove their models. At the same time, donors and development finance institutions can help crowd-in project financing through de-risking and blended finance facilities that enable proven projects to scale.

Recent examples of innovative investments in inclusive carbon projects identified by CGAP help to illustrate three opportunities for funders to leverage carbon markets to drive impact for both people and the planet.

1. Grant funding for early-stage projects 

For early-stage carbon projects, access to grant funding can provide project developers with the resources and time needed to experiment and prove their models. For example, One Acre Fund leveraged grant funding from the MasterCard Foundation and other donors to cover research and development costs for its agroforestry carbon project with smallholder farmers in Zambia. 

One Acre Fund told CGAP that the grant funding was critical to enabling them to test and refine their approach, which involves using carbon revenues to pay farmers for planting and maintaining trees on their farms. Carbon prices are currently too low to fully cover One Acre Fund’s costs, while monetizing the carbon sequestered by each tree planted takes several years. The grant funding allowed One Acre Fund to finance the inputs and training it provides, while also allowing them to compensate farmers fairly for their efforts.  

2. Blended finance for projects approaching maturity

As carbon projects mature, their funding needs shift as well. However, given the high costs of project development relative to the current price of carbon, commercial capital is often too expensive to enable inclusive approaches that prioritize sharing benefits fairly with communities. This is where blended finance can help projects that have already proven their models to begin to scale. 

FMO, the Dutch DFI, worked with Rabobank’s Acorn to develop a 100 million euro blended finance facility that is helping the agroforestry project developer scale its work with smallholder farmers around the globe. Known as Smallholder Agroforestry Finance, the blended finance facility enables Acorn to provide smallholder farmers with loans for inputs and training to adopt agroforestry, which are later repaid through the carbon revenues they earn. By keeping its financing costs low, Acorn is able to share 80% of the revenues from the carbon credits it sells directly with the smallholder farmers. 

3. Debt and equity for social enterprises seeking to access carbon markets

Social enterprises whose core business models involve the provision of green technologies to low-income customers are increasingly looking to carbon markets to support their operations. Such companies require financing to set up and scale carbon projects, which development finance institutions and impact investors are well-suited to provide. In Kenya, British International Investment, in collaboration with the Shell Foundation, recently extended 2.6 million USD in debt financing to enable solar irrigation company SunCulture to pilot a carbon project. The debt facility is designed to pre-finance the carbon credits generated from SunCulture’s water pumps, allowing SunCulture to discount the price of its water pumps by 25 to 40% and reach an estimated 9,000 additional farmers who would otherwise be unable to afford their products. The financing is expected to be repaid by revenues generated through the sale of carbon credits.

Tailored financing, greater collaboration will be key to realizing more inclusive carbon markets

Carbon projects, and carbon project developers, are diverse. Therefore, there is no one-size-fits all financing solution that development funders can rely on. Instead, funders need to consider factors such as project maturity and the project developers’ business model. This can help funders to better identify the investment opportunities that are best suited to their missions and financing instruments. 

Most importantly, funders will need to collaborate to develop effective financing facilities that meet the needs of inclusive carbon projects. From blended finance facilities that bring together donors and DFIs to provide financing at concessional rates, to first loss guarantees designed to crowd in commercial investors, greater coordination between funders will ultimately be key to unlocking access to the capital needed to build more inclusive carbon markets.