Resource Hub
Become more familiar with both the fundamentals and technical aspects of carbon removal markets and nature-based solutions. Each topic has been carefully curated to deepen your overall understanding of this field.
What is the Resource Hub?
Carbon Credits 101
Carbon Credit Procurement
Nature-based solutions 101
Project Development 101
Project Finance 101
Policy Briefs
1. Introduction
This guide provides a basic overview of project finance as it applies to nature-based carbon removal projects (like reforestation, afforestation, soil carbon enhancement, etc.). Understanding these financial structures is key to developing viable, high-impact projects that attract investment and buyers. Our goal is to secure the necessary funding to cover project costs while ensuring fair returns for investors and delivering verifiable carbon removals.
2. What is project finance?
Core Concept
Project finance is a way to fund specific, long-term projects (like infrastructure or energy projects, and increasingly, carbon projects) based on the project's ownfuture cash flows, rather than the general assets or creditworthiness of the project developer.
Key Feature - SPV
Usually, a separate legal entity called a Special Purpose Vehicle (SPV) is created specifically for the project. This SPV owns the project assets, contracts, and debt.
Non-Recourse/Limited Recourse
This means that if the project fails, the lenders or investors typically only have a claim on the project's assets (the SPV's assets), not on the developer's other assets (this is 'non-recourse'). Sometimes, the developer might offer limited guarantees ('limited recourse'). This structure isolates project risk.
Contrast with Corporate Finance
In corporate finance, a company raises funds based on its overall balance sheet and credit rating, and the funds can be used for various purposes. Project finance is tied directly to a single project's success.
3. Why project finance for carbon removal?
Nature-based solutions often involve:
- High Upfront Costs (Capex): Significant investment is needed for land preparation, planting, monitoring setup, etc. before revenues start.
- Long Project Lifetimes: These projects have operated over decades.
- Delayed Revenue: Carbon sequestration takes time, and revenue from carbon credit sales comes years after initial investment.
- Revenue Uncertainty: Carbon prices and verification success can be variable.
- Risk Management: Project finance helps isolate the specific risks associated with a carbon project.
These characteristics make project finance structures, which focus on long-term cash flow generation and risk allocation, a good fit.
4. Key terminology
Special Purpose Vehicle( SPV): The legal entity created solely to own and operate the carbon project.
Capital Expenditures (Capex): Upfront costs to build or establish the project (e.g., land prep, seedlings, planting, initial monitoring equipment).
Operational Expenditures (Opex): Ongoing costs to run the project (e.g., monitoring, maintenance, staff, verification fees, administration).
Offtake Agreement: A long-term contract where a buyer (e.g., a corporate) agrees to purchase a certain volume of carbon credits at a specified price (or pricing formula) in the future. This provides revenue certainty.
Carbon Streaming: An agreement where an investor provides upfront capital to the project developer in exchange for the right to receive a percentage of the future carbon credits generated by the project over a set period.
Carbon Credits: Tradable certificates representing the removal or avoidance of one metric tonne of CO2 equivalent. These are the primary revenue sources for many projects.
Validation and Verification: The process by which an independent third-party auditor confirms that a project meets a specific carbon standard's requirements (Validation) and accurately measures and reports the carbon removals achieved (Verification). Costs are included in Opex/Capex. Validation and verification are usually conducted by Validation and Verification Bodies, or VVBs, at custom rates.
Due Diligence: The process of investigation and analysis is conducted by potential investors or buyers to assess the quality, risks, and viability of a project.
NPV (Net Present Value): The current value of all future cash flows (positive and negative) of the project, discounted back to the present using a specific discount rate. A positive NPV generally indicates a financially viable project.
IRR (Internal Rate of Return): The discount rate at which the NPV of the project's cash flows equals zero. It represents the project's effective rate of return. Investors often have minimum IRR hurdles, usually 15% and higher for carbon projects, based on their risk perception levels.
Buffer Pool: A percentage of carbon credits set aside (not sold) by carbon standards (like Verra, Gold Standard) as insurance against unexpected project failures or reversals (e.g., fire, disease). This is factored into carbon revenue projections.
5. Common financing structures for carbon projects
Structure 1: Corporate Offtake + Upfront Project Finance
How it works: A project developer secures a long-term offtake agreement with a corporate buyer for a significant portion of the expected carbon credits. This guaranteed future revenue stream makes the project less risky and helps secure traditional project finance (debt and/or equity) from banks or investors to cover the initial Capex.
Pros: Provides revenue certainty, can unlock larger amounts of capital earlier on in the project.
Cons: Requires finding a committed long-term buyer early on, potentially locks in prices.
Structure 2: Carbon Streaming
How it works: An investor (often a specialised carbon or natural capital fund) provides upfront cash to the developer. In return, the investor receives the rights to a fixed percentage (e.g., 30%) or volume of the carbon credits generated by the project over the contract term. The developer uses the upfront cash for Capex and Opex.
Pros: Provides non-dilutive (doesn't give away ownership of the project company) upfront capital, developer retains operational control and upside on un-streamed credits.
Cons: Investor takes on carbon delivery risk, complex contract negotiation, developer gives up a portion of future carbon revenue.
Structure 3: Hybrid Model
How it works: Combines elements of the above. For example, a project might secure a smaller offtake agreement to cover a portion of its financing needs and then use a carbon streaming deal to raise the remaining capital. Or, it might use equity investment alongside streaming or offtake.
Pros: Flexibility, can tailor financing to specific project needs and investor types.
Cons: Can increase complexity in negotiations and managing different stakeholder interests.
6. Understanding and managing risk
Nature-based carbon projects face various risks that can impact their financial viability and structure. Identifying, assessing, and mitigating these risks is a core part of due diligence and project finance. Key risks include:
Country and political risk
Description: Instability, changes in government policy, weak land tenure rights, risk of expropriation, corruption. Particularly relevant in emerging economies where many nature-based projects occur.
Impact: Can halt projects, invalidate agreements, or increase operating costs unpredictably. Investors demand higher returns (higher discount rates/IRR hurdles) to compensate. Mitigation includes political risk insurance, strong local partnerships, and thorough legal due diligence.
Regulatory risk
Description: Changes to carbon market rules (domestic or international), evolving methodologies, potential introduction of carbon taxes affecting project economics or additionality claims, lack of clear legal frameworks for carbon rights.
Impact: Can affect credit eligibility, pricing, or project viability. Mitigation involves staying updated on policy developments, engaging with policymakers, choosing robust methodologies, and potentially diversifying revenue streams.
Carbon market risk
Description: Volatility in carbon credit prices, shifts in buyer preferences towards certain project types or co-benefits, delays or failure in validation/verification, changes in carbon standard rules (e.g., buffer pool requirements), risk of project failure leading to reversals (loss of sequestered carbon).
Impact: Directly affects revenue projections. Lower prices or failed verification severely impact IRR/NPV. Mitigation includes securing long-term offtake agreements, high-quality project design aligned with robust standards, conservative yield estimates, and potentially buffer insurance.
Operational and execution risk
Description: Failure to implement the project as planned – planting delays, lower-than-expected survival/growth rates, cost overruns, pest/disease outbreaks, fire, drought, challenges with community engagement leading to conflict or sabotage.
Impact: Increases costs (Capex/Opex), reduces carbon yields (revenue), and can damage reputation. Mitigation involves experienced management teams, technically sound design (e.g., appropriate species, climate resilience planning), strong community engagement, robust monitoring systems, and contingency budgets.
Currency risk
Description: Project costs are often incurred in local currency, while carbon credit revenues are typically priced in USD or EUR. Fluctuations in exchange rates can impact profitability.
Impact: Unfavourable exchange rate movements can reduce net revenues when converted back to the project's functional currency or increase the effective cost of imported goods/services. Mitigation includes currency hedging (can be expensive), structuring payments, or potentially pricing credits in local currency if buyers agree.
Financial risk:
Description: Risk of insufficient funding to complete the project, inability to service debt, or investors not achieving their required returns.
Impact: Project incompletion, bankruptcy, loss of investment. Mitigation involves realistic financial modelling, securing sufficient funding commitments upfront, appropriate capital structure (debt/equity mix), and clear risk/return sharing in agreements.
7. How risk affects finance
IRR/NPV
Higher perceived risk leads investors/lenders to demand higher potential returns (increasing the discount rate used for NPV calculations, or requiring a higher projected IRR). Risks materialising (e.g., cost increases, revenue decreases) directly lower the actual IRR and NPV achieved.
Costs
Many risk mitigation strategies (e.g., insurance, robust monitoring, legal fees, hedging, higher quality inputs) increase project Capex and Opex.
Financing Structure and Revenue Sharing
The allocation of risk is a key negotiation point. Debt providers want security and prefer risks to be borne by equity holders. Equity holders demand higher returns for taking more risk. Offtake agreements shift price risk (partially) to buyers but leave delivery risk with the project. Streaming agreements often shift delivery risk to the investor providing upfront capital. Revenue sharing arrangements (e.g., with communities) need to account for potential revenue shortfalls due to risk.
8. Investor landscape and types of financing
Financing for nature-based carbon projects comes from various sources and through different structures. Understanding the players and instruments is key.
Where does the money come from?
- Much private capital flows through investment funds managed by General Partners (GPs). GPs are the fund managers – specialised firms (e.g., climate funds, impact funds, private equity, venture capital) that raise money, find projects, conduct due diligence, structure investments, manage the portfolio, and report to investors. They earn management fees and 'carried interest' (a share of the profits).
- GPs raise capital from Limited Partners (LPs). LPs are the allocators of capital who invest in the funds managed by GPs. Typical LPs include:
- Institutional Investors (Pension Funds, Insurance Companies, Sovereign Wealth Funds, Endowments)
- Family Offices and High-Net-Worth Individuals
- Foundations seeking impact investments
- Development Finance Institutions (DFIs)
- Corporations (sometimes investing in funds, alongside direct project investments/offtakes)
- Direct Investors: Some large entities like corporations (e.g., Microsoft, Amazon), DFIs, or specialised carbon investors/developers may also invest directly into projects, bypassing funds.
Types of financing instruments
Equity
- Investment in exchange for part-ownership (shares) of the project SPV or the development company. Equity holders share in profits (if any) but are typically last in line to be paid if the project fails (highest risk).
- Source:Project developers, venture capital, private equity, impact investors, family offices.
Debt
- Loans that must be repaid with interest over a set period. Lenders typically require security (e.g., project assets, contracts). Less risky than equity for the provider, seeks stable returns.
- Source: Commercial banks (often require strong guarantees or offtake contracts for carbon projects), DFIs, specialised private debt funds, governments.
Grants
- Funding that does not need to be repaid. Often targeted at specific outcomes or early-stage activities.
- Source: Philanthropic foundations, government agencies (domestic or international aid), multilateral organisations.
Concessional Finance
- Loans or equity provided on terms more favourable than market rates (e.g., lower interest, longer repayment period, subordination to other debt). Aims to reduce risk for commercial investors.
- Source: DFIs, foundations, governments.
Blended Finance
- Strategically combining concessional finance or grants with commercial debt and/or equity. The 'softer' funding helps improve the project's risk/return profile, making it attractive to private investors who wouldn't otherwise participate.
- Example: A grant funds the initial high-risk feasibility and community work, a DFI provides a low-interest loan, enabling a commercial investor to provide equity at their required return hurdle.
Carbon-Specific Finance (overlaps with above, but distinct mechanisms):
- Offtake Agreements (with upfront payment): Buyers pre-pay for future carbon credits, providing upfront capital that functions like debt or working capital finance.
- Carbon Streaming: As defined earlier, an investor provides upfront capital specifically in exchange for a future stream of carbon credits.
9. Conclusion
Structuring the financing for nature-based carbon removal projects requires careful consideration of costs, revenue projections, risks, and the needs of different stakeholders (developers, investors, buyers, and communities). By understanding the basics of project finance, key terminology, and how to build a robust financial model, you'll be well-equipped to support the development of high-quality, financially sustainable carbon projects.