- The Pilot Auction Facility for Methane and Climate Change Mitigation (PAF) is an innovative climate finance model developed by the World Bank Group to stimulate investment in projects that reduce greenhouse gas emissions while maximizing the impact of public funds and leveraging private sector financing.
- Its results-based payment mechanism sets a floor price for future carbon credits in the form of a tradeable put option, which is be competitively allocated via auctions.
- The PAF is backed by Germany, Sweden, Switzerland (Through a joint contribution of the State Secretariat of Economic Affairs (SECO) and the Climate Cent Foundation), and the United States. The facility has a capitalization target of $100 million. In a first phase, it will support projects that cut methane emissions at landfill, animal waste, and wastewater sites facing low carbon prices.
- The establishement of the facility was an outgrowth of the Methane Finance Study Group Report, delivered to the G8 in 2013 as a result of its request for innovative pay for performance approaches to addressing methane. In its design and development phase the facility benefited from the support of Partners in the Climate and Clean Air Coalition.
The Pilot Auction Facility for Methane and Climate Change Mitigation
The PAF is an innovative, pay-for-performance mechanism which uses auctions to allocate scarce public funds and attract private sector investment to projects that reduce methane emissions, taking advantage of the Clean Development Mechanism (CDM) infrastructure already in place for implementation.
The key objective of the PAF is to demonstrate a new, cost-effective climate finance mechanism that incentivizes private sector investment and action in climate change in developing countries by providing a guaranteed floor price on carbon reduction credits. The guaranteed floor price would be delivered through the auctioning of put options supported by donor funding.
The nature of the put option means that the facility’s resources will only be disbursed after the emission reductions have been independently verified, making the PAF a “pay for performance” facility. The put options will be embedded into puttable bonds issued by the World Bank. The World Bank’s obligation under the bonds will be backed by the PAF. Under the terms of the bond, the bondholders will have the right, but not the obligation, to sell the emission reductions achieved by the underlying projects to the PAF at a pre-agreed price, the put option “strike” price.
The optionality allows put option owners to benefit if carbon prices in international markets rise above the strike price. In this case, the PAF will have achieved its objective (to stimulate private sector investment in mitigation) at no cost to it. If prices fall, the put option owner has the right to sell the carbon credits to PAF at the strike price. Either way, the price guarantee has provided the private investors the financial incentive to fund projects.
The competitive nature of the auction used to allocate the put options reveals the minimum price required by the private sector to make such investments, therefore maximizing the impact of public funds and achieving the highest volume of climate benefits per dollar.
Additionally, the PAF will disburse its resources only against independently verified emission reductions, using existing carbon auditing standards such as the CDM or voluntary standards such as the Verified Carbon Standard or Climate Action Reserve. This pay-for-performance feature is attractive for governments facing expanding funding needs and scrutiny on achievements. The combination of an auction process and payments based on performance maximizes value for public money.
In its first phase, the PAF will support projects that cut methane emissions at landfill, animal waste, and wastewater sites. The facility will deliver quick impact by initially targeting the 1,200 methane reducing projects which are at risk of decommissioning due to the low price of carbon credits. The facility has a strong potential for replication and quick scaling up, in methane or other sectors.