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What drives this demand for emissions reductions?. The Kyoto Protocol. 2. Developed country regulations. 3. Corporate social responsibility / branding. The Kyoto Protocol. The developed countries have set an average target of 5% below their ghg emission levels in 1990.

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what drives this demand for emissions reductions
What drives this demand for emissions reductions?
  • The Kyoto Protocol
  • 2. Developed country regulations
  • 3. Corporate social responsibility / branding
the kyoto protocol
The Kyoto Protocol
  • The developed countries have set an average target of 5% below their ghg emission levels in 1990.
  • These targets are to be achieved by 2008-2012, the “first commitment period”.
  • They can use 3 “Flexible Mechanisms” to help them:

- Emissions Trading,

- Clean Development Mechanism (CDM)

- Joint Implementation (JI)

  • Developing countries don’t have targets for the “first commitment period”.
slide3

Emissions Trading

  • Based on the principle of cost efficiency: by establishing a market for emission reductions, you get the most number of reductions at the lowest cost.
  • Greenhouse gases mix uniformly in the atmosphere - so it does not matter where you reduce them
  • Targets are set, and you can either achieve that target by
  • making emission reductions yourself, or you can buy from an
  • emitter that has improved on its target.
  • This creates an incentive to maximize reductions, but
  • emissions trading is controversial!
slide4

Supply and Demand in the Carbon Market – where are the buyers?

Supply of carbon credits

CDM regions

Demand for carbon credits

C

C

C

C

C

C

corporate social responsibility
Corporate Social Responsibility
  • Including:
  • Involvement in trading schemes
  • Carbon offset programmes
  • Project development within multinationals
  • Renewable energy and energy efficiency initiatives
cer s
CER’s
  • A CER is like a share certificate
  • CER’s will be registered in an international bourse and each one will be individually numbered and described.
  • They are anticipated to be fully fungible and so any owner can hold them and speculate with them, or
  • Use them to prove compliance with a country target, in which case they “retire”.
cdm portfolio
CDM portfolio

10 million credits over ten years

600 000 credits over ten years

5 million over ten years

slide8

Step 4: Timing of CER transactions

First Kyoto Commitment Period

First Phase EU ETS

Second Commitment Period?

Feb2004

2005

2008

2012

bilateral unilateral
Bilateral/Unilateral
  • What the hell is this?
  • Alt 1: equity investment for CER swap “bilateral”
  • Alt 2: “unilateral”
      • Sell forward
      • Sell on spot
      • Bank
investors v buyers
Investors:

Contribute

Capital

Technology

Receive

Equity

Profit share

Joint venture

Buyers:

Purchase CERs

Off the shelf

Forward Purchase

Purchasers of CERs

Investors v Buyers
slide12

Steps to reduce Project Participant risk during the transaction process

  • Project Idea Note
  • Project participant identified
  • PDD Complete
  • Financial feasibility with all shareholders identified
  • Technological feasibility undertaken
  • OE identified
  • Validation Complete
  • DNA approval complete
  • Other financial shareholders committed

Necessary

Desirable

First Prize!

slide13

Step 4: Types of Risk and Mitigation Strategies

  • Project Failure
  • Underperformance
  • Project Feasibility
  • Policy (Kyoto)
  • Country
  • Exchange Rate
  • DNA
  • Ownership
  • Validation
  • Market Uncertainties

Construction & operation risk assessment:; written contracts

Conservative CER contracts; insurance

Audited financial and technical feasibility assessments

Transfer risk to buyer through contract; sell into VER market

Prepare country risk report, follow unilateral model

Identify the effects of an appreciation/depreciation; est. financing strategy

Get letter confirming legislative/policy consistency if no DNA/rules

Clearly establish and document ownership

Use accredited DOE; get pre-validation assessment; use approved methodology

Undertake market appraisal; monitor the market; est. a forward price curve

slide14

Steps in the Transaction Process

  • Identify potential buyers
  • Approach potential buyers requesting expressions of interest in the CERs
  • Assess Expressions of Interest (EOIs) and identify the buyer with whom you wish to negotiate and which transaction model you with to transact under
  • Negotiate and structure contract, either an Emission Reduction Purchase
  • Agreement (ERPA) or Direct Purchase Agreement (DPA)
  • Finalise contract and transact

Throughout process… identify and take steps to mitigate risks!

overview of the carbon market
Overview of the Carbon Market
  • Fragmented but emerging
  • Currently: diverse set of buyers interested in trading carbon units (EU ETS, Japanese companies)
  • Carbon credits are ‘created’ through Emissions Trading Schemes or Projects, and registered in a registry
  • Market growth (64m tonnes Jan-May 04, already equal to 2003)
  • Where SA fits (CCC in PointCarbon ratings)
carbon market transactions
Carbon Market transactions..

At this stage of market development, It’s likely that carbon purchasers will purchase forward in some way:

  • option
  • right of first refusal
  • forward purchase on some formula
  • outright purchase

Purchase contracts could therefore span over 10 years.

These are governed by ERPAs

slide17

Steps One and Two:

Who is buying and brokering CERs?

  • Annex One governments:
  • The Dutch, EU governments, Canadians
  • Institutional/Fund Buyers:
  • World Bank
  • CDC IXIX (French Fund)
  • Private Companies:
  • Sumitomo, Nippon, Holcim, Anglo, Nuon
  • Offset Purchasers:
  • 500ppm
  • Brokers
  • Natsource, Evolution Markets, CO2e
slide18

Step 4: CER Contract Considerations

  • The project’s overall viability (CER delivery risk)
  • Credit standing of the project sponsor
  • Kyoto and EB risk
  • Validation and certification costs
  • Type of trade, payment terms
  • Credit vintage
  • Additional environmental and social benefits
  • Project type (scheme eligibility risk)
  • Country and exchange rate risks
slide20

Step 5: Transaction

  • Using ERPA (Emission Reduction Purchase Agreement) for forward sales
  • Using DPA (Direct Purchase Agreement) for over-the-counter sales
  • Incorporating options, forward sales, right of first refusal
  • See IETA website www.ieta.org for an example….
slide21

Who is buying and

brokering CERs?

  • Annex One governments:
  • The Dutch, Danish, Austrians
  • Institutional/Fund Buyers:
  • World Bank PCF
  • CDC IXIX (French Fund)
  • Private Companies:
  • Sumitomo, Nippon, Holcim, Anglo, Nuon
  • Offset Purchasers:
  • 500ppm, Climate Care, Future Forests
  • Brokers
  • Natsource, Evolution Markets, CO2e
slide22

Session Overview

  • 1) Introducing SSN
  • 2) Introducing the case study: Bellville Landfill project
  • 3) An overview of the Carbon Market
  • 4) The risk and reward trade-off
  • 5) Transactions group exercise
  • 6) Feedback and discussion
cer payment
CER Payment..

At this stage of market development, It’s likely that CER purchasers will in most cases purchase forward in some way…

  • This can either by option
  • Or right of first refusal
  • Or forward purchase on some formula
  • Or outright purchase
slide24

Who is buying and

brokering CERs?

  • Annex One governments:
  • The Dutch, EU governments, Canadians
  • Institutional/Fund Buyers:
  • World Bank
  • CDC IXIX (French Fund)
  • Private Companies:
  • Sumitomo, Nippon, Holcim, Anglo, Nuon
  • Offset Purchasers:
  • 500ppm
  • Brokers
  • Natsource, Evolution Markets, CO2e
slide25

Steps in the Transaction Process

  • 1. Identify potential buyers
  • Approach potential buyers requesting expressions of interest in the CERs
  • Assess EOIs and identify the buyer with whom you wish to negotiate and which transaction model you with to transact under
  • 4. Negotiate and structure contract in an Emission Reduction Purchase Agreement (ERPA)
  • Finalise contract and transact
risk is crucial
Risk is crucial!
  • At various points of the project cycle, there exist levels of risk to both the participants and the potential buyer
  • Risk is shared in projects that involve an investor
  • Risks are different for the developer and prospective CER buyer
risks to cdm projects
Risks to CDM Projects

The risks to CDM projects can be classified into two types:

1) General Project Risks

2) CDM Specific Risks

As a general rule, the more advanced

the project, the lower the risks

general project risks
General Project Risks
  • Exchange Rate
  • Financial
  • Demand for product
  • Country
  • Construction, Operation & Maintenance
  • Legislative
  • Project Location
cdm specific risks
CDM Specific Risks

Again, two types: those that are internal and those that are external to the project

External

- Kyoto Ratification

  • EU ETS Demand
  • Full fungibility of CERs
  • Clarity on 2nd Commitment Period
  • EB registration stringency
  • Timing of external market demand
cdm specific risks cont
CDM Specific Risks (cont.)

Internal

  • Methodology approval
  • DNA Approval
  • Validation
  • Gold Standard Certification