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Contracting Carbon: Successful Negotiations and Balanced Contracts

Contracting Carbon: Successful Negotiations and Balanced Contracts. Charlotte Streck Ines Manzano Cartagena de las Indias 19 March 2007. Overview. Part I Selling CERs: The Contracting Process Various transaction structures Corresponding contracts Part II ERPAs: Main features

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Contracting Carbon: Successful Negotiations and Balanced Contracts

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  1. Contracting Carbon:Successful Negotiations and Balanced Contracts Charlotte Streck Ines Manzano Cartagena de las Indias 19 March 2007

  2. Overview Part I • Selling CERs: The Contracting Process • Various transaction structures • Corresponding contracts Part II • ERPAs: Main features • Available contract models • Presentation of the CERSPA initiative

  3. Creation of CERs Carbon Contract CERs € VERs Approval of Methodologies , approval of the project, registration, issuance of CERs Verification by DOE Creation of GHG Reductions (measured in tonnes of CO2e)

  4. CER Marketing: Development of a strategy Project developers developing a CER sales strategy should consider the following questions: • Is the CER cash flow essential for my project? • Do I need additional funds to cover my investment costs? Do I need an advance payment? • How would outsiders value my company? Do I have any credit rating or a balance sheet backing the transaction? • Would I benefit from technical advice and knowledge transfer? • What is the general risk profile of my project? • What are the CDM specific risks of my project? • Do I have more than one project in the pipeline? • Do I have access to full market intelligence (re: pricing and market forecasts)? • What price do I expect and which price can realistically be achieved under a forward contract?

  5. Project Developer CER/ERU Buyer Primary Market: CDM and JI Projects • > 80 % of current CDM and JI market • Forward purchase of carbon credits • Transacted under long-term off-take agreements (ERPAs) • If there is an advance payment, project finance character • Individually negotiated, diverse contracts • Little standardisation

  6. Spot Market Trading environment Sale of Carbon credits Project environment trader trader Project Project trader Issuance of credits trader trader • Trading of issued CERs and ERUs • Spot contracts • Highly standardised

  7. Forward vs Spot Transactions

  8. Price drivers: supply-demand Incl. forestry/transport Methodologies Gas and coal prices DNA approvals Winter temperature EB uncertainties NAPs (2008-2012) Project barriers EUA prices CER supply ETS demand ERU supply Annex 1 demand DNA approvals Canada in/out Project barriers AAU supply Post Kyoto AAU headroom Mitigation options Greening options Performance ETS Political support AAU support Russia, Ukraine in/out Annex 1 compliance

  9. Selling CERs under Forward Contracts (ERPA) Equity investor Technology Supplier € € € Wind Project Tech Bank € € ERPA € CERs e Approval Local currency Construction O&M Access Affected people etc CER Buyer Government Electricity purchaser

  10. Elements of Risk in Carbon Deals Key Issues: • Project Risk • Finance, Approvals, Construction, Production • Has an impact on: • existence of Project • Therefore existence and production of ERs • Needs management for the long term • Protocol Risk • Host Country Approval, Compliance, Eligibility, Transfer • Has an impact on: • Existence and compliance of ERs • Price • Needs management for the long term Principle: Assign risk to the party best able to bear it

  11. Negotiating ERPAs • Negotiations often not balanced, in particular in case the sellers are small or medium sized entities. • Buyers possess superior market knowledge and access, credit rating, more experience and specialized legal advice • ERPAs are complex documents, mostly in English, mostly drafted in the “common law” contract style: lengthy, cryptic, complicated • Sellers often rely on their generalist lawyers, or receive no advice at all • ERPAs therefore often not balanced with a buyer’s bias

  12. Existing ERPA Models • World Bank: The actual World Bank ERPA is based on non negotiable “General Conditions” and a CDM CER [of VER] Purchase Agreement. http://carbonfinance.org/docs/CERGeneralConditions.pdf • IETA: IETA ERPA is a Code of CDM Terms Version 1.0 (2006) (the Code).The Code forms the basis of the IETA ERPA . http://www.ieta.org/ieta/www/pages/getfile.php?docID=1794 • CERSPA Initiative: Freestanding open source CER Sales and Purchase Agreement

  13. CERSPA Initiative: Objectives • While standardization of ERPAs is unlikely to happen soon, there is an need for specialized legal advice in the CDM market. • The CERSPA carbon drafting initiative has developed a resource document and contract template which aims at assisting project developers in CDM contract negotiations. • CERSPA: • An understandable, and balanced CDM project agreement • Tool box of drafting alternatives • Guidance document which explains the background of particular formulations • Open source • To be translated into Spanish, Portuguese, Chinese, and French • Sponsored by the Inter-American Investment Corporation. Climate Focus and Lee Intl serve as secretariat of the initiative. Additional support from Corporación Andina de Fomento (Caracas), Siqueira Castro Advogados (São Paulo), Jun He Law Offices (Beijng), and the Center for International Sustainable Development Law (Montreal).

  14. Key Contractual Provisions Conditions of Effectiveness • Advisable: Registration and commissioning of the Project Sale and Purchase • Definition of commodity: VER/CER contracts • Price Delivery and Payment Conditions • Delivery: to the buyer’s account/instruction to the EB registry administrator • Payment: payment term, advance payments Default Conditions • Defaults: bankruptcy, insolvency; material breach • Willful misconduct: Penalty for selling contracted ERs elsewhere • Payment default Remedies • Outstanding payments with interest • Damage clauses, delivery of replacement VERs/CERs Project Development Dost, Taxes, Force Majeure, Dispute Settlement, Governing Law

  15. Main issues to keep in mind • Protect the project: • Limitation of liabilities necessary • Do not accept any obligations that put at risk the other deliverables/main commodities of the project • Consider the CDM as partnership rather than as a pure sales arrangement: • CER buyers may offer financing and technical assistance • The more the buyer is involved in the project the more it understands the difficulties the project developer faces • Make sure that you create a robust contract with an incentive framework that makes you and your counterparty comply in the long term

  16. Questions Charlotte Streck Climate Focus +31 64 64 2 64 81 C.Streck@climatefocus.com

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