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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

Contracting Carbon:Successful Negotiations and Balanced Contracts

Charlotte Streck

Ines Manzano

Cartagena de las Indias

19 March 2007

overview
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
creation of cers
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)

cer marketing development of a strategy
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?
primary market cdm and ji projects

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
spot market
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
price drivers supply demand
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

selling cers under forward contracts erpa
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

elements of risk in carbon deals
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

negotiating erpas
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
existing erpa models
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
cerspa initiative objectives
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).
key contractual provisions
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

main issues to keep in mind
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
questions
Questions

Charlotte Streck

Climate Focus

+31 64 64 2 64 81

C.Streck@climatefocus.com