What drives this demand for emissions reductions?
1. 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.
• 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”.
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!
Supply and Demand in the
Carbon Market – where are the
buyers?
Demand for carbon credits
Supply of carbon credits
C
C
C
C
C
C
CDM regions
Corporate Social
Responsibility
Including:
•
Involvement in trading schemes
• Carbon offset programmes
• Project development within multinationals
• Renewable energy and energy efficiency initiatives
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
10 million credits over ten years
1m
1m
1m
1m
1m
1m
1m
1m
1m
1m
.06m
.06m
600 000 credits over ten years
.06m
.06m
.06m
.06m
.06m
.06m
.06m
.06m
5 million over ten years
.5m
.5m
.5m
.5m
.5m
.5m
.5m
.5m
.5m
.5m
1
1.06
1.06
1.06
1.56
1.56
1.56
TOTAL
CREDITS
8
9
12
8
10
12
16
Price
8
etc
2006
2007
TOTAL
REVENUE
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
201
9
2020
Step 4: Timing of CER
transactions
First Kyoto Commitment Period
First Phase EU ETS
Feb
2004
2005
2008
2012
Second
Commitment
Period?
Bilateral/Unilater
al
•
•
•
What the hell is this?
Alt 1: equity investment for CER swap
“bilateral”
Alt 2: “unilateral”
1. Sell forward
2. Sell on spot
3. Bank
Step 3: Unilateral vs
Bilateral Transaction
Models
Unilateral
Bilateral/Multilateral
No Annex 1 Project Participant
One or more project participants from
an Annex 1 country
CERs sold over-the-counter or
through forward contracts
CERs contracted as returns to
financial/ technical investment
Low risk to purchaser for CERs Medium risk to investor as they
sold post issuance
contract forward, but have influence
over project success
High risk to purchaser for
forward sales
Unclear whether this model is
eligible under the EB rules
Model initially envisaged by Kyoto
Many projects under
development
Very few projects under development
Purchasers of CERs
Investors v Buyers
• Investors:
– Contribute
• Capital
• Technology
– Receive
• Equity
• Profit share
• Joint venture
• Buyers:
– Purchase CERs
• Off the shelf
• Forward Purchase
Steps to reduce Project
Participant risk during the
transaction process
Necessary
Desirable
First Prize!
• 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
Step 4: Types of Risk and
Mitigation Strategies
- Project Failure
Construction & operation risk assessment:; written contracts
- Underperformance
Conservative CER contracts; insurance
- Project Feasibility
Audited financial and technical feasibility assessments
- Policy (Kyoto)
Transfer risk to buyer through contract; sell into VER market
- Country
Prepare country risk report, follow unilateral model
- Exchange Rate
Identify the effects of an appreciation/depreciation; est.
financing strategy
- DNA
Get letter confirming legislative/policy consistency if no
- Ownership
DNA/rules
Clearly establish and document ownership
- Validation
Use accredited DOE; get pre-validation assessment; use
approved methodology
- Market Uncertainties
Undertake market appraisal; monitor the market; est. a forward
price curve
Steps in the
Transaction Process
1. Identify potential buyers
2. Approach potential buyers requesting expressions of interest
in the CERs
3. Assess Expressions of Interest (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, either an Emission
Reduction Purchase
5. Agreement (ERPA) or Direct Purchase Agreement (DPA)
6. Finalise contract and transact
Throughout process… identify and take steps to mitigate risks!
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..
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
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
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
Step 4: Example of
constructing a
forward price curve
Carbon Market: Forward Price Curve
Price in Euros
16
14
EUAs
12
Anticipated Kyoto ET
credit
10
CERs, seller takes Kyoto
risk
8
6
CERs, buyer takes Kyoto
risk
4
Canadian ETS price cap
2
0
2002
2004
2006
2008
Year
2010
2012
2014
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….
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
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..
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
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
Steps in the Transaction Process
1. Identify potential buyers
2. Approach potential buyers requesting expressions of interest in the
CERs
3. 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)
5. Finalise contract and transact
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
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
•
•
•
•
•
•
•
Exchange Rate
Financial
Demand for product
Country
Construction, Operation & Maintenance
Legislative
Project Location
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.)
Internal
- Methodology approval
- DNA Approval
- Validation
- Gold Standard Certification