Carbon Markets

Capacity building on business opportunities for CDM projects in China

A project funded by the European Union and carried out by CIRPS, Global Environmental Institute, Instituto Superior Técnico and Helio International

Carbon Markets

In relation to CDM projects in China



Main Elements• Carbon funds and facilities

• Carbon brokers

• Feasibility and risk analysis

• Pricing structures

• Carbon contracts



Carbon Markets• Compliance markets Players buy carbon

credits in order to meet a mandatory (legally imposed) emission reduction target

• Voluntary markets Based on voluntary efforts to reduce emissions. They are largely driven by the threat of governmental regulation and compliance targets, in non-Kyoto countries

• Offset markets Retail offset purchasers are typically corporations or individuals aiming to become carbon neutral.



Compliance MarketsKyoto Annex 1 Countries trade:•Certified Emission Reductions (CERs)•Emission Reduction Units (ERUs)•Assigned Amount Units (AAUs)•Units regulated under other schemes e.g. EU Allowances (EUAs) Retail Offset Market

Purchasers (usually individuals, organisations or events) buy CERs and

VERs with high sustainable development benefits in order to become carbon

neutral Voluntary Markets

Non-Kyoto Countries trade Verified Emission Reductions (VERs) and have requirements under various

schemes, e.g. Chicago Climate Exchange (CCX) and New South

Wales Scheme



Sale of Carbon Credits• Spot market transactions occur when

actual, existing, verified or certified credits are transferred.

• Forward sales are the most common transaction form – they are the promise to purchase credits once they are generated, at a specified price.



Market Drivers• European Union Began trading carbon

emission reductions in January 2005 based on a cap-and-trade programme

• United Kingdom Project-based GHG emissions reduction pilot launched in 2002

• United States Chicago Climate Exchange (CCX) has established a voluntary cap-and-trade programme initially in North America and Brazil



EU Emissions Trading Scheme• EU ETS establishes emission reduction

requirements for about 10,000 large industrial and electricity generating sources (about half of Europe’s emissions of CO2)

• Phase 1 started in January 2005 and runs through 2007

• Phase 2 corrsponds to 2008-2012 (first commitment period of the Kyoto Protocol)

• EU allowances are EU ETS compliance instruments allocated by EU governments



EU Emissions Trading Scheme• Market for European Union Allowances

(EUAs) experienced explosive growth in 2005 (from about 9 Mt in 2004 to over 322 Mt in 2005), due largelly to trading activity of electricity generators

• Prices increase dramatically in 2005 from about € 7 to a high of about € 30, due to rising natural gas prices, which resulted in increased coal-fired generation

• Continued expansion in first quarter of 2006



Market Buyers• World Bank/Prototype Carbon Fund Finances

projects that produce high-quality GHG emission reductions

• World Bank Umbrella Carbon Facility (UCF) Created in December 2005, the UCF will aggregate multiple sources of funding to purchase large volumes of emission reductions

• Natsource GHG Credit Buyers Pool US$ 200 million GHG-Credit Aggregation Pool that will purchase project-based GHG emission reductions



Market Buyers• Certified Emission Reduction Unit

Procurement Tender (CERUPT) Provides project funding to purchase CERs

• Emission Reduction Unit Procurement Tender (ERUPT) Purchases carbon emission reductions

• International Finance Corporation-Netherlands Carbon Facility (INCaF) Purchases project-based carbon emission reductions



Market Facilitators• Asian Development Bank Renewable

Energy, Energy Efficiency and Climate Change (REACH) facility Works cooperatively with development funds in Denmark, the Netherlands and Canada

• Global Environment Facility (GEF) Provides cost-sharing grants and concessional funding to help fund projects that protect the environment (climate change mitigation is one of it’s four focus areas)

• Carbon Brokers Natsource, Cantor Fitzgerald/CO2e.com, Evolution Markets LLC



Possible sources of finance• World Bank/Prototype Carbon Fund• Certified Emission Reduction Unit

Procurement Tender• IFC-Netherlands Carbon Facility• Chicago Climate Exchange (CCX)• GHG-Credit Aggregation Pool• Asia Development Bank (ADB)• GEF• Carbon brokers



The future• According to Natsource: EU, Japan and

Canada are likely to be 3 to 4 billion tonnes short of achieving emission reduction targets in 2008-2012

• Continued growth in trading of project-based emission reductions



Risk areas relevant to CDM projectsRegulatory risk: Are the regulations surrounding independent power producers developed and stable? Is the implementation of a new energy efficiency regulation likely?

Technical risk: RE/EE technologies are often new, or new to the location

Credit risk of parties to transaction: How likely is it that the financier will get their investment back should any aspect of the project fail or under-perform?

Country/political risk: What is the likelihood of local government intervention in the project, or appropriation of profits or assets?

Demand and supply risk of outputs: How well has the market demand for outputs, or availability of supply of project inputs been tested?



Institutions Risk Tolerance

Reward Expectations

Commercial Bank Low Low

Government technology agency

High Medium

Export credit agency Medium Medium

Donor organisaton Medium High

Venture capitalist High High

Development Bank Medium Low

Foreign Direct Investor Low Medium



Risk Mitigation Project risks Jurisdiction-specific

issues Counterparty issues Issuance of CERs

• Obligation to act as a prudent operator

• Reporting requiremnts

• Due diligence requirements in host country

• Restricting other project participants

• Credit support, Material Adverse Change clause

• Due diligence and credit analysis

Delivery • Performance guarantees

• Escrow arrangements

• Events of default

Compatibility with back-to-back arrangements

• Conform back-to-back agreements



Prices paid for project-based emissions reductions

• Stage of the project in the project cycle

• Creditworthiness of the seller and buyer

• Delivery guarantees

• Investment and regulatory climate of the host country

• Technology performance



Trends in 2005 and 1st quarter 2006• HFC23 destruction projects accounted for 58%

of traded reductions• 78% of traded emissions reduction in 2005 and

the first quarter of 2006 were non-CO2 gases

• Landfill gases were 9% of traded volume• Coal mine methane gases were 6% of traded

volume• Hydroelectric power, wind, biomass and other

renewables and energy efficiency projects accounted for 12% (down from 25% in 2004)



Regulatory incentives• Companies are liable to a fine of 40 €

per tonne over the permitted limit during the three-year transitional period

• A fine of 100 € per tonne of CO2 will be applicable from 2008 to 2012



Parties involved in CER purchase

Trader

Legal

Credit

Risk Management



CER transaction processInitial Proposal

Term Sheet and

NegotiationSigning of ERPA Ongoing

Monitoring

• Trader discusses principal terms of deal with seller

• Legal checks terms against internal procedures

• Risk Management & Credit analyse Seller and CDM project and give specific requirementzs to legal

• Legal co-ordinates due diligence on CDM project and host country

• Wording agreed between Buyer and Seller

• Final draft subject to review by Board

• Board approves entry into ERPA

• Trader keeps ongoing relationship with Seller

• Risk Management and Credit monitor any events that might affect deal

• If such events occur, all discuss how to respond (termination, amendment, assignment, etc.)



Emissions Reduction Purchase Agreement (ERPA)

ERPA

Risk MitigationType of Purchaser

Time of Transaction

Types of Pricing Mechanisms

Carbon Project Type

Carbon Markets

Documents

Transcript of Carbon Markets