Clean Development Mechanism: Synergies with ESCO Business

Clean Development Mechanism: Synergies with ESCO Business International Conference on ESCO Opportunities in India1-2 June 2005 Presented by:Mohan Reddy, Director, ZenithEnergy (Hyderabad)Urs Brodmann, Partner, Factor Consulting + Management, Zurichwww.zenithenergy.comwww.factorag.ch

STRUCTURE OF PRESENTATION • Introduction to CDM • CDM Market – Status and Prospects • CDM Opportunities in ESCO Business

Kyoto Protocol global reduction of greenhouse gases by 5.2% (1990 - 2010) reduction commitments by developed (Annex 1) countries National Policies direct regulations market instruments enterprises: incentives and/or obligations to reduce net emissions of greenhouse gases direct reductions indirect measures Options technicalmeasures Joint Implemen-tation Clean Development Mechanism International Emissions Trading CDM and the Kyoto Protocol

Annex I Country Joint Implementation ( between Annex I Countries ) Emission Reduction Units sharing ERUs CDM vs. JI Clean Development Mechanism (CDM) ( Annex I / Non-Annex I) Certified Emission Reductions CERs

Baseline project Baseline emissions 30'000 ( t / year ) 20'000 Certified Emission Reductions (CERs) 2 CO 10'000 Project emissions 0 1 5 10 15 year CDM project crediting time Emission Reductions in CDM Projects

CDM Statistics (15 May 2005) • Projects registered: 5 • 1 landfill gas capture, Brazil • 2 small-scale hydro energy, Honduras • 2 HFC-23 decomposition, India & Korea • Projects submitted for registration: 8 • Including 1 biomass power generation in India • Including 3 projects under review by CDM EB • Projects submitted to CDM EB for approval of baseline methodology: 115

CDM Project Cycle CDM ExecutiveBoard ProjectOwner Project Idea Registration Project Owner Monitoring ofEmission Reductions* ProjectOwner Project Design Document Operational Entity Verification & Certificationof Emission Reductions* DNA Host Country Approval CERIssuance * CDM ExecutiveBoard ApprovalBaseline Methodology* * CDM ExecutiveBoard Operational Entity * periodically during crediting time* * unless approved method. is used Validation

Timing of CDM and Conventional Project Cycle

CDM Additionality Tool (Large-Scale Projects)Adopted by CDM Executive Board, Oct. 2004 A CDM project is additional if it is not the baseline scenario, i.e. the project would not happen without the CDM incentive. • Step 0: Eligibility for “early CDM” • Step 1: Identify lawful project alternatives • Step 2: Investment analysis, or • Step 3: Barrier analysis • Step 4: Common practice analysis • Step 5: Impact of CDM Registration

Crediting Periods; Timing • CERs can be generated as from now: • Banking by buyer for use towards compliance in 2008-12 • Banking by project proponent for sale in later years • Start of crediting period: • Usually the later of (i) CDM registration, and (ii) start of project operation • Emission reductions achieved since 2000 can be credited under certain conditions (demonstration of additionality, registration before end of 2005) • Duration of crediting periods: • Fixed crediting period of up to 10 years, or • Renewable crediting periods of up to 7 years (maximum = 3 x 7 years)

Small-Scale CDM Projects • Size limits for for small-scale projects: • Electricity generation from renewable sources, up to 15 MW • Energy efficiency projects saving up to 15 GWh p.a. • Projects reducing, and emitting themselves, up to 15,000 t CO2e p.a. • SSC projects benefit from simplified rules and procedures: • Simplified PDD • Simplified additionality test: Demonstrate that barriers would have led to higher emissions in absence of CDM • 15 pre-approved baseline methodologies (as per 15 May 2005) • Same operational entity may undertake validation and verification / certification

Current Market Volume for project-based emission reductions Jan–May Source: World Bank State of the Carbon Market, 2005

Current Market Prices for CDM/JI Credits • Average price in 2004: 5.6 €/t CO2e • Source: World Bank, State and Trends of Carbon Market 2005 • Prices are for forward trades • Typical price range for CERs: 4-7 €/t CO2e • Risks and their distribution are key for CER price: • Risk relating to CDM registration of project • Counterparty risk: Credit rating of seller and buyer • Whether partial upfront payment is made • Penalties in case of non-delivery

Locations of Emission Reduction projects by share of volume Jan 2003 – Dec 2004 Jan 2004 – April 2005 Source: World Bank State of the Carbon Market, 2005

Current Demand (May 2005) on CDM and JI market for Selected Major Buyers (million $) Source: Environmental Finance, May 2005, plus own research • Total CDM/JI demand currently: over USD 2 billion • Graph excludes corporate OTC demand

Selection of Approved Methodologies Relevant for ESCO Business

Selection of Approved Methodologies Relevant for ESCO Business (2) • ACM0002: Consolidated baseline methodology for grid connected electricity generation from renewable sources Approved small-scale methodologies e.g: • AMS II.D: Energy efficiency and fuel switching measures for industrial facilities • To qualify for this small-scale methodology, aggregate energy savings should not exceed 15 GWh per year • AMS III.B: Switching fossil fuels • To qualify for this small-scale methodology, measures should directly reduce, and emit, less than 15,000 t CO2e annually

Energy Efficiency Measures:Potential for CDM (Illustration) Ideal measures for CDM:CERs needed to reach benchmark (#3), or to mitigate financial risks (#2)

CER Ownership • In CDM projects, the owner of the installation generating the emission reductions typically owns the CERs • E.g., a CDM project for demand-side saving of electricity delivers CERs to the company taking the efficiency measures • In ESCO schemes, ownership of CERs can vary • The contractor (ESCO firm) or the contracting company (client) can be the primary owner of the CERs, depending on precise arrangement • CDM can increase the viability of energy efficiency measures, irrespective of ownership issues • Details of CER ownership need to be addressed in contractual framework for ESCO schemes

Conclusions • CDM can increase the financial viability of ESCO schemes • A real demand for carbon credits has emerged internationally • India is likely to become a leading seller of carbon credits • Relevant project types: energy efficiency and renewable energy • The additionality criterion restricts the range of CDM-eligible measures • Measures “on the margin” (i.e. just below critical profitability threshold) are best suited for CDM: Can be lifted above threshold by carbon revenues • CDM eligibility should be carefully assessed by professionals at the outset of any relevant activity • CDM transaction costs are relevant but not prohibitive • CER ownership issues need to be addressed under ESCO schemes • CDM baseline & monitoring methodologies allow for quantification of energy savings using internationally accepted protocols • CDM is an opportunity worth a try for any ESCO firm

Thank You Factor Consulting + Management AG Switzerland www.factorag.ch ZenithEnergy Hyderabad, India. www.zenithenergy.com

Timeline • Project Design Document • Large scale : 2 to 3 months • Small scale PDD : 1 to 2 months • Host country approval : 2 to 4 months • Validation • Adopt an approved methodology : 2 to 4 months • Propose a new methodology : 6 to 12 months • Small scale PDD : 2 to 4 months • Registration • Large scale : 8 weeks after submission unless revision is requested by the parties • Small scale PDD : 4 weeks after submission unless revision is requested by the parties

Transaction Costs • Transaction costs are those investment which the project proponent shall invest to monetize the CDM Benefits. • Transaction costs mainly include • Costs towards consultants for developing CDM project (PDD) • Costs towards validation of the CDM project • Costs towards registration of the CDM project with EB • Costs towards monitoring of emission reductions • Costs towards verification of CERs and transaction costs • Apart from the above, CDM EB deducts 2% of the CDM revenues to Adaptation fund. • Any other expenses as incurred by the project proponent towards CDM development • Transaction costs varies between 5% to 25% of the total revenues depending on the type and size of the project.

Estimated full market potential till 2012 Source: World Bank, IEA, IETA (2004) • Assumptions: • Countries such as Canada and Japan which have ratified Kyoto actually strive to meet targets • No participation of Australia and the United States • Restricted sales of surplus Kyoto units by Russia and the Ukraine. • Demand for CERs in 2010 of 250 Mt CO2e (range 50 to 500 Mt CO2e) • Price 2010: $11.00 /t CO2e (range +/- 50%). • Total demand of 1'250 Mt CO2e by 2012 (cumulative). • Failure to ensure a market value for post-2012 emission reductions would limit the CDM to an annual supply of 50 to 90 MtCO2e in 2010; and to total supply of 250 to 450 Mt CO2e up to 2012.

Clean Development Mechanism: Synergies with ESCO Business