What drives this demand for emissions reductions?

1. What drives this demand for emissions reductions? • The Kyoto Protocol • 2. Developed country regulations • 3. Corporate social responsibility / branding

2. 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”.

3. 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!

4. Supply and Demand in the Carbon Market – where are the buyers? Supply of carbon credits CDM regions Demand for carbon credits C C C C C C

5. Corporate Social Responsibility • Including: • Involvement in trading schemes • Carbon offset programmes • Project development within multinationals • Renewable energy and energy efficiency initiatives

6. 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”.

7. CDM portfolio 10 million credits over ten years 600 000 credits over ten years 5 million over ten years

8. Step 4: Timing of CER transactions First Kyoto Commitment Period First Phase EU ETS Second Commitment Period? Feb2004 2005 2008 2012

9. Bilateral/Unilateral • What the hell is this? • Alt 1: equity investment for CER swap “bilateral” • Alt 2: “unilateral” • Sell forward • Sell on spot • Bank

10. Step 3: Unilateral vs Bilateral Transaction Models

11. Investors: Contribute Capital Technology Receive Equity Profit share Joint venture Buyers: Purchase CERs Off the shelf Forward Purchase Purchasers of CERs Investors v Buyers

12. Steps to reduce Project Participant risk during the transaction process • 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 Necessary Desirable First Prize!

13. Step 4: Types of Risk and Mitigation Strategies • Project Failure • Underperformance • Project Feasibility • Policy (Kyoto) • Country • Exchange Rate • DNA • Ownership • Validation • Market Uncertainties Construction & operation risk assessment:; written contracts Conservative CER contracts; insurance Audited financial and technical feasibility assessments Transfer risk to buyer through contract; sell into VER market Prepare country risk report, follow unilateral model Identify the effects of an appreciation/depreciation; est. financing strategy Get letter confirming legislative/policy consistency if no DNA/rules Clearly establish and document ownership Use accredited DOE; get pre-validation assessment; use approved methodology Undertake market appraisal; monitor the market; est. a forward price curve

14. Steps in the Transaction Process • Identify potential buyers • Approach potential buyers requesting expressions of interest in the CERs • Assess Expressions of Interest (EOIs) and identify the buyer with whom you wish to negotiate and which transaction model you with to transact under • Negotiate and structure contract, either an Emission Reduction Purchase • Agreement (ERPA) or Direct Purchase Agreement (DPA) • Finalise contract and transact Throughout process… identify and take steps to mitigate risks!

15. 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)

16. 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

17. 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

18. 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

19. Step 4: Example of constructing a forward price curve

20. 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….

21. 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

22. 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

23. 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

24. 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

25. Steps in the Transaction Process • 1. Identify potential buyers • Approach potential buyers requesting expressions of interest in the CERs • 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) • Finalise contract and transact

26. 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

27. 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

28. General Project Risks • Exchange Rate • Financial • Demand for product • Country • Construction, Operation & Maintenance • Legislative • Project Location

29. 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

30. CDM Specific Risks (cont.) Internal • Methodology approval • DNA Approval • Validation • Gold Standard Certification