CDM Projects: Risks and Contracts

1. CDM Projects:Risks and Contracts Sao Paulo, Brazil, November 22, 02 charlotte streckpcf

2. Purpose of our ERPA • Record agreement • Identify responsibilities • Establish rights • Manage Risk

3. Assessing Risk • How does PCF identify and assess risks? • PIN: Risk screen • PCN: Risk matrix • Preparation: Baseline study, Validation, ESR • Appraisal: Assess full range of risks • Structuring: Mitigate risks

4. Defining, Assessing, and Reporting Risk • PCF establishes a risk profile for the project as soon as it signs an Letter of Intent • Project Concept Note • Profiles risk by class, defines specific risk and proposed mitigants • Contains results of “upstream” risk assessment (environment and social or “safeguards” policy risks, sponsor and financing risk, unique carbon asset risk)

5. Sources of Risk I • Project Risks • Construction risk (built/operated on schedule?) • Performance risk (e.g. resource risk) • Counterparty risk (will offtakers pay on time?) • Financial and business risk (is capital structure viable, debt serviceable? Is parent company sound? Will product sell?)

6. Sources of Risk II • Baseline Risk • Eligibility--will ERs be Kyoto-compliant? • Baseline design--is the baseline robust? Will its assumptions remain valid over time? • Performance--actual performance will determine level of ERs generated

7. Sources of Risk III • Market/Price Risk • Will there be a market for project-based ERs? • Will contract price meet market price? • Policy/Compliance Risk • What if the Kyoto Protocol doesn’t enter into force? • What if host country does not ratify or comply? • Market and Policy Risk are closely linked

8. Risk Allocation • Principle: Assign risk to the party best able to bear it • PCF primarily assumes: • Kyoto • Baseline • Market • Investors/creditors assume most project risks • PCF mitigates against project risk • Country risk is shared

9. PROJECT RISKS: Technology Resource Completion Env/Social Transmission Risks/ Factors Delay in plant commissioning, delivery of ERs   Potential Impact =>Evaluate technology and Sponsor experience =>Evaluate resource risk (Baseline study) =>Conduct Env. & Social Review =>Evaluate grid reliability, transco contract Risk Assessment PCF Mitigation =>Limit upfront pmt =>Require EIA Assessing Risk Risk Matrix Financial sustainability =>Evaluate financial projections/assumptions; =>Sensitivity analysis on key parameters Baseline Risk Project generates fewer ERs than expected =>conservative ER projections =>Baseline study to evaluate. COUNTRY RISK Macro stability Kyoto Protocol Risk =>Stable investment climate; “A” rating =>WB evaluates country risk =>WB evaluated KP risk

10. Mitigating Risk • Baseline risk: • Baseline study, assessment of “carbon asset” risk • Reasonable but conservative estimate of ERs • Rigorous monitoring • Market risk: • Purchase of call options • Conservative pricing • Seniority through: • Legal seniority • Overcollateralization – purchase less than 100% of ERs • Structural seniority – purchase early vintages • Policy/compliance risk: • LoA/Host Country Agreements in JI countries

11. Mitigating Risk II • Project Risk: • Seniority: also protects against project risk • Sharing of ERs: provides incentive to perform • Capitalization of costs: PCF costs deducted from payment • Payment on delivery (“commodity” model) • PCF faces reinvestment risk only. • Limitation on up front payment (extraordinary circumstances, 25% limit) • Price discounted to reflect risk

12. Exercising Seniority in PCF Projects Theoretical maximum ER output Anticipated ERs from Validated Baseline Volume of ERs ERs Available for Parallel Purchase PCF Takes First ERs up to its Agreed Annual Volumes PCF’s Contracted Annual ER Purchase 2012 Year 1 Time in Years

13. Exercising Seniority in PCF Projects Parallel Purchaser Contracts rest up to Validated Asset Level Theoretical maximum ER output Anticipated ERs from Validated Baseline Volume of ERs ERs Available for Parallel Purchase PCF Takes First ERs up to its Agreed Annual Volumes PCF’s Contracted Annual ER Purchase 2012 Year 1 Time in Years

14. Exercising Seniority in PCF Projects Parallel Purchaser Contracts rest up to Validated Asset Level PCF Sweeps any annual surplus Theoretical maximum ER output Anticipated ERs from Validated Baseline Volume of ERs ERs Available for Parallel Purchase PCF Takes First ERs up to its Agreed Annual Volumes PCF’s Contracted Annual ER Purchase 2012 Year 1 Time in Years

15. Shortfall Make Up Rights for PCF Parallel Purchaser Contracts rest up to Validated Asset Level Theoretical maximum ER output Anticipated ERs from Validated Baseline Volume of ERs PCF Takes First ERs up to its Agreed Annual Volumes Actual Year Two Production Falls below PCF Annual Contracted Volumes 2012 Year 1 Year 2

16. Shortfall Make Up Rights for PCF Parallel Purchaser Contracts rest up to Validated Asset Level Theoretical maximum ER output Anticipated ERs from Validated Baseline Volume of ERs PCF is made whole in next year before Parallel Purchasers Get ERs PCF Takes First ERs up to its Agreed Annual Volumes Actual Year Two Production Falls below PCF Annual Contracted Volumes 2012 Year 1 Year 2

17. Elements of ERPA Parties: PCF Trustee – Project Entity Content of ERPA: • Obligations of the Parties • Purchase of ERs: Price – Exclusive Right / [Transfer] • Additional obligations of the PCF Trustee • Additional obligations of Project Entity • Events of Default • Remedies • Conditions of Effectiveness

18. Purchase of ERs • Purchase of an agreed amount of ERs • Agreed payment of $US [___] per ton of CO2 • Payment on delivery [annually] • Delivery: Submission of certificate issued by an independent third party • Biennial certification possible [payment annually/biennally] • All ERs /Minimum Amount of ERs /Additional ERs

19. Recovering of Costs • Project preparation costs • Initial validation, verification, certification, periodic certification, supervison Deduct from payment: Estimate [not more than ____]

20. Obligations of the Trustee • Pay the installments of the purchase price (net of costs) • Arrange for the initial verification, and periodic verification and vertification • Others (e.g. exchange of information)

21. Obligations of the Project Entity • Carry out the project with due diligence • Monitoring and data collecting according to the MP • Grant the PCF the exclusive right to arrange for initial and periodical verification and certification • Grant the validator, verifier and certifier access to the project • [Facilitate] transfer of ERs

22. Events of Default Project Entity • Failure to deliver ERs • Significant delay in project construction • Other project financial not in place by a certain date Trustee • Failure to pay purchase price in time • Failure to arrange for validation, initial and periodic verification, and certification

23. Questions ?

24. Risk Mitigation in PCF Transactions Conclusions • Carbon finance can: • Improve IRRs (at zero cost to project) • Help secure financing, reduce project risk • PCF assumes most carbon-related risks in carbon purchase transactions • Price depends on residual risk • Building carbon finance into projects can make them bankable • We are here to help, as part of your team.

25. www.carbonfinance.org