Comprehensive Overview of Carbon Financing for CDM Projects

1. Introduction to carbon financing Presentation prepared for “First DG/GGFR Global Gas Flaring Workshop" Presented by Roman Schibli, South Pole Carbon Asset Management Ltd. Doha, October 6, 2009

2. Contents • Fundamental notions • CDM project risks • Commercialization strategies

3. CDM registration is a long procedure which should be undertaken in parallel with project development Project development Feasibility analysis Financial closure Construc-tion Concept Operation CER issuance Project registration Project docu-menta-tion (PDD) Host country approval (DNA) Monitor-ing and verifica-tion Initial scope (PIN) UNFCCC regis-tration Valida-tion(DOE) CDM development Issuance of CERs Time [# months] 2.5 3 3 2* 6 0.5 * In parallel to validation

4. When should the CERs be sold? 98 CER issuance Project registration Project status Category 1 Category 2 Category 3 Category 4 Project docu-menta-tion (PDD) Host country approval (DNA) Monitor-ing and verifica-tion Initial stages Project under validation Initial scope (PIN) UNFCCC regis-tration Valida-tion(DOE) Project registered CERs issues Issuance of CERs Contract type Spot contract Forward contract Costs CDM costs borne by PO Costs can be shared between PO & CDM developer

5. Credits from more advanced projects fetch a higher price on the market 98 CER prices paid for projects at different stages EUR/CER

6. What drives carbon market prices? 98 Example: EU ETS Fundamental factors… …and major events have driven volatility in carbon prices • Regulatory issues such as allocation plans • Gas-coal spread impacts the economic viability of fuel switching • Economic growth increases demand for power and therefore increases emissions and demand for credits • Weather impacts demand for power, and availability of renewable energy (e.g. hydro in dry conditions) • CDM / JI markets impacts the supply of credits available EUA Prices EUR / ton

7. Contents • Fundamental notions • CDM project risks • Commercialization strategies

8. Carbon market prices are very volatile… EUR

9. ... and dropped substantially during the financial crisis 6 Prices before – after the financial crisis EUR / ER Implications 30 25 -50% • High quality credits held up better during the crisis • „Flight to quality“ -60% 15 13 -46% 10 -67% Pre Post Pre Post Pre Post Pre Post GS CER CER GS VER VCU

10. Different project types have varying exposure to non-registration risks 98 Proportion of projects rejected registration by reason Risk: Low High

11. 114 Issuance risks is highly project specific • Issuance risk is the risk that the project does not issue the full amount of credits estimated in the PDD Major risks • Monitoring complexity – the more complex the monitoring requirements the more likely the DOE or the EB will introduce conservativeness measures • Project performance – if the project underperforms this will impact the number of credits issued (e.g. if less electricity produced than estimated) Relative risk of project Historic average issuance (% of PDD estimate) • actual issuance from flare gas reduction projects is 114% • Only 2 observations • The issuance is higher for simple projects, but lower for more complex projects such as LFG • Project type • Average issuance (%) • Flare gas reduction • Hydropower • Waste gas / heat recovery • Wind power • Energy efficiency • Biogas • Methane recovery • Cement • Fuel switch

12. Contents • Fundamental notions • CDM project risks • Commercialization strategies

13. Forward contracts 1: advantages of fixed price ERPAs 98 • Fixed Price ERPA: ERPA with a fixed price, whatever the market price might be Avantages Illustration • A fixed price ERPA was concluded in September 2008 for 14 EUR • Subsequently the market price fell below the ERPA price • Diminish the carbon market price risks • CDM revenues can easily be accounted for • CDM development costs can be borne by buyer • Credits can be sold at an early stage • CDM developer bears risk of non-issuance

14. Forward contracts 1: disadvantages of fixed price ERPAs 98 • Fixed Price ERPA: ERPA with a fixed price, whatever the market price might be Disadvantages Illustration • A fixed price ERPA for 14 EUR was concluded with Lucky Traders Ltd. in September 08, a carbon buyer with a weak balance sheet • Secondary market price • No participations in price rallies • Price “discount” • for post-2012 offers • ERPA price 2012 • When the credits are issued the market price is equal to 8 EUR • Lucky Traders Ltd should sell the credits at a loss, but declares bankruptcy • Great counterparty risk

15. Forward contracts 2: advantages & disadvantages of revenue share ERPAs 98 • Revenue share ERPA: ERPA where the CER price depends on the market price Avantages • Less post-2012 discount • Lesser counter-party risk • CDM development costs can be borne by buyer Illustration • An ERPA with 80% revenue share for the project owner was concluded • Secondary mkt price Disadvantages • Full exposure to CER price fluctuation • Hard to account for carbon revenues • ERPA price 2012

16. Forward contracts with delivery guarantee: advantages & disadvantages 98 • A delivery guarantee is a guarantee provided by a project to a carbon credit buyer that a minimum number of carbon credits will be delivered by the project Advantage / disadvantage Case illustration • Lucky Traders Ltd realizes that they cannot take on carbon price risk and so decide to enter a back-to-back agreement to sell Gulf Oil’s credits on directly. • However, in order to ensure that they can fulfill this contract, Luck Traders demands that Gulf Oil provides a guarantee that they deliver the estimated number of emission reductions. • Potentially higher price • With a delivery guarantee, Primary CERs have similar risk to Secondary CERs and should therefore fetch a similar price • Multiplication of project risk • If the project underperforms, Gulf Oil will produce insufficient ERs and will therefore have to spend cash to buy CERs on the market when the performance from the project is worst. • Potentially onerous non-delivery clauses • Lucky Traders may insert a clause saying that ownership in Gulf Oil project cedes to Lucky Traders in the event of default. Recom- mendation • Avoid delivery guarantees wherever possible!

17. Advantages & disadvantages of spot contracts 98 • Spot contract: transaction of issued CERs Avantages Illustration • Maximizing carbon revenues • No post-2012 discount • Gulf oil pays a local consultant to develop the PDD & facilitate registration • The company waits for the credits to be issued, and sells them on the secondary market • Gulf oil has full control over selling strategy Disadvantages • CDM development costs borne by seller • Full exposure to CER price fluctuation • Hard to account for carbon revenues • Secondary mkt price 2012

18. Conclusion • Market price volatility • Non-registration risk • Underdelivery • Delay,... • Multiple CDM specific risks • Fixed price ERPA: minimizes market price exposure • Revenue share ERPA: minimizes counter party risk • Delivery guarantee: increases CER price • Spot contract: maximizes CER revenues • Different structures to mitigate different risks • Only partial risk-mitigation is possible • Best strategy depends on the project characteristics & risk appetite of PO • Full understanding of risks will help informed decision • Each approach represents a trade-off

19. South Pole contact South Pole offices South Pole Roman Schibli Project Manager MENA Phone: +41 78 908 00 62 r.schibli@southpolecarbon.com Thank you for your attention South Pole representatives Zurich