financing & t ransaction
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Financing & Transaction
Module 5 Project Financing: Outline
1. The carbon market
2. CER Purchasers
3. Transactions Strategy
4. Matching projects to investors
5. ERPAs
• Your project’s CERs can be sold for a price in the global carbon market • They are one of the ‘products’ your project generates• They are an important part of your project’s financial package•You can use them in return for technology, investment, upfront project finance, or to secure loan finance• Alternatively you can sell them to generate a revenue stream to your project over its lifetime
Introduction
Know your project’s CER profile!
Identify up front: • How large is the total volume of CERs your project will generate? (> 500,000t? (medium) > 1million t (large)?)
• How is this volume distributed over the project’s lifetime?
•What is the average annual CER generation?
•Is your project Gold Standard?
This Module is designed to get you to start thinking about the opportunities CERs offer, and some of the issues involved both in their transaction and the implications for finalising your project financing.
1. The Carbon Market
What is it?What is it?
‘The international transaction of greenhouse gas emission reduction credits’
-Emissions trading schemes (Cap and Trade)
-Project credits (Baseline and Credit)
Chicago Climate Exchange
New South Wales scheme
Japanese Scheme planned
Canadian Scheme
starting 2007
EU scheme started 2005UK scheme
started 2002
Denmark power
generating scheme 2001-3
Global Carbon Credit Transactions
Compliance Timeline
Second Commitment Period2008 2012
First Kyoto Commitment Period
2005
First Phase EU Emissions Trading Scheme
16 Feb 2005 Kyoto entered into force
?(Second Phase EU Scheme)
What is traded?
Units = 1 tonne CO2e reduced or stored
- AAUs
- ERUs
- CERs
- Carbon capture and storage units
- VERs
2. CER Purchasers
Who is purchasing CERs?
Annex One:•Governments•CDM funds•Companies
Offset Purchasers
Investors vs Buyers
• Investors:– Contribute
• Capital• Technology
– Receive • Equity/Profit share • CER ownership
• Buyers:– Purchase CERs for $
Transaction Timing
You can transact at any stage of your project’s development!
• PIN• PDD• Validation • DNA approval • Project commissioned / implemented• Project registered• CERs issued
The timing has implications for the type of transaction, price, and whom you transact with
The Three Broad Transaction Choices…
Self develop the project
andsell CERs forward
at some point during project development
Self developThe project and
sell the CER’s on the spot market
Get a partner/investor on board at outset
1 2 3
• Spot market purchase• Forward sale
- option- right of first refusal- price: fixed / floating / marked to
market
Transaction Modes
Forward purchase
• Currently the most common • High certainty – secures a revenue stream
Pricing
- set price
- floats with a specified market price directly
- floats according to a formula
Options• An option is an open right to make the choice to purchase• An option taker may pay for this right (upfront or in the
credit price)• The price may be stipulated• The right does not mean that the option holder WILL
purchase• You could have a meet-and-beat clause• An option can be used to raise finance, but its not a
guarantee…
Right of first refusal
• This is a form of option where the option holder has an absolute right to be the first person to refuse or take up the credits
• The contract will stipulate when the right is available to be taken up
• You would have to stipulate the price, or a price formula in advance
The type of purchaser and mode of transaction right for your project is intimately related to your project’s:
- institutional architecture and - financial structure
4. Transactions Strategy
•Do I need an investment partner?
•Do I need upfront financing for my project?
•Is there a transfer of technology involved?
•Do I need loan collateral?
•What are my objectives in the CER transaction?
Components:1. project risk profile (conventional and CDM)
2. current carbon market risk profile
3. project’s cash flow requirements4. owner’s transaction requirements,
Developing your transaction strategy
1. Project Risk Profile
• At various points of the project cycle, there exist levels of risk
• These risks are both normal project risk, and additional risks related to the CDM
• Consider moments of risk, timing of these risks and MITIGATION strategies.
• You can structure your project so that risk is shared (investor, partner), transferred through the credit sale, or taken by the seller in a spot market sale.
Stages of Risk I
• Country appraisal – Stability
• Environmental, labour, institutional
– Lawlessness – Litigiousness
MINIMISE BY:Produce a country assessment report!Consider the use of country risk protection as part of
the financial structure
Stage of Risk II
• Project Approval– Is the DNA in existence?– What are the rules and process track– Will the Project contribute to Sustainable
Development?
MINIMISE RISKS BY: Design project according to the Gold Standard SD criteria Obtain a host government Letter of No Objection
Stage of Risk III:CDM cycle risks
• Validation– Is the baseline methodology approved?– How high is the additionality risk?– Any reasons for EB registration review?
MINIMISE RISKS BY
Get a pre-validation opinion, or assessment report; use approved baseline methodology; show stringency
Stage of Risk IV: Financial Feasibility
• Has the project secured all its underlying finance?• How liquid is the Project Participant in relation to the timing of the
production of CERs?• How creditworthy is the project owner?• How far has the financial contracted for the underlying project
progressed?• What are the profit margins in respect of the bigger project
MINIMISE RISKS BY
• Seeking the advice of a project finance specialist; progressing the financing as far as possible; producing financial statements for the project
• Does the project rely on reliable and locally tested Technology?• What is the relationship between the technology and the baseline?• How complicated is the technology?•What provision is there for ongoing training and maintenance?• What possibility is there for technology proliferation/on-selling?What likelihood is there for take-up of the technology?
MINIMISE RISK BY Undertaking a pilot; using locally tested technology
Stage of Risk V: Technological Feasibility
Stage of Risk VI: Underperformance
• How high is the chance that the predicted emission reductions won’t be achieved?
• Is it possible to secure performance insurance? • How high are the contractual, market demand,
exchange rate and other conventional project risks? Are they insured?
• How positive is the project’s relationship with its stakeholders?
MINIMISE RISK BY • Secure project insurance; undertake detailed
stakeholder consultation; elaborate contingency plans in the event of each performance risk.
• Project Idea Note• New Methodology approved• Stakeholder consultation • PDD Complete • Financial feasibility with all shareholders identified• Technological feasibility undertaken• DOE identified • Validation Complete• DNA approval complete• Financial close achieved• Project commissioned / implemented• Registered Project• CERs issued
Lowering your CDM project risks
RISK
2. Current Carbon Market Risk Profile
• How advanced are 2CP negotiations?• What prices are CERs fetching at the moment?• What stage of CER is currently being purchased
(approved?, validated?, registered?)• What is the status of Canadian demand for CERs?• How robust is the offset market?MINIMISE RISK BY
Undertake a market assessment; contact brokers to get a feel for current prices; plan the timing of your sale
Risk and CER price
•CERs do not have a uniform price in the market•Their price depends on the certainty of their delivery; volume sold and GS status•A spot market sale is RISK FREE, delivery is certain. •This will command the highest price (up to $20) •A validated CER can command between $10 - $20•A CER from a PDD between $5 and $10•A premium is paid for Sustainable Development benefits (GS)
SSN Toolkit Group Exercise: Aligning project and market risk
3. Your Project’s CashFlow Requirements
Workshop Activity: (Project cash flow exercise A)
• Is your project profitable (positive IRR) without the CER revenues?
• At what points over the project’s lifetime does it require CER revenues?
• Is up-front CER revenue required?
4. Owner’s Transaction Objectives
- Why are you undertaking a CDM project? Do you need revenue from the CER stream? Are you experimenting and learning about the CDM? Do you need to secure a relationship with a technology partner?
- Do you have a timeframe for transaction? Do you need an early transaction to demonstrate confidence in the CDM to your organisation?
- Is this a funder driven project? Do they require CERs?- Do you have a particular CER price need?
Transaction Strategy: Putting it all together...
What are the implications of your transaction objectives on:- type of purchaser? Mode of transaction? Timing? Volume?
Assess your project’s cash requirements relative to the CER forward price schedule: - when is the best time to transact to realise the highest possible CER revenue? (Note you can transact a number of years CERs in one go)
Remember: Three Broad Transaction Choices…
Self develop the project
andsell CERs forward
at some point during project development
Self developThe project and
sell the CER’s on the spot market
Get a partner/investor on board at outset
1 2 3
Option 1:
Get a partner/investor on board at outset
RISK:here the risk is zero: you get
help to put together the project and you get money
upfront for development
REWARD:the reward is a financed and
transacted project
CER PRICE:will obviously be
greatly discounted againstrisk
OTHER:Low control, autonomy and
capacity transfer
Option 2:
1 Self develop the project
andsell CERs forward
at some point during project development
RISK:here the risk is how to cover
underperformance and future market uncertainty
REWARD:the reward is flow of
capital or letter of credit, and security of
revenue
PRICE:will obviously be
discounted againstrisk
OTHER:Watch the contract terms!
REWARD:have to self finance, but rewards could be great
Option 3:
Self developThe project and
sell the CER’s on the spot market
RISK:here the risk is the market
price at time of going tomarket (issuance or beyond)
PRICE:prevailing price,
Maximum benefit if price is good
OTHER:High control, autonomy and
capacity building
Which Purchaser?
Purchaser Upfront funding
Tech Transfer
Small volume
Investment Top price
Govt √ √ Fund √ √ √ Japanese Co. √ √ EU Co. √ Offset Mkt √ √ Devt Bank √ √
Purchaser PINS
• Purchasers transacting via options 1 and 2 (forward sales) often require project information in their own PIN format
• These all differ, but may require specific information on:– the seller’s creditworthiness– project financing– other project partners– project risk profile
5. ERPAs
• The contract for a forward sale of CERs is called an Emission Reduction Purchase Agreement (ERPA)
• This sets out the terms and price of the transaction
• A number of standard ERPAs are publicly available
• Buyers may prefer to use their own ERPA
•The terms of the ERPA are as, if not more important than the price!
•You need a lawyer with CDM expertise to review the ERPA
• You may sign a number of ERPAs for your project if you transact with more than one purchaser
ERPAs (cont.)
• Definitions• Conditions precedent• Purchase and sale details• Options and exclusivity• Price and delivery conditions• Issuance (who pays for M&V, EB funds etc)• Project operation, management• Interaction with CDM EB• Delivery failure: what happens if…• Warranties, Force Majeur etc.
ERPA sections (example)
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