The limitations of Carbon Credits as a source of financing & Carbon Credits as a Financial Asset

CARBON MANAGEMENT CONSULTING GROUP

www.carbonmcgroup.com

www.ciscarbonrisk.com

Hong Kong Calcutta Curitiba Santiago de Chile 2011 www.carbonmcgroup.com

Background of Carbon Credits as a Financing Mechanism

The global carbon market is estimated to exceed 107 Billion in 2011. Despite a number of well publicized problems, carbon credit generating projects have been a success with total carbon project based transactions valued at US$3.3 billion last year, according to the world bank. However, the CDM process is still encumbered with procedural problems while projects that do attain registration continue to display a wide variation in project performance and carbon credit generation. These difficulties have meant that, in some cases, carbon credits are often treated as an additional extra source of project income rather than as a core part of proposed project. Forecasted revenues from carbon credit sales have not been leveraged and utilised for project funding to the extent that they should have been.
2011 CMC Group

2011 CMC Group

The importance of Carbon Credit Revenue to project returns: Some projects need credits far more than others. In these cases, the requirement to attain successful carbon credit generation is vital in order to ensure that the project is commercially viable

Unless backed with large equity participation or significant collateral some of these projects have had difficulties in raising finance off project carbon revenues
Carbon credit receivables generally have limited value as collateral in cases where non carbon income is low (some of the most deserving & most additional projects). Instead signed forward contracts (ERPAs) mainly serve to provide some certainty to projected cash flows ie price risk removed This impedes on smaller project owners capacity to create and develop new projects particularly more innovative projects with a large percentage of forecasted carbon credit income

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WHY? There are simply too many risks that a project will not attain its expected amount of Carbon Credits

Delivery Risk

Risk of non registration

Performance Risk - Yield

2011 CMC Group

Sub-optimal deals for Project Owners?

-Project Owners generally need to have strong non carbon credit project cashflows in order to raise external financing
-As a result, carbon credit revenues are often seen as an added bonus on top of project revenues. Treated as icing on the cake. This goes somewhat against the spirit of the CDM -The presence of a signed ERPA with a strong counterparty can help as collateral but overall value of an ERPA is limited -In some cases, Buyers have agreed to finance projects through prepayment for some CERs or loans with CERs serving as collateral. However in these cases the project owner has to sell its CERs at a significant discount -The addition of non-carbon receivables (such as PPA revenues) is often much more secure and valuable as collateral The overall Project Risks and limited value of carbon credit receivables as collateral often results in project proponents accepting sub-optimal deals.

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Characteristics of sub-optimal Financing Structures:

1.Low valuations placed on collateral 2.High collateral Requirements 3.Fewer Financing choices 4.High Interest Rates 5.Excessive Equity Participation by 3rd parties 6.Smaller borrowers punished 7.More innovative projects with high carbon credit cashflows more difficult to finance than traditional renewable projects

2011 CMC Group

Existing Risk Mitigation Products:

There are a few products that seek to remove elements of project uncertainty and would thus provide added certainty prior to funding. These generally cover risk from a buyside rather than project proponent perspective: Structured Deals Sale of forward credits from a CDM portfolio for upfront payment. Large project developers and funds have monetized portions of their carbon credit portfolios by selling certain portions of their future carbon receivables for cash. The diversification of risks across a number of projects means that this is only suitable for large developers and not for single project operators. Eg Camco / Standard Bank & EcoSecurities / Credit Suisse Delivery Insurance Some insurance products have recently been unveiled to cover risks of project non performance. Market undeveloped and premiums are high. Current offerings only cover project yield risk and not registration risk. Options Market CER options are traded on the ECX. High premiums because of risk and requires high degree of sophistication. Still a requirement to measure project risk in order to purchase necessary amount of options. Generally more suited to compliance buyers and traders rather than project owners and developers.
2011 CMC Group

What can be done: Clear Risk Identification Tools Standardized risk assessment tools need to be adopted to help better identify and quantify project risk. Carbon project ratings or 3rd party valuations could help to reduce information asymmetry Clearing of UN backlog / procedural reform Already occurring to some extent but it may be too little too late. Standardization and more transparency in approval process needed in addition to shortening of approval time. Would take some time to build up trust Development Bank Pooled Securitization? Upfront financing window whereby development bank or agency organises upfront payment for a small portion of a number of projects credits. The diversification and scale benefits offered by the development banks pooled portfolio means that upfront payment to participants would be far higher than if project owners tried to sell individually.
2011 CMC Group

Question or Comments? Thank you for Listening!

Philippe Delhaise Chief Executive Officer Carbon Management Consulting
philippe.delhaise@carbonmcgroup.com For more information, please visit: www.carbonmcgroup.com www.ciscarbonrisk.com

Hong Kong Kolkata Santiago de Chile 2011 www.carbonmcgroup.com