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Combining Project Finance with Trading ERU’s? Eric Boonman Head of Environmental Markets 24 May 2017 Designator | author 1 Moscow Carbon Forum | April 29 2008 | 2 Kyoto protocol The Kyoto protocol is the fundamental international agreement governing the global carbon market. The European Union has established the EU ETS in response to its member states’ Kyoto obligations and to help its industry to prepare for the challenges and opportunities presented by global response to climate change. Moscow Carbon Forum | April 29 2008 | 3 The EU-ETS as part of the Kyoto target Not ONE but multiple international agreements: 1992 United Nations Framework Convention on Climate Change, 1997 Kyoto Protocol, 1998 EU Burden Sharing Agreement, EU ETS Directive 2000, Marrakech Accords 2001 The European Union Emissions Trading Scheme New assets, new liabilities, new values Two main ways to reduce emissions under the EU ETS - Allowance trading sets a cap on emissions and companies can either buy or sell strictly European allowances depending on their emissions and the cost of abatement. - Credit origination involves generating credits by investing in individual projects in developing countries that reduce emissions under the Kyoto Flexible Mechanisms The EU ETS covers ±40% of EU CO2 emissions Penalty €100 (2008 to 2012) Stringent 2020 European reduction target of 20% have been established and currently new global targets are being negotiated according to the Bali Roadmap. Moscow Carbon Forum | April 29 2008 | 4 Global supply and demand outlook Japan BAU short ~1,500Mt EU non ETS >50% emissions Canada BAU short ~1,500Mt ? (100) 1,000 ? (700) 1,000 CER & ERU 2,000M ??? MtCO2 +/- 1,000M ~1,400 2,400 2,300 2,200 ? 2,100 2,000 1,900 OTHERS 1,800 2005 2006 2007 2008 2009 2010 2011 2012 emissions allocations Phase II total ~1,400Mt short US states, Australia, NZ, voluntary, … PHASE III Moscow Carbon Forum | April 29 2008 | 5 Fortis: new products for the emerging carbon markets Carbon Financial Services Trading Services Accepting returns in carbon Including carbon value in financing and due diligence CDM / JI project financing Trading on demand or to order Index based procurement/divestment CER / ERU purchasing and sales Delivery date swaps (quasi repo’s) Administration and Trust Managing customers carbon accounts Custody of other Kyoto Compliance Units Fund custody and administration Investing in and developing funds Co-sponsorship of the European Carbon Fund to ensure reliable deliveries of Kyoto Compliance Units for customers Clearing CDP Climate Leadership 2006 – Top 50 Global Eliminate counter party risk and guarantee trades Cross commodity correlation model Co-sponsor and guaranteed placement CP for European Carbon Fund Initiated index based position management contracts for customers Trading on behalf of 300 customers Cross selling successfully with trust, custody, escrow & settlement Moscow Carbon Forum | April 29 2008 | 6 Fortis: a pioneering role in Carbon Banking 2004 – – Fortis realizes first-ever trade of European Union Emission Allowances (EUA's) using an ISDAbased contract: Carbon Deal of the Year ( Euromoney) Fortis becomes a co-sponsor of the European Carbon Fund, investing 15 million Euros to help emerging countries combat climate change. December 2004: the Fortis carbon trust and custody services is launched – – – Started offering carbon clearing services October 2005 : won best diversified financial and made Climate Change Leadership Index December 2005: concluded first index based carbon compliance contracts with clients – – – – – – – January: European Carbon Fund awarded Most Promising investment Opportunity February: Structured and executed first ever CER call option deal April: Concluded first complete second phase strip transaction from 2008-2012 Jun: Executed first combined trading/trust/escrow/settlement carbon transaction July: reached the 100th customer milestone with a record 4 new customers in 1 day August: transacted and received ownership of issued CERs for the first time October: executed first to second phase roll – – – – Launch of the Fortis Carbon Neutrality Program March: start of global 24hr carbon banking services from Amsterdam, Hong Kong and Houston June: Be selected as the FSP for the UNDP MDG Carbon Facility for its initial pipeline of 15MT March: Best Trader 2008 reward according to Pointcarbon – 2005 2006 2007 Fortis, has quickly established itself as the reference for the market, serving more than 300 clients’ needs on a daily basis Moscow Carbon Forum | April 29 2008 | 7 CDM project cycle CDM project identification + service agreement PIN Project Design Document International buyer search Validation starts ERPA Letter of Approval Validation ends Registration Monitoring JI two options: Verification + Certification Track 1 via host country Issuance Track 2 comparable to cdm CER Distribution An emission reduction project needs to go through a lengthy procedure before being registered at the United Nations CDM Executive Board and eventually receiving CERs. Normally, 6-10 months is needed to get a project through the process. An independent consultancy is normally hired to provide an in-depth analysis of the project’s emission reduction potential, methodology, feasibility and social impact. The expected emission reduction is detailed in the PDD (project design document). The standard contract of forward CER purchase transaction is named ERPA (Emission Reduction Purchasing Agreement). After the validation by a Designated Operational Entity and the approval by a Designated National Authority, the project is submitted to the United Nations’ CDM Executive Board for registration. If the project gets officially registered at the UN CDM EB, it is recognized as a CDM project. Following that, verification & certification occurs every 1-3 years. Upon verification, a corresponding number of CERs will be issued by the UN CDM EB. This quantity will vary compared to the planned quantity in the PDD. Moscow Carbon Forum | April 29 2008 | 8 Nature of carbon finance for a typical JI project Capital Markets (Financial Institutions, Private Equity, Hedge Funds...) Equity and/or Debt Ownership + Dividend and/or Principle + Interest Power Purchase Agreement ERUs Cash Global Carbon Market Cash By-product: ERUs Main product: Electricity Moscow Carbon Forum | April 29 2008 | 9 CDM and JI project’s risk assessment Fortis Bank Environmental Markets has undertaken significant research in the field of CDM and JI project risk assessment. Technological Risk A thorough understanding and assessment of the JI project’s delivery risk will enable us to maximize our investment return by constructing a diverse CER and ERU portfolio in terms of technology, stage, size and geography. Country Risk Delivery Risk Operational Risk Counterparty Risk Fortis Environmental Markets’ desk has developed a highly objective and autoimproving Delivery Risk Model to screen most CDM and JI projects. This model combines a serie of quantitative and qualitative metrics to help us gauge a potential CDM and JI project’s expected performance. Moscow Carbon Forum | April 29 2008 | 10 Custody Agreement The Custody agreement transfers economical and legal ownership Custodian receives power of attorney from seller and buyer and will become focal point The pdd CERs or ERUs are inputted into delivery risk model Outcome will be taken as collateral within financing package Mitigating counter party risk To build up investor confidence a similar role for ji projects is recommended Moscow Carbon Forum | April 29 2008 | 11 Fortis JI project selection criteria Project size: The project should generate an expected quantity of at least 500,000 tonnes of ERUs up to and including 2012. We accept bundled smaller scale projects. There are no upper limits to the project size. We could consider smaller projects based on other merits such as sustainability advantages. Technology: The project should use an approved methodology by the United Nations GHGs: The emission reduction should be created by abating GHGs defined by the Kyoto protocol, e.g. CO2, CH4, N2O, HFCs, PFCs and SF6 Sectors: Renewable energy, energy efficiency, methane recovery and utilization, industrial processes, waste management and fuel switch Start date: Projects that have already started or plan to start operation over the next 1-2 years Purchasing period: We purchase ERUs forward 2008-2012 Moscow Carbon Forum | April 29 2008 | 12 Conclusion To date, many of the world’s premier institutional investors have invested in CDM and JI projects. This strong interest is mainly due to CDM and JI projects’ unique return profile and superior diversification benefits due to its total lack of correlation with traditional securities market. The window of opportunity for purchasing CDM credits from low hanging fruit type projects has passed but in JI there is still low hanging fruit The next wave of carbon reduction projects will need to account for the value of carbon abatement in their discounted cash flow models, and in part rely on the carbon credits for repayment, especially for CDM projects. Due to the volatile nature of the international carbon market, significant risk discounting on the future value of carbon credits needs to take place, but there is enough confidence in the carbon market to be able to use carbon credits as collateral. However, given the nature of carbon project proponents, a custody agreement governing the legal and economic ownership and title of forward carbon streams can strongly mitigate counterparty risks, leaving primarily technological risks. Thank you [email protected] +31 653258817 24 May 2017 Designator | author 13