CDM – Carbon Finance Workshop
Session 6: Discussion of carbon
financing structures
Accra, June 24-26 2009

Contents
• Introductory quiz 10
• Carbon financing explained 30
• Key terms covered
• Case study
• Major concepts explained
• Some special cases
• Group work 30
• Report back and key learning 30
2

Introductory quiz
Question Carbon financing analogy
• Without any additional information, would • Then why would you expose yourself to
you buy shares in Afrocentric on the carbon market price risk without a sufficient
Johannesburg Stock Exchange? understanding of the market
• Would you finance a power project which • Then why would you finance an emission
has signed a power purchase agreement reduction project which has signed a carbon
with a new company with no assets? offtake agreement with a high counterparty
risk player?
• Would you invest in a project based on a • Then why would you invest in a project
feasibility study conducted by a company where all the carbon documentation has a
with absolutely no experience? high chance of being incorrect to such an
extent that CDM registration fails
3

Contents
• Introductory quiz 10
• Carbon financing explained 30
• Key terms covered
• Case study
• Major concepts explained
• Some special cases
• Group work 30
• Report back and key learning 30
4

During this session you will learn about…
Key concept Definition
• ERPA • Emission reduction purchase agreement – the agreement
defining the terms of sale of carbon credits
• Fixed price ERPA • An ERPA in which a fixed price is paid for carbon credits,
irrespective of price fluctuations in the market
• Carbon share ERPA • An ERPA in which the price paid for carbon credits is linked to
some kind of market price metric
• Delivery guarantee • A guarantee provided by a project to a carbon credit buyer that
a minimum number of carbon credits will be delivered by the
project
• Counterparty • The carbon credit buyer with which the project signs the ERPA
• Upfront CDM costs • The costs incurred to register a project under the CDM.
Includes development costs (e.g. PIN, PDD), validation costs
and registration costs
• Upfront payments • Payments made by a carbon credit buyer to a project for
carbon credits not yet delivered
• Carbon fund • A fund which makes equity or debt investments into a project
on the basis of securing carbon credits as one of its revenue
streams 5

Case study: Energy production and methane avoidance
from groundnut husks
• Ghana Groundnut Growers Association (GGGA) currently leaves husks in
large piles which decompose anaerobically, releasing methane
• Under the project, the groundnut husks will be fired instead of coal in a
Project
description boiler to produce energy, thereby reducing emissions of carbon dioxide
from the burning of fossil fuels
• By not allowing the husks to decompose anaerobically, the release of
methane will also be avoided
98
85
76 Methane
Estimated 67 48
52 55 60 35 avoidance
emission 17 26
2 5 10
reductions
(‘000
tCO2e) 50 50 50 50 50 50 50 Fuel switch
2010 11 12 13 14 15 2016
• By examining similar projects in the UNFCCC pipeline, you find that these
Other types of projects deliver only 60% of methane avoidance emission
reductions on average
6

The major carbon financing concepts explained:
Advantages of a Fixed Price ERPA
A fixed price ERPA is an ERPA in which a fixed price is paid for carbon credits, irrespective
of price fluctuations in the market
Advantage Case illustration
• Hedge away carbon • GGGA entered fixed price contract for carbon credits in
market price risk and so September 2008 for EUR14
benefit if market
underperforms
ERPA price
Secondary
CER
market
price
7

The major carbon financing concepts explained:
Disadvantages of a Fixed Price ERPA
A fixed price ERPA is an ERPA in which a fixed price is paid for carbon credits, irrespective
of price fluctuations in the market
Disadvantage Case illustration
• GGGA enters fixed price contract for carbon credits in Sept 08
for EUR14 with Lucky Traders Ltd, a private carbon trader with
an insignificant balance sheet
Secondary
• Forgo potential price CER
upside market
price
ERPA price
• Potentially high • When the first credits are delivered, the market price is at
counterparty risk EUR8. Lucky Traders Ltd was planning to resell credits on the
market but now cannot afford to and declares insolvency
• The contract falls away at GGGA is forced to sell credits at
EUR8 to the market
8

The major carbon financing concepts explained:
Advantages & disadvantages of a Carbon Share ERPA
A carbon share ERPA is an ERPA in which the price paid for carbon credits is linked to
some kind of market price metric
Advantage / disadvantage Case illustration
• GGGA entered carbon share agreement where they receive
80% of secondary CER market price
Secondary
CER
market
price
ERPA price
• Share in performance • Share in price upside if market price increases, but also share
in downside if market price decreases
• Lower counterparty • If price decreases, less financial strain is put on the carbon
risk credit buyer, reducing counterparty risk compared to a fixed
price agreement
9

The major carbon financing concepts explained:
Which to choose: Fixed Price of Carbon Share?
A fixed price ERPA is an ERPA in which a fixed price is paid for carbon credits, irrespective
of price fluctuations in the market
A carbon share ERPA is an ERPA in which the price paid for carbon credits is linked to
some kind of market price metric
If:
• A fair fixed price can be secured, and
• Counterparty has a relative good credit rating
Recom- Then rather hedge away risk through a fixed price contract
mendation Unless:
• You have studies the fundamentals of the market and are confident that
prices will increase, and
• You have the appetite and means to take on carbon market risk
10

The major carbon financing concepts explained:
Advantages & disadvantages of a Delivery Guarantee
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 realises that they cannot take on carbon
price risk and so decide to enter a back-to-back agreement to
sell GGGA’s credits on directly.
• However, in order to ensure that they can fulfill this contract,
Lucky Traders demands that GGGA 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 • If the project underperforms, GGGA will produce insufficient
project risk ERs and will therefore have to spend cash to buy CERs on the
market when the performance from the project is worst.
• Potentially onerous • Lucky Traders may insert a clause saying that ownership in
non-delivery clauses GGGA’s project cedes to Lucky Traders in the event of default.
We have seen this before – especially in cases like this where
the project is expected to underperform! Beware the sharks!
Recommendation Avoid delivery guarantees wherever possible! 11

The major carbon financing concepts explained:
Advantages & disadvantages of various Counterparties
A counterparty is the carbon credit buyer with which the project signs the ERPA
Advantage / disadvantage Case illustration
• GGGA goes out into the market again and finds another
potential buyer: the Swiss Government
• GGGA checks with a credit rating agency and finds that the
Swiss Government has a rating of AAA and estimates that
Lucky Traders has a rating of D+
• Lower carbon market • The lower the counterparty risk, the less likely that the ERPA
risk will fall through, and the less likely that the project will have to
go out into the market and be exposed to carbon market risk
• Higher value ERPA • Banks and other investors usually recognise the value of a
strong counterparty (as they do with power purchase
agreements) and so will be more likely to provide finance if
there is less counterparty risk
• Lower price • There is a misconception that stronger counterparties
recognise their value and offer lower prices as a result. This is
not the case – in fact all of South Pole’s buyers are AAA-rated
and offer above market prices
Recommendation Sign an ERPA with the strongest possible counterparty to
minimise risk 12

The major carbon financing concepts explained:
Advantages & disadvantages of covering upfront costs
Upfront CDM costs are the costs incurred to register a project under the CDM. Includes
development costs (e.g. PIN, PDD), validation costs and registration costs
Advantage / disadvantage Case illustration
• GGGA is approached by Super Penguins Ltd, a carbon
developer which offers to cover all upfront costs and be paid a
commission on sale of credits on a no-cure-no-pay basis.
• No cash flow • The average CDM project costs EUR60-90k to register. These
requirement upfront upfront cash requirements can therefore be minimized by the
project
• Reduced exposure to • If CDM registration fails, the project has not sunk upfront costs
CDM risk which cannot be recovered
• Higher probability of • The carbon developer is better incentivized to see the project
CDM success succeed. In fact, EB records show a strong trend that the
quality of projects developed under such an arrangement are
of far higher quality
• Lower price • Carbon developers may discount price as a result of increased
risk covered
Recom- Unless the project owner has a surplus of cash, if a fair carbon price is
mendation offered, go for a contract in which upfront costs are covered 13

The major carbon financing concepts explained:
Advantages & disadvantages of covering upfront costs
Upfront payments are payments made by a carbon credit buyer to a project for carbon
credits not yet delivered
Advantage / disadvantage Case illustration
• Big Bucks Ltd offers to pay GGGA 25% of pre-2012 carbon
credits upfront
• Early cash flow • Upfront payment serves as an early cash flow to the project
which can be used to cover initial capital costs, raise financing,
etc
• Lower price • In order to compensate themselves for the additional risk, Big
Bucks Ltd is likely to offer a lower price than if credits were
sold on a regular fixed price contract
• Often onerous • Many buyers who are willing to provide upfront payments
guarantees required require bank guarantees to do so. If a project is in a position to
get a bank guarantee, they can rather get a loan directly from
the bank
• To overcome this, South Pole and BP are aiming to provide
upfront payments secured by project assets
Recom- Upfront payments are often very useful for getting a project off the ground
mendation if the terms for the security are realistic 14

The major carbon financing concepts explained:
Advantages & disadvantages of carbon funds
A carbon fund is a fund which makes equity or debt investments into a project on the basis
of securing carbon credits as one of its revenue streams
Advantage / disadvantage Case illustration
• Platinum Carbon Capital offers to take a 25% equity stake in
GGGA’s project, in return for 25% of project returns (including
25% of carbon credits)
• Access to capital • The presence of carbon credits allows a project access to
potential investors who may not have been interested
otherwise
• Potential strategic • As carbon funds invest in many related projects, they may
partner bring networks or expertise which are very useful to a project
• Potentially lower price • In order to minimize carbon market risk, a carbon fund may
assume a conservative carbon price when performing a
valuation on the project
Recom- Explore potential carbon funds if there is a funding gap in the project, but
mendation ensure you are satisfied with carbon price assumptions
15

Contents
• Introductory quiz 10
• Carbon financing explained 30
• Key terms covered
• Case study
• Major concepts explained
• Some special cases
• Group work 30
• Report back and key learnings 30
16

Case study: Mini-grid hydropower project in Ghana
• The Rural Hydro Company is in the process of developing a 10MW hydro
project to supply power to a mini-grid system in Ghana
• The project also involves the development of a mini-grid system, and will
Project
description supply power to homes, schools and hospitals in the region, reducing the
need for the diesel powered generators which are currently used
• The project is expected to commission in Sept 2010
• The project is eligible under methodology AMS.I.A under the CDM
61 61 61 61 61 61
Estimated
emission
reductions
(‘000 15
tCO2e)
2010 11 12 13 14 15 2016
17

Case study: Mini-grid hydropower project in Ghana
• Substantial interest has been shown in the project by the global community
and as a result the Rural Hydro Company has been approached by 2
buyers with the following terms and characteristics:
Buyer name Swiss Government Conco
Credit rating AAA C
Probability of default Low price = 0% Low price = 50%
Medium price = 0% Medium price = 20%
Carbon High price = 0% High price = 10%
financing Fixed price offered EUR11 EUR12
terms with no delivery
offered
guarantee
Discount if upfront EUR1 None offered
costs covered
Carbon share offered 80% None offered
no delivery guarantee
18

Case study: Mini-grid hydropower project in Ghana
• You have commissioned an external consultant to do some external
research and have determined the following:
Low price Medium price High price
External Price level EUR 5 EUR 11 EUR 16
research
Probability 25% 50% 25%
• If upfront costs are not covered, a CDM project has a 20% non-registration
risk
• If upfront costs are covered, this risk reduces to 5%
• What carbon financing structure would you recommend to the project? Be
specific in terms of:
Questions
to be • Buyer
answered • Fixed price or carbon share
• Upfront costs covered or not
19

Contents
• Introductory quiz 10
• Carbon financing explained 30
• Key terms covered
• Case study
• Major concepts explained
• Some special cases
• Group work 30
• Report back and key learnings 30
20

Case study feedback
Low price Medium price High price
Market price EUR 5 EUR 11 EUR 16
Probability 25% 50% 25%
• Option A: Swiss government: Risk adjusted price of EUR11
If a fixed Price offered EUR11 EUR11 EUR11
price
contract Chance of default 0% 0% 0%
was chosen
which Default risk adjusted price EUR11 EUR11 EUR11
buyer 25% x EUR5.50 +
would you 50% x EUR11.80 +
go for? • Option B: Conco: Risk adjusted price of EUR10.30 25% x EUR12.40
Price offered EUR12 EUR12 EUR12
Chance of default 50% 20% 10%
Default risk adjusted price EUR5.50 EUR11.80 EUR12.4
80% x EUR12 + 20% x EUR11
21

Case study feedback
Low price Medium price High price
Market price EUR 5 EUR 11 EUR 16
Probability 25% 50% 25%
• Option A: Swiss government: Risk adjusted price of EUR8.60
Price offered EUR4 EUR8.80 EUR12.80
Is the
Chance of default 0% 0% 0%
carbon
share offer Default risk adjusted price EUR4 EUR8.80 EUR12.80
more
attractive?
EUR5 x 80% EUR4 x 25% +
EUR8.80 x 50% +
EUR12.80 x 25%
So far, the fixed price contract with the Swiss Government is the
most attractive offer
22

Case study feedback
• CDM risk adjusted price without upfront costs covered from the Swiss
Should the Government is:
upfront
costs be EUR11 x (1 – risk of non-registration) = EUR11 x 80% = EUR8.80
covered in
return for a • CDM risk adjusted price with upfront costs covered from the Swiss
EUR1 price Government is:
discount?
EUR10 x (1 – risk of non-registration) = EUR10 x 95% = EUR9.50
• The project should enter into:
• Swiss Government
Conclusion • Fixed price contract
• With upfront costs covered
23

Key learnings
If:
• A fair fixed price can be secured, and
• Counterparty has a relative good credit rating
Fixed price Then rather hedge away risk through a fixed price contract
vs Carbon
Share Unless:
• You have studies the fundamentals of the market and are confident that
prices will increase, and
• You have the appetite and means to take on carbon market risk
Delivery
Avoid delivery guarantees wherever possible!
guarantee
Counter-
Sign an ERPA with the strongest possible counterparty to minimise risk
party
Covering Unless the project owner has a surplus of cash, if a fair carbon price is
CDM costs offered, go for a contract in which upfront costs are covered
Upfront Upfront payments are often very useful for getting a project off the ground if
payments the terms for the security are realistic
Carbon Explore potential carbon funds if there is a funding gap in the project, but
funds ensure you are satisfied with carbon price assumptions 24