TBLI EUROPE, Paris, November 9-10, 2006 CER risk mitigation through Emissions Reduction  Purchase  Agreements  Ranjan Moul...
The backdrop <ul><li>Achieving significant greenhouse gas reductions on a global scale is urgent: institution of “cap and ...
The “products” <ul><li>Carbon transactions  :  purchase contracts where one party pays another for a given quantity of GHG...
 
<ul><ul><li>The requirements: </li></ul></ul><ul><ul><li>The functioning of the CDM Executive Board </li></ul></ul><ul><ul...
<ul><li>EU ETS : operational in January 2005. </li></ul><ul><li>Increasing volumes & trades : </li></ul><ul><ul><li>Traded...
The price behaviour
The market / price drivers  <ul><ul><li>Policy & regulation:  largely responsible for high volatility (sharp peaks & troug...
The risk factors  <ul><ul><li>Regulatory risks </li></ul></ul><ul><ul><li>-  Post 2012,  </li></ul></ul><ul><ul><li>-  Hos...
ERPAs: their objectives  <ul><ul><li>Minimise the discount to the EUA s that CERs contracts are traded: enhance fungibilit...
ERPAs: illustrative structures  <ul><ul><li>A third of transactions by buyers with intent to enter into secondary transact...
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Mitigating risks associated with Emissions Reduction Purchase Agreement

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Ranjan Moulik, Director Energy - Dexia Crédit Local - France

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Mitigating risks associated with Emissions Reduction Purchase Agreement

  1. 1. TBLI EUROPE, Paris, November 9-10, 2006 CER risk mitigation through Emissions Reduction Purchase Agreements Ranjan Moulik DEXIA Crédit Local
  2. 2. The backdrop <ul><li>Achieving significant greenhouse gas reductions on a global scale is urgent: institution of “cap and trade” </li></ul><ul><li>under the auspices of the Kyoto Protocol. </li></ul><ul><li>National allocation plans set up to formalise commitments of consenting parties to the Protocol (EU case) </li></ul><ul><li>Optimal use of the opportunities of market based Flexible Mechanism will assuage compliance burden. </li></ul><ul><li>Nov./Dec. 2005 COP/MOP1 in Montreal: consolidated operational aspects of the rules and modalities of the Flexible Mechanisms through the adaptation of the 2001 Marrakesh Accords. </li></ul><ul><li>EU to finalise NAP II in Nov 2006 and hopefully clarity on post 2012 at Nairobi in Nov; 2006. </li></ul>
  3. 3. The “products” <ul><li>Carbon transactions : purchase contracts where one party pays another for a given quantity of GHG emission reductions (allowances or “credits”) that the buyer can use to meet its compliance objectives. </li></ul><ul><li>Payment for emission reductions can be made using cash, equity, debt, or in-kind contributions </li></ul><ul><li>Two main categories: </li></ul><ul><li>Allowance-based transactions , in which the buyer purchases emission allowances created and allocated (or auctioned) by regulators under cap-and-trade regimes, such as Assigned Amount Units (AAUs) under the Kyoto Protocol, or EUAs under the EU ETS. </li></ul><ul><li>Project-based transactions , in which the buyer purchases emission credits from a project that can credibly and verifiably demonstrate that it reduces GHG emissions compared with what would have happened otherwise - CDM and the JI Framework under the Kyoto Protocol, generating CERs and Emission Reduction Units (ERUs) respectively. </li></ul><ul><li>EU Linking Directive: mechanism to convert units from one scheme into units from the other - Allows for the use of CERs in the first phase of the EU ETS for compliance. </li></ul><ul><li>Allows for the use of CERs and ERUs, subject to a quantitative limit to be provided in the national allocation plans in the second phase of the EU ETS. </li></ul>
  4. 5. <ul><ul><li>The requirements: </li></ul></ul><ul><ul><li>The functioning of the CDM Executive Board </li></ul></ul><ul><ul><li>The functioning of the JI Supervisory Committee </li></ul></ul><ul><ul><li>Article 17 of the Kyoto Protocol to be complied with if transfers from one registry to the other has to be ensured. </li></ul></ul><ul><ul><li>The International Transaction Log (ITL) to be in place </li></ul></ul>
  5. 6. <ul><li>EU ETS : operational in January 2005. </li></ul><ul><li>Increasing volumes & trades : </li></ul><ul><ul><li>Traded volumes in EU allowances via brokered-OTC transactions were 8.44 Mt CO2 in 2004, versus 306.68 Mt CO2 traded volumes in 2005 (including exchanges). </li></ul></ul>The EU carbon market
  6. 7. The price behaviour
  7. 8. The market / price drivers <ul><ul><li>Policy & regulation: largely responsible for high volatility (sharp peaks & troughs) </li></ul></ul><ul><ul><li>- the NAPs, </li></ul></ul><ul><ul><li>- Hot air, </li></ul></ul><ul><ul><li>-JI mechanism fine tuning (Track 1 & 2), </li></ul></ul><ul><ul><li>-Post 2012 & banking </li></ul></ul><ul><ul><li>Economic & corporate growth rates </li></ul></ul><ul><ul><li>Efficiency measure undertaken by compliance burden holders </li></ul></ul><ul><ul><li>Supply of CERs </li></ul></ul><ul><ul><li>Weather, Fuel & Power prices </li></ul></ul><ul><ul><ul><ul><ul><li>55% of EUAs held by power & heat sectors </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Coal / Gas substitution </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Rainfall: the hydroelectric factor </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Extremely hot summers & very cold winters </li></ul></ul></ul></ul></ul>
  8. 9. The risk factors <ul><ul><li>Regulatory risks </li></ul></ul><ul><ul><li>- Post 2012, </li></ul></ul><ul><ul><li>- Host country institutions e.g. DNA, </li></ul></ul><ul><ul><li>Delivery risk: registers & functioning of the ITL </li></ul></ul><ul><ul><li>Host country institutions: DNAs, local regulatory practices </li></ul></ul><ul><ul><li>Project specific risks: performance, additionality, under-tonnage </li></ul></ul><ul><ul><li>Accounting uniformity and tax treatment </li></ul></ul><ul><ul><li>Transparence: work to de done to obtain unequivocal and clear price signals (largely OTC market and data relatively scant on transaction terms & prices) </li></ul></ul>
  9. 10. ERPAs: their objectives <ul><ul><li>Minimise the discount to the EUA s that CERs contracts are traded: enhance fungibility to extract value </li></ul></ul><ul><ul><li>Provide incentives for project completion and continued performance </li></ul></ul><ul><ul><li>Implication of all parties in EB approval process (focal points, participation in due diligence) </li></ul></ul><ul><ul><li>Avoid seller exposure to downside price risk and provide flexibility for upsides </li></ul></ul><ul><ul><li>Ideally, buyer invests in underlying project: importance of creating mutual interests </li></ul></ul><ul><ul><li>Creation of carbon portfolios with varying levels of risk associated: extracting value by bundling and reduce transaction costs </li></ul></ul><ul><ul><li>Strive to create standard documentation </li></ul></ul><ul><ul><li>Mutually beneficial & optimally structured ERPAs in terms of risk allocation are most likely to be sustainable and and are least likely to default. </li></ul></ul>
  10. 11. ERPAs: illustrative structures <ul><ul><li>A third of transactions by buyers with intent to enter into secondary transactions i.e. buyers hedge risk by selling CER contracts back-to-back(on basis of bank or corporate gtees) or hedge down-side by buying put options to sell CERs at fixed price in the future. </li></ul></ul><ul><ul><li>Most common guarantee structures for primary transactions: Gtee applicable for a fraction of CERs delivered (25 to 50%): enables seller to secure a revenue stream and aid bankability of underlying project – however, such gtee entails price premium </li></ul></ul><ul><ul><li>Market practice has been that largely sellers bear CER registration & issuance risk (exception: World Bank) </li></ul></ul><ul><ul><li>Hybrid deals: portion of contracted volumes at fixed price (usually 2005-2007 vintage) and 2008-2012 vintage indexed to an EUA price paid on basis of agreed formula & payable on delivery </li></ul></ul><ul><ul><li>In 2006, most common contracts: </li></ul></ul><ul><ul><li>- price indexed to EUA price & supported by floor – sellers offered a % of EUA spot price prevailing at delivery date. </li></ul></ul><ul><ul><li>- contract sets floor price & floats with EUA up to certain level, above which both parties share benefits </li></ul></ul>
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