Sustainability ForumSustainability Forum

The Global Carbon Market

Business Opportunities for Sustainable Development

Zurich, September 24-25, 2001

www.prototypecarbon.org

Greenhouse gases emission reductions:

an unusual commodity

• ERs become a commodity after certification.

• Before certification ERs are very heterogeneous depending on the plausibility of their baseline.

Emission Reduction=

Hypothetical baseline emissions - effective emissions

Early developments of the market 1997 to 2001

• Partial information available.

• Within OECD and EITs: 40-60 MtCO2e have been transacted.

• In developing countries: Less activity but growing. Mostly government funded, but private activity growing.

• General trend towards sophistication: buyers clubs (PCF), traders, financial derivatives (options), integrated marketplaces, etc.

$0t/Co2

$1t/Co2

$2t/Co2

$3t/Co2

$4t/Co2

$5t/Co2

$6t/Co2

$7t/Co2

$8t/Co2

$9t/Co2

$0/tC

$5/tC

$10/tC

$15/tC

$20/tC

$25/tC

Optionss

Non verified ERs

Third-Party Verified

CDM

Government approved permits

Carbon prices on past transactions

Demand and supply under Kyoto scenarios

Total Annex Bdemand for ERs

Mitigation within Annex B(domestic or via trading or JI)

Hot Air financial flow to Russia and EE

CDM Market

Domestic Carbon Sinks

Volumes in Kyoto w/o the US

Gross annual demand for ERs 1400 – 2400MtCO2ebetween 2008 and 2012

- Credits for hot air 950 – 2150

- Credits for Annex B Sinks 330 ( 200)

= Net demand 0 – 1800 MtCO2e

Carbon Market Impact

• Hot Air and new Annex I Sinks Allowances depresses CDM/JI market– W/o US, up to 100% of OECD needs may be

met by Hot Air+sinks.

• Both CDM/JI “project-based” Market and “Hot –Air” (emissions trading) market will be “policy-driven”– Hot Air may be cheap but politically

unpalatable– CDM/JI project-based more expensive and

difficult but high quality and politically acceptable

Prices in Post CoP6 World

• With full competition, our market analysis suggests:

– CDM trades from near zero up to $7/tCO2;

– Range of $1.50-4/tCO2 more likely in our view

– PCF currently pays $3-4/tCO2

• Non-KP Market drivers are significant: OECD domestic regimes and Corporate Voluntary market

Other Emerging Market Drivers

• Regulations constraining carbon emissions are being developed– National policies (UK, Denmark, The

Netherlands, etc.)– Sub-national regulations (e.g. some US

States)– Regional initiatives (EU-wide trading)

• Some firms are taking voluntary emission commitments

Current or projected national policies

Trading Start-up Project-based mechanism?

EU Yes 2005 At least from 2008UK Yes . 2001 YesFrance Yes 2003? YesNorway Yes 2005 or earlier YesGermany No LaterDenmark Yes 2001 YesSweden Yes 2005 or later YesNetherlands Ongoing work YesFinland Ongoing work YesIreland Ongoing work Ongoing workAustralia Yes US dependent YesUSA Yes ? YesCanada Yes US dependent Japan Ongoing work YesNew Zealand Yes Not decided YesRussia No Yes`

Regional regulations in the US

• Oregon: CO2 emissions standard for new energy utilities. Price cap: $0.57/tCo2. Utilities can offset emissions using project based mechanisms.

• Washington: New plants must demonstrate the use of best available techniques for CO2 emissions control.

• Massachusetts: CO2 emissions cap for energy utilities effective in 2005. Utilities can offset excess emissions using project-based mechanisms.

• New England and Canadian Eastern Provinces: 10% voluntary reduction of GHG emissions below 1990 levels by 2020

Voluntary corporate commitments

• Rapid survey indicates more than fifty companies representing one billion tCO2e emissions in 1999 have pledged to reduce GHG emissions by 2010.

• Resulting demand depends on the baseline. If we set baseline at 1999 emissions, we obtain a total demand of 500 MtCO2e over the next decade.

• At least eight have said they would use project based mechanisms.

Alcoa -- 25% below 1990 in 2010BP Amoco 79.8 Cumulative 2%/year below 1990 Chubu EPCo. 51.3 0.410 kgCo2/kWh in 2005Dupont 44.4 65% below 1990 in 2010Kodak -- 20% below 1990 in 2004Fortum 9 0.5 MtCo2e below baseline in 2010 IBM 4.1 Cumulative 4%/year below 1998 until 2004

Intel 3.3 10% below 1995 in 2010 (PFCs) Johns. & John, 1.5 7% below 1990 in 2010Motorola -- 50% below 1995 in 2010 (PFCs)Ontario Pow.Gen. 26 6% below 1990 in 2010 PEMEX 177 -1% per year until 2010 Shell 99 103 MtCo2e in 2002 Statoil 8.3 1.5 MtCo2e below baseline in 2010 Suncor 5 -1.5%/year until 2002 (-1%/year for 2003-2008)

Transalta 38.5 ----- Keidanre n 478.6 Level of 1990 in 2010

(34 Japanese industries representing 75% of Japan’s industrial emissions)

1999 Emissions

Commitment Internal Trading

CDM/JI

Corporate voluntary commitments

The Opportunity of CDM/JI• For international business

– To support strategic positioning in new markets with carbon finance (increasing profits, reducing risk)

– Align current business development strategy and GHG reduction compliance needs

– Grow entirely new businesses in financing, brokering, intermediation, insurance, and carbon asset servicing (certification, validation, baselines/MVP)

• For developing or transition economy entities (governments, parastatals, local private sector)– Create new export business in new “sovereign

commodity”– Catalyze private investment flows in infrastructure and

forestry through cleaner and greener technologies

Impact of Carbon Finance on Project Financing at $3/t CO2e

Technology IRR

Energy Eff.-District Heating 2.0

Wind 0.9-1.3

Hydro 1.2-2.6

Bagasse 0.5-3.5

Biomass with methane kick Up to 5.0

Municipal Solid Waste with methane kick

>5.0

Note: data are preliminary

Impact of Carbon Finance on Sample Renewable Energy and Energy Efficiency Projects

0

2

4

6

8

10

12

14

16

18

20

DH Wind Hydro Bagasse Biomass Methane

Fin

anci

al I

RR

(%

)

IRR w ith carbon f inance

IRR w ithout carbon f inance

Waste-to-Energy project : Chennai, India, MSW

• Gasification of solid waste• 15 MW plant, 95 GWh/ann, $38m cost• ERs from:

– Power generation displacing fossil fuel (40%) – Methane capture & conversion (60%)

Project IRR Equity IRR• Without carbon finance 14% 16%• With carbon finance >19% > 25%

Impact of Carbon Finance on Project Financing at $3/t CO2e

Impact of Carbon Finance on Project Financing at $3/t

CO2e

Annual Uganda1-7MW

Costa Rica Chile25MW     Mini-Hydro

  off-grid grid grid

ERs (000 t) 49 61 79-138*

Net Gen.(GWh) 30 75 160

CO2 ERs/GWh 1664 807 494-860

ER (USc/kWh) 0.50 0.24

* Gas vs.

0.15-0.26

coal BL

Hydro: Off-grid vs. Grid

• Methane-capture projects: carbon finance can turn “dogs” into “cash cows”

• “Traditional” renewables: boost return by 0.5-2.5%– Off-grid projects have higher carbon factor– Makes marginal deals bankable– Reduces subsidy required – may attract ODA (addl

boost)• Improves project’s access to capital markets thru:

– Certain, contractual flow of FX from reliable counterparty

– “Seal of approval” – Improved Quality of cash flows

Sponsor can borrow against contract (like PPA)

Impact of Carbon Finance on Project Financing at $3/t CO2e

The Constraints

• Regulatory Risk– UNFCCC/Kyoto Protocol related

• Now through 2004 in finalizing regulations• Interpretation and administration of rules

– National Regulatory Risk (Hosts and Non-Annex I)

• Ratification of Protocol• Maintenance of compliance and capacity to implement• “seemlessness” of OECD domestic regimes

• Transaction Costs– Added time and uncertainty in bringing deals to

closure (trade-offs may be positive or negative)– Costs of delivering carbon finance to small

projects

The ConstraintsShort-Term UNFCCC Regulatory Risk

• Transferability and Fungibility of Credits– Are CER’s bankable for later commitment periods?

• Requirements of CDM Host Countries to participate

• Crediting Period– Starting Date for eligible projects (1/1/2000, 1/3/2000?)– 3 x 7 years for up to 21 years, but how to renew crediting

period? What criteria? What data to assess?

• Annex I (including OECD) country eligibility to participate in CDM/JI– Ratification? Retrospective credits possible? Acceptance of

Compliance Regime?– Requirement to obtain approval from ALL governments in a

deal? A show-stopper for brokers, intermediaries, multi-country funds

• JI Issues: few rules decided; early crediting for ERUs?

Public Sector (6)

Governments of Netherlands, Finland, Sweden, Norway, Canada, and Japan Bank for International Cooperation

Private Sector: (17)

RWE - Germany, Gaz de France, Tokyo Electric Power, Deutsche Bank, Chubu Electric, Chugoku Electric, Kyushu Electric, Shikoku Electric, Tohoku Electric, Mitsui, Mitsubishi, Electrabel, NorskHydro- Norway, Statoil -Norway, BP-Amoco, Fortum, RaboBank, NL

PCF Subscribers ($145 million)

PCF Status and FocusDeal flow far exceeds funding - several carbon

contracts now under negotiation� >50 deals with $350m+ carbon purchases

reviewed� Targeting signed Emissions Reductions Purchase

Agreements (ERPAs)� by end 2001, 6 deals of $20-25mm in Chile,

Costa Rica (3), Brazil, Uganda;� by July 2002 ~$50mm in Morocco, Nicaragua,

India, Guatemala, Argentina, Honduras, Thailand, Czech, Poland, and Kazakstan;

� Under active review for CY2002 ~$30mm: Guyana, Hungary, El Salvador, Brazil (small-scale), Kenya, and Colombia (and others awaiting Govt. endorsement)

� Constraints: PCF and country capacity, quality of asset

PCF Deals under Negotiation

• Uganda: W. Nile small hydro displacing small diesels, carbon purchase negotiations this week; indicative price $3/t/CO2; about 1 million tCO2 through 2016

• Chile: 25 MW run-of-river hydro; displacing coal or gas for grid supply; pre-negotiations completed for final deal mid-October; about 1 million tCO2; indicative price $3.5/tCO2, plus options

• Brazil: Sustainable Fuelwood/Charcoal displacing imported coal in pig iron industry; indicative price $3/tCO2; about 5 million tCO2; negotiations complete mid-December

• Cost Rica: small hydro and wind; streamlined procedures; indicative price $3/t/CO2; up to 3 million tCO2 over 7-8 projects. First 3 deals closed in November

Sustainable Development Brazil’s Plantar Case

• UNFCCC/KP promotes sustainable development

• Host Governments decide and assert � PCF deals certify other environmental

and social attributes if feasible and cost-effective to� Quantify for stakeholders sustainable

development outcomes, and� Increase the market value of these reductions

� Brazil Plantar project will:� Certify biodiversity assets from restoring

‘cerado’ forest ecosystems;� Certify improvements in worker health

•Methane to atmosphere

•Pyrolytic Oils/Tars & Particulates

•Poor Respiratory Health

From

To•Carbon Credits/$s from methane flaring

•Fines made to briquettes with tars

•Healthier workers certified

Annexes

Impact of Carbon Finance on Project Financing at $3/t CO2e

Country Project Tot. ($m)

ERs ($m)

IRR w/o

IRR w/ER

IRR

Romania DH 37 5.5 16.9 18.9 2.0

Costa Rica Wind 18.6 0.5 9.7 10.6 0.9

Jamaica Wind 26 4 17 18 1.0

Morocco Wind 200 14 12.7 14.0 1.3

Chile Hydro 37 4 9.2 10.4 1.2

Costa Rica Hydro 1.3 0.1 7.1 9.7 2.6

Guyana Bagasse 50 6 7.2 7.7 0.5

Nicaragua Bagasse 3.1 0.3 14.6 18.2 3.6

Brazil Biomass 53 13 8.3 13.5 5.2

Latvia Methane 16 2.5 11.4 18.8 7.4

India Methane 40 8 13.8 18.7 4.9

Typology of Funds/Plays

• Pure Carbon Funds (PCF, National Funds)• Private Equity Funds

Aimed at JI/CDM Projects New Energy, RE, EE Funds with Carbon Credits Forestry Funds with Carbon Credits Energy or Forestry Funds that Could Add Carbon Credits

• Mutual Funds with % in Private Equity• NGO Funds• Sustainability, Social, Ethical Mutual

funds• Corporate “Funds” Earmarked for

Carbon Credit Investment

Carbon Funds(All leverage private finance)

• PCF $145M + potential fund subscription by Participants up to $180m

• Netherlands Clean Development Funds: ~$230m over three to four years

• Commonwealth Bank’s Clean Fuel Program BP is first participant, other companies expected. Funded by consumer “checkoff.” Program invests in GHG mitigation projects in Australia. AGO certifies.

• National FundsAustralian government funds/initiatives The Netherlands – Eru-PT – government

funded

Summary Findings from Fund Manager Interviews

• 5 private Funds to capture C-credits in all investments (UBS, Hancock, Commonwealth, Carbon Trader, Env Fin Prod)

• Handful of private equity funds also seeking carbon credit investors to raise IRR in deals

• Major forestry funds thinking about C credits• New energy private equity and mutual funds

might seek C credit deals if demand rises• Social funds use C as screening indicator• total capital driving C credits: $2.5-4 billion in

Energy sector; $1bn+ in forestry

Investor Carbon Market Sentiment

February 2001• Most fence sitting – waiting for national

and international regulations• Early movers in deals and funds:

– have high carbon exposure and regulatory risk,

– are seeking strategic positioning – are seeking to influence policy– are at an early stage– wish to capture upside speculative C benefit

• Mainstream investment, “big” money still skeptical