Managing carbon project risks

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Managing carbon project risks
Presented by Adam Shepherd Regional Workshop
on Legal, Institutional and Financial aspects of
Carbon Finance Istanbul, Turkey 21-22 January
2008
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Carbon project risks

• A thought about lawyers

A prudent perspective enables a good lawyer to
see every conceivable snare and catastrophe that
might occur in any transaction. Martijn E.
Seligman Ph.D.

• WARNING
• This presentation focuses on
• Everything that could go wrong!

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Why might there be risks?

• THE CARBON MARKET
• Science engineering finance laws
  industry Public Sector Private Sector
  International law National laws Transboundary
  flows of information Trading in valuable
  commodities

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Project / Regulatory Risk
RISK MANAGMENT
Failure to obtain letter of Approval Letter of Approval as precondition in contract Guarantee from Host Country Option to sell credits as VERs (Seller)
Project fails validation or registration Validation as a precondition Payment only upon delivery (Buyer) Option to sell credits as VERs (Seller)
Methodology fails to be approved Methodology approval as a precondition
Project under-performance ERPA obligation to source replacement credits Duty to pay liquidated damages
Registry delays / malfunctions Flexible delivery provisions Force Majeure Alternative accounts for delivery
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Financial Risk Carbon Market Risk

• Managing Market Risk
• Pricing
• Fixed price
• Floating price with floor/ceiling
• Secondary sales (forward)
• Passing on the market risk
• What about delivery issues?

EU Allowance Market Price (2006 to mid-2007)
Phase II Market Price
Phase I Market Price
Source European Climate Exchange
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Legal risks
RISK MANAGMENT
Third party claims ownership to credits - Performing due diligence - Warranties in ERPA
Litigation affecting project Due diligence Warranties
Counterparty fails to make payments Due diligence regarding counterpartys credit Third party guarantees obligations (Guarantor)
Environmental liabilities Due diligence Warranties Indemnities
Failure to obtain / comply with local authorizations / permits Due diligence Warranties Indemnities
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Host Country / Political risks

• Participants in carbon projects will consider
  political risks in the host country prior to
  making investment decisions
• What are the Host Country risks
• Delays in obtaining Letters of Approval
• Uncertainty regarding criteria for Letters of
  Approval
• Uncertainty regarding taxes
• Nationalization of project assets or carbon
  credits
• Coup d'état or civil strife
• Strikes labor, transport

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Case Study
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Country Case Study
China Giant of the CDM
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China Overview

• Annex I party to Kyoto Protocol
• Eligible to host CDM projects
• Enacted national CDM Rules
• Regulate CDM projects in China
• Recognise CERs
• Promote foreign investment
• Why is China a good case study?

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Why is China a good case study?
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CDM Country Sellers (2006)
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Chinas DNA

• National Development and Reform Commission
• Sustainable development criteria
• China floor price
• In the vicinity of 8.50
• Does setting a floor price promote investment?
• Restrictions on foreign ownership of Project
  Developer
• Equity joint ventures with foreign partners
• Restrictions upon consultants fees

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China Taxes on CDM projects

• CDM Taxes Taxation on CER revenues
• 2 Energy efficiency, renewable energy,
  methane capture, forestry small scale
• 30 Nitrous Oxide (N20)
• 65 Industrial gases
• General Taxes (non carbon)
• Corporate income tax, personal income tax, land
  tax
• Tax benefits
• Income tax refunds for foreign entities which
  re-invest profit in China
• Materials imported for carbon projects might be
  exempt from import taxes/tariffs for materials

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Carbon Risks Quiz

• Project Facts
• Seller is a wind farm project developer based in
  India.
• Seller has established a wind farm and intends to
  generate carbon credits under the CDM.
• Buyer is a French company who buys and sells
  carbon credits.
• Buyer and Seller intend to enter into an Emission
  Reductions Purchase Agreement (ERPA).

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Carbon Risks Quiz

• Seller is concerned that Buyer will not be able
  to pay for the carbon credits. What can Seller
  do to manage this risk?
• Buyer intends to buy the credits and then sell
  them to a third party. Buyer is concerned that
  the CER market price might fall. What can Buyer
  do?
• Both parties want to enter the ERPA immediately,
  but are worried that the project may not obtain
  registration. What can they do?

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Questions? Thank you For more
information Adam.Shepherd_at_undp.org