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Managing carbon project risks
Presented by Adam Shepherd
Regional Workshop on Legal, Institutional and Financial aspects of Carbon Finance
Istanbul, Turkey21-22 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
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
Pric
e pe
r ton
ne (E
UR
)
Source: European Climate Exchange
EU Allowance Market Price (2006 to mid-2007) Managing Market Risk
•Pricing
• Fixed price
• Floating price with floor/ceiling
•Secondary sales (forward)
• Passing on the market risk
• What about delivery issues?
Phase II Market Price
Phase I Market Price
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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 counterparty’s 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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UNDP MDG Carbon Facility
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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China’s 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 consultant’s 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?