Introduction of International Law Related to the CDM Development Process

Peter Corne China Business Group Eversheds LLP November 2007

I.

Overview of the International Legal Framework

Basic International Treaties on CDM

• United Nations Framework Convention on Climate Change (“UNFCCC”) was signed in 1992 and came into force on 21 March 1994 • Kyoto Protocol (the “Protocol”), aimed at reducing greenhouse-gas (“GHG”) emissions, was signed in 1997 and became a legally binding treaty on 16 February 2005 • The Marrakesh Accords were adopted in 2001 to flesh out the Protocol rulebook and further advance implementation of UNFCCC To-date, 175 countries have ratified the Protocol

Inside the Kyoto Protocol

The Protocol sets up quantitative objectives for reducing GHG emissions up to 2012 Annex I countries are obliged to reduce their collective emissions by at least 5% during 2008-2012 Credits obtained from 2000 to 2008 may be used to achieve compliance

Three Flexible Mechanisms

• Three mechanisms set out in the Protocol for emission reduction JI: Joint Implementation (Article 6) (Annex I countries Annex I countries) CDM: Clean Development Mechanism (Article 12) (Annex I countries Non Annex I countries) IET: International Emission Trading (Article 17) (Annex B countries Government Annex B countries Government)

Implementation of Kyoto

• EU: launched the European Climate Change Programme in 2000 • UK: successful emission control and a centre of emission trading • Canada: behind target - recent legislation

Different Approaches: China Vs India

• • • India has the most issued CERs China has the highest overall projected CER volumes Unfettered competition Vs government regulation

Indian Vs Chinese Project Development

• • • More than 50% (11 out of 20 projects) rejected by the CDM Executive Board until August 2007 are from India, none from China 55 out of 136 projects that have been available for public comment before the end of 2005 but not been registered so far are from India, but only three from China Most of the Indian projects have not been developed on account of the CDM incentive and thus do not fulfil the additionality criterion

Indian Vs Chinese Project Development (ii)

• • Indian DNA thus far does not seen its role as providing a PDD quality check Indian DNA supports principle of unilateral CDM • • China's DNA has a list of far-reaching requirements that project developers have to fulfil Unilateral CDM is now allowed but only takes up a small proportion of Chinese submissions ?? Which approach is more efficient to encourage environment-friendly projects?

II. Fundamental Legal Principals of CDM

Key Rules Affecting CDM

• • • • • The use of CERs must be supplementary to domestic action The requirement of additionality The “Baseline” scenario CDM projects are defined by reference to strict conceptual boundaries CDM projects must account for “Leakage”

Supplementarity

• • • The Marrakesh Accords demand that emission reduction targets of Annex B Countries cannot be met solely through JI, ET or CDMs (“Flexible Mechanisms”) At present there is no numerical definition of supplementarity Although not directly binding on private sector participants in CDM projects, the supplementarity requirement raises commercial risks both on the supply and purchase side of CDM trades

Supplementarity – Risks of Infringement

• Annex I Governments purchasing CERs may seek to impose contractual terms on a project permitting them to reduce or terminate purchasing commitments where they have a supplementarity problem

Supplementarity – Risks of Infringement (ii)

• • Annex I Governments may unexpectedly withdraw support for a project in development (which otherwise meets requirements) on these grounds.

This poses a development risk to sponsors

Supplementarity – Risks of Infringement (iii)

• Inability of individual Annex I investors to manage this risk (as they cannot control the activities of other investors of the same country) may dampen demand from the private sector for CERS

III. Recent Negotiations and Discussions On International Rules

Negotiations on Post-2012 Arrangements

• • Negotiations on-going – Participants all recognize achievements through UNFCC and the Protocol – – Abandonment of the Protocol post 2012 will be a global tragedy CDM: a good tool to mobilize climate-friendly policies and investments, but need to be improved Further discussion in Bali next month

Difficulties

• Commitments from developing countries?

– India – China

Difficulties

• Voluntary vs Compulsory

Difficulties

• • • • • • • • Energy resources are limited Energy policy is strategic for national economy Energy consumption countries and energy production countries have different perspectives Internationally, there are different interest groups, e.g., OPEC and IEA Even within a country, there are different interest groups Difficult to reconcile positions of different countries, difficult to reconcile positions within a country, US withdrawal from the Kyoto Protocol is an example Difficult to established a international mechanism: after UNFCCC was signed in 1992, it took 5 years for the Kyoto Protocol to be signed in 1997, and another 8 years for it to be approved and took effect in 2005 Wise to stick to the established Kyoto mechanism and aim to improve it

Discussions on Post-2012 Arrangements

• • Pending formal agreement, there are discussions about: – Unilateral declaration by Annex I countries to extensively utilize post-2012 CERs; – Extension of the period of the next commitment to 10 years or more; – – Goal for developing countries: pledge to reach intensity level in given sector, rewarded if achieved, no penalty if not achieved Proactive support for post-2012 CERs by multilateral financial institutions Post-2012 Carbon Fund launched by EIB

EU ETS Discussion on Post-2012 Improvement

• • • • • Post-2012 cap: consistent with 2020 reduction target of at least -30% compared to 1990 levels Allowances: to be auctioned as from 2013 Limits: to set quantitative and qualitative limit on the use of CDM/JI credits in the EU ETS Expansion of coverage: sector (e.g., aviation) and GHG (e.g., N2O and CH4 from coal mine) No inclusion of domestic offsets and JI credits from EU countries into the EU ETS

IV. Key Documents in CDM Project Transaction

Key documents in CDM Project transaction

• • • • Traditional project documents: construction agreement, purchase agreement, project finance agreement, power purchase agreement etc.

Contract with CDM project consultant Contract with DOE ERPA

Key features of an ERPA

• International sale and purchase agreement • Subject matter – a special type of good • Different degrees of risks at different stages: approval, construction, cost overruns, project underperformance, delays, DOE fails to verify GHG emission reductions, rejected by CDM EB, changes in laws

Allocation of risks in an ERPA

Risks Seller to assume the risks

Project Registration/ DNA Approval/ Project Participation Status Conditions Precedent - Seller to apply for Registration CERs shortfalls purchase quantity schedule replacement CERs or market value of CERs Seller guarantees minimum negotiate amended delivery Pay cost of purchasing Terminate contract

Buyer to assume the risks

Conditions Precedent - Buyer to obtain DNA approval to project participation quantity Buyer purchases actual Buyer has first right of refusal to purchase excess CERs Failure to pay Legal title to CERs Payment on delivery Seller warrants full title to CERs delivered Upfront payment standby L/C Seller warrants full authorisation to dispose of CERs (in an agency scenario)

Allocation of risks in an ERPA (continued)

Risks Seller to assume the risks Buyer to assume the risks

Creation of a security interest, transfer of assets Seller will not create security interest over project/assets Seller does not transfer project-related assets No corporate restructuring which may affect the Seller’s ability to perform its obligations Seller to notify Buyer when creating security interest on project or assets or when transfer any project-related assets Seller to notify Buyer in scenarios of corporate restructuring Share of costs Post 2012 credits Seller grants to Buyer first right of refusal and exclusive period for negotiation Buyer has no first right of refusal and no exclusive period for negotiation Change in law/ failure of central systems Change in law provisions/ Force majeure provisions/ Change in law provisions/ Force majeure provisions/ Focal point Seller bears project operation and monitoring costs, PDD fees, DOE validation fees, verification fees, EB registration fees, share of proceeds Buyer bears PDD fees, DOE validation fees, verification fees Buyer / CDA acts as focal point Seller acts as focal point

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